Morningstar's 2008 Performance

Our performance through the midst of the historic events that shaped the past year was mixed. While our 5-star calls [marginally] outperformed the S&P 500, losses greater than 30% are still painful on an absolute basis.

What stands out in 2008 is the huge divergence between the performance of wide-moat stocks and no-moat stocks. Investors rewarded quality companies. Wide-moat stocks returned -22% in 2008 compared with -34% for narrow-moat stocks and -42% for no-moat stocks.

It's also helpful to look at the performance of our star "buckets," which are constructed similarly to our strategies shown on the previous page. For example, the 5-Star bucket can be thought of as a Buy at 5, Sell at 4, 3, 2, or 1 strategy. In 2008, stocks we rated at 5 stars significantly outperformed stocks we rated 1 star as well as the S&P 500, and the three intermediate buckets also lined up as we would hope. This holds true for our trailing five-year performance as well.

While our strategies and buckets may show outperformance, they are not what we would consider investable strategies (given the number of stocks involved). We run a number of actively managed portfolios, such as the Tortoise and Hare that appear in Morningstar StockInvestor, and the Dividend Builder and Dividend Harvest that appear in Morningstar DividendInvestor. These portfolios are real-world examples of our research in practice. In addition, our Wide Moat Focus Index $MWMFT tracks the 20 cheapest wide-moat stocks in our coverage universe. Each of these portfolios has outperformed over the past year, and they are all beating the S&P 500 over their available trailing two-, three-, four-, and five-year time periods as well.

The Trader's Finger

John Coates, a research fellow in neuroscience at Cambridge University, recruited 49 male traders from a London trading floor for his study. These were futures traders who trade at a frenetic pace -- their holding period is typically measured in minutes (and sometimes even seconds!).

Coates found that traders with a lower ratio of index-finger to ring-finger length were both successful financially and more likely to last in the business, after controlling for a number of other factors, including experience and level of risk-taking.

The explanation? In men, a longer ring finger indicates a higher exposure to masculinizing hormones in the womb. That, in turn, produces a host of characteristics that are beneficial in this type of trading: increased confidence, higher risk preference, faster reaction times, etc.

On the road?

"Owners of capital will stimulate working class to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and State will have to take the road which will eventually lead to communism"

- Karl Marx, Das Kapital 1867

[via investwise]

[2/27 via Payam Ahdout] Actually that quote is a hoax.

2007's winners

returned an average of 242% (compared to 4% for the S&P 500). In 2008, these same ten stocks returned -61% (compared to -38% for the S&500).

a protracted recession?

The American Consumer has been the engine of the last expansion. We have bought houses, cars, flat screens, beach condos, etc. and financed the purchases either by extracting the equity from our increasing home prices (home equity lines) or incurring additional debt through credit cards and other forms of consumer finance. In the average American's mind, as long as the bottom line of the balance sheet continued to increase (i.e., assets greater than liabilities) then all was well. But in 2008 something happened that had not happened to these Baby Boomers before: the value of all assets (stocks, houses, rental properties, etc.) declined. As a result the debt party began to unwind as the value of the assets declined while the debt (liabilities) remained, thereby shrinking the balance sheet. Americans are feeling poorer … much poorer.

If one considers that the average 401(k) is now a 201(k) and the average house (according to Case/Shiller) declined 26% from its peak value in 2006, then it's easy to understand why the Baby Boomer is feeling gut punched. The financial shock of watching the asset side of their balance sheets crumble while the debt side remained the same or actually grew has now forced the American consumer into a dilemma: How do I retire and live the same lifestyle that my parents enjoyed? Answer: I have to save money and reduce debt.

The consequence to the economy is, in my opinion, going to be a protracted, painful recession. Why? Because this recession is driven by asset devaluation, and that is different than a cyclical downturn. There is a need for institutions and households alike to reduce debt and restore equity to the balance sheet. For the consumer/individual this will only happen with an increase in his/her saving rate to reduce debt and fund future retirement. For example, if the average consumer goes from a 1.7% savings rate to a 5% savings rate, then that equates to $400 billion a year in either debt reduction or retirement funding. From the contra angle, that means there will be $400 billion less of American consumption. I label this the "Paradox of Thrift," in that we can't restore our balance sheets without additional savings, and our stock markets cannot recover without consumer spending and corporate profitability.

-- by Cliff Draughn

As the calendar turns

A rare event occurred as the calendar turned from 2008 to 2009: A single trading day when at least 75% of New York Stock Exchange (NYSE) stocks rise is uncommon (there have been only 65 such occurrences in the last 10 years), yet this happened on three consecutive trading days from December 30 through January 2 (79%, 83% and 82% of stocks, respectively).

According to Bespoke Investment Group (B.I.G.), the market has performed a feat like that only twice before—both times in 1938. In each case, the Dow Jones Industrial Average was positive during the following day, week and month.

Last year was the single worst for the S&P 500 since the Great Depression—1931 to be exact. Nothing escaped the carnage, with global equity, credit and commodity markets imploding, and only U.S. Treasuries saving the day.


I asked a number of my Wall Street friends the following question during the holiday break: There were 253 trading days in 2008. How many days was the market (S&P 500) up versus down? With no exception, the answers were heavily skewed to down days making up the majority. Nope. Remarkably, the market rose on 126 days, and the market fell on 126 days (with one flat day).

So then what drove the overall massive market decline? The skewing of the down days. The average up day increased 1.6%, but the average down day decreased 1.9%. In addition, there were 42 days (nearly 17%) when the market rose or fell by more than 3%: 19 days that were up and 23 days that were down.

Clearly, volatility was off the charts, particularly following the Lehman Brothers bankruptcy in September, with 18 single-day moves of at least 5%. There had only been 17 such moves in the prior 53 years! In October, stocks enjoyed two of the six biggest one-day percentage gains in history—but gave back all of the gains, and then some. Four of the 20 biggest daily percentage declines in history occurred during the last four months of 2008.


Reviewing the 10 worst calendar year total returns for the S&P 500, take comfort in knowing that the average subsequent five-year annualized total return was 10.8%, with all five-year periods in positive territory—even those that began with 1931's 43% drop and 1974's 27% fall.


NDR did an interesting study of "waterfall" declines, similar to what we experienced last fall. In waterfall declines, the Dow loses more than 20% in a short period, and near the end, the 10-day average of NYSE total volume rises to two times its average seen just a few months earlier. In the majority of cases, the end of the waterfall decline wasn't the end of the bear market.

However, in the composite average, the lows were tested but not broken, followed by a basing phase of up to three months before a breakout to a new bull market.

Three post-waterfall phases were designated, and it appears to us that we're currently in the second phase—bear-market bottom to recession end.


Given current cash hoarding, there's now $8.85 trillion held in cash, bank deposits and money market funds. That's equal to 74% of the market value of all U.S. companies—the highest ratio since 1990, according to Fed data compiled by Leuthold Group and Bloomberg. According to SentimenTrader.com, assets in money market funds alone are now enough to buy 42% of the entire S&P 500 index.

The latest asset allocation survey from the American Association of Individual Investors showed another push into safe investments. Individual investor allocations to the stock market dipped to 42%, the lowest since 1991. And these folks' investments in cash instruments moved up to 42%—the highest in the history of the data (November 1987).

Never before have these investors allocated as much or more to cash as they have to stocks. The only other times when the two allocations came close were in January 1991 (42% to stocks, 38% to cash) and October 2002 (43% to stocks, 39% to cash). Both turned out to be good times to be taking a long-term contrary stance against these investors.

2009 Predictions

An article published on Bloomberg.com contains a table summarizing the predictions of Wall Street strategists for the performance of the S&P 500 in 2009. They’re a pretty optimistic bunch, predicting an average increase of 17% this year (with a range between negative 3.2% and positive 44%!).

Even if they’re right, the S&P 500 would end 2009 at 1,056, 28 percent below where the benchmark index for American equities started in 2008 and 35 percent lower than where the analysts said it would be now, based on the consensus of 11 strategists surveyed by Bloomberg News. Some of the biggest investors are growing more optimistic as the S&P 500 advanced 24 percent since reaching an 11-year low on Nov. 20.

* * *

Mauldin chimes in:

Ten out of ten analysts in the recent Barron's forecast saw stock prices rising 10-20% this year. For reasons I outlined last week, I think we could see a tradable rally in the next few months, but at the very least test the lows this summer, if not set new lows. Earnings are going to be far worse than any analyst's projections I have seen. And earnings drive stock prices.

Further, this recession is going to be the longest in anyone's memory. It is going to seem like it is never going to end (it will, I promise), and more and more investors are just going to give up on stocks. The buy and hold for the long run mantra is wearing thin. In inflation-adjusted terms, the stock market is about where it was in 1973! If you reinvested dividends, that gets you to 1991 (again, inflation-adjusted). It takes a lot of buying to make a bull market. It only takes an absence of buying to make a bear market.

Could we get a rally after the summer or fall lows? Sure. And it could be a good one. A lot depends on how fast the stimulus kicks in and whether it really has an effect.

