This is a reprint from a 2005 Article I wrote regarding the Real Estate Bubble (Before it burst). An interesting re-read for me, after watching the market for the past few years.
The Perfect Storm; Bubble Trouble
By Michael J. Rebibo, CFP®
April 2005
A friend of mine recently asked me if I were interested in going “in with him and some of his neighbors” to buy some townhouses to “flip for a profit”. They were forming a partnership in order “to get in on some of the hot real estate deals” that are now available. These were not traditional real estate investors but successful businessmen in the cable industry. Another friend said she doubled her investment on a second home she purchased at the beach less than a year ago. A few others have purchased speculative condos and are “hoping to make a killing”.
It all reminds me of 1989, the year I purchased my first home. The market was red hot and interest rates were on the rise. I couldn’t wait to get into the real estate market so I could enjoy some of the appreciation everyone else was realizing. I purchased the home for $289,000. Less than three years later, I listed it for $262,000, a drop of nearly 10%. After fix up and closing costs, I had to write a check for $14,000. Most of you will remember this time when rates were increasing, housing prices were falling, and the stock market was stagnant. Is this what the next 3 years have in store for us? As financial planners, it is our job to see through the noise and lead our clients down the safer path.
Real Estate Reaches Record Appreciation Levels
Recently, the Office of Federal Housing Enterprise Oversight, the government entity charged with ensuring the capital adequacy and financial safety and soundness of FNMA and FHLMC, published its House Price Index for 2004. For the 5th consecutive year, housing prices have increased by more than 7.5% nationwide. National housing prices increased by 10.24% in the 2004.
Conundrum
The Federal Reserve has increased short-term rates at a “measured pace” 8 times since June of 2004. Yet long-term rates such as mortgages remain below their levels of 1 year ago. Fed Guru Greenspan recently referred to the current low long term interest rates as a “conundrum” (which by the way is also a great white wine made by Caymus Vineyards)! Fed tightening, higher core inflation, near record oil prices, lower dollar, record federal budget deficit, and above trend economic growth create the perfect storm for higher long term rates and an immediate halt to appreciating property values.
Testifying before the House Financial Services Committee last month, Greenspan stopped short of calling home buyers “irrationally exuberant”, but stated "I think we're running into certain problems in certain localized areas. We do have characteristics of bubbles (in those markets) but not, as best I can judge, nationwide." Publicly traded homebuilders stocks fell 10% on the comment.
Home Sales Slowing
According to Merrill Lynch economist David Rosenberg, “the backlog of unsold homes has risen steadily, and in January approached a five-year high of 4.7 months supply. However, raw data, excluding seasonal adjustments indicate that the backlog has reached six months, which would mark an eight-year high.” While our local markets remain strong, this may be the last rush to purchase property before rates increase by too much.
Home Appreciation Outstrips Personal Income
“Median house prices have risen about 30% since March 2001, well ahead of an 11% gain in personal income”, says Michael Youngblood, head of asset-backed research at Friedman Billings & Ramsey.
Speculation on the Increase
Meanwhile, “unfettered access to easy money has inflated home prices nationwide, particularly on the coasts, and lately has let to an upsurge in speculative buying.” says Kopin Tan of Barron’s. Just as with the stock bubble in 2000, recent increases in speculative buyers and property flippers have driven up values in many urban areas like Washington DC.
“Household real-estate assets now equal nearly 14% of Gross Domestic Product, the highest proportion in two decades and eerily close to the ratio of household mutual fund and equity holdings relative to GDP at the stock market’s peak in 2000.” says Kopin Tan of Barron’s.
David Berson, the chief economist for Fannie Mae, observed in his weekly commentary that investor ownership of housing hasn't been this high since the late 1980s, which led to a crash in housing prices. "Many analysts think that a high investor share in the Northeast and California helped exacerbate the housing downturn that happened during the 1990-1991 recession”.
Bubble
Yale University economist Robert Shiller, author of "Irrational Exuberance," the 2000 best-selling book about the '90s stock-market bubble, said the only similar housing boom in U.S. history was when GIs returned home from World War II, lifting a depressed market. The latest addition of “Irrational Exuberance includes a chapter on the current real-estate trend.He thinks the current boom is a "classic bubble" because people keep buying houses they know are too expensive because they expect prices to rise even higher.
Conclusions
Ultimately it will be the level of long term interest rates that will create a local or national housing bubble. If rates exceed 6%, expect a 10% correction across the board. Larger homes will most likely be hit harder. If rates stay below this threshold, we may still see some localized drop in values in the higher end prices of homes in localized areas. The question is when?
As financial planners, it is our job to help our clients steer clear of disaster. Most real estate acquisitions are highly leveraged. This leverage works against you in a falling market. If your clients have an over allocation of real estate, it may be time to rebalance.
Friday, March 11, 2011
Friday, July 24, 2009
1st Portfolio Lending is the new name for Pineapple Lending
FOR IMMEDIATE RELEASE:
1st Portfolio Lending is the new name for Pineapple Lending.
Tysons Corner, VA - July 22, 2009 – 1st Portfolio Holding Corporation’s mortgage lending subsidiary, Pineapple Lending has officially changed its name to 1st Portfolio Lending. Clients of the new 1st Portfolio Lending can expect all of the great service, customer care and thoughtful advice that the 1st Portfolio name has come to stand for.
1st Portfolio Lending specializes in conforming and FHA mortgages up to $729,750 as well as portfolio jumbo mortgages that are necessary for larger home purchases. The difficult housing and mortgage markets of today necessitate a high quality loan advisor like 1st Portfolio Lending to assist those that want to get the best possible loan and get their transaction completed. There may never have been a better time to refinance or purchase a new home than today. Interest rates remain artificially low because of massive, but temporary, purchases of mortgage backed securities by the Federal Reserve. Home prices also have fallen more than 30% from their 2006 peak.
1st Portfolio Lending is the new name for Pineapple Lending.
Tysons Corner, VA - July 22, 2009 – 1st Portfolio Holding Corporation’s mortgage lending subsidiary, Pineapple Lending has officially changed its name to 1st Portfolio Lending. Clients of the new 1st Portfolio Lending can expect all of the great service, customer care and thoughtful advice that the 1st Portfolio name has come to stand for.
1st Portfolio Lending specializes in conforming and FHA mortgages up to $729,750 as well as portfolio jumbo mortgages that are necessary for larger home purchases. The difficult housing and mortgage markets of today necessitate a high quality loan advisor like 1st Portfolio Lending to assist those that want to get the best possible loan and get their transaction completed. There may never have been a better time to refinance or purchase a new home than today. Interest rates remain artificially low because of massive, but temporary, purchases of mortgage backed securities by the Federal Reserve. Home prices also have fallen more than 30% from their 2006 peak.
For additional information on 1st Portfolio Lending or to discuss your potential mortgage loan needs, please contact Barbara Evans at 703.564.9100 or visit www.firstportfoliolending.com
Contact:
Barbara Evans
8300 Boone Blvd. Suite 200
Vienna, VA 22182
www.firstportfoliolending.com
Ph: 703-564-9100
###
www.firstportfoliolending.com
Ph: 703-564-9100
###
Thursday, July 23, 2009
Losers are Winners and Winners are Losers
Why do individual investors typically under perform institutional investors? The answer lies in the chart below. Many individual investors chase returns - buying last years’ winners and selling off losers. After being burned in the stock market in 2008, these investors moved to bonds, cash and gold, last year’s top asset classes. I call this the Money Magazine strategy. Pick up Money Magazine in December and buy what they recommend. Then watch last years winners become this year’s losers as institutional investors reallocate assets. Next year’s Money will have a whole new set of losers to chase.
The top 3 asset classes on the Chart below have now moved to the bottom of the chart in the first 6 months of 2009. Last years losers are this year’s top performers as Emerging Markets and Growth oriented stocks out performed all other classes.
Show all
(click to enlarge)
The top 3 asset classes on the Chart below have now moved to the bottom of the chart in the first 6 months of 2009. Last years losers are this year’s top performers as Emerging Markets and Growth oriented stocks out performed all other classes.
Show all
(click to enlarge)
Book Review: Outliers - The Story of Success
Outliers: The Story of Successby Malcolm Gladwell
Malcolm Gladwell takes us on an intellectual journey through the world of "outliers"--the best and the brightest, the most famous and the most successful. He asks the question: what makes high-achievers different? His answer is that we pay too much attention to what successful people are like, and too little attention to where they are from: that is, their culture, their family, their generation, and the idiosyncratic experiences of their upbringing. Along the way he explains the secrets of software billionaires, what it takes to be a great soccer player, why Asians are good at math, and what made the Beatles the greatest rock band. -B&N
Book Review: The Ascent of Money
The Ascent of Moneyby Niall Ferguson
With the clarity and verve for which he is known, Ferguson elucidates key financial institutions and concepts by showing where they came from. What is money? What do banks do? What’s the difference between a stock and a bond?
Perhaps most important, The Ascent of Money documents how a new financial revolution is propelling the world’s biggest countries, India and China, from poverty to wealth in the space of a single generation—an economic transformation unprecedented in human history.
-From jacket
Emerging Markets Offer Emerging Opportunities
Emerging Markets Offer Emerging Opportunities by Neil Macker
For many U.S.-based individual investors, emerging markets represent the “Wild West” of investing, offering unmatched and almost limitless returns. In the view of others, the term “emerging markets” invokes the specters of extreme risk and political instability. Most investors tend to either lump emerging markets into one large bucket or simply examine the BRIC (Brazil, Russia, India and China) markets. Financial pundits have recommended emerging markets as an asset class for hedging due to historically low correlation with the U.S. stock market. Let’s discuss these commonly held beliefs and why we still believe in the importance of an emerging markets allocation in your portfolio.
Wild West?
Until recently, many investors viewed emerging markets as a magical place that provided astronomical returns, driven by “China” and “commodities”. The idea that emerging markets can move upwards without large downward swings, though is hard to justify. Even before the events of 2008 the two largest, most diversified emerging markets (India and China) experienced wild swings in annual results as seen in Chart 1. Also, note that the S&P 500 outperformed the primary emerging market indices in only two of the nine years from 2000 to 2008. Both outperfomances occurred during recession years (2001 and 2008).
(click to enlarge)
Despite the large downward swings, the two primary emerging markets offer significantly higher average returns since January 2000. Table 1 shows what a hypothetical investment of $10,000 in each index at the beginning of 2000 would have been worth as of June 30, 2009. Returns for both of the emerging market indices are more than three times that of the S&P 500.
(click to enlarge)
Even when we cherry pick the best four-year continuous sample for the S&P, the U.S. index provided lower returns as shown in Table 2.
(click to enlarge)
Frontier Markets vs. Maturing Developing Markets
The large swing in returns likely causes some investors to adopt the pessimistic view of emerging markets as pools of extreme risk and political instability. Part of this belief may lie in the inability of investors to segregate emerging markets. A simple method of separating emerging markets is to define a non-developed market as either a frontier market or maturing developing market.
Frontier markets include countries such as Bahrain, Bangladesh, Botswana, Bulgaria, Cambodia, Colombia, Cote D’Ivoire, Croatia, Ecuador, Estonia, Georgia, Ghana, Jordan, Kazakhstan, Kenya, Kuwait, Lebanon, Lithuania, Nigeria, Oman, Pakistan, Panama, Qatar, Romania, Slovenia, Sri Lanka, Tunisia, Ukraine, United Arab Emirates, Vietnam, and Zimbabwe. The equity exchanges in frontier markets feature undercapitalization and weaker regulatory frameworks along with lower levels of foreign ownership, borrowing, liquidity, and transparency than maturing developing markets. Most frontier markets also suffer from political instability, tenuous financial policies, and lesser- developed/diversified economies. Historically these countries have conformed to the pessimistic view of emerging markets and as such, most investors outside the most aggressive should stay clear of frontier markets.
