Less Securities Analysts at Work

A year ago, about one quarter of securities research departments announced they were dropping coverage of small=cap stocks, while about one sixth no longer covered mid-cap stocks. A large percentage of large cap stocks were no longer reviewed because less analysts were employed. The situation remains about the same today.

This backs up my position that it does not pay for an investor to evaluate securities. Whether they are professionally analyzed or not.

It’s extremely difficult to know what is going on in any business. Even insiders in a corporation don’t know how outside events will affect their business. So why should investors bother to buy individual securities after a so-called analysis?

Their best bet is to invest in low-cost mutual funds or ETFs, matched to indexes. ( See the Earl J Weinreb NewsHole® comments.)

Unknown Income Tax Possibilities

Very few of the public know much about the tax consequences of much of the financially-oriented news they see or hear. Some examples:

That foreclosed mortgages and any reductions in credit card loans and other loan forgiveness, result in an income tax bite. Amounts saved are considered income.

Prize money won in a TV contest by a lucky contestant is taxable as income.

And that free vacation trip or new car gift is probably going to be taxed at the retail value, not at the discount you could have gotten, had you bought it directly.

So, the contestants may be getting non-cash items for cash outlays they may not even possess.

Separate Regulation For Small and Sophisticated Investors

The need to send out complicated literature that small investors do not read and cannot even understand is unwarranted. Yet, the Securities and Exchange Commission requires them.

I am referring to such as costly prospectuses and notices and material which ought to be filed, but which can be made available only for those who really are interested in reading them.

All that is required are outlines of important information, put forward in a manner the average investor can easily understand.

Government Regulation of Mutual Fund Fees

The government has been questioning whether fees charged by mutual funds for management may be a regulatory matter. Should Uncle Sam be the one to advise how high they ought to be?

Investors should know enough to compare funds’ expenses and to choose to buy those with the lowest expense of operation. The funds give this information very clearly.

In fact, management of mutual funds often has little to do with success. Lower-cost funds which follow market indexes often perform better than managed funds. The overall success factor for choosing the right fund is low cost.

However, that should not be the government’s function. Politics have a nasty habit of interfering with choice, and politicians are not the wisest advisers around.

The Federal Reserve’s Conflict of Interest

I recently commented on the new financial regulation law which, in effect. has tilted the effect of the Fed in many ways, giving the executive branch of government much more power that it ever had.

Independent-minded economists, however, have always come to the Fed’s defense, in its attempt to keep the Federal Reserve as free from politics as possible.

Despite the logic for the Fed’s independence, Congress always has wanted to impose some influence. It has to an extent. Since 1978 the Fed has had to enforce the Full Employment and Balanced Growth Act, known as Humphrey-Hawkins. That conflicts with the Fed’s stated currency/inflation activity.

The Humphrey-Hawkins Full Employment Act enforcement creates an inflating bias. Certainly not one of dollar stability. So there is always a conflict of interest.

Congress would want the Government Accountability Office, their investigative arm, to audit Fed monetary policy. And the Obama administration constantly wants to add fresh responsibilities, which are bound to sap the Fed’s objectivity and main focus.

The Assault on the Independent Federal Reserve System

There always has been sentiment against the Federal Reserve. The idea of a quasi-government agency, the head of which is appointed by the president, independent of congressional influence, has been suspect.

Congress in the past, especially when dominated by the Democrat party, has never been happy with the Fed.

The role of the twelve regional Fed banks has also been questioned. They are overseen by private-sector boards of directors, composed mainly of commercial bankers. That never pleases the Left.

The proposed financial regulation law has, in effect. tilted the influence on the Fed in many ways, giving the executive branch of government much more power that it ever had.

I will comment on how it does in the future.

Media Exaggeration

The media love to exaggerate, and that includes members of the financial fraternity.

One example: When Bernard Madoff said he made off with $65 billion and was subsequently convicted of fraud, his case pointed out a problem that prevails in the financial media, as it does elsewhere.

Investigators now believe the total sum involved was actually closer to about $12 Billion. The sensationalist media continues to pick up the $65 billion number because it suits their purpose.

Or they are just Ignorant, or merely lazy?

A Managed Mutual Fund Not Doing Well?

The question of what to do when a managed mutual fund is not doing well has little to do with holding or selling or the merits of its management. Instead, it concerns whether you should have anything to do with a managed mutual fund.

I have always commented that indexed mutual funds or exchange traded funds ( ETFs), are better than managed funds. They usually outperform them, and at lower cost.

Moreover, the lower the fund cost, the more return an investor will get over the years.