* * *

Liz Ann Sonders says the conditions are right for a rebound, though it may (or may not) be too early.

you just missed the bull market

While no one is calling it that, we are technically in a new cyclical bull market and have been since December 8th. Since the 11/20 lows, the S&P 500 is up 24%, which meets the standard bull market definition of a 20% rally that was preceded by at least a 20% decline. But the unwillingness for the majority to call it a bull market is what bulls should be thankful for, since the market typically climbs a wall of worry where investors are full of doubt throughout the rally.

Regardless of what you call it, some of the performance numbers since the 11/20 lows are downright crazy. Even though the S&P 500 is up 24% since 11/20, the average stock in the index is up 41.25%. This means the smaller cap names in the index are up much more than their larger cap brethren. And the stocks that were down the most during the 10/9/07-11/20/08 bear are up much more than the ones that were down the least. As shown below, the average performance since 11/20 of the 50 stocks that were down the most during the bear market is 112%!

[via paraguay2es]

German billionaire commits suicide

German billionaire Adolf Merckle has committed suicide, in despair over the huge losses suffered by his business empire during the financial crisis, his family said on Tuesday.

The media-shy billionaire, whose family controls some of Germany's best-known companies, was hit by a train on Monday evening, local officials said.

"The desperate situation of his companies caused by the financial crisis, the uncertainties of the last few weeks and his powerlessness to act, have broken the passionate family entrepreneur and he took his own life," a family statement said.

State prosecutors from the southern city of Ulm said Merckle, 74, left work on Monday and died after being hit by a train near the town of Blaubeuren. He left behind a suicide note to his family, they added.

Merckle, a father of four, inherited the basis of his fortune from his Bohemian grandfather, but went on to build up the chemical wholesale company into Germany's largest drugs wholesaler.

The passionate skiier and mountain climber assembled a business conglomerate with about 100,000 employees and 30 billion euros ($40.45 billion) in annual sales.

His family controls a number of German companies including cement maker HeidelbergCement and generic drug company Ratiopharm.

But the empire was rocked last year by wrong-way bets made on shares in Volkswagen after a surprise stakeholding announcement from Porsche sent the VW share price rocketing as short sellers scrambled to cover their positions.

Banking sources had told Reuters the family lost hundreds of millions of euros on investments, with about 400 million euros lost on Volkswagen shares alone.

Since then the family has been in talks for weeks with banks to renegotiate loans. Banking sources said on Tuesday his death was not expected to affect loan agreements with the family.

[via paraguay2es @ chucks_angels]

how cheap are stocks?

Unless you are in your late 80s and were an adult as World War II ended, stocks are cheaper, adjusted for tax rates and interest rates, than they've been at any time in your adult life. That's a simply stunning statement looking forward. You're walking forward. Stop myopically looking at your feet and focus on the horizon. Just buy great franchises at cheap prices now and be patient.

yes, we are in a recession

[12/1/08]

The National Bureau of Economic Research said Monday that the U.S. has been in a recession since December 2007, making official what most Americans have already believed about the state of the economy.

The NBER is a private group of leading economists charged with dating the start and end of economic downturns. It typically takes a long time after the start of a recession to declare its start because of the need to look at final readings of various economic measures.

Many people erroneously believe that a recession is defined by two consecutive quarters of economic activity declining. That has yet to take place during this recession.

The current recession is one of the longest downturns since the Great Depression of the 1930's.

The last two recessions (1990-1991 and 2001) lasted eight months each, and only two of the 10 previous post-Depression downturns lasted as long as a full year, according to the NBER.

several economists said the real concern is that there is no end in sight for the downturn.

Some suggested that the best case scenario for the economy is that it would reach bottom in the second quarter of 2009. And even if that happens, that would still make this recession the longest since the Great Depression.

Recessions and stock market performance

[1/1/09] To better understand how recessions typically work, note these four important trends:

1. On average, the S&P 500 has started to lose ground approximately seven months before recessions began.
2. Recessions have lasted an average of 10 months.
3. On average, the stock market has started to recover six months into the recession or four months before it ended.
4. It took approximately 13 months for the stock market to traverse from its peak to its trough.

These averages might not apply to the current recession, but we believe there's a strong chance that some trends could repeat. For example, the stock market could anticipate the beginning and end of the recession before the economic data reflects it.

[6/3/08] Ned Davis Research (NDR), an investment research firm, recently analyzed market performance before, during, and after the 10 recessions since 1945. These have had a median duration of about 10 months. The stock market has generally been a good indicator of these economic slumps.

In past recessions, the broad market began declining several months beforehand, as investors anticipated weaker corporate profits, and continued to drop over the five to six months after the start of the recession, the NDR study shows. From pre-recession bull market peak to recession low, the S&P 500 Index of large-cap stocks fell an average of 23.6%, NDR calculates.

But just as the stock market has anticipated economic downturns, it also has looked ahead to the economic recovery and an earnings rebound. The market historically began rising about midway through these past recessions. On average, the S&P 500 gained 24% six months after reaching a recession low and skyrocketed an average of 32% a year after the recession low.

However, it has taken an average of 20 months for the index to recover to its pre-recession peak after hitting its recession low. (It took the index more than five years, though, to recover from the severe 1973–74 and 2000–2002 bear markets, both of which were accompanied by recessions.)

NDR observes that each of the 10 postwar recessions was accompanied by a bear market, as defined by the firm. In each of these cases, the stock market’s low during the recession was also the bottom of the bear market. (Unlike recessions, there is no official definition of a bear market. The firm notes that 10 of the past 18 bear markets were accompanied by a recession.)

Small-cap stocks tend to underperform those of larger companies leading into and during the early stage of a recession. However, NDR says, just as the S&P 500 Index starts its recovery about six months into a recession on average, small-cap stocks tend to significantly begin outperforming large-cap stocks at about the same time and typically continue leading for at least a year after the recession has ended. For the 12-month period following the end of the last nine recessions, small-cap stocks on average provided a 24% gain compared with 17.6% for the S&P 500.

In terms of market sectors during recessions, NDR found that health care and consumer staples (such as food, household products, and beverage firms) were the bestperforming sectors on average six and 12 months after the start of the last five recessions, dating back to 1973. In fact, health care led in each of these five recessions.

-- T. Rowe Price Report, Spring 2008

Worst Year Since 1931

Few investors will mourn the passing of 2008. For good reason.

The Dow Jones Industrial Average fell 33.8%, it's worst drubbing since 1931 and its third-worst year ever. The Dow's loss has been exceeded only by a 53% loss in 1931 and a 38% loss in 1907. It was slightly worse than its loss in 1930.

The Standard & Poor's 500 Index fell 38.6%, its worst performance since 1937 and third-worst loss.

The Nasdaq Composite Index, established in 1971, lost 40.5%, its worst year ever -- even worse than after the dot-com bust.

Next year may not be anything like 2008 and could even see a rebound. But there are enough minefields facing both the economy and investors that deep caution will be the watchword.

The housing industry still hasn't bottomed, and the year-old recession is likely to be the worst since the 1970s. Meanwhile the fates of General Motors (GM, news, msgs), Ford Motor (F, news, msgs) and Chrysler are problematic.

Yet a new administration takes over in three weeks, with promises of a big stimulus package to jump-start the economy. An administration's first year is often good for stocks.

investing books

Vitaliy Katsenelson, author of Active Value Investing, writes:

We find ourselves glued to the computer screens or CNBC waiting to find out what the Dow’s next tick is going to be. Unfortunately, we are left with only a headache and wasted time. OK, what’s next? Here is my advice –- read. Read books that will bring you sanity, the ones that will snap you back into the shell of investor and out of the sorry shell of nervous observer of the daily stock market melodrama. The following books are excellent choices and will come with plenty of sanity and sage advice.

Dividend All-Stars

I'm looking at dividendinvestors.com (from an article in the paper).

One neat feature is that they tell you how many consecutive years the company has increased their dividends. For example, JNJ had increased their dividend for 45 years in a row. MMM for 49 years. PG for 54 years.

Maybe I'll actually sign up to see more.

* * *

According to this article there are high dividend achievers and high dividend aristocrats. The Achievers are those who have increased dividends 10 or more years. The aristocrats have increased 25 or more years. There are 312 achievers, but only 59 aristocrats.

Well, looking now, there are only 52 (five financial companies have cut their dividend). Among them are XOM, GE, LOW, PFE, TGT, WAG.

time to buy?

The 2007-08 bear market has been the worst since the Great Depression, more savage than that of 1973-74, which most of us remember only dimly, if at all, and 2000-02, which we remember all too well.

What's more, the combination of two deep bears in less than a decade has poisoned many people against common stocks. The Standard & Poor's 500 Index ($INX) has gone down an average of 0.9% a year over the past 10 years, from November 1998 through November 2008.

Since this bear market began 14 months ago, virtually every asset class, from foreign and domestic stocks to commodities to real estate, has been driven down at least 50%. Even among bonds, only U.S. Treasurys have held up well. The benefits of diversification, in short, have proved to be illusory.

