FiPod

U.S. Economy Falling Farther Behind

2011-08-25T11:25:00.016-05:00

While Washington was busy debating whether or not to sabotage the recovery by failing to raise the federal debt ceiling, the economy seemed to be doing everything in its power to demonstrate that it’s in feeble health to begin with.
Leading indicators, like an index of manufacturing activity, have printed poorly, about at the levels that suggest the economy is on the brink of another recession. Although bearish economists have been warning about recession risk for some time now — and looking the wiser for it — concerns about a double-dip have crossed into the mainstream. The Harvard economist Martin Feldstein thinks there is a 50-50 chance of another recession. We may even be in a recession right now.
In some sense, however, this is beside the point. The American economy lost a ton of ground during the global financial crisis. Slipping back into a recession — meaning negative growth — obviously wouldn’t help matters at all. But neither, really, would slow growth of the sort we have experienced during the first half of the year.
In the chart below, the United States’s gross domestic product, adjusted for inflation, dating back to 1877 is plotted. The data incorporates the recent substantial downward revisions to G.D.P., which suggested both that the economic crash was even worse than economists had previously believed — at one point, G.D.P. was declining at an annualized rate of nearly 9 percent — and that the recovery has been even more timid.

G.D.P. is plotted on a logarithmic scale in the chart, which reflects the fact that, over the long-run, the American economy has been growing exponentially. The rate of growth has in fact been quite steady over the long run: since 1877, the annual rate of G.D.P. growth has averaged about 3.5 percent after inflation. There has also been strong a tendency for these numbers to revert to the mean: periods of above-average growth have generally been followed by periods of below-average (or negative) growth, and vice versa.
So far, however, there has not been much of a rebound from the Great Recession. In the next chart, the plot displays how far ahead or below of the long-term trend that the economy is at any given time. Basically, instead of thinking about the economy in terms of the rate of growth, we’re instead thinking about how strong or weak it is in an absolute sense. An economy may technically be out of recession — meaning, that it is no longer shrinking — while still being well below its productive capacity.

Here, you can really see the effects of the Great Depression. In early 1933, G.D.P. was about 40 percent below what it “should” have been based on long-term growth rates. But the economy recovered at a rapid clip over the course of the next decade. In fact, G.D.P. temporarily overshot, exceeding the long-term trend during World War II as America employed all the industry and labor that it could get its hands on to help with the war effort.
By this measure, most post-World War II recessions are barely detectable. They look more like reversions to the mean after years of above-average growth. The Great Recession, however, is highly visible. G.D.P. had already been a couple of percentage points below the long-term trend before it began, as the recovery from the 2001-2 recession was not particularly robust. But things got much worse in a hurry.
Looked at this way, in fact, not only is the worst not yet over — the situation is still deteriorating. Every quarter that the economy grows at a rate below 3.5 percent, it loses ground relative to the long-term trend. Although the economy grew at a 3.8 annual percent rate from fall 2009 through summer 2010, over the past year growth has averaged just 1.6 percent, putting us farther behind.
Right now, gross domestic product is about $13.3 trillion dollars, adjusted for inflation — when it “should” be $15.7 trillion based on the long-term trend. That puts us more than 15 percent below what we might think of as full output, by far the worst number since the Great Depression.
If the economy were to enter another recession and shrink by 1 percent over the course of the next year, we would wind up 19 percent behind the long-term trend. But even if it were to grow at 2 percent, we would still be 17 percent behind. What we need, instead, is above-average growth — in fact, quite a lot of it. Even if the economy were to begin growing at a 5 percent annual rate, it would take until 2018 for it to catch up to the long-term trend.