This question also will come up when a managed mutual fund you may have gets merged into another. These mergers are usually done for either or both of two reasons. To get economy of scale. Or to hide losing records.

In most instances, index funds or exchange traded funds are always a better choice. So, don’t attempt to trade managed funds on relatively short term performance.

Besides, their internal managements generally change constantly. (See the Earl J Weinreb NewsHole® comments.)

Credit Rating Accuracy

One way to solve the lack of accuracy we have had with credit ratings in the past, is to allow competition among those offering such services. One solution: Why not allow any company who feels qualified to register as a ratings analyst? Today, a small handful has a government monopoly.

If a company can show the Securities and Exchange Commission that it has qualified analysts and capability to evaluate bonds and other securities, why not have a license?

Another problem will have to be resolved: Do credit rating companies have First Amendment free speech immunity? A ruling currently going through the courts has said they possibly could be sued for errors of judgment.

That could actually impair all security analysis with its future implications.

The Credit-Default Swaps Market

Credit-default swaps got a bad name during the 2008 financial debacle. Yet, they are still used, to the tune of about $28 trillion, despite the media rhetoric about how bad they are.

The major marketplace, is owned by a group of banks, Markit Group Holdings Ltd., and this also gets undo criticism.

The problem with credit-default swaps is that the market for the swaps index based on their data may not have been entirely accurate. Perceptions of value may have been off during the 2008 meltdown.

All market-determining values being watched may not be trustworthy. It appears. though, credit-default swaps may have been even more accurate than many other major financial statistics we rely on.

Such as the figures on which mark-to-market accounting helped bring about that 2008 financial meltdown.

Erratic Corporate Bonds?

It’s shocking and dismaying to see how professionals in the financial industry constantly get the bond market wrong. Mind you, professionals, not amateurs.

They make up well over 80% of the market so they should know better. And the media, who discuss bonds, are usually in error, when reporting about them.

At the first sign of economic problems, there is talk about corporate defaults and the effect on the bond market. How bond prices are bound to fall because of the risk of possible defaults. And with that talk, the bond market weakens and prices do fall.

But remember: The possibility of default is very quickly factored into bond prices. And the lower the price, the higher the yield, in a direct relationship.

Take high yield corporate bonds, called “junk” for an unfortunate reason having to do with lower ratings. The fact they have lower ratings is compensated by higher yields. If you buy them in a fully diversified, low-cost mutual fund or ETF, and you reinvest dividends, you have factored in much risk.

If the default rates of the holdings were to rise to an unusual high from lower level, the higher yields more than make up for the risk. Yet, all the media will discuss is the risk of default and not the built-in compensation.

Moreover, the media will NEVER discuss how you can avoid that loss, along with any inflation hit, with proper use of bond duration.

This is possible with low-cost mutual funds and use of dividend reinvestment. The media, instead, waste time with superfluous discussions on such instruments as TIPS which are expensive and not really needed. ( See the Earl J Weinreb NewsHole® comments.)

Tax Financial Transactions?

Liberal politicians and their powerful unions seek to tax frequent financial transactions whenever they can pass the legislation, and thus discourage what they call “excess speculation.” The estimated tax revenue this would bring the government is just under $200 billion over about six years.

A similar move is afoot in Britain and Europe amidst their left-thinking politicians.

The dire consequences of such tax on the economies of countries involved is the problem. Securities trading is integral to economics. The tax would therefore be indirectly felt, in time, by everyone.

In addition, so-called speculation will be penalized whenever politicians do not favor a particular action. That opens a Pandora’s Box of political terror; typical of a fascist-type government.

All this hides the fact that speculation in a capitalistic society does not cause problems. It merely reflects pricing, something politicians of the left will never comprehend. Capitalism’s presence may appear to help boost rising prices, but works the other way just as easily, when prices fall.

Anti-capitalists, however, only notice when prices go up, not down.

Consequences of Financial Liberalism

Basic thoughts and ideas contribute to what is currently political liberalism.

They are ingrained in liberal minds and no further education will dissuade that thinking. Sometimes they may be merely a political device for getting votes when running for office, or organizing workers on behalf of unions.

Experience and common sense has always proven that liberal or left-oriented financial thinkers have almost always been wrong. Their actions usually have unintended consequences that are damaging in the long term, even to their own interests, and to their political constituents.

The Difference Between A Market-Maker, Adviser and Broker

The public show trial staged by Congress featuring the executives of Goldman Sachs, showed up the general ignorance of members of Congress and the inability of most of the media to educate the public.

So here is some Finance 101.

When a company creates a form of security and places it up for sale, it is technically a market-maker, not an adviser, and thus has no fiduciary responsibility. Neither is it a broker, unless it sells the security.