Maturing developing markets include the big four BRIC markets along with familiar names such as Israel, Mexico, South Africa, South Korea, Taiwan, and Turkey. Many investors have focused on the BRIC countries as those markets have benefited from investor in-flows and high GDP growth sparked by export growth (China and India) and commodity price increase (Russia and Brazil). However, the other markets also offer relative political stability, more diversified economies, larger domestic markets, lower levels of official/government corruption, and more robust ties to the developed countries.
Diversification, Not a Hedge
Ties to developed countries have in part led to the demise of the “de-coupling” theory, which stated that emerging markets had effectively moved far away from developed countries and would not be affected by a meltdown in the developed world. Some financial pundits advised that emerging market investments would act as a “hedge” against investments in developed markets. Even before the events of last year, the theory was already beginning to lose adherents as correlations between emerging market ETFs and the S&P 500 ETF (SPY) rose and as investment dollars began to flow in larger amounts into emerging market funds. After the global meltdown in 2008, where correlations among all asset classes increased, the idea of “de-coupling” faded as did the concept of hedging using asset classes.
The Future
So with no appreciable value as a hedge and increased risk, why allocate funds into emerging markets? While emerging market investments do not provide a strict hedge, the investments do offer diversification benefits as the correlations remain below one (at correlation of one, two assets classes would move in lockstep). Also, emerging markets provide access to different risk premia in the same way that an allocation to U.S. small and mid-cap stocks does despite the two sectors having a much higher correlation to each other than US equity and emerging markets. Another factor in favor of emerging markets is higher GDP growth over the near future. The only two major economies, developing or otherwise, that are projected to have GDP growth in 2009 are China and India as seen in Chart 2. Projections for 2010 also predict that China and India will also have the largest GDP growth of 9% and 7% respectively, versus 6% for emerging markets and 1% for developed economies.
(click to enlarge)
Another reason to allocate to emerging markets is as the U.S. and most governments in the world inject funds into domestic economies, the level of public debt is projected to increase dramatically. As seen in Chart 3, the U.S. was in relatively decent standing with public debt at 40% of GDP at the end of 2008, but was well behind three of four BRIC countries. Current Congressional Budget Office projections estimate that the U.S. public debt to GDP will reach 51% at the end of 2009 and will peak at 54% in 2011. These projections reflect the belief that the government will move back towards a more balanced budget versus the $1.5 trillion deficit projected for 2009. Some commentators such as Bill Gross of PIMCO, suggest that the U.S. government may have to continue running trillion dollar deficits over the next several years and that the new “normal” GDP growth rate will be 1% to 2% versus the 3%+ of the past.
(click to enlarge)
As the U.S. and other developed countries increase overall debt levels, their corresponding stock markets will experience increased risk levels with lower expected returns. As a result, emerging markets may provide greater risk/return rewards.
Given these factors, we continue to believe that allocation to emerging markets is appropriate for many clients. The amount allocated to emerging markets will vary by portfolio given individual risk tolerances/time horizons and will change over time as we continue to monitor the economic factors.
For many U.S.-based individual investors, emerging markets represent the “Wild West” of investing, offering unmatched and almost limitless returns. In the view of others, the term “emerging markets” invokes the specters of extreme risk and political instability. Most investors tend to either lump emerging markets into one large bucket or simply examine the BRIC (Brazil, Russia, India and China) markets. Financial pundits have recommended emerging markets as an asset class for hedging due to historically low correlation with the U.S. stock market. Let’s discuss these commonly held beliefs and why we still believe in the importance of an emerging markets allocation in your portfolio.
Wild West?
Until recently, many investors viewed emerging markets as a magical place that provided astronomical returns, driven by “China” and “commodities”. The idea that emerging markets can move upwards without large downward swings, though is hard to justify. Even before the events of 2008 the two largest, most diversified emerging markets (India and China) experienced wild swings in annual results as seen in Chart 1. Also, note that the S&P 500 outperformed the primary emerging market indices in only two of the nine years from 2000 to 2008. Both outperfomances occurred during recession years (2001 and 2008).
(click to enlarge)
Despite the large downward swings, the two primary emerging markets offer significantly higher average returns since January 2000. Table 1 shows what a hypothetical investment of $10,000 in each index at the beginning of 2000 would have been worth as of June 30, 2009. Returns for both of the emerging market indices are more than three times that of the S&P 500.
(click to enlarge)
Even when we cherry pick the best four-year continuous sample for the S&P, the U.S. index provided lower returns as shown in Table 2.
(click to enlarge)
Frontier Markets vs. Maturing Developing Markets
The large swing in returns likely causes some investors to adopt the pessimistic view of emerging markets as pools of extreme risk and political instability. Part of this belief may lie in the inability of investors to segregate emerging markets. A simple method of separating emerging markets is to define a non-developed market as either a frontier market or maturing developing market.
Frontier markets include countries such as Bahrain, Bangladesh, Botswana, Bulgaria, Cambodia, Colombia, Cote D’Ivoire, Croatia, Ecuador, Estonia, Georgia, Ghana, Jordan, Kazakhstan, Kenya, Kuwait, Lebanon, Lithuania, Nigeria, Oman, Pakistan, Panama, Qatar, Romania, Slovenia, Sri Lanka, Tunisia, Ukraine, United Arab Emirates, Vietnam, and Zimbabwe. The equity exchanges in frontier markets feature undercapitalization and weaker regulatory frameworks along with lower levels of foreign ownership, borrowing, liquidity, and transparency than maturing developing markets. Most frontier markets also suffer from political instability, tenuous financial policies, and lesser- developed/diversified economies. Historically these countries have conformed to the pessimistic view of emerging markets and as such, most investors outside the most aggressive should stay clear of frontier markets.
Maturing developing markets include the big four BRIC markets along with familiar names such as Israel, Mexico, South Africa, South Korea, Taiwan, and Turkey. Many investors have focused on the BRIC countries as those markets have benefited from investor in-flows and high GDP growth sparked by export growth (China and India) and commodity price increase (Russia and Brazil). However, the other markets also offer relative political stability, more diversified economies, larger domestic markets, lower levels of official/government corruption, and more robust ties to the developed countries.
Diversification, Not a Hedge
Ties to developed countries have in part led to the demise of the “de-coupling” theory, which stated that emerging markets had effectively moved far away from developed countries and would not be affected by a meltdown in the developed world. Some financial pundits advised that emerging market investments would act as a “hedge” against investments in developed markets. Even before the events of last year, the theory was already beginning to lose adherents as correlations between emerging market ETFs and the S&P 500 ETF (SPY) rose and as investment dollars began to flow in larger amounts into emerging market funds. After the global meltdown in 2008, where correlations among all asset classes increased, the idea of “de-coupling” faded as did the concept of hedging using asset classes.
The Future
So with no appreciable value as a hedge and increased risk, why allocate funds into emerging markets? While emerging market investments do not provide a strict hedge, the investments do offer diversification benefits as the correlations remain below one (at correlation of one, two assets classes would move in lockstep). Also, emerging markets provide access to different risk premia in the same way that an allocation to U.S. small and mid-cap stocks does despite the two sectors having a much higher correlation to each other than US equity and emerging markets. Another factor in favor of emerging markets is higher GDP growth over the near future. The only two major economies, developing or otherwise, that are projected to have GDP growth in 2009 are China and India as seen in Chart 2. Projections for 2010 also predict that China and India will also have the largest GDP growth of 9% and 7% respectively, versus 6% for emerging markets and 1% for developed economies.
(click to enlarge)
Another reason to allocate to emerging markets is as the U.S. and most governments in the world inject funds into domestic economies, the level of public debt is projected to increase dramatically. As seen in Chart 3, the U.S. was in relatively decent standing with public debt at 40% of GDP at the end of 2008, but was well behind three of four BRIC countries. Current Congressional Budget Office projections estimate that the U.S. public debt to GDP will reach 51% at the end of 2009 and will peak at 54% in 2011. These projections reflect the belief that the government will move back towards a more balanced budget versus the $1.5 trillion deficit projected for 2009. Some commentators such as Bill Gross of PIMCO, suggest that the U.S. government may have to continue running trillion dollar deficits over the next several years and that the new “normal” GDP growth rate will be 1% to 2% versus the 3%+ of the past.
(click to enlarge)
As the U.S. and other developed countries increase overall debt levels, their corresponding stock markets will experience increased risk levels with lower expected returns. As a result, emerging markets may provide greater risk/return rewards.
Given these factors, we continue to believe that allocation to emerging markets is appropriate for many clients. The amount allocated to emerging markets will vary by portfolio given individual risk tolerances/time horizons and will change over time as we continue to monitor the economic factors.
Stocks Rebound Strong, But Will it Continue?
The Second Quarter of 2009 most likely marked the beginning of the next bull market and the first increase in the stock market since 2007. US stocks, as measured by the S&P 500, were up nearly 16% for the quarter and up nearly 37% since the market low on March 9th. However, it will take three more rallies of this amount to regain the market peak reached in 2007.
While we may be nearing the end of this recession, don’t expect things to get back to “normal” quickly. The US and international developed markets are likely to grow much more slowly in the coming years than over the past decade. Aging populations, increasing savings rates, high unemployment rates and the deleveraging of both corporations and individuals are likely to keep GDP (Gross Domestic Product) growth lower than during previous recoveries. In addition, the massive debt piled up by the US along with likely higher taxes in the future will slow growth for the foreseeable horizon.
With a slower U.S. economy, the U.S. stock market is likely to advance at a slower pace than in the recent past. From 1990 to 2007, GDP grew at an average rate of 2.8%. During the same period, the S&P 500 expanded at an annual rate of 7.5%, a 4.7% premium over GDP. If the average GDP growth for next several years falls between 1% and 2% as predicted by some observers including PIMCO’s Bill Gross, expect average US stock market returns to average only 5.5% to 6.5% in the coming years.
However, significant growth in US companies may occur in particular sectors. These sectors are likely to be the industrial sector, high tech, renewable energy and clean technologies, natural resources and the beaten down financial services. Internationally, we expect emerging market countries to continue to outperform developed markets.
Tuesday, April 21, 2009
Money For Nothing and a Mortgage for Free
The US government is spending trillions of dollars to keep our ailing economy afloat. This has already softened the free fall in the equity markets and hopefully we will see it in our housing markets. But it comes at a cost, which is the likelihood of higher taxes and inflation in the future.
My friend Tom Millon, a secondary mortgage market specialist in the U.S. mortgage business, says it this way in his recent newsletter, "Never fear. We have a new put option protecting us. Remember the Greenspan put? That's the one that protected the stock market in the late 'Nineties. It was always safe to buy stocks because Greenspan would lower rates to support stocks every time they dipped. Today we have the Obama-Bernanke-Geithner put option." The new put option Tom is referring to is government subsidized mortgages. Our government is using printing money to buy mortgage back securities, which has pushed mortgage rates down to an artificially low price. This free money is being offered to you or anyone else to go spend on a new house or refinance your existing one. Everyone in the country who can afford to buy a house or refinance must take advantage of this "put option". It is basically free money and will not last!
The downside of this government generosity is it debases our currency and increases our debt. There are no free lunches and it may unleash inflation. Imagine a future with inflation above 5% and interest rates above 8%. Your house will be going up at this time and you will have locked your mortgage at 5% or below! There is no better way to protect yourself, except maybe moving to a Latin American Country, from the pain that is yet to come! Pay down your loan if necessary to qualify. Conforming loans are now up to $729,000.
1st Portfolio recently purchased a mortgage company, previously known as Pineapple Lending, now called 1st Portfolio Lending. Please give us a call so that we can analyze your personal financial circumstances and help you save on a new home mortgage. If you mention this newsletter, we will provide you with a $250 closing cost credit to reduce your expense.