"Today, in my view, the stock market is presenting you with one of the great buying opportunities of your lifetime -- perhaps the greatest," says Steve Leuthold, the manager of the Leuthold Core Investment (LCORX) fund, which ranks in the top 2% of similar funds over the past 10 years. "Buy 'em when they hate 'em."

Having pointed out the negative returns of stocks over the past 10 years, Leuthold tracked the history of stock performance in every 10-year period in which the market averaged an annual gain of 1% or less. Then he looked at the succeeding 10 years. The worst performance in those periods was a gain of 101% between 1938 and 1948. The best was a surge of 325% between 1974 and 1984. The average was 183%.

Fred on the economy

Fred Thompson explains how bailouts work.

(Fool comments)

rebounds follow drops (usually)

Through the end of November, we experienced a very rare event, with the S&P 500 down 30% during three straight months of declines. Looking at the history of the market since its inception, there were only five prior cases where returns were this weak—four during the Great Depression. As you can see in "Market physics: rebounds have typically followed sharp drops" below, the market was higher during subsequent periods the vast majority of the time.

Bernard Madoff

NEW YORK (AP) — They had known him for years as a golf partner, a family friend. Some were neighbors or fellow members of country clubs on Long Island and in Florida.

Many had begun investing with 70-year-old Bernard L. Madoff decades ago, often after being referred by a friend or relative who had known the Wall Street veteran even longer.

There had been some warnings: Financial consultants had been suspicious for years about his astounding run of success.

They couldn't figure out how he managed to produce steady returns, month after month, even when everyone else was losing money — and leave almost no footprint while moving billions of dollars in and out of the markets.

"People would come to me with their statements and I couldn't make heads or tails of them," said Charles Gradante, co-founder of the Hennessee Group and advisor to hedge fund investors.

"He only had five down months since 1996," Gradante said. "There's no strategy in the world that can generate that kind of performance. But when people would come to him and say, 'How did I make money this month?' he didn't like it. He would get upset with people who probed too much."

Those investors were scrambling Friday to learn whether they had been wiped out by what prosecutors described as a multibillion-dollar Ponzi scheme. The assets of Madoff's investment company were frozen Friday in a deal with federal regulators and a receiver was appointed to manage the firm's financial affairs.

According to the criminal complaint, Madoff estimates he lost as much as $50 billion over many years. If true, it could be one of the largest fraud schemes in Wall Street history.

* * *

[12/24/08] PARIS - A French investment fund manager badly hit by the multi-billion-dollar Madoff scandal committed suicide in his New York office on Tuesday, a French newspaper reported.

Thierry de la Villehuchet, 65, was the co-founder of Access International, a company that raised funds on the European markets to plough into Bernard Madoff's fraud-hit investment scheme.

Villehuchet "could not cope with the pressure following the outbreak of the scandal. He took his own life, this morning, in his office in New York," the website of la Tribune business daily quoted his relatives as saying.

"This is a farewell from someone who had done nothing wrong," they said.

"For the past week, he had tried day and night to find a way to recoup his investors' money and had begun legal action in the United States against US authorities," his relatives said.

***

[10/13/09 via libertarians_2000] Madoff wins one

negative interest on t-bills

Treasuries rose, pushing rates on the three-month bill negative for the first time, as investors gravitate toward the safety of U.S. government debt amid the worst financial crisis since the Great Depression.

The Treasury sold $27 billion of three-month bills yesterday at a discount rate of 0.005 percent, the lowest since it starting auctioning the securities in 1929. The U.S. also sold $30 billion of four-week bills today at zero percent for the first time since it began selling the debt in 2001.

buying in a meltdown

In our 30 plus years of investing, we have rarely seen opportunities the likes of which we are seeing today. In times such as this, we are comforted by the fact that we have survived and prospered through many other crises over the years. Not to be flip, but we are reminded of the time back in 1962 when Russian missiles were on their way to Cuba to confront the U.S. blockade. Joe Reilly, a former partner of Tweedy, Browne, was in our trading room feverishly buying stocks in one of the biggest market meltdowns in stock market history. When asked by Howard Browne how he could be so confident in the face of such impending doom, Joe remarked, “Either this is going to turn out OK and the markets will turn around, or the world is going to come to an end. In either event, I’ll be fine as long as God doesn’t require cash.”

[Tweedy Browne Investment Adviser's Letter via iluvbabyb]

dividend yields top treasury yields

[11/19/08] U.S. stocks’ dividend yields were lower than the yield on 10-year Treasury notes for half a century. Not any more.

Dividends paid by Standard & Poor’s 500 Index companies in the past 12 months amounted to 3.51 percent of the benchmark’s closing value yesterday. In early trading today, the 10-year yield fell as low as 3.42 percent.

The CHART OF THE DAY tracks the yields, and the difference between them, on a quarterly basis since 1953. S&P provided the dividend yields. The data on the Treasury’s yield, holding the maturity constant at 10 years, comes from the Federal Reserve Bank of St. Louis.

[via brknews]

The Day Trader's Aptitude Test

Do you have what it takes to be a day trader?

[the second link is via cougar3, the first link is from the original that I found in 2001 but which dates back to 2000 or earlier]

Stranger than fiction

Imagine that we were sharing a cup of coffee a bit more than a year ago and I told you that in a year that Bear Stearns, Lehman Brothers, Merrill Lynch, Freddie Mac, Fannie Mae, and AIG would be out of business or a fraction of their current size. I’m sure you would have been more than a tad skeptical. In fact, I’m sure you would have considered it outrageous given the strength of those companies at the time. To be quite honest, I would have found it hard to believe too, even if someone had given me today’s newspaper (via time machine) one year ago. But in this case fact is stranger than fiction.

The Five Dive

Have any of your stocks recently tumbled below $5 a share? If you own Citigroup (NYSE: C) stock, then you know that it is among the former blue chips like General Motors Corp. (NYSE: GM) and Ford Motor Co. (NYSE: F) that have breached that $5 limit. They currently trade at $3.88, $2.84, and $1.45 a share respectively. And there's a good chance that if that company has breached $5 a share -- it will drop further.

How so? It turns out that under some circumstances, big institutional investors such as pension funds, endowments, and asset managers must sell a stock when it drops below $5. I have not been able to find out exactly why, however it's likely that these institutional investors owe their shareholders a fiduciary duty to act prudently to protect their investments.

[from a comment by veryearly1]

Money Personalities

Every year, The Phoenix Companies Inc., surveys wealthy people to see how they feel about the economy, their financial goals and the like. The survey ultimately is aimed at selling them financial products, but when the Phoenix folks toss all the data in the hopper, it spits out some interesting information on demographics, attitude and tendencies -- a wealth personality of sorts.

The survey came up with six wealth personalities: Satisfied Savers, Status Chasers, Altruistic Achievers, Secret Succeeders, Disengaged Inheritors and Deal Masters. Most of the personalities share some positive characteristics: They work hard, live below their means and they know how to make their money work for them. On the other hand, some of them are so worried about losing money that it's a source of daily concern.

[via aquarian]

* * *

For most of us, money and our feelings toward it are dynamic and intense. We love money or we hate it, we fear it or we worship it - but we certainly never ignore it. And yet, we know so little about why we experience these emotions.

As a psychologist who specializes in money related matters, I have confronted these money emotions every day of my practice. I have worked with hundreds of men and women from all kinds of backgrounds and income levels. I've learned that not only do we have a physical self, an emotional self and a social self, but we have a financial or money self. This money self is an integral part of our behavioral repertoire. Most of us fail to realize the extent to which it affects our financial habits and affects the degree of satisfaction we get from what money we have.

Understanding your money style will help you gain insight into how and why you react emotionally to money - why you have those reactions and how they affect your financial success or lack of success.

* * *

Mind Over Money: What's Your Money Personality?

booms and busts

if we look at 10-year returns for the Dow Jones Industrial Average over the past 100 years, a pattern emerges:

10-Year Dow Jones Industrial
Period Average Return
1998-2008 (9%)
1988-1998 331%
1978-1988 165%
1968-1978 (19%)
1958-1968 77%
1948-1958 226%
1938-1948 14%
1928-1938 (49%)
1918-1928 254%
1908-1918 60%

After booms come busts, after busts come booms. That's how markets work.

Bear Market Rally?

Before we are all swept away into total despair, let's take a step back and imagine what could get stocks round the world going up for a while.

First, let me point out that by definition the bottom of a bear market has to be the point of maximum bearishness. Thus sentiment becomes a crucial indicator. The systematic work that we do on measuring sentiment (and we monitor about 20 indicators for the US and a dozen or so for other equity markets) show very extreme and in many cases record levels of bearishness.

Second, valuations are cheap. There's no point in going into an elaborate dissertation; it's an inexact science. Using the best historic measures, normalised earnings, book value, and free cash flow, stocks are very cheap, but not as cheap in absolute terms or versus interest rates as they were in the 1930s or at the 1974 bottom. Nevertheless, the 4 per cent dividend return on the S&P 500 exceeds the yield on the 10 and 30-year Treasury bonds for the first time in 50 years. If emerging market equities, where the growth is, at six to eight times earnings are not cheap I don't know what is.