Up to now, brokers have had no fiduciary responsibility. They do have to sell what is "suitable” for the customer. Therefore, a broker cannot sell risky securities, for example, to widows and orphans without their express knowledge. They can sell suitable risks to highly sophisticated investors.

Goldman Sachs, under the Congressional spotlight, were market- makers. They were also dealing with seasoned institutions who knew risks and frequently sold short, in the hope markets would fall; often with both positions at the same time.

Advisers, on the other hand, generally give advice and suggestions only. They are not market-makers, nor are they brokers.

It may be rough for Congress to comprehend, when their eyes are only on courting votes.

The SEC and Sophisticated Investors

The SEC has important work protecting those who are not fully aware of conventional investment knowledge.

But those, for example, who invest in hedge funds, ordinarily are not the usual mutual fund investors. It’s strange, therefore, why SEC watchdogs take time to look into such questions as “side-pocket” arrangements” that hedge funds make with their more sophisticated investors. Using them, funds may, for instance, limit the ability for hedge investors to prematurely cash in their stakes.

Hedge funds are not mutual funds. That is why some folks choose to use them. Hedge fund managers may not want investors making early withdrawals, which may help abrogate hedging strategic discipline.

Certainly the SEC has better functions than to teach sophisticated investors how to read simple agreements.

What Investment Bankers Sometimes Do When Let Go

Many who have been on Wall Street for years, have shown their true interests when terminated. Perhaps they were not interested in finance after all. They eventually wind up doing work outside finance.

They have become chefs, gardeners, nutritionists, any endeavor but financial.

You would think they knew enough about finance to have it in their bones to write, talk or teach about investments. To stick to finance in some way.

But seemingly they never do. Finance to many is a job that pays more than it ought to. Better than at another mundane position.

And it shows too frequently in Wall Street’s efforts.

Turn off Your TV Sets

One of the problems with 24/7 TV news is the constant looping of stock market reports.

One of my investment rules is to avoid what I call media noise at all times. Once you have an investment strategy in place, and you are set in that strategy, why let incessant, daily media chatter and sheer nonsense dissuade you from your original goals?

It becomes almost impossible to be disciplined when you have ad salesmen and a slew of “experts” of all stripes and objectives throwing investing ideas at you all the time.

Government Experts and Bailouts

Bailouts have invariably been failures when you look back. So why do we still hear of them as solutions?

The 2008 financial disaster was a bailout attempt through a whole assortment of action:

One: The takeover of banks.

Two: The takeover of Fannie Mae and Freddie Mac.

Three: The takeover of AIG.

Four: The Troubled Asset Relief Program (TARP) to buy bad mortgages from banks.

Five: The Public-Private Investment Program to buy the same troubled assets.

Six: The takeover of GM and Chrysler.

Though we had perfectly good car companies operating in the US to pick up business and relocated jobs, we had to bail out General Motors and Chrysler. That helped their powerful union but did little else for the economy. Ford and others in the industry operating in the U.S. were able to carry on without bailout help.

The government pumped out money. Federal Reserve funds were priced down to practically nothing in the banking system.

All this outlay cost trillions upon trillions that must be repaid with taxes and cheaper-valued dollars to come.

And with little success to show, compared to what would have happened if the politicians and “experts” simply sat on their hands.

Small Cap Stocks and Index Funds

It is often argued that mutual fund managers who invest in smaller companies can do better than index funds which specialize in the smaller cap stocks. At times they have not done as badly as their colleagues, when trying to outperform the indexes of larger companies.

But there is a fallacy here. Few managers can truly evaluate smaller companies, just as they cannot evaluate larger companies. Smaller companies are more erratic than those larger, and their corporate fortunes more difficult to anticipate.

Smaller public companies may do better than larger companies for shorter periods but are more susceptible to business hazards and cycles.

Costly Credit Overhaul of Banks

The Obama Administration says it wants to help business, especially as the economy is poor. One way is to loosen credit. At the same time, it is creating regulations which will overhaul big bank credit.

This means many bigger banks will receive lower credit ratings. When they do, they, themselves, will have to borrow at higher cost in the bond markets. Moreover, the regulations will not have any practical effect in making banks more secure.

The administration cannot have it both ways. The media, for the most part, goes along with the charade, and gives the administration a free pass.

That is not surprising. The media does little to screen out the anti-business dogma that spews forth daily from Washington.

Investing Wisely Without Expensive Advice: Part 2

What do you do about actual investing. especially if you are just starting or are not a professional investor?