Monday, March 9, 2009
A Light at the End of a Long Tunnel
A year ago I began writing this article, but concluded that the “light at the end of the tunnel” was a train. Again last summer I set pen to paper on the same theme and came to the same conclusion. I tried in December and failed. As I write, I wonder that it might be a little too soon to release this. I was early when I wrote my article in April of 2005 entitled Bubble Trouble, calling for a major drop in real estate prices and I may be a bit early in suggesting we may be very close to a bottom in home real estate values.
There are still significant forces putting downward pressure on real estate values. These include the insane run up in values over the first 6 years of this decade; very tight credit markets; increasing unemployment; record foreclosures; excess capacity; and general market fear.
However, many of these forces may increasingly be “priced in” and are being replaced by positive forces that may create a real estate bottom in the coming months. These positive forces include the precipitous drop in prices from market peaks creating greater affordability; record low interest rates, a record drop in new home starts; the near trillion dollar stimulus plan; the $8,000 first time homebuyer tax credit; and the increases in the FHA and Conforming loan limits for both purchases and refinance transactions. Let us first take a look at where we are now before we dive into where we might be headed.
Falling off a Cliff
At the Chicago Mercantile Exchange (CME), where many financial instruments such as interest rate swaps, currencies contracts, and commodities are traded, options and futures on residential real estate also are available. These products are based on the most accurate real estate index available on the market, the S&P/Case-Schiller U.S. National Home Price Index. This measure is generally considered the best and most unbiased indicator of real estate prices. The index is calculated from data on repeat sales of single family homes, an approach developed by Yale economists Karl Case and Robert Schiller. The index is normalized to a value of 100 in the first quarter of 2000 and measures home values in the 20 largest US metropolitan markets or MSAs.
According to the Case-Shiller Index, average U.S. single family housing values peaked in the summer of 2006 (July to be specific) doubling in value since January of 2000. Since that peak, housing prices nationwide have fallen off a cliff, dropping about 30% on average. This drop varies significantly in the 20 Metropolitan Statistical Areas (MSAs) listed. For example, in Charlotte, North Carolina, home prices fell just 4% compared to Phoenix, Arizona where prices fell 45%. Coincidently, Bank of America, BB&T and Wachovia are all based in North Carolina. Maybe this explains why these banks were willing to make such aggressive bets in the residential mortgage market.
Forces Pushing Prices Down
In Real Estate Finance class, students generally are taught to assume a 3% appreciation rate for real estate growth in all financial calculations. This was always considered to be the historical long term rate of growth. For some reason, the rating agencies and large brokerage houses missed this in their Real Estate Finance class. Home values appreciated at a rate of about 14% per year from 2000 to 2006 due to low rates, easy credit and speculation. Assuming values revert back to the mean of 3% per year, we may still have a ways to go. Using the Case-Schiller Index values from 20 years ago in 1989, and projecting forward appreciation of 3% per year, average real estate values nationwide must fall another 9% from their year-end values before they reach a 3% year over year appreciation rate. While this is a big number, home values fell 6% in the forth quarter of 2008 alone. Thus it would not be a much of a stretch to see a 9% drop by summer.
Tight Credit Hurts
Tighter credit standards are hurting home buyers. Conventional and FHA loan standards have tightened dramatically. In addition, many of the mortgage products available to home buyers have vanished. No income verification loans, so called 80-20 loans, sub-prime loans and even competitivly priced jumbo products are no longer in existence. This means that few potential buyers can pick up the slack of excess homes.
Unemployment Continues to Increase
The unemployment rate, currently at 8.1%, is expected to continue to rise throughout this year and into next year. The Fed is projecting a rate of 8.8% by the end of 2009 and possibly higher in 2010. Unemployment has a direct impact on housing prices. As people lose jobs, they lose their ability to make house payments, and many lose their homes in foreclosure. Unemployment can be devastating to housing markets, but is a lagging indicator of economic activity and is likely to remain high well after the economy starts to grow.
(click to enlarge graph)
Delinquency Rates Increased in Q4 but Foreclosures Rates Began to Drop
The Federal Reserve reported that fourth quarter 2008 mortgage delinquency stood at 6.29% up from 5.2% in the third quarter. Mortgage delinquency is generally below 2% under normal market conditions. “Foreclosure filings were reported on 274,399 U.S. properties during the month of January, a 10 percent decrease from the previous month but still up 18 percent from January 2008” according to the RealtyTrac U.S. Foreclosure Market Report.
“The extensive foreclosure efforts on the part of lenders and government agencies appear to have impacted the January” said James J. Saccacio, chief executive officer of RealtyTrac.
“January REOs, which represent completed foreclosure sales to the foreclosing lender, were down 15 percent nationwide from the previous month.
Excess Capacity
Total housing inventory peaked in November at an 11.2-month supply meaning that it would take 11 months before all of the homes listed were sold at the current rate of absorption. However, at the end of December, this figure fell to a 9.3-months supply due to a substantial increase in home sales. “The higher monthly sales gain and falling inventory are steps in the right direction,” according to Lawrence Yun, chief economist at the National Association of Realtors, “but the market is still far from normal balanced conditions.”
General Market Fear and the Herd Mentality
The same factors that pushed housing up to insane levels are now pushing it down at an even faster rate. In 2006, buyers were willing to enter bidding wars and in some cases write “escalator” clauses to compete against as many as 20 or more purchasers on the same property. Today, fear of further price deterioration has kept renters from buying, which in turn stops the move up buyer from moving up the chain. I call this the “Herd Mentality”. It is what creates all bubbles and eventually busts.
(click to enlarge)
Now for Some Good News
Ok, enough of the bad news, lets look at the positive factors that may be establishing a floor in housing. Why is this important? I believe that the fall in housing prices led us into this recession and a floor in prices will spark the end of the recession.
Affordability
The National Association of Realtors, biased though they may be, reports that their Housing Affordability Index is at 135, which means that the average American family can not only afford to purchase a home, but also will have excess money for living expenses. According to the association, a score of 100 indicates that a typical family would have the exact amount required based on a 20% down payment and monthly payments of no more than 25% of their household income.
I did my own calculations based on Fairfax County’s numbers. For the past few years, an average Fairfax County couple earning the median household income of $105,000 per year could not even afford to purchase a home in Fairfax County. Now that prices have fallen 30% from 2006, a home that used to cost $600,000 now costs $420,000. Using the a conventional loan limit of $417,000 or the new higher FHA loan limits of $729,750, this couple can now purchase this home with 10% down with a conventional loan or as little as 3.5% down at a rate near 5%. Add Obama’s $8,000 first time home buyer tax credit and things get even better. These first time home buyers are the key to the real estate chain. As they buy new and existing homes, existing owners are free to sell their homes and possibly move up. This is a huge step to establishing a floor on real estate values.
Record Low Rates and New HUD and FNMA Guidelines
As of February 26th 2009, the national average mortgage rate is 5.07% with an average of ¾ of a point according to Freddie Mac’s Primary Mortgage Market Survey. This rate is near all time lows and allows buyers to afford significantly more house for the money. For example, mortgage rates were approximately 8% in the year 2000. In that year, the Case-Schiller Composite 20 Index was set at base of 100. Today the index stands at 152 showing a 52% increase in home values from the year 2000. Should homes be worth 52% more today than in 2000?
Considering real income are the same today as in 2000 and the population has grown by less than the number of new homes built, not likely. But if rates were at the same level as they are today, then home buyers can afford a 35% larger purchase price. This has a direct correlation on home values. This would put the index at 135 vs. 152 where it stands today. Combine that with the new max FHA insured loan amount of $729,750 and the more lenient FNMA guidelines on refinance transactions indicates that we may be approaching the bottom.
Record Drop in New Home Starts
According to Bloomberg, “U.S. builders broke ground in January on the fewest houses on record as a lack of credit and plunging sales exacerbated the worst real-estate slump since the Great Depression. Housing starts plunged 17 percent.” While this may seem like bad news it has a very positive impact on future home inventories. Eventually the demand for housing will exceed supply again and home prices will begin to recover. This may take some time but a virtually moratorium on new homes certainly helps.
Government Stimulation
Over the next two years our government will spend nearly a trillion dollars stimulating our battered economy. While one can debate the value of this stimulus, there is little debate that it will have a positive impact on stemming foreclosures, increasing employment, and providing prospective purchasers a nice credit of $8,000 to purchase a home in 2009. The administration will also use $75 billion to bring down mortgage rates and encourage loan modifications to stem repossessions. “The problem with the build-up in inventory is coming from the increasing number of foreclosures,” Nicolas Retsinas, director of Harvard University’s Joint Center for Housing Studies in Cambridge, Massachusetts, said in a Bloomberg Television interview. “It’s about time the government intervened so directly in the problem.”
So Where Does This Leave Us?
As I explained earlier, falling real estate values led us into this recession and stabilizing values will mark the beginning of the end. If one can accurately predict when and at what level home values will stop falling, one can predict when the stock market will likely turn positive and when the economy will truly begin to rebound. We live in a world of uncertainty, and it is this uncertainty that defines risk and ultimately opportunity or failure. Predictions on when the real estate market might begin cannot be relied upon at all. There are far too many factors that are still unknown. However, now that I have hedged myself, here is a summary of my thoughts on the light at the end of the tunnel.
As I explained earlier, falling real estate values led us into this recession and stabilizing values will mark the beginning of the end. If one can accurately predict when and at what level home values will stop falling, one can predict when the stock market will likely turn positive and when the economy will truly begin to rebound. We live in a world of uncertainty, and it is this uncertainty that defines risk and ultimately opportunity or failure. Predictions on when the real estate market might begin cannot be relied upon at all. There are far too many factors that are still unknown. However, now that I have hedged myself, here is a summary of my thoughts on the light at the end of the tunnel.
A bottom in the current residential real estate cycle will be reached between April and September of this year at a value of 11 to 15% below year end 2008 values. While an additional drop of this magnitude will be painful, it will be reached shortly. Capitulation caused by short sellers and foreclosures will likely end this spring. Thus some of the best buying opportunities may be right around the corner. If my predictions are correct, this would mean a peak to trough decrease in values of about 37% and put properties priced at their 2002 levels. These estimates are based on national averages and will vary significantly in different parts of the country and in different price points in each MSA. For example, property values inside the Washington DC Capital Beltway have fallen by less than half that of those further out. So if you are in the market for a home and plan to stay at least 5 years, 2009 might just turn out to be the ideal time to buy.
Do Your Part To Help Economy
Do Your Part To Help Economy: Take Some of the Government Hand Outs, Lower Your Mortgage Payments or Buy a New House.
Our government is giving away tax dollars in an effort to stop home depreciation and help the economy. Here is a summary of how to get some of these tax dollars in your pocket while helping the faltering economy. Falling real estate values are killing the Nation’s financial institutions, not to mention damaging the stock market and to the equity in your home. Take advantage of the $787 Billion Stimulus Package and the $75 Billion Treasury’s “Making Home Affordable” Programs and help stop the bleeding. Here is a quick summary of how you can help:
1. Refinance Now: The US Treasury has been buying mortgage backed securities at an unprecedented rate. This has lowered fixed mortgage rates to the low 5% range. This, combined with the new, higher loan limits of $625,000 has helped many to lower their mortgage payments. If your loan amount exceeds $625,000 or if you are over 80% loan to value, consider paying down the mortgage to meet the lender’s guidelines. Remember, if you reduce debt costing you 6%, you are guaranteed to earn that rate of interest on your investment.