Third, stock markets have been obliterated and are deeply oversold. Even dead cats bounce. The Dow has had the steepest decline since the 1930s, and the spread between the price and the 200-day moving average at 34 per cent is the greatest since July 19, 1932. The US market is down almost 50 per cent from its highs, Europe is off 55 per cent, and emerging markets 65 per cent with some unfortunates, such as Russia, off 70 per cent. History shows that even in enduring, secular bear markets there are not just 20 per cent bounces but usually one 30-50 per cent rally. We should be due.

If I'm bullish why am I not in there now? Because I would like to see the credit markets unclog and spreads come in more. At the bottom of a panic, the news doesn't have to be good for stocks to rally, it just has to be less bad than what has already been discounted. I want the markets to stop going down on bad corporate and macro-economic news.

The fact that it still does shows the bad news has not yet been fully discounted. I have no idea when the next bull market starts, but I do think we are setting up for the mother of all bear market rallies.

-- by Barton Biggs [via veryearly1]

Obama unveils economic team, stocks surge

With the financial crisis looming as a priority of his term, President-elect Barack Obama sought to put his imprint on efforts to stem the turmoil as he introduced his economic team on Monday, nominating Timothy F. Geithner as Treasury secretary and Lawrence H. Summers to head the White House Economic Council.

By naming a team deeply experienced in dealing with financial crises — Mr. Geithner was heavily involved over the weekend in the efforts to stabilize Citigroup — Mr. Obama underscored his determination to assure Americans and foreign investors that he would aggressively step into a leadership vacuum in Washington during the transition.

Moreover, by pledging that his economic team would begin work “today” on recommendations to help middle-class families as well as the financial markets, the president-elect sought to convey an impression of continuity and coordination, so that his administration can “hit the ground running.”

The president-elect also announced that he had chosen Christina D. Romer to head his Council of Economic Advisers and Melody Barnes as director of his White House Domestic Policy Council. Ms. Romer is an economics professor at the University of California, Berkeley, while Ms. Barnes is a longtime aide to Senator Edward M. Kennedy of Massachusetts.

The recent economic news, capped by the Citigroup effort, “has made it even more clear that we are facing an economic crisis of historic proportions,” Mr. Obama said at a news conference. He listed the drop in new home purchases, the surge in unemployment claims to an 18-year high and the likelihood of up to a million further job losses in the coming year.

“While we can’t underestimate the challenges we face,” he said, “we also can’t underestimate our capacity to overcome them to summon that spirit of determination and optimism that has always defined us, and move forward in a new direction to create new jobs, reform our financial system and fuel long-term economic growth.”

* * *

Stocks surged Monday in a broad rally as Citigroup's massive rescue package and President-elect Obama's picks for his economic team pushed investors off the sidelines.

The Dow Jones industrial average (INDU) gained 397 points, or 4.9%, after having been up 552 points earlier in the afternoon. The Standard & Poor's 500 (SPX) index rose 6.4% and the Nasdaq composite (COMP) gained 6.3%.

The market also rallied Friday. The two-session gain of 891.10 points was the biggest two-session gain ever, according to Dow Jones. The percentage gain of 11.8% was the biggest two-session percentage gain since Oct. 1987.

The S&P 500 also saw its biggest two-session percentage gain since Oct. 1987, rising 13.2%. Its point gain was not significant statistically.

bury it

The day the Dow fell 777 points, David Latham, a 45-year-old Alabama cattle farmer and electrician, was busy doing errands. Driving his Chevy pickup into Montgomery, he dropped by the hardware store, then stopped into the bank, where he withdrew $8,000 from his CD account, all in 20s. Back home, he slipped the four inch-thick bundles into a Ziploc bag, popped them into a waterproof PVC tube and set out for a remote location on his 300-acre property, where he dug a deep hole with a post digger. And then he buried his money.

Is there an American alive who hasn’t considered burying his savings—or at least stashing it in the mattress — as this financial crisis has deepened? Latham assumes the Federal Deposit Insurance Corp. will step in if his bank collapses, but he figures it might take a few weeks to get his money. Now, he says, “I can get my hands on cold, hard cash anytime I want.” But beyond that, there’s the nagging fear that the world isn’t as secure as we’d like to believe. Latham says the $8,000 is an insurance policy against, well, who knows? “I’m hedging my bets,” he says.

[via scalenet]

The missteps of the Great Depression

Wall Street's struggle to recover from this month's devastating drop is coinciding with the anniversary of another dark period for the stock market — the crash of 1929.

The dramatic selling of Oct. 28-29 of that year sparked widespread panic and helped trigger the Great Depression largely because the government, wary of meddling in the economy, failed to take many of the steps that the Treasury and Federal Reserve are now using to try to prop up the hammered financial system.

But there are also parallels with today's crisis on the Street — including missed warning signs before the crash and faltering investor confidence in the aftermath.

In the 79 years since the Great Crash, history hasn't been kind to U.S. policymakers' response back then, which financial expert now say reads like a blueprint of what not to do during a similar debacle.

Among the missteps: The government shrank the supply of credit through high interest rates, raised import tariffs in a botched attempt to protect American industry and hiked income taxes in the 1930s to balance the budget.

"Basically, the government did exactly the opposite of what they should have been doing," said Sung Won Sohn, an economics professor at California State University, Channel Islands. "When we think about these things today, it's almost ridiculous and comical what we did back then."

The government also failed to recognize the importance of a crucial role in today's crisis: credit. After the 1929 crash, one out of five U.S. banks failed, causing a massive contraction of the available money supply and turning "a recession into a depression," said Vincent R. Reinhart, former director of the Federal Reserve's monetary affairs division.

"The Fed just sat by and watched thousands of depository institutions fail," Reinhart said. "That's a major difference from the current policy. Now we understand of the role of credit, and policymakers feel a responsibility for stabilizing that activity."

And just like the rash of foreclosures that presaged today's housing crisis, there were warning signs back then.

After the rough years following World War I, the unprecedented growth of the Roaring Twenties sent the stock market soaring a staggering 667 percent, launching a wave of speculative-driven euphoria that experts say was clearly unsustainable. Along with stocks, a burgeoning middle class snapped up bonds, real estate and commodities like oil and coal.

But as Wall Street began crumbling and fear replaced the frenzy, investors rushed to yank their money out of one holding or another to cover mounting losses, along the way driving down the value of all of their assets.

Individual investors weren't the only ones panicking.

Large holding companies and investment trusts — entities that existed only to hold stock in other companies — began buying up shares in their own company in a desperate bid to survive — a move economist J.K. Galbraith later described as an act of "fiscal self-immolation" in his book, "The Great Crash of 1929."

Experts have largely praised the government's reaction this time around, and say it should keep the economy from falling into another depression.

For starters, Federal Reserve Chairman Ben Bernanke, a former academic and expert on the Great Depression, has aggressively cut interest rates and pumped billions of dollars in liquidity into the financial system to keep the supply of money from drying up.

The tactic, known as a "helicopter drop," is borrowed from famed economist Milton Friedman. Bernanke touted the practice in a famous 2002 speech, leading critics to sometimes refer to him as "Helicopter Ben."

"The idea is that if people have access to extra liquidity, some portion of that will be spent," stimulating the wider economy, Sohn said.

Another decision that may have averted catastrophe was the Treasury's $700 billion emergency plan to remove banks' troubled mortgage-related assets as well as taking equity stakes in banks in a move designed to get stagnant lending going again. That, experts say, has so far helped avoid the wave of bank failures that preceded the Great Depression and has helped keep credit available if not easy to obtain.

But as these uncertain times show, the government can't fix everything.

Even with the sweeping government rescue plans, stock markets around the globe have continued to tumble, including a worldwide plunge on Friday from Tokyo to New York. Experts say the persistent fear in markets is a reflection of the limitations of American economic power in an increasingly globalized world.

"Today you have the Federal Reserve sending good signals to the market, but there are lots of other types of bad news out there that is hard to control," said Eugene White, an economics professor at Rutgers University and an expert on the 1929 crash.

As an example, he mentioned the banking collapse earlier this month in Iceland, which wiped out investors across Europe and sent waves of worry around the globe.

In the old days, "who would have thought that would be a problem?," White said.

capitulation is not a bottom

In a declining market, traders often speak of the need to have capitulation, or a selling climax, in order to find a low in the market. I believe selling climaxes or capitulatory moves that end a decline are bull-market phenomena; they are not how a bear market ends.

Panic selling is what occurs when investors get scared out of the market during a bull market. But while we have a tendency to look for such selling in a bear market, it doesn’t occur very often in my view. We tend to get a series of panic-selling lows, but none leads to more than a short-term rally.

In a bear market, the news that comes out is almost always awful and just keeps getting worse. The general feeling is that there is no reason for hope. In other words, there is no panic at the lows—there is simply doom and gloom and disgust with the market.

