Thursday, August 19, 2010

Q&A Series - Extra Edition - A Special Series Devoted to Answering Your Burning Financial Questions

Bill, a client and reader of the Rollins Financial Blog, provided the following quote from leading financial media company,

"In case you hadn't heard, Thursday's action on the New York Stock Exchange registered a technical anomaly known as the Hindenburg Omen. Read: just like the doomed German airship, the markets are fated to crash and burn. Still worse, Wednesday's trading action almost sparked Hindenburg Omen conditions. It takes two Hindenburg Omen trading days within a 36 day window to trigger the end of life in the markets as we know it."

Q. What is your take on the significance of the Hindenburg Omen?

There's been a lot of press about the Hindenburg Omen lately. Several other clients asked me this question over the weekend, so I thought I would go on and respond to it now instead of waiting until next Tuesday's Q&A post.

The Hindenburg Omen is a technical indicator that foreshadows not just a bear market, but a stock market crash. Its creator, mathematician Jim Miekka, said his indicator is now predicting a market meltdown in September.

I have never been much of a believer in technical stock market analysis because there are too many variables to give it a whole lot of credence. Most of the well-known theories were created by back-testing the stock market. This means that scenarios were put together and then tested back through time. Analysts would then draw a conclusion based on the formation of the trading patterns. The Hindenburg Omen is such a stock market indicator.

The reason I have never given much credibility to technical analysis is because it only takes into account matters that are happening in the stock during a given time. They rarely take into account external economic events that could have a dramatic effect on trading and be vastly different at any two given points in time.

For example, it doesn't make sense to compare a trading pattern between 1982 when CD's paid 15% interest and 2010 when CD's pay less than 1% interest almost across the board. However, almost every day I see a comparison between the U.S. recession of 1981 and 1982 and the recession in the United States in 2008 and 2009. Given that external economic events were so completely opposite during those time periods, there is no comparing those time periods from a stock market point of view.

For instance, if you could earn a CD rate of 15% annualized or you could buy U.S. Treasury bonds paying 12% interest, there seems to be little incentive to buy anything in the stock market during that timeframe. That was the case in 1981 and 1982. Given that you can earn almost nothing by investing in CD's today, 2008 and 2009 do not seem very comparable to those years.

There are stock market theories for virtually everything. One of the more famous is the Super Bowl stock market indicator. This theory implies that if an original NFL team wins the Super Bowl, then the stock market will be up that year. While this pattern was true for several years, it has not been true in recent years -- but it did have a chance for being 50% correct.

You may have also heard about the January Effect, which basically indicates that if the stock market is up during the month of January, then the entire year will also be up. Once again, this is interesting reading, but it's not particularly accurate.

My favorite stock market technical analysis pattern is the length of women's skirts in Paris fashions. The theory is that the shorter the skirts, the higher the market. I don't need to explain the analogy.

As for the Hindenburg Omen, once again, there is not a clear piece of documentation that it's particularly accurate. It's true that in every major stock market crash, the Hindenburg Omen gave a signal. However, it's also true that there have been many Hindenburg Omen indicators that have not resulted in a stock market crash. The success rate for predicting a market crash with this indicator is only about 25%.

When asked about a Hindenburg Omen causing a market meltdown in September, Andrew Brenner, the managing director at Guggenheim Securities, commented amusingly to his clients, "Personally, it sounds like [people] are starting their weekend drinking early."

While the Hindenburg Omen is fairly technical, it's not that hard to understand. When there are an extreme number of stocks trading at their 52-week high and as many trading at their 52-week low, it causes concern since there is a great misunderstanding about whether the market is going up or going down. More importantly, the 10-week moving average must be rising and the McClellan Oscillator must be negative -- both issues of volatility in a rising market. Even though the Hindenburg Omen flashed last week (incidentally, on Friday the 13th, which perhaps explains the whole frenzy), it has not been confirmed.

There was a lot of publicity on Monday morning when famous, long-term CNBC reporter Art Cashin indicated that the second part of the Hindenburg Omen would play out within three to four weeks. Obviously, no one really has a clue whether or not this will actually happen, but the fact that Cashin made this comment on national television drew some attention.