You can start out doing what the most experienced, even the professionals never do, and at least avoid many of the pitfalls they stumble into.

1) Do not trade securities for the basic reason: Research invariably shows that you cannot time the market. So avoid any web sites that entice you with stock trading delights.

2) Open an account with a very low cost mutual fund family of funds. (I mention the Vanguard Group(®, Inc, which operates on a cost-plus basis. But shop around.)

3) Do not make a habit of buying individual securities. The analysts who claim they know all about them know very little for two reasons. One: They are not really versed in business as the bulk could not operate a pushcart. Two: They really cannot get close enough to understand a business that even the CEO often finds difficult to comprehend.

4) If you are starting out you may want to use a minimum amount with which to invest in a corporate bond index ETF and also a minimum amount in a total market securities ETF. If you have sufficient funds do the same in an REIT ETF. In all cases, reinvest your dividends.

5) In dealing with bonds, keep your duration factor below the term of your holdings. If you will be holding the securities for more than 7 years, for example, the duration can be 7 years or less. If you will be holding the securities for more than 10 years, the duration can be 10 years, etc.

6) Avoid media noise at all times. Once you have an investment strategy in place, and you are set in your strategy, why let incessant, daily media chatter and sheer nonsense dissuade you from your original goals?

7) The only adviser you need is an accountant for taxes or a lawyer for your estate.

And see the Earl J Weinreb NewsHole® comments.

Investing Without Expensive Advice: Part1

I have always advised against the use of expensive advisers who take 1 1/2% or more of your assets each year. That can represent as much as 20% and up of your annual investment earnings.

Look at a compound interest table and see what a chunk of your wealth this adds up to after just a few years.

I also advise against taking investment advice from salesmen and sales ads. You get only one story they want you to hear. It’s the other that would probably be the correct one for you.

And be wary of stock brokers who have to sell you to make a living or who simply do not have the time or expertise to be of real help. Their training is mostly brokerage back-office and to conform to extremely broad “suitability” standards.

More on this in my future blogs.

The Worst Recession since the 1930s?

Politicians love to estimate past recessions to suit their views. It comes in handy when they are running for office, when they need to paint a suitable economic picture.

In 2000, with unemployment about 4.0%, we were being told by Democrats out of office, that we had the worst depression since the 1930s. We actually were in the midst of a booming economy.

What about the mid 1970s, when President Reagan took office. We were experiencing a severe downturn that could be considered as bad, if not worse, than what we have today. The fall in GDP was 4.9%. Compared to a drop of 18.2% in 1937-38. That truly was the worst economic cycle since the 1930s.

What we can therefore correctly say is that today’s is the worst recession since 1973-75.

Resolving Financial Bubbles

I want to repeat my comments on systemic risk and the role of the Federal Reserve. I see where our past experiences are going to naught, both domestically and overseas.

In my studies in both graduate school and as a market analyst and businessman, I have seen how bubbles originate, and then cause their damage. I would like to make a suggestion about bubbles.

Bubbles usually are not stopped by Federal Reserve action on interest rates, as is usually suggested by pundits. That is because politicians always take over, and often preclude any dampening of interest rates by the Fed.

Not in a manner that can have an effect on a bubble. It would, for example, have had done absolutely nothing with the internet bubble. Or even the mortgage bubble because interest rate adjustments then would have been applied too late. The Fed’s miscues were too early to have been recognized.

Action or inaction by the Securities and Exchange Commission would have been effective. Just sitting on obviously useless and dangerous financings, instead of open-handed approvals of questionable underwritings created the internet bubble.

By merely slowing down the underwriting of questionable firms, the SEC would have dampened many such past debacles.

So the Fed had little to do with the bubble solution all the time.

Investing in Commodities to Offset Inflation

Investing in oil, gas, mining shares, gold, silver and other precious metals, to overcome inflation is not as simple as it sounds.

Many commodities can only be held in the form of futures contracts of less of a year. They are speculative and have to be continually renewed over the long term. It takes trading experience to handle them, with no assurances of lasting success.

Mining corporation investments involve all the detailed complications of securities investing that cloud that conventional strategy. The ability to master discipline is mandatory. Few investors, professionals as well as amateur, are adept at this crucial aspect of successful investing.

Buying gold or silver coins or bullion presents other problems including the need for adequate storage and possibly insurance.

My comments on other investments to offset inflation appear here from time to time. (See the Earl J Weinreb NewsHole® comments.)

Use the FDIC To Remedy Too-Big-to-Fail Institutions

The one member of the Obama administration involved with financial regulation, who seems to have a handle on the problems of financial institutions. appears to be Sheila Bair of the Federal Deposit Insurance Corporation.