In a typical bear market, doom and gloom persist. We tend to get a series of panic-selling lows but none leads to more than a short-term rally. Panic selling occurred several times in the 2000–2002 bear market, yet in each instance the market continued lower. The final low of the 2000–2002 bear market was a case of sellers going out with more of a whimper than a bang, which in my view is indicative of the nature of true bottoms.

So when you hear the talking heads call for capitulation this time around, please understand that I think a capitulation low only leads to a short-term rally, not a long-lasting bottom. I believe if we manage to go sideways for many months, or even a year or more, we have a better chance at making a bottom that is long-lasting, since we might have the beginning of some base-building.

CPI decline biggest ever

In October, the Consumer Price Index [CPI] fell 1.0%, its largest decline ever (since the stats started being kept in 1947), although prices are still 3.7% higher than a year ago. Inflation is, like, so last summer, as an economic concern.

The decline in prices was led by a 8.6% decline in energy costs, which follows declines of 1.9% in September and 3.1% in August. Food prices rose just 0.3%, but are still up 6.1% year over year.

In addition to energy, prices also fell for apparel (retailers desperate to get customers in the door) and prices for both new and used autos also fell. But even stripping out food and energy prices, the core CPI fell 0.1%.

Under normal conditions, this would be a huge green light for the Fed to cut the Fed funds rate. However, these are not normal conditions. The Fed funds official target rate is just 1.0%, and even that overstates things since the effective Fed funds rate is just 0.37%. Thus, even if the Fed were to cut by another 50 basis points in December, it would still be behind the curve with the market. On the official target rate, there are just four 25 basis-point bullets left in the gun, and it is not clear just how effective those bullets would be.

The velocity of money is slowing like it never has before, or at least since the 1930's. "Velocity" is the technical term for people just sitting on their wallets and banks just stuffing every spare dollar into 3-month T-bills. This is very important since nominal GDP is equal to the amount of money in circulation times the velocity of that money.

uncharted territory?

One of the fallacies about the recent financial turbulence is that the markets are in “uncharted territory” and that there are no historical precedents for the volatility, panic, or economic uncertainty that we've observed. To make statements like this is to admit that one has not examined historical evidence prior to the 1990's. The fact is that we've observed similar panics throughout market history. This decline has been deeper and more rapid than most, but that is largely a reflection of the rich valuation and overbought condition that characterized the market in 2007.

If we seriously deem it necessary to talk about the Great Depression, fine. Even the Great Depression can be adequately used as a precedent for current conditions provided that one recognizes that the market's valuation during the Depression didn't fall to the levels we currently observe until 1931 when the rate of unemployment was already 15%. Sure, if U.S. unemployment is headed to 25%, as it did in the Great Depression, then stock prices might fall in half even from here, as they did by 1932. But this is important – even if stock prices were to fall further, it would not be because of earnings losses that would permanently impair the fundamental value of U.S. companies. Rather, if further losses emerge, it will be because of increases in risk premiums that will be associated with extremely high subsequent returns. Indeed, even though unemployment shot to 25% in 1932, the S&P 500 more than doubled in the year following the 1932 Depression low, and tripled off of that low within less than three years.

The handful of historical instances when stocks fell to 7 times prior record earnings were also points that were accompanied by 15-25% unemployment, 12% yields on commercial paper (as at the 1974 lows), or 15% Treasury yields (as at the 1982 lows). Similar data is unlikely in this instance – and even if conditions deteriorate to that point, it will involve months and months of ebb and flow in the economic reports. We can be virtually certain that stocks would experience enormous rallies, not simply continuous decline, while the evidence accumulates. Meanwhile, it is notable that data that measure investor panic, such as risk-premiums and intra-day market volatility, already match historical extremes (1932, 1974, 1982, and 2002) – points where stock prices were not far from their lows even though negative economic news persisted for a longer period.

That's not to say that I believe stocks have “hit their lows.” We always have to allow for the market to move significantly and unexpectedly, and there is plausible downside risk from here. Our activity as investors is not to try to identify tops and bottoms – it is to constantly align our exposure to risk in proportion to the return that we can expect from that risk, given prevailing evidence.

Investors can get a good understanding of market history by examining a great deal of data, or by living through a lot of market cycles and learning something along the way. Only investors who have done neither believe that current conditions are “uncharted territory.” Veterans like Warren Buffett and Jeremy Grantham have a good handle on both historical data, and on the concept that stocks are a claim to a very long-term stream of future cash flows. They recognize that even wiping out a year or two of earnings does no major damage to the intrinsic value of companies with good balance sheets and strong competitive positions. Most importantly, these guys never changed their standards of value even when other investors were bubbling and gurgling about a new era of productivity where knowledge-based companies would make the business cycle obsolete, and where profit margins would never mean-revert. They knew to ignore the reckless optimism then, because they understood that stocks were claims on a very long-term stream of cash flows. They know to ignore the paralyzing fear now, because they still understand that stocks are a claim on a very long-term stream of cash flows.

If we seriously need to talk about the Great Depression (I personally believe that it is an outrageously dire comparison), we should recognize that even during that prolonged decline, it rarely made sense to sell into a major break of a previous low, because investors invariably had a chance to sell on a later recovery to the prior level of support. Below is a chart of the Dow Jones Industrial Average during the Depression. Even if one hung on after the enormous rally of nearly 50% that followed the initial 1929 low, the market's initial break of that low (the first horizontal bar) was followed several months later by a rebound to that prior level of support. The break of the second intermediate low of early 1931 (the second horizontal bar) was followed by a rebound later in the year to that same level. Third break, same story.

It is a typical market dynamic to have massive rallies toward prior levels of support, even within ongoing market declines. Once valuations are favorable, that tendency is even stronger, even in a weakening economy. Only the final panic decline of a bear market offers investors virtually no chance to get out on rebounds, but it is precisely that final decline that is recovered almost immediately in the subsequent bull market.

Even if the U.S. economy experiences a much deeper recession, I believe that the 1000-1100 level on the S&P represents a reasonable estimate of “fair value” for the S&P 500. That estimate is somewhat conservative since I am adjusting for the fact that earnings in recent years have been based on very wide profit margins, but could be too conservative given that long-term interest rates are very low. Long-duration instruments like stocks should not be priced off of short-duration instruments like 10-year Treasury bonds, or even 30-year Treasuries, so low interest rates shouldn't make investors recklessly optimistic about their valuation estimates. In any event, I do believe that current levels represent value from the standpoint of long-term investment prospects.

As for extreme and less likely benchmarks, the 780 level on the S&P 500 would represent a 50% loss from the market's peak, and would put the market in the lowest 20% of all historical valuations. I would expect heavy demand from value-conscious investors about that level if the market were to decline further, and a decline below that level could be expected to reverse back toward 780 fairly quickly. Further down, but very unlikely at this point from my perspective, the 700 level on the S&P 500 would represent the lowest 10% of historical valuations, 625 would put the market in the lowest 5% of valuations, and anywhere at 600 or below would put the market in the lowest 1% of historical valuations. I don't expect to see such a level, but there it is. Note that these estimates are unaffected by how low earnings might go next quarter or next year. Stocks are not a claim on next quarter's or next year's earnings – they are a claim on an indefinite stream of future cash flows.

Recent market conditions seem like they have no precedent only because so many investment professionals know only the data they've lived through. If one actually examines market data from the Great Depression, 1907, and other less extreme panics, one realizes how much the recent decline has already discounted potential economic negatives. At this point, further declines in stock prices simply increase the long-term returns that investors can expect over time. We can't rule out the possibility that investors could get more frightened, or that they might abandon their stocks at prices that would offer extremely high long-term returns to the buyers. It is important to establish exposure slowly, but long-term investors who ignore attractive valuations are not investors at all.

[via playstennis]

collateral crisis

... we believe this will prove to be a good time—and maybe even a great time—to invest for people with time horizons beyond a year or two. While there’s no way to know where the market will be in the short term, many conditions are in place for better performance. More directly, we believe the market at these levels represents substantial value for long-term investors.

Let’s start at the top with a brief take on recent events. Clearly, there’s been no lack of commentary on what’s happened over the last 15 months or so. The way we would characterize it, in the mid 2000s the world enjoyed a strong growth phase led by global expansion, simultaneous with relatively low volatility. The low volatility and higher asset prices encouraged investors (including financial institutions) and consumers to get comfortable with greater leverage. Increasing leverage in a low-volatility environment makes sense on some levels—for example, it helps boost returns for investors and increases affordability for consumers.

The problem comes when the system overreaches, which started happening in 2006 and for sure in 2007. This overreaching was most pronounced with the U.S. housing market.

So we are now in a substantial unwinding process. And this unwinding process means we have a collateral-based, not a liquidity-based, crisis. Specifically, a collateral-based crisis is marked by a very devastating positive feedback loop: an asset price drops, leading to a margin call, leading to asset sales, leading to a further drop, leading to another margin call, and so on. What’s key is governments can solve liquidity-based crises with injections of liquidity, as we saw in 1987 and 1998. Collateral crises, in contrast, require more action.

