Senate passes financial reform

The U.S. Senate voted 59-39 late Thursday to pass the most sweeping financial reform legislation since the Great Depression in an effort to prevent a repeat of the financial crisis of 2008.

The bill would create a consumer protection agency, place new capital restrictions on banks and increase oversight of derivatives trading. Critics have slammed the bill for not addressing Fannie Mae (FNM) and Freddie Mac (FRE), the government-backed mortgage companies that many say contributed to the financial market meltdown.

Four Republicans voted for the bill, and two Democrats voted against it. The legislation will now have to be reconciled with the House version, then both chambers of Congress will vote on the final bill.

Klarman can see another lost decade

BOSTON, May 18 (Reuters) - Star hedge fund manager Seth Klarman sees few bargains in the current environment and predicted on Tuesday that the stock market could suffer another lost decade without any gains.

"Given the recent run-up, I'd be worried that we'll have another 10 years of zero returns," Klarman, who rarely speaks in public, said at the CFA Institute's annual conference in Boston.

Current market conditions remind Klarman of a Hostess Twinkie snack cake because "everything is being manipulated by the government" and appears "artificial."

"I'm more worried about the world broadly than I've ever been in my whole career," Klarman said.

Klarman has 30 percent of assets at his $22 billion Baupost Group in cash, he said. He started the firm in 1982 with $27 million and has averaged 20 percent annual gains ever since. In 2007, amid the depths of the credit crash, Baupost had its best year, gaining 52 percent.

Inflation is a risk that Klarman said he is particularly concerned with given the government's high rate of borrowing to bail out the financial system. Baupost has purchased far out-of-the-money puts on bonds to hedge the risk, he said.

The puts, which Klarman said he viewed as "cheap insurance," will expire worthless even if long-term interest rates rise to 6 or 7 percent. But if rates rise to 10 percent, Baupost would make large gains, and if rates exceed 20 percent the firm could make 50 or 100 times its outlay.

Typically, Baupost focuses on out-of-favor stocks and bonds. Klarman cleaned up in 2007 and 2008 buying distressed debt and mortgage securities that later recovered.

One area Klarman said he is currently scouring for potential investments is private commercial real estate below the top quality. Publicly traded real estate investment trusts, however, have "rallied enormously" and are "quite unattractive," he said.

Copies of Klarman's long out-of-print investment guide, "Margin of Safety," sell at auction for $700 or more. Klarman said on Tuesday he has "no immediate plan" to reissue the book published in 1991 because he does not have enough free time to update it or even to write a fresh introduction.

[via chucks_angels]

Eddy Elfenbein on gold

What you need to understand about investing in gold is that you’re not really investing in gold. You’re investing against the U.S. dollar. It’s not that gold goes up, it’s that the value of a dollar goes down.

Actually, it’s even more subtle than that. What you’re doing is you’re betting against the interest rate on the dollar. I know this sounds odd, but any currency you carry around in your wallet has an interest tied to it. That’s essentially what the currency is—that rate—and it’s the reason why anyone would want to use it. Gold can be seen as the way to keep all those currencies honest.

People mistakenly believe that gold is all about inflation. That’s not quite it, but high inflation is usually very helpful for gold. What gold really likes is to see is very low real (meaning after inflation) interest rates. Gold is almost like a highly-leveraged short on short-term TIPs.

Here’s a good rule of thumb. Gold goes up anytime real rates on short-term U.S. debt are below 2% (or are perceived to stay below 2%). It will fall if real rates rise above 2%. When rates are at 2%, then gold holds steady. That’s not a perfect relationship but I want to put it in an easy why for new investors to grap. This also helps explain why we’re in the odd situation today of seeing gold rise even though inflation is low. It’s not the inflation, it’s the low real rates that gold likes.

[via maverick@investwise]

Bogle's new old idea

With all of the high-priced creative and imaginative talent in this industry, I find myself wondering why someone, somewhere, hasn't dreamed up a still better way to enhance after-tax mutual fund returns. Surely the opportunities abound. Let me describe my own idea. I start with a fund that simply buys a large sampling of high quality blue chip growth stocks, and holds them unless fundamental circumstances change radically. Where, you ask, do we find the budding Warren Buffett to manage it? Honestly, I don't know. So, I shift gears. Why not a fund that buys, say the 50 largest stocks in the S&P Growth Index universe? (That's nearly 30% of the capitalization of the entire stock market.) Simply hold them "forever" and don't rebalance as prices change. If there is a merger, keep the merged company; if a company is bought for cash, reinvest the proceeds, either in the next largest company or in the fund's other holdings (it probably won't matter which you do); if it fails and goes out of business, well, just realize that can happen.

Then, run the fund at an expense ratio of 20 basis points, just incurring bare-bones operating costs. Minimize exposure to shareholder redemptions with a stiff redemption fee and/or strong limitations on daily liquidity (i.e., open the fund for redemption only, say, on the last day of each quarter). These latter steps will, of course, make it difficult to attract quick-triggered opportunists. That's good! But—over time—they will make it commensurately easy to attract serious long-term investors (today, an endangered species). The rewards for them should be far larger than the risks.