It's important that we look at the last time the Hindenburg Omen occurred and evaluate its impact on the stock market. The last time there were two confirmed Hindenburg Omens were in June and August of 2008. You may recall that shortly thereafter, the stock market moved up a cool 80%. If the stock market will move up 80%, I'd be happy to have a confirmed Hindenburg Omen today.

So, to answer your question, Bill, I do not give much credence to the Hindenburg Omen. For the reasons above, I'm not sure there's any technical analysis pattern that is any better than another, and none of them in my opinion are very valuable, unless you take into account external economic events. As I have said for many years in my posts, interest rates and earnings are what affect stock market performance; interest rates are incredibly low right now and earnings are incredibly high. The combination of those two positive economic events will almost assuredly lead to higher stock prices in the coming years.

Thanks for your question, Bill. I hope my answer has been helpful to you in evaluating the importance of the Hindenburg Omen.

Best regards,
Joe Rollins

Tuesday, August 17, 2010

You Can't Make Up This Stuff

From the Desk of Joe Rollins

The stock market sold off 3.5% last week for no particular reason. This probably reflects the dog days of summer and the light trading volume that is going on. If professional traders made the concentrated effort to move the market lower, it is relatively easy to do when there is low volume.

The reported reason for this sell off was the lack of action by the Federal Reserve System. This is one of the most quoted but misunderstood government agencies. The Federal Reserve System only has two stated goals as stated by the legislation that created it: to encourage full employment and maintain price stability. It is not the Fed's specific job responsibility to encourage the economy. Even with the slowdown in GDP in recent quarters, they are doing an excellent job at maintaining price stability.

There's a lot of talk in the press right now regarding the GDP, which was previously announced at 2.7%. Since imports greatly exceeded exports for the month of June, most learned economists forecasted that the GDP's previous 2.7% announcement would be cut to around 1.5%. Even at 1.5%, the economy continues to grow, and that's not a negative matter. However, it's important that you understand the effect of imports exceeding exports for the second quarter.

Since GDP is determined by "gross domestic activity," is doesn't have any effect on goods manufactured outside the United States. This so-called negative is interesting because many goods manufactured outside the U.S. are actually manufactured by U.S. companies. A significant portion of the Chinese imports are produced by companies that are somewhat U.S.-owned. Therefore, the real effect of this reduction in GDP is to take out GDP from the second quarter of 2010 and flip it into the third quarter. Even though economically nothing has really happened, if the first quarter GDP is downgraded when the imports are actually sold to the 1.5% range, I project that third quarter GDP will be 3% or greater. You'll see a lot of press on this subject, but it doesn't mean a whole lot economically.

Last week's stock market sell off was supposedly based on the Fed's announcement that they would use their excess money from the retirement of assets to acquire Treasury bills. Quite frankly, that is not news at all. For some time, the Fed has been in a quasi-tightening mode by taking money out of the Federal Reserve System and accumulating it on its own balance sheet. Anytime the Federal Reserve uses their excess cash to acquire assets that is an easing technique.

Envision a bank that holds particular assets that the Fed buys them, then the bank has excess cash it must loan. That improves the economy by putting more cash in the system for the banks to make business loans. Therefore, the Fed's announcement that they would be using their excess cash to buy Treasury bonds essentially indicated that they were no longer in a tightening mode. Frankly, the Fed doing that is a good thing, and the sell off of the stock market was because they just didn't understand the moves.

I have a client that often sends me strange stories that represent the weird part of our population. Almost always, they come with the anecdote, "You Can't Just Make Up This Stuff!" The more I read about Congress and the bills they've passed to supposedly help the economy, I come to the same conclusion -- you just can't make up such weird stories.

Recently Congress was called back into session after they recessed for summer vacation in order to pass an emergency $27 billion appropriation to fund teacher salaries across the United States. While this sounds honorable, it is almost laughable when you research what they were actually doing.

First and foremost, teacher salaries are a local function. In fact, education is a state function, not a federal function. Education in the U.S. has always been local -- that is the way it should be. While it's true that the federal government provides grants and other enticements for local school systems, the management of school systems is solely a function of state governments. That fact makes this appropriation even weirder.