Collateral crises are much more damaging and prolonged than liquidity crises, and require substantial natural deleveraging and government action to encourage lending again. The good news is that governments around the world are on the case. And while there have been missteps, and there will be unintended consequences we have yet to recognize, the global government mobilizations suggest this downturn will be more akin to the early 1970s, early 1980s, or early 1990s than to the Great Depression.

... we looked at the distribution of stock market returns since 1926. In that time, the arithmetic mean return has been a shade under 12 percent and the standard deviation about 20 percent. So if the market finished 2008 at current levels, it’ll be well over a two standard deviation event—something you’d expect once every 40 or 50 years. Indeed, the year-to-date 2008 returns rank it among the worst in the past 85 years, behind only 1931.

And just to put a finer point on this volatility, October 13 and October 15 represented two of the five largest absolute changes in the market since World War II. In other words, of the prior 17,000 trading sessions, two of the biggest five days happened within three days during the week of October 13, 2008. It would not be unreasonable to expect more large moves, akin to earthquakes aftershocks.

... where might we go from here? The first thing to recognize is the stock market is a discounting mechanism. In times of extremes, it is important to carefully distinguish between fundamentals—which will be challenging for the foreseeable future—and the expectations built into asset prices. Dwelling solely on fundamentals, a natural tendency, encourages investors to overlook the way to make money: finding gaps between price and value.

... you can make a decent case for the market based on dividends alone. The current dividend yield on the S&P 500 is only about 80 basis points below the yield on the 10-year Treasury note (see Exhibit 3). You have to go back to the early 1960s to find a similar relationship. 6 If you add in share buybacks, the yield is over 300 basis points above the 10-year note yield, and that’s with buybacks down sharply this year.

... One of the ways to think about environments like today is to step back and take a normalized view of things. Exhibit 5 shows the rolling 10-year returns for large-capitalization stocks. Over the past century-plus, the market has tended to bottom out around zero percent rolling ten-year returns. That happened in the 1930s and 1970s, and that is where we are today. The rolling 10-year figure is worth examining for psychological reasons, too. If the average investor is in a mutual fund, they have lost money after taking fees into consideration. Further, most investors lose an additional 200 basis points due to bad timing. So the bottom line is on a dollar-weighted basis, the average investor has been down substantially in the U.S. stock market in the past decade. That is very psychologically damaging.

We also place significance on Warren Buffett’s actions and comments.

what appears most significant is the juxtaposition of his November 22, 1999, Fortune article and his October 17, 2008, New York Times commentary. Buffett very rarely takes the initiative to comment on the overall market, but he did so in these articles. In the 1999 article, within four months of the market’s top, he suggested that real returns from the market going forward were likely to be about four percent, and if he was wrong, he thought his number was likely too high. In the past decade, we’ve been very close to a zero real return.

In October 2008, he wrote that “the market will move higher, perhaps substantially so, well before either economic sentiment or the economy turns up.” He also added that he’s buying U.S. stocks in his personal account. His partner, Charlie Munger, echoed these thoughts separately. Exhibit 6 plots Buffett’s market calls on the rolling 10-year returns. He has proven to be reliably prescient.

... To finish, here are a couple of observations from behavioral finance. The first relates to a great piece of research that is very relevant today. In this study, normal people were pitted against people with brain damage in a contest. The brain damage had nothing to do with mathematical or logical abilities, but dealt with the emotional seat—ability to feel fear, greed, anxiety and so forth.

The contest was simple. Each participant was given 20 dollars, and for 20 rounds had a choice to do one of two things: they could either keep their dollar or hand the dollar to the researcher who then flipped a coin and paid $2.50 for a win and zero for a loss. So the expected value of handing over the dollar was $1.25.

The bottom line is the brain-damaged participants ended up with 13 percent more money than the normal players. The reason is how frequently people were willing to gamble. Everyone understood that playing made sense, and almost all players started off handing over their dollars. But when the normal people lost a round or two, they often chose to hold on to their dollars in the next round. In other words, normal people forgo explicitly net present value positive bets after they have lost.

This is very akin to today’s environment: most people recognize there is value in the market, but they would rather hold their cash than risk losing again. To state the obvious, the way to end up with the most money is to participate in net present value positive investments, even when your emotions tell you not to.

tax loss math

For those considering booking a tax loss this year, please keep in mind Longleaf’s short-term trading policy which prohibits trading in and out of the Funds within a six month window. This policy encourages long-term investing to benefit all shareholders.

While managing taxes is important to a number of our partners, successful investing offers significantly higher rewards over time. Tax loss selling of mutual funds has fewer benefits than often assumed because of two primary factors. First, the benefit of taking a loss this year versus paying a gain in the future is equal only to the difference between the tax offset this year and the net present value of the higher gains to be paid in the future assuming that you will buy back shares at the current price.

For example, if you bought shares at $30 and sell them at $23 to book the loss, the tax loss value is the 15% gains tax rate times the $7 loss, or $1.05/share. If you then repurchase the shares at $23 and sell them for $45 in the future, your capital gains will be $22 versus $15 had you not booked a loss previously. Assuming the same 15% tax rate, you would owe $3.30 versus $2.25 per share in taxes.

Selling is worth only the difference between the $1.05 “benefit” today and the net present value of the $1.05 cost in higher taxes paid in the future.

Time Magazine covers

The market makes the news — not the other way around.

Far too many investors fail to understand that. When the news is very negative, its usually AFTER the market has been deeply whacked. They are reporting what has already occurred; That’s their jobs.

My goal here isn’t to bash the Press (that stuff is silly). Rather, it is to show you that the media is not telling you what is most probably going to happen next. To investors, news mostly old — its pretty much history as far as stock prices are concerned. What matters most to your portfolio is what the near future holds.

As an example, consider this collection of Time Magazine covers.

[via shaun1776]

the bear bottoming process

Let's take a step back from the current market volatility and consider what a recovery might look like. Here's a set of charts showing the eight completed bear markets since 1950 and how the S&P 500 index performed during the 12 months following the bottom. For the sake of completeness, we've included the near-bear decline that accompanied the Gulf War of 1990 — just shy of the 20% decline of an "official" bear.

As the charts show, bear markets typically spent six weeks to eight months working though the bottoming process. Rather than a sharp V-shaped decline and recovery, these bears bounced around the lower range before transforming into the next bull market.

In recent weeks the current bear market has fallen sharply to its present level. As our review of recoveries suggest, patience will be required while today's bear thrashes around his bottom.

* * *

[However the above assumes that the current bear market is similar to the other bear markets since 1950. If indeed this is the worst financial crisis since the Great Depression, we might expect a decline to be somewhere between the other bears (loss of approximately 50%) and the Great Depression (loss of 90%). A loss of 90% would bring the Dow down to 1400 - me]

* * *

The news is increasingly filled with references to the Crash of 1929 and the Great Depression. For the past few months we've been comparing today's bear market with the two other 40% plus declines in the S&P since 1950.

Let's now add in the Dow stats for the epic bear market from October 1929 to July 1932. Click on the image to the right for a pictorial comparison of these four bad bears.

As you can see, all four markets declined to the vicinity of minus 48%. But the Crash of 1929 included a major bear rally before settling into a leisurely decline to bottom out nearly 90% off its high set 30 months earlier.

[via Wyman]

Louise Yamada

Louise Yamada was also a guest on Fast Money today.

The previous five years were great for investors living in a dream world, but with market seeing the fourth worst decline in the last 80 years the real question is, is the nightmare now beginning?

Unfortunately, the short answer is yes, according to technical analyst Louise Yamada. She says, “I think the charts have been forewarning us that the markets are deteriorating.”

"The 2002 lows are very vulnerable and chances are good they are going to be broken," she tells the traders, grimly.

If you look at the chart below you see a massive double top with a critical 10 year support at 2002, she says. “And the bigger the top the bigger the drop.”



In other words, not only will we break the 2002 lows, but the market will continue lower from there.

Sound far-fetched? Maybe but Yamada is one of the most celebrated technicians on the Street, winning the award for best chart analyst 4 years in a row from 2001 to 2004.

She has a 600 target on the S&P 500 and a 6,000 target for the Dow.

Peter Schiff

Peter Schiff was a guest on Fast Money today.

Almost two years ago he predicted that the financial markets were heading for crisis. At the time he told CNBC, "We're on the verge of a major, major recession that's probably going to start by the end of this year, maybe early next year. The housing market is just beginning to unravel. We're seeing the tip of the iceberg here.”

In fact he went on to compare the economy to the Titanic then added, “I am here with the lifeboat trying to get people to leave the ship.”

Here's a U.S. News article from May.

There's nothing good to say about our situation. The policies both the Fed and government are pursuing are making the situation worse. We've been getting a free ride on the global gravy train. Other countries are starting to reclaim their resources and goods, so as Americans are priced out of various markets, the rest of the world is going to enjoy the consumption of goods Americans had previously purchased. This is a natural consequence of this phony economy. If America had maintained a viable economy and continued to produce goods instead of merely consuming them, and if we had saved money instead of borrowing, our standard of living could rise with everybody else's. Instead, we gutted our manufacturing, let our infrastructure decay, and encouraged our citizens to borrow with reckless abandon.