2. Get your first time homebuyer $8000 tax credit[1] when you buy a home before December 1st 2009. A “first time home buyer” is anyone who has not owned a home for three years. If you plan to buy before the deadline, you can begin saving by reducing your withholdings now. The law also allows taxpayers to choose ("elect") to treat qualified home purchases in 2009 as if the purchase occurred on December 31, 2008. This means that the 2008 income limit (MAGI) applies and the election accelerates and can be applied by filing 2008 returns instead of for 2009 returns. Income must be lower than $75,000 for individuals and $150,000 for couples. If you already own a home and have a twenty something year-old living in your house, give them a push! Now is the time to pick up a steal!
3. The Home Affordable Refinance[2]: This program will be available to 4 to 5 million homeowners who have a solid payment history on an existing mortgage owned by Fannie Mae or Freddie Mac. This program is aimed at homeowners whose loan to value is greater than 80% and do not qualify for a traditional refinance. These borrowers may be eligible to refinance their loan and take advantage of today’s lower mortgage rates or to refinance an adjustable-rate mortgage into a more stable mortgage, such as a 30-year fixed rate loan. The Home Affordable Refinance program ends in June 2010. Only homeowners in good standing whose loans are held by Fannie Mae or Freddie Mac qualify. The property must be owner-occupied and the borrower must have enough income to make payments on the new mortgage debt. Borrowers can't owe more than 105 percent of their home's current value on their first mortgage. Borrowers with a second mortgage still can qualify as long as their first mortgage isn't more than 105 percent of their home's value. Homeowners can't take cash out during the refinancing to pay other debt.
4. The Home Affordable Modification[3]: This program will help up to 3 to 4 million at-risk homeowners avoid foreclosure by reducing monthly mortgage payments. Who can qualify? The program applies to mortgages made on Jan. 1 or earlier. If your mortgage payment including taxes, insurance and homeowners association dues exceeds 31 percent of your gross monthly income you may qualify for modification. The property must be the homeowner's primary residence. Home loans for single-family properties that are worth more than $759,750 don't qualify. Homeowners are eligible for up to $1,000 of principal reduction payments each year for up to five years! You do not need to be behind on your mortgage to qualify for this program.
5. Mortgage Analysis: Need help to figure it out? Call for a free mortgage analysis. 703-821-5554
[1] http://www.federalhousingtaxcredit.com/
[2] http://www.treas.gov/press/releases/reports/guidelines_summary.pdf
[3] http://www.treas.gov/press/releases/reports/guidelines_summary.pdf
Our government is giving away tax dollars in an effort to stop home depreciation and help the economy. Here is a summary of how to get some of these tax dollars in your pocket while helping the faltering economy. Falling real estate values are killing the Nation’s financial institutions, not to mention damaging the stock market and to the equity in your home. Take advantage of the $787 Billion Stimulus Package and the $75 Billion Treasury’s “Making Home Affordable” Programs and help stop the bleeding. Here is a quick summary of how you can help:
1. Refinance Now: The US Treasury has been buying mortgage backed securities at an unprecedented rate. This has lowered fixed mortgage rates to the low 5% range. This, combined with the new, higher loan limits of $625,000 has helped many to lower their mortgage payments. If your loan amount exceeds $625,000 or if you are over 80% loan to value, consider paying down the mortgage to meet the lender’s guidelines. Remember, if you reduce debt costing you 6%, you are guaranteed to earn that rate of interest on your investment.
2. Get your first time homebuyer $8000 tax credit[1] when you buy a home before December 1st 2009. A “first time home buyer” is anyone who has not owned a home for three years. If you plan to buy before the deadline, you can begin saving by reducing your withholdings now. The law also allows taxpayers to choose ("elect") to treat qualified home purchases in 2009 as if the purchase occurred on December 31, 2008. This means that the 2008 income limit (MAGI) applies and the election accelerates and can be applied by filing 2008 returns instead of for 2009 returns. Income must be lower than $75,000 for individuals and $150,000 for couples. If you already own a home and have a twenty something year-old living in your house, give them a push! Now is the time to pick up a steal!
3. The Home Affordable Refinance[2]: This program will be available to 4 to 5 million homeowners who have a solid payment history on an existing mortgage owned by Fannie Mae or Freddie Mac. This program is aimed at homeowners whose loan to value is greater than 80% and do not qualify for a traditional refinance. These borrowers may be eligible to refinance their loan and take advantage of today’s lower mortgage rates or to refinance an adjustable-rate mortgage into a more stable mortgage, such as a 30-year fixed rate loan. The Home Affordable Refinance program ends in June 2010. Only homeowners in good standing whose loans are held by Fannie Mae or Freddie Mac qualify. The property must be owner-occupied and the borrower must have enough income to make payments on the new mortgage debt. Borrowers can't owe more than 105 percent of their home's current value on their first mortgage. Borrowers with a second mortgage still can qualify as long as their first mortgage isn't more than 105 percent of their home's value. Homeowners can't take cash out during the refinancing to pay other debt.
4. The Home Affordable Modification[3]: This program will help up to 3 to 4 million at-risk homeowners avoid foreclosure by reducing monthly mortgage payments. Who can qualify? The program applies to mortgages made on Jan. 1 or earlier. If your mortgage payment including taxes, insurance and homeowners association dues exceeds 31 percent of your gross monthly income you may qualify for modification. The property must be the homeowner's primary residence. Home loans for single-family properties that are worth more than $759,750 don't qualify. Homeowners are eligible for up to $1,000 of principal reduction payments each year for up to five years! You do not need to be behind on your mortgage to qualify for this program.
5. Mortgage Analysis: Need help to figure it out? Call for a free mortgage analysis. 703-821-5554
[1] http://www.federalhousingtaxcredit.com/
[2] http://www.treas.gov/press/releases/reports/guidelines_summary.pdf
[3] http://www.treas.gov/press/releases/reports/guidelines_summary.pdf
Thursday, February 19, 2009
Obama Signs Economic Stimulus Package into Law
Here is a great summary of how the stimulus package might effect your taxes:
On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009, which contains nearly $800 million in economic stimulus spending and tax relief designed to help individuals and businesses in the current economic climate. While the tax and accounting specialists at Cherry, Bekaert & Holland, L.L.P. (CB&H) review the Act to develop more detailed guidance for our clients and friends, here is a list of some of the new law's major provisions. Note that most of the benefits included in the new law are eliminated or phased out for higher income individuals; however, there is something for virtually everyone in this Act:
"Making Work Pay" Tax Credit
For 2009 and 2010, the Act creates a refundable tax credit of up to $400 for working individuals or $800 for couples with modified adjusted gross income (MAGI) that does not exceed $75,000 or $150,000 respectively. Qualified taxpayers will receive this credit either in the form of reduced withholding from their paychecks during the year or when they file their annual tax returns.
AMT Patch for 2009
The Act includes an alternative minimum tax (AMT) patch for 2009, which raises AMT exemption amounts above 2008 levels to $70,950 for joint filers and surviving spouses (up from $69,950 in 2008); and $46,700 for single filers and heads of households (up from $46,200).
First-Time Homebuyer Tax Credit
The Act expands the first-time homebuyer tax credit, originally enacted under the Housing Assistance Tax Act of 2008, increasing the maximum amount of the credit to $8,000 and eliminating the repayment obligation for qualified principal residences purchased from January 1, 2009 through November 30, 2009.
New Car Deduction
Effective for new vehicle purchases on or after February 17, 2009, the Act allows qualified taxpayers an above-the-line deduction for all state, local sales and excise taxes paid relating to the first $49,500 of the purchase price of a new car, light truck or other vehicle through the end of the year.
"American Opportunity" Education Tax Credit
For 2009 and 2010, the Act expands and renames the existing HOPE education credit, increasing the credit amount (subject to income limits) from $1,800 to $2,500 a year and applying the credit to all four years of college. The Act also makes 40% of the credit refundable and adds course materials as qualifying expenses.
Bonus Depreciation
The Act extends the first-year 50% bonus depreciation enacted under the 2008 Economic Stimulus Act for new business equipment purchases through December 31, 2009. The Act also extends through 2010 bonus depreciation for other qualified property.
Section 179 Expensing
The Act extends through 2009 the Section 179 depreciation deduction, originally enacted under the 2008 Economic Stimulus Act, for new and used business equipment, increasing the expensing amount to $250,000 and the threshold for reducing the deduction to $800,000.
Net Operating Loss Carryback
The Act enables qualified small business with average gross receipts of $15 million or less to carry net operating losses (NOLs) back for up to five years. The carryback provision applies to any NOL for tax years beginning or ending in 2008.
Cancellation of Indebtedness
The Act allows qualified businesses to recognize cancellation of indebtedness income over five years, beginning in 2014, for specified types of business debt repurchased or forgiven by the business after December 31, 2008, and before January 1, 2011.
Qualified Small Business Stock
The Act allows investors to exclude, through 2010, up to 75% of the gain from the sale of qualified small business stock acquired after February 17, 2009 and before January 1, 2011 and held for more than five years.
S Corp Built-In Gain Period
For C corps that become S corps in 2009 and 2010, the Act reduces the holding period to seven from 10 years for assets subject to the built-in gains tax.
This short summary is by no means a comprehensive review of the new law. Look for more details soon about how these and other provisions of the Act may provide you and your business with considerable opportunities to maximize tax savings, or contact your local CB&H tax professional today to ensure that you and your business receive the maximum possible benefit of these provisions.
FOR MORE INFORMATION, PLEASE CONTACT:Brooks Nelson, Partner bnelson@cbh.com 1.800.849.8281
About Cherry, Bekaert & Holland, L.L.P. (CB&H) www.cbh.comAs the Southeast’s accounting and consulting Firm of Choice, Cherry, Bekaert & Holland, L.L.P. (CB&H) is uniquely positioned to provide quality, cost-effective and value-added services to a diverse and successful client base. The Firm sets itself apart by delivering the extensive industry specialization and service opportunities of a national firm, but with the accessibility, service continuity and level of personal relationship expected from a local business. Ranked nationally among CPA firms, CB&H’s resource network stretches regionally across six states, including the large metro markets of Atlanta, Charlotte, Hampton Roads, Raleigh, Richmond, Tampa, South Florida, and Washington D.C., and nationally and internationally through an alliance with Baker Tilly International, a worldwide network of independent accounting firms.
U.S. Treasury Department Circular 230 Disclosure: In accordance with applicable professional regulations, please understand that, unless specifically stated otherwise, any written advice contained in, forwarded with, or attached to this communication is not a tax opinion and is not intended or written to be used, and cannot be used, by any person for the purpose of (i) avoiding any penalties that may be imposed under the Internal Revenue code or applicable state or local law provisions or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.
Source: Cherry, Bekaert & Holland, L.L.P. (CB&H)
On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009, which contains nearly $800 million in economic stimulus spending and tax relief designed to help individuals and businesses in the current economic climate. While the tax and accounting specialists at Cherry, Bekaert & Holland, L.L.P. (CB&H) review the Act to develop more detailed guidance for our clients and friends, here is a list of some of the new law's major provisions. Note that most of the benefits included in the new law are eliminated or phased out for higher income individuals; however, there is something for virtually everyone in this Act:
"Making Work Pay" Tax Credit
For 2009 and 2010, the Act creates a refundable tax credit of up to $400 for working individuals or $800 for couples with modified adjusted gross income (MAGI) that does not exceed $75,000 or $150,000 respectively. Qualified taxpayers will receive this credit either in the form of reduced withholding from their paychecks during the year or when they file their annual tax returns.
AMT Patch for 2009
The Act includes an alternative minimum tax (AMT) patch for 2009, which raises AMT exemption amounts above 2008 levels to $70,950 for joint filers and surviving spouses (up from $69,950 in 2008); and $46,700 for single filers and heads of households (up from $46,200).