Congress has developed a conscience as of late. I hope it's not too late, but I hope they've decided that for every new outrageous spending bill they pass, they must find an offset so that the net cost to the budget is neutral. I certainly wish they would've thought of that concept about $3 trillion ago.

Anyway, the $27 billion appropriation was designed to prevent teachers from being laid off and supplement teacher salaries. No one would question that this is an honorable goal. However, the way it was paid for certainly raises concerns. In order to pay for this particular bill, Congress withdrew $14 billion from the food stamp program and added some reduction of foreign tax credits for corporations to offset the costs.

It's easy to see that this does nothing to stimulate the economy. While the people retaining their teaching jobs would have money to improve the economy by additional spending, it would be almost universally offset by the reduction of food stamp program, which would reduce the amount of money spent in the economy by poor people. Hardly seems to be a fair offset.

In addition, it should be clear to everyone that these do not create lasting jobs. While you can supplement a teacher's salary for a short period of time with this federal budget allocation, it will not create lasting jobs and therefore, only is a short-term stimulus that probably does more harm than good. Who pays that salary next year? It doesn't even address the issue as to what the local school systems are going to do about their cost structure.

Perhaps its time that some of these teachers do go away and costs be cut in other areas of the school system. The fact that the school systems cannot raise property taxes doesn't prevent them from being frugal in their operations since they can go to the federal government and cover up waste and abuse of funds by having the government subsidy. Any federal reimbursement of state expenses only "kicks the can down the road" since it does nothing to address the issue of local funding of education and forcing the states to deal with their own internal problems.

I just wonder how you as a taxpayer feel about funding the abuse that is going on in California and their budget deficits that are approaching $5 billion per year. I think it's perfectly reasonable that taxpayers in Georgia are funding the state of California (not!), which has demonstrated that they have neither the capacity nor desire to even come close to funding their own budget deficits.

I don't like to think of myself as a conspiracy theorist, but I am concerned that they are passing such a bill 12 weeks from the mid-term election (which will replace one-third of all U.S. Senators and the entire House of Representatives). Isn't it interesting that we took money away from poor people and gave it to a teacher's union which openly advocates and supports only one political party? I don't want to think that taxpayer money would be used to buy votes, but it's hard to argue in this particular case that it was in the country's best interest to subsidize these teacher salaries. Perhaps it is in the best interest of a political party representing one-half of the U.S. population.

Thirty year mortgages today hit 4.5%. You can get a 15 year mortgage for 4%. By using Freddie Mac or Fannie Mae, you can receive the lowest long-term mortgage rates ever seen in the United States.

What is ironic about his particular matter is that all of these government agencies are now losing in the aggregate roughly $3 billion a quarter. Do you have any concern about paying in taxes to subsidize a governmental agency so some people in American can get lower interest rates? I particularly have this concern for those who have no mortgage whatsoever. Do you think it's reasonable and fair that you are paying higher taxes in order to subsidize Freddie and Fannie so that they can give a lower interest to your neighbor. I don't want to be an alarmist, but maybe you should think about these matters.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Wednesday, August 11, 2010

Q&A Series - Week One - A Special Series Devoted to Answering Your Burning Financial Questions

We've received some great submissions from our readers in response to our special Q&A series. This week's questions come from Mike, a long-term client and Rollins Financial Blog subscriber. Mike and his wife are in their 60's. He is still working and she is recently retired. Both are drawing Social Security benefits.

Q: We tend to gravitate toward high dividend stocks in our personal investments. Can you discuss the pros and cons of this approach, especially considering the fact that many dividends have disappeared with the economic issues at hand?

A: Dividend stocks are a great alternative to interest bearing accounts. For instance, the large telecommunications companies, AT&T and Verizon, both pay dividend yields in excess of 6%. Given that most institutions are paying interest income of less than 1% on non-jumbo money market accounts, a 6% dividend rate certainly appears attractive. If Congress leaves the Bush tax cuts in place for couples making less than $250,000, which is what they're saying right now, these dividends also currently have preferred income tax rates of a maximum rate of 15%. One of the major benefits of dividend stocks is that they pay a high rate of return, while a major drawback is that these stocks are unlikely to appreciate much over time. Basically, since the companies pay out a large portion of their income in dividends, they do not seek stock appreciation. Rather, they provide income return to their shareholders.