The potential rewards, in fact, are huge. In a stock market which averages a 10% pretax return, an average fund, assuming a 2% expense ratio, should provide a pretax return of 8.0% and an after-tax return of 6.5%. A low-cost buy-and-hold fund with a 10% gross return and expenses of 0.2% should achieve a net return of 9.8% before taxes and 9.0% after taxes. (This is a conservative hypothesis, with an after-tax spread of 2.5% that is well below the shortfall of 3.3% that actually existed between active funds and the S&P 500 Index during the past 15 years.)

For the long-term investor, these numbers would be little short of dynamite. $100,000 invested at the outset would, after 25 years and after all taxes, have grown in the actively managed fund to $483,000. But the buy-and-hold fund would have almost doubled that amount to $862,000. I guess it's fair to conclude: "Yes, costs and taxes matter."

-- John Bogle, 11/12/97

[via rcthacker@chucks_angels]

nearly half don't pay income tax

Tax Day is a dreaded deadline for millions of Americans, but for nearly half of U.S. households, it's simply somebody else's problem.

About 47% will pay no federal income taxes for 2009. Either their incomes were too low, or they qualified for enough credits, deductions and exemptions to eliminate their liability. That's according to projections by the Tax Policy Center, a Washington research organization.

In recent years, credits for low- and middle-income families have grown so much that a family of four making as much as $50,000 will owe no federal income tax for 2009, as long as there are two children younger than 17, according to a separate analysis by the consulting firm Deloitte Tax.

Tax cuts enacted in the past decade have been generous to wealthy taxpayers, too, making them a target for President Barack Obama and Democrats in Congress. Less noticed were tax cuts for low- and middle-income families, which were expanded when Obama signed the massive economic recovery package last year.

The result is a tax system that exempts almost half the U.S. from paying for programs that benefit everyone, including national defense, public safety, infrastructure and education. It is a system in which the top 10% of earners — households making an average of $366,400 in 2006 — paid about 73% of the income taxes collected by the federal government.

The bottom 40%, on average, make a profit from the federal income tax system, meaning they get more money in tax credits than they would otherwise owe in taxes. For those people, the government sends them a payment.

The vast majority of people who escape federal income taxes do pay other taxes, including federal payroll taxes for Social Security and Medicare, and excise taxes on gasoline, aviation, alcohol and cigarettes. Many also pay state or local sales, income and property taxes.

424 Dividend Boost

I got this blurb from Stansberry Research as a sponsor to the Zacks.com Profit From The Pros email letter that I receive.

While most folks earn tiny 2%-6% dividends on Blue Chips (like Pepsi, Johnson & Johnson, and AT&T) savvy Americans are secretly "boosting" those small yields to dizzying heights – earning incredible 30%-50% on the exact same shares. Originally available only to executives at America's richest Blue Chip firms, this income secret is now available to regular folks like you and me.

How the heck is it possible to make 10 to 20-times more than "normal" dividends?

Pretty simple actually.

I'll show you...

"The Best-Kept Secret on Wall Street"

~The Wall Street Journal

Right now you can "boost" an ordinary miniscule dividend yield to 20%... 30%... even 40% or more simply by taking advantage of what was once an obscure corporate perk...

Don't worry, you don't have to use options or sell covered calls... or anything tricky or speculative like that. It simply takes one small but radical change in the way most people buy ordinary stocks. It's a perk Fortune 500 employees have been taking advantage of for decades.

I call it the "424 Dividend Boost." And I first learned about this benefit after spending several years working at one of the companies' that offers it, Citigroup.

Working there, I saw firsthand how this secret enabled co-workers and some in-the-know shareholders to earn an enormous 34% on their initial stake—while most other folks were getting the company's regular 2% dividend.

Best of all, The 424 Dividend Boost Research Report is absolutely free of charge.

The only thing I ask in return is that you try my monthly dividend research advisory called The 12% Letter.

* * *

Sounds too good to be true. But that's because of the way they wrote it.

Looking it up, here's what the Stock Gumshoe has to say

Sounds pretty nice, eh?

I haven’t written about the ads from Stansberry & Associates too much lately, though they may be the most aggressive marketers out there … but in recent weeks I’ve seen lots of ads for Tom Dyson’s 12% Letter from Stansberry, and had several questions about what they’re calling the “424 Dividend Boost.”

So let’s have a look, shall we?

We get several examples from Dyson to support the incredible claims — the three claims at the top of the ad are as follows:

“Johnson and Johnson:
Current yield: 2.7%
With the “Dividend Boost”: 39%

“AT&T:
Current Yield: 5%
With the “Dividend Boost”: 43%

“PepsiCo:
Current Yield: 2.4%
With the “Dividend Boost”: 53%”

Sounds unbelievable, doesn’t it?

But it is, in part, real …

You see, the “424 Dividend Boost” is nothing but another iteration of what Dyson used to call the “801K Plan” — it’s a teaser for investing in Dividend Reinvestment Plans, or DRIPs.