[5/22/09] What is Schiff saying now? He sees the present rally as a mirage, opining that the "premature conclusion ... that the crash of 2008/2009 is now a fading memory, is just as delusional as [the] failure to see it coming in the first place." On the massive fiscal response to the crisis, he believes that: "By throwing money at the problem, all the government is creating is inflation. Although this can often look like growth, it is no more capable of creating wealth than a hall of mirrors is capable of creating people."

market at 11-year low

Wall Street slumped Thursday, with the S&P 500 plunging to an 11-1/2 year low as fears of a prolonged recession sparked a massive selloff.

The Standard & Poor's 500 (SPX) index lost 6.7% and closed at its lowest point sine April 14, 1997.

The Dow Jones industrial average tumbled (INDU) 5.6% and the Nasdaq composite (COMP) slumped 5.1%. Both the Dow and Nasdaq closed at their lowest points since March 12, 2003, which was just above the low of the last bear market.

The Dow has lost 872 points, or 10.4%, over the last two sessions. It saw a bigger two-day point drop in the two sessions after the presidential election, but it hadn't seen either two-day percentage drops since October 1987, according to Dow Jones.

Stocks slipped through the early afternoon following miserable readings on the labor market and manufacturing sector. The major gauges briefly bounced after hitting fresh 5-1/2 year lows. But the recovery attempt dissolved as Congress haggled over the fate of the automakers and Citigroup led the bank stocks sharply lower.

Since peaking at an all-time closing high of 1,565.15 on Oct. 9, 2007, the S&P 500 has lost 52%. The Dow has lost nearly 47% since closing at an all-time high of 14,164.53 on the same day. Since hitting a bull market high of 2,859.12 on Oct. 31, 2007, the Nasdaq has lost 54%.

panic

While a nominal level of fear is a necessary component of markets because it helps us avoid mistakes, outright panic can be devastating. A behavioral finance professor at Santa Clara University has even studied how panic creates a vicious cycle of irrational behavior. In his 2000 paper, Hersh Shefrin points out how panicked investors misread events, taking small threats as catastrophes that spur them to action. The end result? Investors sell out of valuable companies at low prices on an inflated sense of fear and uncertainty.

A Minsky Moment

a fierce economic cycle fueled the past decade. It went something like this:

* We needed ultra-low interest rates after 9/11.
* Those low rates fed insatiable demand for housing (real estate was especially attractive, because investors' fingers had just been burned by the dot-com bubble, so stocks were taboo).
* Rising home values led to a surge in consumer spending -- funded by debt, of course.
* Spending sprees led to massive trade deficits.
* Massive trade deficits led to massive capital inflows by foreign investors.
* Massive capital inflows kept interest rates low.
* Hey, hey ... low interest rates? We're back to square one!
* Repeat cycle until wealthy.

That self-reinforcing behavior carried us through the highs of last year. And, man, wasn't it good? Tiffany (NYSE: TIF) could hardly keep its display cases stocked. Homebuilders like Toll Brothers (NYSE: TOL) and Beazer (NYSE: BZH) could build without giving much thought about demand. Like any other bubble, people used phrases like "the new economy," chalking it up as globalization at its finest. The world lent. We spent. No one complained. Provided each party did its fair share of lending and spending, there wasn't much that could slow the cycle down.

That's when we had our Minsky moment.

Have a seat, Dr. Minsky will see you in a moment
A Minsky moment is a phenomenon named after economist Hyman Minsky, which describes what happens when an economy simply can't afford its debt anymore. Think of it in Wile E. Coyote terms: We reach the Minsky moment when, suspended in midair, we realize we've outrun our road, look down, and panic. The dangerous part isn't just that debt becomes a pain in the rear, but that it'll cause our half of the aforementioned cycle to grind to a halt.

That's where it gets ugly. When we can't come through on our half of the deal, things might start to spin in reverse. Events could go something like this:

* Lower home and stock prices leads to less consumer spending.
* Less consumer spending leads to smaller trade deficits.
* Smaller trade deficits lead to less foreign capital inflows.
* Less foreign capital inflows lead to higher interest rates.
* Higher interest rates cause property and stock values to plunge.
* Plunging values leads to less consumer spending.
* Less consumer spending ... haven't we been here before?
* Repeat cycle until broke.

That's one of the biggest threats to our economy today: the possibility of being sucked into another self-reinforcing cycle like we were in the past last decade. Only this time, it'll drive us unreasonably poorer, rather than unreasonably richer.

Dow closes below 8000

Stocks slumped to their worst levels in more than five years today as fears about the deteriorating economy intensified.

The Dow Jones industrials closed down 427 points, or 5.1%, to 7,997, its first close below 8,000 since March 31, 2003. The Standard & Poor 500 Index was down 53 points, or 6.1%, to 807, its worst close since March 12, 2003. In the process, the index fell below 819, its intraday low on Nov. 13 and a closely watched support level. The Nasdaq Composite dropped 97 points, or 6.5%, to 1,386, its first close below 1,400 since April 16, 2003. The Nasdaq-100 Index ($NDX.X) fell 68 points, or 5.9%, to 1,088, its lowest close since April 25, 2003.

Today's selloff reflected three forces at work:

A sharp decline in financial stocks, reflecting investor unhappiness that the Treasury Department has junked its plan to take over the troubled assets of a number of financial institutions.

Increasing worries that the recession will be much worse than anyone thought, with deflation problems growing. The Federal Reserve issued new projections today showing unemployment would jump well above 7% next year. Prior forecasts had seen jobless peaking at no more than 6%. The economy is "deteriorating faster than any time since the second quarter of 1980," former Fed governor Lyle Gramley told Bloomberg Television today.

Fears that inaction in Congress will lead to the collapse of General Motors (GM, news, msgs), Chrysler Group or both.

Citigroup (C, news, msgs) shares fell 23.4% to $6.40, its first close below $7 since May 1995.

* * *

Eyeballing a long-term chart of the $SPX, the market is near the lows of 2002-2003. Before that the market last reached those levels in 1997. It was at about 200 in 1987, 400 in 1992, 800 in 1997, near 1600 in 2000, back to 800 in 2002, back up to 1600 in 2007, back down to 800 in 2008. That's a big decline in a short time.

http://img391.imageshack.us/img391/4588/spx081120pb8.gif

wailt 'til next year?

John Mauldin thinks we might get a bear market rally next year (or sooner)..

Everyone knows that there are large amounts of hedge fund redemptions being processed. Some blame the current vicious sell-off on forced hedge fund sales as they have to meet these redemptions at the end of the quarter.

This brings up an interesting possibility. My guess is that the large bulk of that money is going back to institutions that will need to put the money to work. Where will they deploy it? If they are projecting 7-8% total portfolio returns, they cannot put that money in bonds. My guess is that it will go back to other hedge funds or into long-only managers. This money will start to go to work in mid- to late January. We could see a very large rally the first quarter of next year. For traders, this will be a chance to make some money. I think it will be a bear market rally, as the recession will still be in full swing, and we could see a pullback when that money gets fully deployed. But it will be fun while it lasts.

As traders begin to sense that possibility, we could see a serious year-end rally as well. Would I bet the farm? No, but I offer up the idea as a possibility. And I know a lot of people have large short positions that have made them a lot of money this year. Maybe it is time to think about taking profits.

Japan enters recession

Japan's economy entered its first recession in seven years after the government reported that GDP contracted for the second consecutive quarter. The world's third-largest economy behind the US and the eurozone shrank at an annualized rate of 0.4% in 3Q, according to preliminary data, missing the consensus forecast of a scant 0.1% rise. GDP in 2Q was revised lower. Japan's economy minister conceded the economy has slipped into a recession, and analysts are worried conditions may worsen due to the strengthening yen and struggles in the US and in Europe. Stocks reacted poorly at the opening but shares came off lows in midmorning action on a modest drop in the yen, which aided exporters. The benchmark Nikkei 225 Index closed up 0.7%.

Elsewhere, China National Petroleum said problems with the economy are causing oil demand to quickly drop and inventories to rise. China's central bank has been cutting rates to prop up domestic demand and said this morning that it will follow a moderately loose monetary policy and will actively work to expand domestic demand. Stocks in China ended the day higher. A focus on the country's economic stimulus plan helped shares.

-- Schwab Center for Financial Research - Market Analysis Group

you think this is bad?

You think this is bad? During the Great Depression, share prices fell about 90%. At the lows, recounts historian Ron Chernow in "The House of Morgan," members of the Union League Club in New York wallpapered a room with stock certificates rendered almost worthless. A few years later, the market had recovered sufficiently that some members asked for the certificates back.

You think this is bad (Part II)? In the early 1970s the London stock market collapsed by about three quarters; a string of banks failed, and the financial crisis threatened the economy and political stability. At the lows, a leading financier told a London audience that their best "investments" would be cans of food, gold coins "and a gun." A few months later, the stock market began booming again and prosperity returned.