First-Time Homebuyer Tax Credit
The Act expands the first-time homebuyer tax credit, originally enacted under the Housing Assistance Tax Act of 2008, increasing the maximum amount of the credit to $8,000 and eliminating the repayment obligation for qualified principal residences purchased from January 1, 2009 through November 30, 2009.
New Car Deduction
Effective for new vehicle purchases on or after February 17, 2009, the Act allows qualified taxpayers an above-the-line deduction for all state, local sales and excise taxes paid relating to the first $49,500 of the purchase price of a new car, light truck or other vehicle through the end of the year.
"American Opportunity" Education Tax Credit
For 2009 and 2010, the Act expands and renames the existing HOPE education credit, increasing the credit amount (subject to income limits) from $1,800 to $2,500 a year and applying the credit to all four years of college. The Act also makes 40% of the credit refundable and adds course materials as qualifying expenses.
Bonus Depreciation
The Act extends the first-year 50% bonus depreciation enacted under the 2008 Economic Stimulus Act for new business equipment purchases through December 31, 2009. The Act also extends through 2010 bonus depreciation for other qualified property.
Section 179 Expensing
The Act extends through 2009 the Section 179 depreciation deduction, originally enacted under the 2008 Economic Stimulus Act, for new and used business equipment, increasing the expensing amount to $250,000 and the threshold for reducing the deduction to $800,000.
Net Operating Loss Carryback
The Act enables qualified small business with average gross receipts of $15 million or less to carry net operating losses (NOLs) back for up to five years. The carryback provision applies to any NOL for tax years beginning or ending in 2008.
Cancellation of Indebtedness
The Act allows qualified businesses to recognize cancellation of indebtedness income over five years, beginning in 2014, for specified types of business debt repurchased or forgiven by the business after December 31, 2008, and before January 1, 2011.
Qualified Small Business Stock
The Act allows investors to exclude, through 2010, up to 75% of the gain from the sale of qualified small business stock acquired after February 17, 2009 and before January 1, 2011 and held for more than five years.
S Corp Built-In Gain Period
For C corps that become S corps in 2009 and 2010, the Act reduces the holding period to seven from 10 years for assets subject to the built-in gains tax.
This short summary is by no means a comprehensive review of the new law. Look for more details soon about how these and other provisions of the Act may provide you and your business with considerable opportunities to maximize tax savings, or contact your local CB&H tax professional today to ensure that you and your business receive the maximum possible benefit of these provisions.
FOR MORE INFORMATION, PLEASE CONTACT:Brooks Nelson, Partner bnelson@cbh.com 1.800.849.8281
About Cherry, Bekaert & Holland, L.L.P. (CB&H) www.cbh.comAs the Southeast’s accounting and consulting Firm of Choice, Cherry, Bekaert & Holland, L.L.P. (CB&H) is uniquely positioned to provide quality, cost-effective and value-added services to a diverse and successful client base. The Firm sets itself apart by delivering the extensive industry specialization and service opportunities of a national firm, but with the accessibility, service continuity and level of personal relationship expected from a local business. Ranked nationally among CPA firms, CB&H’s resource network stretches regionally across six states, including the large metro markets of Atlanta, Charlotte, Hampton Roads, Raleigh, Richmond, Tampa, South Florida, and Washington D.C., and nationally and internationally through an alliance with Baker Tilly International, a worldwide network of independent accounting firms.
U.S. Treasury Department Circular 230 Disclosure: In accordance with applicable professional regulations, please understand that, unless specifically stated otherwise, any written advice contained in, forwarded with, or attached to this communication is not a tax opinion and is not intended or written to be used, and cannot be used, by any person for the purpose of (i) avoiding any penalties that may be imposed under the Internal Revenue code or applicable state or local law provisions or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.
Source: Cherry, Bekaert & Holland, L.L.P. (CB&H)
Wednesday, December 10, 2008
Target Funds Miss The Mark!
Nearly every mutual fund, index or exchange traded fund has lost significant value in 2008. However, one group, Target Date Funds, specifically the “2010” funds, have performed worse than nearly all others given their objective. These mutual funds, also known as lifecycle funds or age based funds are designed to provide a simple investment solution through a portfolio whose asset mix becomes more conservative as the target date (usually retirement) approaches.
Laura Bruce with Bankrate.com describes them as follows: “The formula seems simple. Determine the year in which you want to retire and put a bull's-eye on the calendar. Go to your employer-sponsored 401(k) or IRA, or to your individual brokerage account, and find the "target date" mutual fund that matches your retirement date. Start pouring your retirement dollars into that one fund. As the years go by, your fund is routinely rebalanced and becomes incrementally more conservative. The theory is that as your retirement date arrives, the changing asset mix will provide the proper recipe for stability and growth.”
In addition, a February 2008 article of Kiplinger Magazine touted this simple approach to investing. “Target-date funds simplify long-term investing. Choose the year you wish to retire, then pick the fund with the date closest to your target.” Simple as that! The article goes on to recommend their favorites, T. Rowe Price, Fidelity and Vanguard, coincidently the same companies that advertise in Kiplinger’s Magazine.
Investors have pumped nearly $26 billion into Target Date funds. Most of these investors are the leading edge of the baby boomers born in the mid-1940s and are now nearing retirement. So how has this “simple” new investment performed in the current environment?
Target Date 2010 funds, those with the earliest retirement target and presumably the most conservative, were pounded in 2008. Here is a sample as to how these funds performed so far this year:
Laura Bruce with Bankrate.com describes them as follows: “The formula seems simple. Determine the year in which you want to retire and put a bull's-eye on the calendar. Go to your employer-sponsored 401(k) or IRA, or to your individual brokerage account, and find the "target date" mutual fund that matches your retirement date. Start pouring your retirement dollars into that one fund. As the years go by, your fund is routinely rebalanced and becomes incrementally more conservative. The theory is that as your retirement date arrives, the changing asset mix will provide the proper recipe for stability and growth.”
In addition, a February 2008 article of Kiplinger Magazine touted this simple approach to investing. “Target-date funds simplify long-term investing. Choose the year you wish to retire, then pick the fund with the date closest to your target.” Simple as that! The article goes on to recommend their favorites, T. Rowe Price, Fidelity and Vanguard, coincidently the same companies that advertise in Kiplinger’s Magazine.
Investors have pumped nearly $26 billion into Target Date funds. Most of these investors are the leading edge of the baby boomers born in the mid-1940s and are now nearing retirement. So how has this “simple” new investment performed in the current environment?
Target Date 2010 funds, those with the earliest retirement target and presumably the most conservative, were pounded in 2008. Here is a sample as to how these funds performed so far this year:
How did this happen? According to Craig L. Israelsen, Ph.D., an associate professor at Brigham Young University, the Target 2010 Index had an equity allocation of about 8%. However, the four largest Target 2010 funds had equity allocations in excess of 50%. In order to compete for more assets, fund managers went for higher returns in an attempt to beat the index. They failed.
There are a number of lessons to be learned from this. First, investing is never “simple” or “easy”. If it were, we would have a lot more wealthy people on this planet. Second, Kiplinger and Money Magazine are in the business of making money, not investing your money. Following their advice generally ends you up at the bottom of the heap. Third, never put all of your eggs in one basket. There is simply too much risk in investing in one fund.
There are a number of lessons to be learned from this. First, investing is never “simple” or “easy”. If it were, we would have a lot more wealthy people on this planet. Second, Kiplinger and Money Magazine are in the business of making money, not investing your money. Following their advice generally ends you up at the bottom of the heap. Third, never put all of your eggs in one basket. There is simply too much risk in investing in one fund.
Wednesday, October 15, 2008
US Financial Crisis: Selling Two Legged Stools
Many people ask me how the financial sector got so messed up. Here is the best analogy I can give you:
Imagine a world where stools are a critical component to the economy. Stupendous Stool Store, Inc (SSS) is one of the five largest stool companies in the world. For years, SSS sold four legged stools with various degrees of quality to retail stores
worldwide. SSS sells its stools in bundles of 10, improving efficiency and lowering costs. They bundle together both high and low quality stools to give the retailer a nice mix to sell to consumers. For many years, this was a very profitable business.
One day, the SEC (Stool Exchange Commission) relaxed the capital requirement laws for companies like SSS. Before, they could only borrow 10 times their equity for the inventory needed to make the stools. Now they could borrow 40 times their equity to purchase and make stools for repackaging. SSS set up more lines of credit to purchase more raw materials to make more stools. In order to carry this new debt load, SSS needed to make lower cost stools. One highly paid executive at SSS decided that they could lower prices of the stools, by including a few three legged stools in their bundles. They modeled the use of the new stool by sending “Stool Samples” to various bars and pubs around the world. They quickly determined that the three legged stool is just as good as a four legged stool, but costs less to make and takes up less room. Buyers of the stools did not seem to mind at all.
SSS then sent the Stool Samples to their independent external rating agency, Dumb and Dumber, Inc. After speaking with the executives at SSS and reviewing their “Stool Samples”, those at Dumb and Dumber, Inc. concluded that the new stool bundles should receive the same AAA rating as before. Now SSS could sell both three and four legged stools in bundles for the same price as they sold a bundle of higher quality four legged stools. The executives and sales people at SSS pocketed the additional profits and were happy.
Then one of the highly paid commission sales persons at SSS came up with an even better idea. How about adding some 2 legged stools to the package? These stools would only be effective for sober customers with good balance. Since they are only going to put a few of these stools in each bundle, along with three and four legged stools, they were able to lower their costs yet again. They went to Dumb and Dumber, Inc. with their “Stool Samples” and explained that since 20% of the customers who buy stools were sober, the two legged stools really had no effect on the quality of the stool package. Those at Dumb and Dumber, Inc. agreed and rated the stools packages AAA yet again. SSS could sell its stool package at the same price as before, but with much lower costs and pocket a handsome profit.
In order to keep production going, SSS always maxed out its leverage so that it had plenty of Stool Bundles available for the market. Eventually however, the stools reached a saturation point in the market and sales began to decline. At the same time, people were getting hurt falling off the three and two legged stools. Some companies began to return their stool bundles and others simply stopped buying.
It was at this point that Dumb and Dumber decided to lower the rating of the Stool Packages from AAA to BBB. Now no one wanted to buy any stools from SSS. SSS was still holding forty times its equity in lower rated stool packages in its inventory. These Packages were now “marked to market” by SSS’s auditor, an arbitrary process used to kick you when you are down. When they are marked down just 4%, the entire equity of SSS is wiped out. It is about this time that the banks that lent money to SSS began calling in their loans. They wanted their money back. At the same time, giant hedge funds began shorting the SSS stock, hammering its value even further. Eventually SSS had to either declare bankruptcy, be forced into a shotgun marriage with a stronger company, be taken over by the government or, as an interim step, be converted to a bank to be taken over later.
Imagine now that there are two legged stools hidden in dark pubs around the globe. They are owned by various institutions who no longer want them and the stools cannot be valued. As you can see, the world would be in quite a pickle if we relied on stools as a major source of financial security.
I used the stool in this analogy for two reasons. First, for many years, banking decisions were made by analyzing the 4 “C’s” of lending. Think of these 4 “C’s” as the 4 legs of a stool. They are Character, Cash Flow, Credit and Collateral. In residential lending, character was eliminated some time ago when loans were securitized and borrowers and their ultimate lenders never met. That left a three legged stool that functioned pretty well through the 1990s. However, in the first few years of the new millennium
, new products were coming out that eliminated one of the remaining legs of the stool. No income verification loans, no down payment loans, and loans to people who exhibited poor credit decisions were created. Soon the three legged stools became two or even one legged stools. They were then packaged and sold and somehow obtained AAA ratings.
Loose lending guidelines combined with leverage and poor regulation has been the recipe for an unprecedented financial meltdown in this country. The mortgage back securities created by these firms have filled our financial institutions with financial crap; the second reason for my “stool” analogy.