Using this strategy, you could certainly have put down an initial investment a few decades ago in a stock, like Johnson and Johnson or AT&T, and reinvested your dividends, to the point that the dividend you receive today is equivalent to a 40% or even much higher yield on your original investment.

That’s because of two things — raising dividends, and the compounding from dividend reinvestment. Most large American companies that pay dividends try very hard to raise those dividends every year, or at least keep them stable in bad years. That means if you bought shares in Johnson and Johnson back in 1970, for example, you would have received an annual dividend of just under a penny a share. Today, the annual dividend for JNJ is $1.84, so that’s incredible growth right there.

But the real power comes from dividend reinvestment — as those dividends climbed over close to 40 years, you could have turned each one into more fractional shares of JNJ, and the following quarter those fractional shares would have entitled you to slightly more dividend, so each quarter you would both add to your number of shares, and increase the dividend payment on each of those shares, which builds upon itself like compound interest, the force that Albert Einstein is reputed to have said (he almost certainly didn’t) is the most powerful force in the universe.

Buffett the lazy way

But why not just buy what Warren buys? I set out in this writing to examine whether following Berkshire Hathaway's investments utilizing Form 13Fs could offer the investor the opportunity to piggyback on Buffett's stock picks, and consequently, achieve outsized excess returns.

Buffett's current clone portfolio would be: Coca-Cola Company (KO), Wells Fargo (WFC), American Express (AXP), Procter & Gamble (PG), Kraft Foods (KFT), Wal-Mart Stores (WMT), Wesco Financial (WSC), ConocoPhillips (COP), Johnson & Johnson (JNJ), and U.S. Bancorp (USB).

Buffett returns more than 8% a year, which doesn't sound that spectacular but $100,000 invested in the Buffett portfolio would be worth approximately $240,000 today vs. about $100,000 invested in the S&P500. About 85% of Buffet's portfolio is concentrated in his top ten holdings. Volatility was low, surprising given that the portfolio contained only 10 holdings.

If you ran a mutual fund with these numbers you would be one of the best performing mangers in the U.S. over the time period. A recent academic paper has examined the strategy for Buffett all the way back to 1976 and found results consistent with mine. From the abstract: Contrary to popular belief, we find Berkshire Hathaway invests primarily in large-cap growth rather than "value" stocks.

Over the period the portfolio beat the benchmarks in 27 out of 31 years, on average exceeding the S&P 500 Index by 11.14%. We find that Berkshire Hathaway's portfolio is concentrated in relatively few stocks with the top five holdings averaging 73% of the portfolio value. While increased volatility is normally associated with higher concentration we show the volatility of the portfolio is driven by large positive returns and not downside risk.

-- via Warren Buffett International Fan Club

Dow down 999

The Dow Jones Industrial Average posted its biggest intraday loss since the market crash of 1987, the euro slid to a 14-month low and yields on Greek, Spanish and Italian bonds surged on concern European leaders aren’t doing enough to stem the region’s debt crisis. U.S. Treasuries surged.

“It’s panic selling,” said Burt White, chief investment officer at LPL Financial in Boston, which oversees $379 billion. “There’s concern that the European situation might cool down global growth and freeze the credit markets.”

The Dow average lost as much as 998.5 points, or 9.2 percent, before paring its drop to 383.17 points at 3:40 p.m. in New York. The Standard & Poor’s 500 Index fell as much as 8.6 percent, its biggest plunge since December 2008, before trimming its decline to 3.5 percent.

***

The selling was a result of technical glitches that caused some stocks, including Dow component Procter & Gamble (PG, Fortune 500), to plunge 37% to $39.37 per share from the close of $62.12 Wednesday. The consumer products maker recovered most of that loss by the close, ending just 2% lower.

But the faulty P&G trading was responsible for 172 of the 998.50 points that the Dow Jones industrial average (INDU) lost at its worst, the biggest one-day point decline on an intraday basis in Dow Jones history.

China crash coming?

Investor Marc Faber said China’s economy will slow and possibly “crash” within a year as declines in stock and commodity prices signal the nation’s property bubble is set to burst.

The Shanghai Composite Index has failed to regain its 2009 high while industrial commodities and shares of Australian resource exporters are acting “heavy,” Faber said. The opening of the World Expo in Shanghai last week is “not a particularly good omen,” he said, citing a property bust and depression that followed the 1873 World Exhibition in Vienna.

“The market is telling you that something is not quite right,” Faber, the publisher of the Gloom, Boom & Doom report, said in a Bloomberg Television interview in Hong Kong today. “The Chinese economy is going to slow down regardless. It is more likely that we will even have a crash sometime in the next nine to 12 months.”

Faber joins hedge fund manager Jim Chanos and Harvard University’s Kenneth Rogoff in warning of a crash in China.

China is “on a treadmill to hell” because it’s hooked on property development for driving growth, Chanos said in an interview last month. As much as 60 percent of the country’s gross domestic product relies on construction, he said. Rogoff said in February a debt-fueled bubble in China may trigger a regional recession within a decade.

[via Maverick@investwise]