Of course, those of us with bank stocks suffered terrible losses in 2007 and 2008. They were once high dividend payers, but in many cases, those dividends went away. Today the exact opposite is occurring. Corporate profitability is at historically high levels and a concentration of cash in corporations has never been greater. There's been an absolute explosion of companies increasing their dividends over the last six months due to their high profitability and even higher cash levels. Since stocks are trading at historically low multiples, major U.S. corporations are increasing their dividends almost monthly.

The major disadvantage of dividend stocks is that you can't just fall asleep on them -- they must be actively managed. In other words, it's imperative that the companies be reviewed on a periodic basis to determine whether their economic future continues to be bright. While dividend stocks are great income producers, they can also be major losers if the company's economic situation changes while you are holding the stock. The greatest positive is, of course, earning a 4% to 6% dividend yield when interest rates are paying virtually nothing and inflation is even lower.

In a nutshell, dividend stocks are a great way to go if you are of a certain age and are looking for income rather than growth.

Q: How should retirement planning change to adjust to the fact that there may be less Social Security benefits in the future?

A: Those who are presently drawing Social Security benefits have almost zero chance of their benefits being cut. Social Security is one of the few sacred cows that politicians just don't seem to have the courage to address for fear of public backlash. While changes to the program are clearly necessary, it's doubtful that any cuts would have an effect on those who are currently drawing benefits. There's no question that the retirement age for drawing Social Security will increase at some point in the future. It also wouldn't surprise me to see a needs-based Social Security system implemented at some point in the future. However, those who are currently over the age of 55 are highly unlikely to face any benefit reductions.

Tara Siegel Bernard's recent article in the New York Times, Social Security Jitters? Better Prepare Now, provides excellent illustrations of the repercussions of benefit cuts to a 35-year old, a 45-year old and a 55-year old. As for those who might be affected, my suggestion is that you meet with a qualified financial advisor to develop a strategic retirement plan. Your plan should be designed based on your specific background with your needs and goals in mind.

My advice to younger individuals is save enough through an individual retirement account, a company sponsored profit sharing plan or some other retirement savings account to provide for their retirement needs. Then, any amounts they receive in Social Security benefits will just be gravy.

My hope is that everyone under the age of 50 saves enough to provide adequate income from their own assets for their retirement years notwithstanding Social Security payments. That way, what is collected through Social Security will just be extra money to vacation with and have some fun.

Q: Are reverse mortgages ever a viable option for people 65 and older?

A: I have heard nothing but bad experiences regarding reverse mortgages. First and foremost, the upfront fees on these types of programs are prohibitive, and you can almost understand why when you take into account what a bank is doing in this type of transaction.

A reverse mortgage enables older homeowners (in a typical scenario, someone who is 62-years old or older) who own their homes free and clear (or close to it) to exchange part of the equity in their homes into tax-free cash without having to sell the home, give up title, or take on a new monthly mortgage payment. In other words, the payment stream is “reversed” -- the bank pays the homeowner each month and gets the equity in their home in return.

In a reverse mortgage, the bank is basically taking a risk on how long you will live. Therefore, in the event that the homeowner lives longer than the bank anticipates, the bank cushions the transaction by charging expensive upfront costs, monthly interest charges, and, in most cases, a monthly servicing fee.

A major problem with reverse mortgages today is that the bank can only pay the homeowner an interest rate commensurate with what it can earn on its own investments. Given that the return on U.S. Treasury bonds and other types of investments is so low, you cannot expect significant payouts on a reverse mortgage regardless of the term.

Instead of obtaining a cost prohibitive reverse mortgage, I recommend that homeowners obtain a standard loan to value mortgage; those loans are currently being offered at rates in the 4% range. This money could then be used to make house payments and pay other bills for years into the future.

We have also seen many clients establish short-term home equity lines-of-credit to have available cash in the event of an emergency. I like this idea, too.

With the availability of the various lending products available in America today, it seems to me that a reverse mortgage is the least desirable.

Q: With mortgage rates extremely low and houses relatively cheap, would it make sense for a couple in their 60's to invest in rental property or other real estate?