Imagine a world where stools are a critical component to the economy. Stupendous Stool Store, Inc (SSS) is one of the five largest stool companies in the world. For years, SSS sold four legged stools with various degrees of quality to retail stores
worldwide. SSS sells its stools in bundles of 10, improving efficiency and lowering costs. They bundle together both high and low quality stools to give the retailer a nice mix to sell to consumers. For many years, this was a very profitable business.
One day, the SEC (Stool Exchange Commission) relaxed the capital requirement laws for companies like SSS. Before, they could only borrow 10 times their equity for the inventory needed to make the stools. Now they could borrow 40 times their equity to purchase and make stools for repackaging. SSS set up more lines of credit to purchase more raw materials to make more stools. In order to carry this new debt load, SSS needed to make lower cost stools. One highly paid executive at SSS decided that they could lower prices of the stools, by including a few three legged stools in their bundles. They modeled the use of the new stool by sending “Stool Samples” to various bars and pubs around the world. They quickly determined that the three legged stool is just as good as a four legged stool, but costs less to make and takes up less room. Buyers of the stools did not seem to mind at all.
SSS then sent the Stool Samples to their independent external rating agency, Dumb and Dumber, Inc. After speaking with the executives at SSS and reviewing their “Stool Samples”, those at Dumb and Dumber, Inc. concluded that the new stool bundles should receive the same AAA rating as before. Now SSS could sell both three and four legged stools in bundles for the same price as they sold a bundle of higher quality four legged stools. The executives and sales people at SSS pocketed the additional profits and were happy.
Then one of the highly paid commission sales persons at SSS came up with an even better idea. How about adding some 2 legged stools to the package? These stools would only be effective for sober customers with good balance. Since they are only going to put a few of these stools in each bundle, along with three and four legged stools, they were able to lower their costs yet again. They went to Dumb and Dumber, Inc. with their “Stool Samples” and explained that since 20% of the customers who buy stools were sober, the two legged stools really had no effect on the quality of the stool package. Those at Dumb and Dumber, Inc. agreed and rated the stools packages AAA yet again. SSS could sell its stool package at the same price as before, but with much lower costs and pocket a handsome profit.
In order to keep production going, SSS always maxed out its leverage so that it had plenty of Stool Bundles available for the market. Eventually however, the stools reached a saturation point in the market and sales began to decline. At the same time, people were getting hurt falling off the three and two legged stools. Some companies began to return their stool bundles and others simply stopped buying.
It was at this point that Dumb and Dumber decided to lower the rating of the Stool Packages from AAA to BBB. Now no one wanted to buy any stools from SSS. SSS was still holding forty times its equity in lower rated stool packages in its inventory. These Packages were now “marked to market” by SSS’s auditor, an arbitrary process used to kick you when you are down. When they are marked down just 4%, the entire equity of SSS is wiped out. It is about this time that the banks that lent money to SSS began calling in their loans. They wanted their money back. At the same time, giant hedge funds began shorting the SSS stock, hammering its value even further. Eventually SSS had to either declare bankruptcy, be forced into a shotgun marriage with a stronger company, be taken over by the government or, as an interim step, be converted to a bank to be taken over later.
Imagine now that there are two legged stools hidden in dark pubs around the globe. They are owned by various institutions who no longer want them and the stools cannot be valued. As you can see, the world would be in quite a pickle if we relied on stools as a major source of financial security.
I used the stool in this analogy for two reasons. First, for many years, banking decisions were made by analyzing the 4 “C’s” of lending. Think of these 4 “C’s” as the 4 legs of a stool. They are Character, Cash Flow, Credit and Collateral. In residential lending, character was eliminated some time ago when loans were securitized and borrowers and their ultimate lenders never met. That left a three legged stool that functioned pretty well through the 1990s. However, in the first few years of the new millennium
, new products were coming out that eliminated one of the remaining legs of the stool. No income verification loans, no down payment loans, and loans to people who exhibited poor credit decisions were created. Soon the three legged stools became two or even one legged stools. They were then packaged and sold and somehow obtained AAA ratings.Loose lending guidelines combined with leverage and poor regulation has been the recipe for an unprecedented financial meltdown in this country. The mortgage back securities created by these firms have filled our financial institutions with financial crap; the second reason for my “stool” analogy.
Wednesday, October 8, 2008
Who Does Your Financial Adviser Represent?
In a world of uncertainty, where one hundred and fifty year old financial institutions declare bankruptcy or are seized by the government over night, it becomes crucial for investors to understand who the advisers handling their money represent. Does their financial adviser put their clients’ interests above those of their own and their company, or are they simply selling them the recommended investment product du jour.
In 2008, customers of UBS, Merrill Lynch, Wachovia, Bank of America, and other larger financial institutions were shocked to find that their savings were locked up or wiped out when their “safe” option rate securities were no longer liquid. They were “sold” these products by their trusted advisers as an alternative to money markets. Meanwhile, their companies were being paid to create these securities. These companies were sued by their customers and several state attorneys' general and forced to pay for any losses incurred.
Others are now being told by their investment advisers that variable annuities are an excellent alternative for investing. These annuities offer a minimum “guaranty” of principal invested so that when the market goes down, “your money is still safe”. Thus, if you invest $100,000 and wait ten years past the penalty period, you will be “guaranteed” at least your money back. Why were these products not offered before the market collapsed? What are the costs associated with them? How good is the “guaranty” when companies as large as AIG can fail?
The people dispensing financial advice are split primarily into to two camps; those that have a legal fiduciary relationship to their employer, and those that have a fiduciary relationship to their client.
Fiduciary Relationship Lies With Employer or Broker Dealer 
Financial Advisors that have a fiduciary relationship to their employer are called “Registered Representatives”. They are registered with their broker dealer, usually their employer, which they represent. They carry cards with such titles as “Financial Advisor”, “Investment Advisor”, “Financial Consultant”, “Financial Planner”, “Registered Representative”, “Insurance Agent”, and many others. In most cases, they work for large brokerage firms like Lehman Brothers, Bear Sterns, Merrill Lynch, Morgan Stanley, just to name a few. Some work for insurance companies such as AIG or banks such as Washington Mutual or Wachovia. These advisers generally carry Series 7 and insurance licenses so that they can legally receive commissions or referral fees on products they sell.
These individuals are tasked with selling products their organizations have created or recommend to their customers. Their regulator is the National Association of Securities Dealers, or the NASD. According to Scott Simon, author of the Prudent Investor Act: A Guide to Understanding, “registered reps follow the “suitability” standard under NASD regulations. This standard doesn’t require a registered rep to place the interests of its clients ahead of its own. Under this non-fiduciary suitability standard, a registered rep need provide only “suitable” advice to its clients-even if it knows that the advice is not the best advice.”
As Liz Pullium West, author of Easy Money: How to Simplify Your Finances and Get What You Want Out of Life, puts it, “At best, they're held to a "suitability" standard, which means they're supposed to reasonably believe that the investment and insurance products they want you to buy are appropr
iate for your situation. Just "appropriate" -- not "the best choice" or "in your best interests." Let's say you have $10,000 a year to save for retirement. Your financial adviser could recommend you invest the money in a low-cost index fund that might net you a return of 8% a year. After 30 years you'd have over $1.1 million. But let's say the adviser could earn a fat commission for recommending a higher-cost investment being promoted by his financial-services firm. So instead of netting 8% a year, you might net 6%. After 30 years, your nest egg would grow to just under $800,000, a difference of more than $300,000. The high-cost investment might be perfectly "suitable," since it meets your financial objective of saving for retirement, even if it could leave you significantly poorer than had you invested in the index fund.”
Merrill Lynch has gone to court to defend this concept of having a fiduciary duty to the company instead of the client. In an attempt to have its cake and eat it too, Merrill Lynch was able to get a court ruling, now called the “Merrill Lynch Rule”, to allow them to operate like a true advisor to the client while still representing the firm. This rule was overturned in 2007.
Fiduciary Relationship Lies with the Client
The second camp of investment advisors are Registered Investment Advisors (RIAs). Under the law, these advisers have a fiduciary duty to their client. They must register with the Securities Exchange Commission (SEC) once they have over $25 million under management. According to Mr. Simon, “Given its fiduciary status, an RIA must follow the “trust” standard- the highest known in the law-which requires it to place the interest of its clients ahead of its own and fulfill critical fiduciary duties…” Most hold the Certified Financial Planner designation which has its own separate “code of ethics”. Unless they are also a “registered representative”, they do not receive commissions or referral fess for investments they recommend. As a fiduciary, they have clients rather than customers. The have no incentive to select products based on commission paid nor are they required to provide specific investment products by their employer. They are free to select the best investments for their clients based on what is best for the client.
So why do so many wealthy individuals take the advice of those that represent their company rather than their client? The answer is the implied additional security combined with the sales power of a large firm. Here is a quick comparison of the financials of Charles Schwab and Merrill Lynch as of June 30, 2008:
(click to enlarge)
According to Wikipedia, “leverage (or gearing) is using given resources in such a way that the potential positive or negative outcome is magnified and/or enhanced. It generally refers to using borrowed funds, or debt, so as to attempt to increase the returns to equity.” ML is levered up 60 times! This is a primary cause of its forced sale to Bank of America.
With an increasingly complex financial world it becomes more important than ever to seek sound advice. Just make sure that advice comes from a professional who puts your interests first.
With an increasingly complex financial world it becomes more important than ever to seek sound advice. Just make sure that advice comes from a professional who puts your interests first.
Sunday, October 5, 2008
Book Review: Hot, Flat and Crowded
by Thomas L. FriedmanThis is Friedman’s sequel to his widely popular book, The World is Flat. Friedman explains that the old problems of the cold war have been replaced by a host of new problems in what he terms the “Energy Climate Era”. Friedman argues, “We can no longer expect to enjoy peace and security, economic growth and human rights if we continue to ignore the key problems of this new era. These new problems include:
• Energy Supply and Demand
• Petro Dictatorship
• Climate Change
• Energy Poverty
• Biodiversity Loss
Friedman describes these problems in detail and precisely how we can solve them. If you want to learn how we can make the planet a better place for our children, this is a must read.
Saturday, October 4, 2008
Market Update
Today’s investment environment is reminiscent of a recent article on fox hunting by Dominic Bliss of The Financial Times, entitled “Manhunt”. Since fox hunting has been banned in England and Wales since 2004, Bliss went to Blackpool England to see how things have changed. She described the modern day fox hunt as follows:“At Peagram's Farm [Blackpool, England], 35 excited riders - the huntsmen in smart red jackets, the rest in black or tweed - are waiting for the hunt to start. They sip port and sherry to brace themselves against the wind coming in off the Irish Sea, while their finely groomed horses jig their heads and stamp their hooves.
Below them, whining and barking in anticipation, is a pack of about two dozen bloodhounds. Mingling with the dogs, and looking decidedly apprehensive, are two "foxes" - Richard Davies, a 49-year-old civil servant from Kirkham, and Matthew Ray, a 32-year-old (off-duty) journalist from Brighton. Both are accomplished athletes.
As they pet the hounds, allowing the animals to memorize their scent, the master huntsman Clive Richardson offers a few words of encouragement. "Don't worry," he says. "When a limb's torn from you, it really doesn't bleed that much."
I believe many investors feel a little like the human quarry in this fox hunt as they try to navigate the financial wreckage that was third quarter of 2008. This historic quarter will be found in the next generation’s financial and history text books. It is a period when companies recently valued at a combined $500 billion vaporized. It is a time when the oldest money market fund “broke the buck” and fell below $1.00. A period when people were willing to buy US Treasury Bills for more than they would be re-paid after holding them for 1 month. It also marks the creation of the world's largest sovereign wealth fund, the US Treasury.