Stock-market panics were once so common that, according to 19th-century Wall Street manager Henry Clews, some investors living in the countryside grew very rich simply by waiting for the crashes and then scooping up stocks. These gentlemen, Mr. Clews recalled in his memoirs, only appeared in New York during a panic. They sold their stocks again at huge profits when the market had recovered, and then returned to their country estates to await the next crash. The nation prospered nonetheless.

Anyone with shattered nerves could do worse than spending $20 on Fred Schwed's hilarious investment classic "Where Are The Customers' Yachts?" It was written in 1940, and it's still right on the money. "When there is a stock-market boom, and everyone is scrambling for common stocks, take all your common stocks and sell them," he wrote. "Take the proceeds and buy conservative bonds." If shares keep rising, don't worry: Just wait for the market to crash. It will. When that happens, and "the panic … becomes a national catastrophe, sell out the bonds (perhaps at a loss) and buy back the stocks." Hold them until the next boom. "Continue to repeat this operation as long as you live, and you'll have the pleasure of dying rich."

No, it's not quite as simple as that. But as Mr. Schwed knew, you're better off buying stocks when nobody wants them and their prices are cheap than when everybody wants them and the prices are dear.

There's your double-bottom

NEW YORK (CNNMoney.com) -- Stocks surged Thursday, with the Dow posting its third best single-session point gain ever, as the major stock gauges bounced back from levels not seen since 2003.

The Dow Jones industrial average (INDU) added 552 points, according to early tallies, after falling to within 81 points of its 5-1/2 year low earlier in the session. Between the close and the low, the Dow's swing was 870 points; it was 911 points between's the day's high and the day's low.

The Standard & Poor's 500 (SPX) index gained 6.9% and the Nasdaq composite (COMP) rose 6.5%, both after touching a lows not seen since 2003.

Stocks had tumbled each day this week and through early Thursday afternoon. But the selloff left the major gauges at levels that many market pros think could represent a bear market bottom, at least in the near term.

After hitting those lows, stocks bounced back into positive territory.

"As soon as the Dow fell below 8,000, we saw a rush of buying," said Matt King, chief investment advisor at Bell Investment Advisors.

It was the second time the market "retested" those lows, which were first hit around Oct. 10. The major gauges slumped to around those levels at the end of October and now again in mid November.

"It was very positive," he said. "It seems like we have put a bottom in place."

However, he said that because the two retests happened so rapidly, there's a possibility that the market could rally for a few months and then retest again. If so, that would be similar to what happened when the last bear market bottomed in 2002 and 2003.

Russia halted

trading in Russia's stock market was halted after its main index fell over 12%. Yesterday, the central bank widened its trading range for its currency and traders speculated the government was prepared to let the ruble weaken. In order to prevent foreign capital from fleeing the country, the central bank raised its key interest rate yesterday by a full percentage point. Political uncertainty, heavy-handed government tactics, nervous foreign investors, and plunging oil prices have been pressuring stocks in recent months. Today's losses are on top of a decline of 10% on Tuesday.

-- Schwab Alerts, 11/12/08

Declines and Rebounds

Top 10 Worst Declines and Rebounds Within One Year*

                    Decline Rebound 
Sept. 1929-July 1932 -89.5% +172.2% 
Mar.  1937-Mar. 1938 -50.2%  +63.0% 
Jan.  1973-Dec. 1974 -46.6%  +56.0% 
Sept. 1939-Apr. 1942 -41.3%  +48.3% 
Aug.  1987-Oct. 1987 -41.2%  +35.8% 
Jan.  2000-Oct. 2002 -38.8%  +36.9% 
Dec.  1968-May  1970 -36.9%  +52.7% 
Nov.  1961-June 1962 -29.2%  +39.7% 
Sept. 1976-Feb. 1978 -27.7%  +22.3% 
Feb.  1966-Oct. 1966 -26.5%  +29.4% 
Current bear market   
Oct.  2007-Oct. 2008 -44.5%**

AVERAGE REBOUND +55.6%

*Based on Dow Jones Industrial Average. Index is property of Dow Jones & Company.
**Date of this study is 10/26/08.

-- from Zacks.com email ad

(So assuming that this time isn't different, we should be expecting about a 50% bounce from the lows of this bear market.)

* * *

[11/22/08] Between 1926 and 2008, the U.S. experienced 16 corrections or bear markets — periods of at least six months during which the S&P 500® Index fell 10% or more. During the 15 historical bears (excluding the one still unfolding), the market declined an average of 28% and the bears averaged 13.6 months.

Yet, when those 15 bear markets ended, the stock market bounced back, typically in short, powerful bursts. As the “Bear Market Recoveries ...” table shows, an investor who was fully invested in the stock market when the bear markets ended could have enjoyed an average return of 45% in the year after the bear market—but much less if he or she’d been holding cash for even short periods.

Missing those periods of explosive growth would have seriously damaged a portfolio’s long-term return. Over the 12 months starting in July 1932, the S&P 500 had three months when it was up more than 38%. And it rose nearly 17% in October 1974, 41% from January through June 1975, and 21% from March through August 2003.

Why Japan continues to fail

In late 1989 the Nikkei 225, Japan's leading stock index, hit an intraday high of 38,957. Today, 19 years later, it's at 8,800. This multi-decade loss speaks to two things -- one, just how out of control Japan's asset bubble was, but two, the fact that the Japanese government has, for the sake of maintaining jobs, not made the hard decisions that would have allowed the country to grow.

In the aftermath of the bubble, Japan's government rushed in to prop up its banking system, which was teetering under the weight of non-performing loans. Rather than letting businesses fail, this has had the effect of propping them up to continue operating.

As I look at the pressure being placed on the US government to bail out or even nationalize the US auto manufacturers, I see the same faulty logic being used. So desperate is the government to protect these jobs and these massive companies that it is willing to spend taxpayer money to keep Detroit afloat. It might be a good use of capital if the Big Three were thriving companies that had simply suffered from exogenous events that they'd reacted to improperly. But they aren't. These companies are sick and dying, and they have not generated a positive capital return in decades.

China stimulus package

SHANGHAI — China announced a huge economic stimulus plan on Sunday aimed at bolstering its weakening economy, a sweeping move that could also help fight the effects of the global slowdown.

At a time when major infrastructure projects are being put off around the world, China said it would spend an estimated $586 billion over the next two years — roughly 7 percent of its gross domestic product each year — to construct new railways, subways and airports and to rebuild communities devastated by an earthquake in the southwest in May.

The package, announced Sunday evening by the State Council, or cabinet, is the largest economic stimulus effort ever undertaken by the Chinese government.

* * *

[11/13/08] the fundamental difference between China's stimulus package and our bailouts: China can afford them, but we can't.

inflation or deflation?

Frankly, I have been surprised by the number of questions we have been getting about the inflation risks associated with the various liquidity and stimulus plans coming from the Federal Reserve and Treasury Department. Am I concerned about inflation? Sort of. But, what I'm concerned about is the lack of inflation … or better put, my concern is more about deflation than inflation.

We're in a recession that, I believe, began a year ago. It's unlike any seen in the post-Depression era. Typically, recessions are caused by rising inflation, related aggressive Fed policy tightening and/or inventory cycles. This is a balance-sheet recession with deep roots in asset deflation and deleveraging, and is accompanied by careening global equity markets, falling commodity prices, stagnant wages and declining production. This is all disinflationary, if not deflationary.

the Fed's balance sheet has swelled massively, as you can see in the chart below.

Fed's balance sheet goes parabolic

Under normal circumstances, an increase in dollars would elevate inflation risks, but this environment is anything but normal. The global credit crisis is rapidly slowing the circulation of dollars, which will offset the effects of an increase in global money supply.

Even if reliquified, are banks going to jump to lend aggressively again? Not likely. Are households and businesses going to line up to the credit trough aggressively? Not likely.

The simple force of a decline in credit will not only limit economic growth, but inflation, too. Indeed, as I suggested in my recent report on deleveraging, "A Transformational Era of Deleveraging," the government will likely be stepping in as the spender of last resort, but as it represents a fraction of the weight in gross domestic product (GDP) relative to consumer spending, it's not likely to fuel inflation.

Yes, the growth rate in the monetary aggregates is accelerating, but this is neither a sufficient nor necessary condition for rising inflation. What also impacts inflation is the "money multiplier," or the ratio of M2 money supply to the monetary base. It shows whether the rise in bank reserves is spreading out into the broader economy. As you can see in the chart below, it has nose-dived recently and if it fails to accelerate after the normal lags, expect more action from the Fed.

History shows that during major periods of deleveraging, the "velocity" of money ebbs and acts as an offset to the rise in money supply. That's exactly what happened in Japan during the deleveraging era of the 1990s. The money supply remained confined to banks' balance sheets as demand for credit remained weak. When bank and household balance sheets are shrinking simultaneously, it's deflationary, not inflationary.

-- by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.