A:  While low mortgage rates and cheap housing definitely make real estate more desirable, there are two major negatives to investing in rental property and other real estate. Two of the major determinations of value in real estate are scarcity and inflation. Since there is such a large supply of houses on the market, housing prices will remain cheap for several more years. Something that has always made real estate more valuable is that inflation impacts everything that goes into building a house. The higher the rate of inflation, the more likely that real estate will appreciate. Given that, in all likelihood, we are facing a very low inflationary period for the next five to ten years, it's unlikely that a house will appreciate due to inflation.

Another negative of investing in real estate is its lack of liquidity. Even though an investment property may have value, it is difficult to quickly cash it out. In other words, you can't use a house to buy groceries. Rental properties are also risky because there is a chance it will be vacant. With that, you incur the risk of paying the mortgage payment, property taxes, and repairs without having any rental income.

In summary, investing in real estate is a good option for younger people who have a high income from other sources, and not for retirees who may need their cash for living expenses and medical needs.

Thanks for your thought provoking questions, Mike. We hope our answers have been useful to you and to our other readers. Again, we encourage all of our readers to submit questions for this special series. If it proves to be popular, we may make it a more permanent fixture on our blog.

Best regards,
Joe Rollins

Interesting Trivia:

August of 2010 has been a very unique month in that it has five Sundays, five Mondays and five Tuesdays. This rare calendar occurrence last occurred 823 years ago. So, this "month of fives" business makes this sweltering hot month feel even longer this year. In any event, at least we can look forward to an extra weekend of 95-degree plus temperatures! Great!! I think I'll go visit Miami Beach, where the temperatures are cooler.

Tuesday, August 3, 2010

Whoops! Did I Really Read that in America?

From the Desk of Joe Rollins

I make it a point to read a lot of opinion pieces in various newspapers around the country. Every day, I read the Atlanta Journal-Constitution along with The Wall Street Journal, Investor’s Business Daily and the New York Times, and on the weekends, I also read Barron’s. Because of my mostly conservative viewpoints, a client this weekend was surprised to hear that I bother reading the New York Times. It’s impossible to get a good feel for everything that goes on politics, economics and finance if you don’t look at opinions from all sides of the aisle.

Historically, the New York Times has supported the progressive viewpoint (formerly called “liberal”) while The Wall Street Journal, with its acquisition by Rupert Murdoch, has taken the more conservative view. The Atlanta Journal-Constitution basically doesn’t have an editorial page worth reading, and the Investor’s Business Daily is even more conservative that The Wall Street Journal. In any event, I try to read them all so I can get a feel for the public sentiment on various subjects.

Over the weekend, I read in disbelief an Op-Ed in the New York Times by staff columnist Bob Herbert (“A Sin and a Shame” published July 30, 2010). I have re-read Herbert’s piece several times now to make sure I understand his viewpoint correctly. Bob Herbert is a respected reporter who has worked for various respected outlets over the years, including being a national correspondent for NBC. While he’s always represented the progressive line on politics and economics, his July 30th was way over the top.

While you may read Herbert’s column differently, I understand Herbert to opine that corporations in America have an obligation to employ people and increase their wages. That sentiment is wrong on so many levels that it hardly warrants a discussion, much less an Op-Ed in a respected newspaper.

First and foremost, corporations are not owned by the government, and hopefully, they never will be. They have no obligations to anyone other than their shareholders. No corporation is obligated legally, financially or otherwise to employ people other than to fulfill their corporate goals. Their obligation and responsibility is to make profits, not to employ people and give pay increases just because enough time has passed.

Governments in other countries require their corporations to employ its citizens – communist countries like China, Cuba and Venezuela spring to mind. It is almost unbelievable to me that a columnist for a respected newspaper like the New York Times would promote a line that mirrors communist ideology.

The way to increase employment in America is to inspire corporations to expand and to exercise entrepreneurial spirit of higher profits and utilization of innovative processes. This country was built on the innovative, entrepreneurial spirit, and not on government-controlled mandates. Hopefully Bob Herbert will review a history book at some point to help himself understand how America was truly built – it certainly was not with governmental mandates for employment, profits or anything else for that matter.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Sunday, August 1, 2010

July Performance – Now THAT’S What I’m Talking About!