For the quarter, the S&P 500, the index which holds the 500 largest companies in America, was down 9% and down 20% for the year to date. More alarming is that the S&P 500 is up only 2.8% for 10 years. Investing internationally did not help with this bear market. The EAFE index was down 21% for the quarter and 31% for the year to date! Emerging markets where especially hammered, with the EM index down 27% and 37% year to date. The bond market, which usually moves in the opposite direction as equities also fell 0.6% for the quarter and was up only 0.5% for the year to date.
Is there a silver lining in all this bad news? Yes. Recessionary environments and market corrections are the best time to make smart investments. Today, everything is on sale. The question of the day is, "Will there be a “clearance” tomorrow?” The key to navigating this mess is to focus on the long run. If your investment horizon is seven years or longer and you can handle the risks of the market fluctuations, this may prove to be the best time to invest in a generation.
Wednesday, October 1, 2008
Sector Performance Report
As of September 30, 2008
Nowhere to Hide: All sectors were down in the past 12 months with telecom getting hit the hardest. In the past three months, Consumer Staples, Financials and Health Care were the only sectors that did not fall. Expect that trend to continue over the coming year.
(click to enlarge)
Nowhere to Hide: All sectors were down in the past 12 months with telecom getting hit the hardest. In the past three months, Consumer Staples, Financials and Health Care were the only sectors that did not fall. Expect that trend to continue over the coming year.
(click to enlarge)
Monday, September 8, 2008
The US Government Take Over of Fannie Mae and Freddie Mac: Winners and Losers
Over the weekend, our government seized two of the largest financial institutions in the world, Fannie Mae and Freddie Mac. They fired the boards of directors and the CEOs and they diluted the shareholders by 80%. Who are the winners and losers of this historical takeover?
First the losers:
↓Common stock holders of Fannie (down 89% from Friday to $1.18) or Freddie (down 85% from Friday to $1.08). As Warren Buffet said this morning on CNBC, The common shareholders are going to get nothing until the Treasury gets paid back, and even then, as I understand it, the Treasury is getting a warrant at a nominal sum for 79.9 percent of the resulting common, so assuming there is anything left for the common four or five years down the road, the Treasury will get 80 percent of it, so they're getting paid very well for stepping in. And like I say, the question of whether the common gets anything is problematical. The common is an option at this point.”
↓Preferred stock holders of Fannie or Freddie
↓Holders of long term U.S. treasuries: Given the additional risk the US is putting on its books its only natural that its bonds would be down graded.
↓Shareholders or executive level employees of one of the 17 banks that had a concentration in common or preferred shares of Fannie Mae or Freddie Mac that surpassed 10% of their Tier 1 Capital. For example, Sovereign bank’s (down 10% on the news) securities losses could wipe out an entire year of earnings.
↓Owners of Dodge and Cox Funds which as of June owned nearly 119 million shares of FNMA.
↓Owners of Bill Miller’s flagship Legg Mason Value Trust which placed huge bets on Freddie Mac and Fannie Mae. The fund is already down 31% year to date.
Now the winners:
↑Home owners and potential home owners in need of a mortgage: Mortgage rates should improve. According to a Tom Millon, a mortgage backed securities guru, owner of Capital Markets Cooperative and good friend, “Mortgage yields have every reason to come down. The spread between mortgage and Treasury yields has been a thorn in the mortgage industry’s side. The spread has spent the past few weeks again at historic highs – exceeding a whopping 2.75%. All of a sudden there are two key reasons to believe that mortgage rates will drop relative to Treasury yields. First, mortgage yields have contained at least 0.50% of credit premium due to fears that the agencies might fail. That fear has been eliminated. Standard & Poor’s said Sunday that the government’s AAA/A-1+ sovereign credit rating would not be affected by the takeover. Second, in an unprecedented move, the government is enacting a program to buy mortgage-backed securities. Aptly named the GSE Mortgage Backed Securities Purchase Program, the program will allow purchases (nobody has said how much the government will buy) starting later this month.”
↑Home owners: The falling real estate market should begin to stabilize. According to the most recent Case-Shiller Home Price Index, the value of homes in the largest 20 US metropolitan areas have fallen an average of 18.8% in the last 24 months. With an improvement in mortgage rates and some stability in the credit markets, real estate stabilization should follow.
↑Mortgage backed securities holders will receive a wind fall. Now that the government guaranty is no longer implied but actually guarantied, the securities should increase significantly in value.
↑Banks that hold Fannie/Freddie issued mortgage backed bonds will have an increase in value.
↑US Equities should rally, at least in the short term. This is because one of the biggest market uncertainties has now become certain. The market hates unknowns and generally sells off in the face of uncertainty. Now that the government has stepped in, the market can value these securities properly. Most of the financial sector will be winners propelling the market upward.
↑Tax payers. Yes, tax payers. The government did not bail out the shareholders of Fannie and Freddie. They wiped them out. It may take 5 years for the companies to get healthy again and I believe this government will be able to sell them back to the market at a healthy profit. This is far better than the hit the government would have taken should Fannie and Freddie been allowed to fail.
↑Daniel Mudd and Richard Syron, ex-CEOs of Fannie and Freddie will be walking away with exit packages of around $14 million each.
I am sure I missed a few winners and losers so please send your feedback in or leave a comment below!
First the losers:
↓Common stock holders of Fannie (down 89% from Friday to $1.18) or Freddie (down 85% from Friday to $1.08). As Warren Buffet said this morning on CNBC, The common shareholders are going to get nothing until the Treasury gets paid back, and even then, as I understand it, the Treasury is getting a warrant at a nominal sum for 79.9 percent of the resulting common, so assuming there is anything left for the common four or five years down the road, the Treasury will get 80 percent of it, so they're getting paid very well for stepping in. And like I say, the question of whether the common gets anything is problematical. The common is an option at this point.”
↓Preferred stock holders of Fannie or Freddie
↓Holders of long term U.S. treasuries: Given the additional risk the US is putting on its books its only natural that its bonds would be down graded.
↓Shareholders or executive level employees of one of the 17 banks that had a concentration in common or preferred shares of Fannie Mae or Freddie Mac that surpassed 10% of their Tier 1 Capital. For example, Sovereign bank’s (down 10% on the news) securities losses could wipe out an entire year of earnings.
↓Owners of Dodge and Cox Funds which as of June owned nearly 119 million shares of FNMA.
↓Owners of Bill Miller’s flagship Legg Mason Value Trust which placed huge bets on Freddie Mac and Fannie Mae. The fund is already down 31% year to date.
Now the winners:
↑Home owners and potential home owners in need of a mortgage: Mortgage rates should improve. According to a Tom Millon, a mortgage backed securities guru, owner of Capital Markets Cooperative and good friend, “Mortgage yields have every reason to come down. The spread between mortgage and Treasury yields has been a thorn in the mortgage industry’s side. The spread has spent the past few weeks again at historic highs – exceeding a whopping 2.75%. All of a sudden there are two key reasons to believe that mortgage rates will drop relative to Treasury yields. First, mortgage yields have contained at least 0.50% of credit premium due to fears that the agencies might fail. That fear has been eliminated. Standard & Poor’s said Sunday that the government’s AAA/A-1+ sovereign credit rating would not be affected by the takeover. Second, in an unprecedented move, the government is enacting a program to buy mortgage-backed securities. Aptly named the GSE Mortgage Backed Securities Purchase Program, the program will allow purchases (nobody has said how much the government will buy) starting later this month.”
↑Home owners: The falling real estate market should begin to stabilize. According to the most recent Case-Shiller Home Price Index, the value of homes in the largest 20 US metropolitan areas have fallen an average of 18.8% in the last 24 months. With an improvement in mortgage rates and some stability in the credit markets, real estate stabilization should follow.
↑Mortgage backed securities holders will receive a wind fall. Now that the government guaranty is no longer implied but actually guarantied, the securities should increase significantly in value.
↑Banks that hold Fannie/Freddie issued mortgage backed bonds will have an increase in value.
↑US Equities should rally, at least in the short term. This is because one of the biggest market uncertainties has now become certain. The market hates unknowns and generally sells off in the face of uncertainty. Now that the government has stepped in, the market can value these securities properly. Most of the financial sector will be winners propelling the market upward.
↑Tax payers. Yes, tax payers. The government did not bail out the shareholders of Fannie and Freddie. They wiped them out. It may take 5 years for the companies to get healthy again and I believe this government will be able to sell them back to the market at a healthy profit. This is far better than the hit the government would have taken should Fannie and Freddie been allowed to fail.
↑Daniel Mudd and Richard Syron, ex-CEOs of Fannie and Freddie will be walking away with exit packages of around $14 million each.
I am sure I missed a few winners and losers so please send your feedback in or leave a comment below!
Thursday, July 24, 2008
KLD Green Returns
I just received this press release from KLD and wanted to share it. KLD's Global Climate Index has three year anniversary and posts an average annual return of 15.24%! This compares quite favorably to the S&P 500 return over the same period of just 4.4%. Another good reason to invest in companies committed to a sustainable planet. They make money!
The KLD Global Climate 100 Index
Marks Three Year Anniversary:
The First Climate Change-focused Index
Returns 53% since Launch
Boston, MA, July 17, 2008 – KLD Research & Analytics, Inc. has marked the third anniversary of its Global Climate 100SM Index (GC100) – the first global index focused on solutions to climate change. The GC100 has returned 53% (15.24% annualized) from its launch on July 1, 2005 through June 30, 2008. The index holds a diversified group of companies that are leaders in renewable energy, clean technology & efficiency, and future fuels.
“Over the past three years, we’ve witnessed formation of a scientific, public policy and business consensus on the need to combat global climate change. If our economy must depend less on fossil fuels, then our portfolios must do the same,” said Thomas Kuh, Managing Director of KLD Indexes. “Renewable energy is part of the answer, but energy conservation and pollution prevention are also essential. The GC100 looks for opportunities on all these fronts.”
The GC100 includes companies who make promising energy-saving products, such as “smart” electric meters and superconductors, as well as alternative energy stocks.
(click to enlarge)
KLD Global Climate 100: Holdings and Top Performers
The GC100 holds leading companies in the climate solutions value chain, including small, pure-play firms like Novozymes and GS Yuasa as well as large diversified companies, like Siemens and General Electric. The Index is equal weighted to ensure that investors benefit from these innovative companies regardless of their size.
“As the following chart shows, the holdings in the GC100 are positioned to profit from the trend toward de-carbonization of the economy in response to climate change,” said GC100 Index Manager Jed Sturman. “As the price of oil has soared, GC100 constituent stocks like Vestas Wind Systems of Denmark and SolarWorld of Germany have shown strong returns; smaller firms such as Conergy, Solon, and American Superconductor have also performed well.”
(click to enlarge)
KLD created the GC100 in partnership with the Global Energy Network Institute, a research organization that seeks to build connections among the world’s energy systems, with an emphasis on renewable energy resources. “In the energy sector, we get what we invest in. If we want a cleaner, more sustainable world in the future, we need to invest in climate solutions today,” said Peter Meisen of GENI.
KLD Global Climate 100: Methodology and Index Performance
The GC100 includes a mix of 100 global companies that will provide near-term solutions to global warming while offsetting the longer-term impacts of climate change. GC100 constituent companies include producers and distributors of:
Renewable Energy, such as solar and wind;
Future Fuels, such as biofuels and hydrogen; and
Clean Technology & Efficiency, such as technologies and services that help to reduce energy consumption and emissions of greenhouse gases.
The GC100’s constituent companies include large-, mid-, and small-capitalization companies representing sectors ranging from energy and utilities to industrials and consumer products. This broad focus distinguishes the GC100 from other carbon-sensitive investment strategies that include only energy and utility stocks. The GC100 is an equal weighted index, which means that KLD allocates a 1% weight to each of its 100 constituents. This increases the GC100’s exposure to small-capitalization companies and ensures that investors benefit from innovative companies who are poised for growth.