The FDIC, which insures its bank member deposits, takes over institutions when in trouble. This often involves takeovers by other, sounder institutions.

The principle can be applied to the problems that perplex so many in Washington. Too many feel regulation must entail new government agencies and meddling with unexplored ideas and ventures.

What Are Repos?

In the usual repo transaction, a firm sells assets to another company, while agreeing to buy them back at a slightly higher price after a short period. It can be for as little as overnightIn other words, this is a short-term loan. The assets are the collateral.

Because the term is so short, there is little risk the collateral will lose its value. The lender or firm making the purchase thus takes a low interest rate.

With repo transactions, a borrower can get funds more cheaply than it could with one long-term loan that would put the lender at greater risk.

Under standard accounting rules, ordinary repos are considered loans, and the assets remain on the firm's books, But if a borrower could find a way that removes the assets from its books, often just before the end of the quarterly financial reporting period, the move temporarily makes the firm's debt levels appear lower than they really are.

This procedure has its standing in a rule FAS 140, approved by the Financial Accounting Standards Board in 2000. It modified earlier rules that allow companies to "securitize" debts such as mortgages, bundling them into packages and selling bond-like shares to investors.

FAS 140 allowed the pooled securities to be moved off the issuing firm's balance sheet, protecting investors who bought the securities in case the issuer later ran into trouble or bankruptcy.

Because repurchase agreements were loans and not sales, they did not fit the rule's intent. The rule contained a provision saying the assets involved would remain on the firm's books so long as it was agreed that the buy-back be for a price between 98% and 102% of what had been received for them. If the repurchase price fell outside that, the transaction would be treated as a sale, and not a loan.

In the case of the Lehman Brothers repos, it is alleged that the firm agreed to buy the assets back for 105% of their sales price and booked the transaction as a sale, to remove the assets from the books. The Lehman transactions were made under the advice of their counsel.

Differences in ETFS

Aside from the types of securities they invest in, ETFs. or exchange traded funds, vary over the lot.

They may differ when they track an index set by securities’ earnings rather than by securities’ market weightings. That will make a difference. Of course, index makeups may vary within the group types. The number of shares in an index is important, as the size and trading value of those shares will then vary.

Trading volume is important as liquidity helps traders in ETFs. And there are many who periodically want their dividends reinvested. It’s important they get better pricing on small purchases.

Even if the ETFs use the same stock indexes, the underlying costs of operation may vary. Lower-cost is always the better choice.

Indexed Mutual Funds and Exchange Traded Funds (ETFs)

Investors are continuing to buy managed mutual funds though most fund managers rarely consistently beat the securities averages. That is why more and more are turning to the use of indexed mutual funds and related Exchange Traded Funds( ETFs).

Also, index mutual funds and ETFs are generally much lower-cost than managed funds. Low cost is a most important investment factor you can rely upon for long-term results.

Another good reason: When some managers actually do better than indexes in a particular type of fund, they sometimes get nervous. Then, they play it safe and merely attempt to emulate the averages the rest of the year. They may be afraid to defy the odds of being successful, compared to indexes.

I have always suggested that index funds be bought instead of managed funds. Especially when, with large mutual fund portfolios, managers tend to find it very difficult to outperform indexes.

Wall Street’s Earnings Estimates

As you may know by now, I am not a fan of securities trading. My research on over 1600 securities strategies have given me enough insights that have personally weaned myself from strategies involved with trading. I leave them to insider, very heavy volume pros on Wall Street who can profit from that inside position.

Wall Street gets excited about how companies and analysts estimate earnings and whether analysts, particularly, manage to hit their estimates closely, or not at all. In fact, there are strategies based on the percentages of closeness-to-estimates that analysts get.

The sharp pencil folks on the Street can come up with anything that will attract believers. The machinations add up to little in the real world.

What is Wrong With Buying Risk?

It’s easy for politicians and their media hangers-on to quote analyst emails out of context about derivatives, while losing sight of the fundamentals of the subject. How many legislators and media folk would want their off-hand comments published the same way as if each were written in stone or as gospel?

The fact is, many investors seek risk, the riskier the better. They weigh that risk against the added return they get from the risk. Sometimes the added return comes from short selling, or betting prices will fall.

In every transaction there is a buyer who wants in and a seller who wants out. Especially when sophisticated buyers and sellers are available, as in derivatives, why is the government the arbiter of risk?

As far as the non-sophisticated are concerned, the media’s job is to explain the basics, so the masses keep away from what they are not familiar. (See the Earl J Weinreb NewsHole® comments.)