From the Desk of Joe Rollins

Notwithstanding all the gloom and doom being reported by the media these days, for investors, July was an excellent month (with only one more trading day to go this month). As you know, investors suffered a serious decline in June, but thankfully, the market rebounded in surplus of those losses during July. Through July 29, 2010, the S&P Index of 500 Stocks is virtually flat for 2010. Given that the S&P was down 6.7% at June 30th, the gain of almost 7% over the last month has been nothing short of extraordinary.

This morning, the Commerce Department reported that the GDP for the quarter ending June 30, 2010 was at 2.4%. While this certainly can’t be considered a robust number, it’s not abysmal, either. You may recall that the Federal Reserve has a target GDP growth rate of 2.5%, so this very nearly falls within that range. As such, even though the economy is growing, it is doing so at a low level. At this level, it’s unlikely that the increase in employment will be anything other than normal over the next 12 months, and certainly not high enough to absorb the current unemployment rate of 9.5%.

Most interesting about the Commerce Department’s report is that they revised the first quarter of 2010 GDP report from 2.7% all the way up to 3.7%, an almost unbelievable 40% increase. GDP reports are given in two preliminary announcements of the number for the preceding quarter. The final number was announced last month at 2.7%. It is highly unusual for the government to later change those GDP announcements after the final GDP number is announced. Accordingly, this morning’s announcement of a 40% increase for the first quarter GDP was atypical. It just goes to show that government bureaucrats do almost nothing well. Do you realize how many business and economic decisions are based on GDP numbers? Here our government missed it by a cool 40% last quarter. Once again, I ask the theoretical question: “Do you really want a bunch of bureaucrats in Washington controlling your health care plan?” I guess we will know soon.

Interest rates are returning almost nothing at the current time. If you’ve not looked at your money market account recently, you will be surprised to learn that it probably pays less than 1% annualized. I noticed yesterday that the money market accounts at Charles Schwab are returning virtually zero on an annualized basis. Even a 10-year Treasury bond today is paying 2.9% annually. Interest rates have never been this low for such an extended period of time. Therefore, investing in fixed-rate instruments is a losing proposition to inflation and nothing competes with the potential investment returns for equity and bond investments.

Corporate America will realize in the third quarter of 2010 its highest corporate profits ever! The amount of cash on corporate balance sheets is at the highest level ever recorded in U.S. finance -- $1.8 trillion in cash. All of these robust profits and massive accumulations of assets probably means higher stock prices in the future. If you haven’t invested in your future, now is an excellent time to do so.

Mortgage rates hit an all-time record low of 4.54% this week. Just think about it: you can now obtain a 30-year mortgage and tie-up a fixed rate at roughly 4.5% for 30 years. What an amazing deal for potential homeowners! If you haven’t refinanced, don’t wait any longer. These rates won’t last long.

Ironically, every single month Freddie Mac, Fannie Mae and the FHA in aggregate lose approximately $30 billion. Additionally, these government subsidized agencies are cutting out the banks from making loans. At the current time, few banks are willing to extend home mortgages because the rates are so low they feel they are only guaranteed to lose money. Therefore, the taxpayers (meaning me and you) are subsidizing governmental agencies that are loaning money at record low interest rates to the tune of $30 billion, but that is preventing the private banks from making loans. If you’re not confused yet, you can bet you will be soon!

Even though are government finances are currently being poorly managed by an inept and highly disliked Congress, there was much good news in the GDP regarding management of money by U.S. businesses. During the quarter ended June 30, 2010, business investments grew at a stunning 17%. For the first time in over two years, businesses are now investing in corporate technology, land and buildings to expand their businesses. Given their high levels of cash, it’s been easy for them to make this commitment to new capital investments. Some of the technology will surely be used to increase productivity of existing businesses, which is without question the first step towards expanding employment and hiring more people to service demand.

As I’ve pointed out on numerous occasions, it is corporate profits that lead to higher stock prices. Profits have never been higher and are continuing to grow. Almost assuredly the higher profits and increase in employment will lead to a better business environment over the next 18 months. If any theory regarding stock market valuation is true, then this should lead to higher stock prices in the coming years.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.