The GC100 has returned 57 percent (17.23% annualized) since index launch, as of 5/31/08. The same constituents under a market cap weight would have returned 39 percent (12.54% annualized). As explained by Peter Meisen of GC100 partner GENI: “It just makes good business sense to reduce one's dependence on fossil fuels – for investors as well as companies.”
KLD Global Climate 100: Licensees and Investment Products
The GC100 serves as the basis for an assortment of investment products including:
Institutional and Separate Accounts
Northern Trust • USA
Shinko ITM • Japan
Mutual Funds
Shinko ITM • Japan
Chikyu Ondanka Boushi Kanrenkabu Fund I (06312066:JP)
Chikyu Ondanka Boushi Kanrenkabu Fund II (06311077: JP)
Chikyu Ondanka Boushi Kanrenkabu Fund PLUS
Cominvest Asset Management • Germany
Cominvest Klima Aktien PLUS (WKN: A0MSTB)
Unit Investment Trust
Advisors Asset Management • USA
KLD Global Climate 100 Index Portfolio, Series III (ADTKFX)
_________________________
About KLD Indexes
KLD Indexes is a unit of KLD Research & Analytics, Inc., a leading provider of environmental, social and governance (ESG) research for institutional investors. KLD Indexes develops and licenses benchmark, strategy and custom indexes that investment managers use to integrate ESG criteria into their investment decisions. KLD Indexes are designed to be transparent, representative and investable.
Products based on KLD Indexes include:
Mutual Funds
ETFs
Separately Managed Accounts
Unit Investment Trusts
Variable Annuities
Structured Products
More than $10.5 billion is invested in vehicles based on KLD Indexes. For more information about KLD’s indexes visit http://www.kldindexes.com/
For information about licensing a KLD index for the creation of an investment product, please email indexes@kld.com
Contact:
Amy Blumenthal/Karen Myers
Blumenthal & Associates
617-879-1511
Peter Ellsworth
KLD Research & Analytics, Inc.
617-426-5270 x218
Marks Three Year Anniversary:
The First Climate Change-focused Index
Returns 53% since Launch
Boston, MA, July 17, 2008 – KLD Research & Analytics, Inc. has marked the third anniversary of its Global Climate 100SM Index (GC100) – the first global index focused on solutions to climate change. The GC100 has returned 53% (15.24% annualized) from its launch on July 1, 2005 through June 30, 2008. The index holds a diversified group of companies that are leaders in renewable energy, clean technology & efficiency, and future fuels.
“Over the past three years, we’ve witnessed formation of a scientific, public policy and business consensus on the need to combat global climate change. If our economy must depend less on fossil fuels, then our portfolios must do the same,” said Thomas Kuh, Managing Director of KLD Indexes. “Renewable energy is part of the answer, but energy conservation and pollution prevention are also essential. The GC100 looks for opportunities on all these fronts.”
The GC100 includes companies who make promising energy-saving products, such as “smart” electric meters and superconductors, as well as alternative energy stocks.
(click to enlarge)
KLD Global Climate 100: Holdings and Top Performers
The GC100 holds leading companies in the climate solutions value chain, including small, pure-play firms like Novozymes and GS Yuasa as well as large diversified companies, like Siemens and General Electric. The Index is equal weighted to ensure that investors benefit from these innovative companies regardless of their size.
“As the following chart shows, the holdings in the GC100 are positioned to profit from the trend toward de-carbonization of the economy in response to climate change,” said GC100 Index Manager Jed Sturman. “As the price of oil has soared, GC100 constituent stocks like Vestas Wind Systems of Denmark and SolarWorld of Germany have shown strong returns; smaller firms such as Conergy, Solon, and American Superconductor have also performed well.”
(click to enlarge)
KLD created the GC100 in partnership with the Global Energy Network Institute, a research organization that seeks to build connections among the world’s energy systems, with an emphasis on renewable energy resources. “In the energy sector, we get what we invest in. If we want a cleaner, more sustainable world in the future, we need to invest in climate solutions today,” said Peter Meisen of GENI.
KLD Global Climate 100: Methodology and Index Performance
The GC100 includes a mix of 100 global companies that will provide near-term solutions to global warming while offsetting the longer-term impacts of climate change. GC100 constituent companies include producers and distributors of:
Renewable Energy, such as solar and wind;
Future Fuels, such as biofuels and hydrogen; and
Clean Technology & Efficiency, such as technologies and services that help to reduce energy consumption and emissions of greenhouse gases.
The GC100’s constituent companies include large-, mid-, and small-capitalization companies representing sectors ranging from energy and utilities to industrials and consumer products. This broad focus distinguishes the GC100 from other carbon-sensitive investment strategies that include only energy and utility stocks. The GC100 is an equal weighted index, which means that KLD allocates a 1% weight to each of its 100 constituents. This increases the GC100’s exposure to small-capitalization companies and ensures that investors benefit from innovative companies who are poised for growth.
The GC100 has returned 57 percent (17.23% annualized) since index launch, as of 5/31/08. The same constituents under a market cap weight would have returned 39 percent (12.54% annualized). As explained by Peter Meisen of GC100 partner GENI: “It just makes good business sense to reduce one's dependence on fossil fuels – for investors as well as companies.”
KLD Global Climate 100: Licensees and Investment Products
The GC100 serves as the basis for an assortment of investment products including:
Institutional and Separate Accounts
Northern Trust • USA
Shinko ITM • Japan
Mutual Funds
Shinko ITM • Japan
Chikyu Ondanka Boushi Kanrenkabu Fund I (06312066:JP)
Chikyu Ondanka Boushi Kanrenkabu Fund II (06311077: JP)
Chikyu Ondanka Boushi Kanrenkabu Fund PLUS
Cominvest Asset Management • Germany
Cominvest Klima Aktien PLUS (WKN: A0MSTB)
Unit Investment Trust
Advisors Asset Management • USA
KLD Global Climate 100 Index Portfolio, Series III (ADTKFX)
_________________________
About KLD Indexes
KLD Indexes is a unit of KLD Research & Analytics, Inc., a leading provider of environmental, social and governance (ESG) research for institutional investors. KLD Indexes develops and licenses benchmark, strategy and custom indexes that investment managers use to integrate ESG criteria into their investment decisions. KLD Indexes are designed to be transparent, representative and investable.
Products based on KLD Indexes include:
Mutual Funds
ETFs
Separately Managed Accounts
Unit Investment Trusts
Variable Annuities
Structured Products
More than $10.5 billion is invested in vehicles based on KLD Indexes. For more information about KLD’s indexes visit http://www.kldindexes.com/
For information about licensing a KLD index for the creation of an investment product, please email indexes@kld.com
Contact:
Amy Blumenthal/Karen Myers
Blumenthal & Associates
617-879-1511
Peter Ellsworth
KLD Research & Analytics, Inc.
617-426-5270 x218
Wednesday, July 16, 2008
How to Fight a Bear
In my last newsletter I suggested a recession may have begun in the first quarter of this year. I was wrong. The economy squeezed out a 0.6% annualized growth rate in Q1 ‘08. However, according to Warren Buffet anytime that GDP is less than U.S. population growth, we are in recession. The U.S. population growth rate in 2008 is estimated at 0.88% leaving us with a real economic growth of -0.28%. I think I will go with Mr. Buffet’s definition! Either way, it sure feels like a recession. The stock and real estate markets are both down nearly 20% from their peaks. Even bonds, which are normally a good bet going into a recession are getting hit due to inflationary fears. Recessionary times are generally accompanied by “bear” markets, a term investors refer to when the market declines by 20% or more. The last recession, which started in March of 2001 and lasted about eight months, was primarily due to a bubble in technology related stocks. That recession was accompanied by a bear market, which began in January 2000 and lasted until October 2002. Stocks lost 49% during this time period. However, the real estate market was very strong and helped to offset losses investors had in the equities markets. In addition, bonds rallied as interest rates fell and inflation remained low. This time its different. Both stock and real estate markets are in bear territory, while the credit crunch and inflation issues are causing havoc in the bond market. We may be closer to a 1970s style bear market than the 2001 bear.
The average bear market lasts about 14 months with a drop of 32%. However, averages do not tell us what to expect. One of the largest market drops was during the 70’s oil crisis when the market fell 48%.
In nearly every case, the stock market bottoms well before economic activity bottoms. This is because the stock market provides a signal for future earnings, generally at least six months out.
Fighting the Bear
Should we abandon the picnic basket and give it to the bears? Definitely not. First things first, don’t panic. I searched the web for stories written in late 2002 and early 2003 near the end of the last recession. After three straight years of declines, the US markets were off by nearly 50%. Market commentators were fueling the panic with pessimistic articles about expectations in 2003. Many were predicting 30% market sell offs, while others suggested moving entire portfolios to cash. These are the same folks that coined the term “The New Economy” and helped to fuel the tech bubble. As it turns out, 2003 was one of the best markets on record - up 28.7% including dividends and led by “old economy” stocks. The good news about today’s market is stocks are cheaper in relative terms than at the end of 2002!
(click to enlarge image)
1. Invest for the Long Term
Investing in the stock market is for long-term investors only. Investment horizons should be at least seven years or longer. I cannot predict what the market will do in the next 12 months, but a well balanced equity portfolio should be up at least 9% over the next 7 to 10 years. Why? Because bear market sell offs present terrific buying opportunities for patient investors. When was the last best time to buy equities? In October of 2007 when the market reached the end of it bull market cycle, or in December of 2002 when investing in stocks felt like jumping into a bottomless pit? If you invested in the S&P500 in January of 2003, you would be up an average of 12.8% a year over the next four years. Despite the occasional sell off, the market (S&P 500) on average has increased by 11.9% per year over the last 60 years.
2. Do Not Try to Time the Market
Trying to time market swings is a classic investor mistake during bear markets. It is nearly impossible to predict when the market will rebound. Rebounds are usually swift and erratic. As I said earlier, the average bear market drop is over 30%. However one month after the market bottoms out, the average recovery is 10.6%. After three months, the average recovery is 14.7%; six months after bottom, the average recovery is 23.1%. Finally, investors who held on were rewarded with an average 34.8 percent recovery 12 months following a bear market bottom.
3. Doing Nothing Will Not Work Either
Investment portfolios need to be reviewed periodically. During bear markets, additional scrutiny must be made. Now is the best time to shed poor investments. Not every position will come back to its previous value and some will go to zero. We still have not reached the 2000 NASDAQ peak and may not for several years, and this is because many of the highest fliers never recovered.
(click to enlarge image)
4. Converting to Cash May Be a Mistake
Unless you had the prescience to convert to cash in October of 2007, converting to cash now after a 20% correction may not be the best idea. How will you know when to get back into the market? Inflation rates are currently almost double what you can get in a money market, so in addition to missing a rebound, you will lose real asset value due to inflation.
5. Search for Value
It is markets like these where fortunes are made. Many investments are selling at cheap values due to overall market devaluations rather than specific investment risk. For example, nearly all banks are off 50% from their market peaks. However, not all banks are in bad shape. The current environment will make some folks very rich and others lose fortunes.
6. Rebalance
Steep market drops are the best time to rebalance your portfolio. For example, if you held TIPS or other government bonds in your portfolio, now is a great time to sell off some of your profits and re-invest in other sectors that have been hit hard. This allows you to increase your profits when the market improves.
Certainly, the best time to buy is when something is on sale. At this point, equities are now 20% off. The question is, will there be a bigger sale later? Are they about to go on clearance? The approach here is to buy some on sale, but to maintain some powder for a clearance.
Subscribe to:
Posts (Atom)