Managing Risk in this Market

2011-08-23T11:17:00.007-05:00

Part of a good defense in investing is knowing the impact of losses and why we want to keep them small. Losses do not get better as they float downstream. Look at what an investor has to make back each time they take an excessive loss and this is just to get back even:

25% loss = 33% gain to get back to where you started
33% loss = 50% gain to get back to where you started
50% loss = 100% gain to get back to where you started
75% loss = 300% gain to get back to where you started

These are the numbers. Having them top of mind might help when you get tempted to make a high risk trade with your hard earned money. It is not very hard to lose 50% on a stock these days, even in “defensive” stocks. When was the last time you made a 100% on a trade in this market?
All stocks are risky; every trade entails risk. Managing that risk is critical for long-term success. Besides proper stock selection and timing, handling losses is the most important part of risk management. In most firms, if they are down 7% on a position, they close it. Period. You should never let the story or the fundamentals override a loss. Never, no matter how much you like the company.
Numerous emotional traps are avoided by staying disciplined with these rules. To further put the odds in our favor, we always consult a stock chart before making a trade. Where a stock is on the chart is as important as a good story with solid fundamentals. In your shop, defense should always comes first.

Week Ahead: Will We Bounce?

2011-08-21T11:16:00.000-05:00

With the S&P looking vulnerable, will stocks retest the August lows? In a nutshell we say yes, the market will retest the lows. But we also believe that technical signs suggest the lows should hold.

The trouble is that too many investors expected the stock market to just bounce and historically that is not what happens. Typically the market makes 'W' bottoms; we make a low bounce and re-test the low bounce and re-test again. This pullback could provide an important - and potentially bullish tell. As we pull back we will be finding out if people will again buy stocks at the August lows (of about 1120 on the S&P). How it plays out over the next 3-4 days will be critical.

S&P Downgrade: The Only 2 Questions You Should Be Asking

2011-08-11T09:51:00.000-05:00

As a normal investor who has colorful fantasies and nightmares regarding the financial markets, there is a better than even chance that following yesterday’s route you have a flood of thoughts swirling around your head. The fact that all of the information contained in the entire world, along with the opinions that come in tandem with that information are at your fingerprints may seem like a blessing during times like this. However, it is more often than not a curse. Simplification is the only answer.
There are only two things you need to be concerned with as an investor currently:

At what point should I raise more cash?
Where will be the point at which I should put that cash to work?

That is it. Your problems have all been condensed into two basic questions that you must now answer.

For reasons that I outlined in an article I wrote over the weekend, I believe that the S&P 500 is headed for 1150 on the downside, as a minimum target. This downside target is gaining increased credibility as I am not seeing the proper levels of panic amongst investors as of yet. The attitude remains one of “at what point can I buy in for a bounce” as opposed to “the thought of being long the stock market makes me want to vomit”.
What will get us to that vomit point is a continuing pattern of failures in the market that should take place over the next few days, weeks and possibly months. Nothing makes traders and investors give up on the long side like a continuing pattern of rallies that fail. That is exactly why you see so much chop around important market bottoms. That chop or volatility is the motion of an ocean of investors not being able to sustain the torment any longer.
The fact that we will be experiencing rallies along the way means that investors will have multiple opportunities to lighten up on their long positions. In the midst of the snap back rally you will see a lot of false hope and optimistic expectations that the worst is behind us. It will not be. Barring some type of surprise intervention from the Fed, ECB or combination of the two, there is little chance of a sudden “V shaped” bottom taking place. The damage has simply been too great and there will be too many investors maneuvering into the markets during subsequent rallies. This maneuvering will inevitably cause the choppy, violent movement that is typical of bear raids on the stock market. It is a long, drawn out process that will need a month or two of work, at a minimum.
A move above 1250 on the S&P 500 should be used as a point to lighten up on long positions. I would expect to see this take place over the short term as the downside is extremely compressed. A move below 1160 on the S&P 500 is the point that the cash should be maneuvered back into the markets with an intermediate to long term time horizon. September seems more than appropriate to see the type of panic necessary to put in a sustainable bottom. October at the latest.
During the point in time when this type of frightening decline takes place, Wall Street will make sure to pull out all the photos of past monsters, goblins and vampires to frighten away all but the bravest of investors. It is the equivalent of telling a small child to stay away from a closet where you keep your valuables with stories of a three legged, reptilian creature that wears scary hats.
2008 is sure to come up, as this has been the scariest monster of all. The market will want you to think that the monster of 2008 has come to revisit us in 2011. And as usual, what the market wants you to think will be the least profitable path of thought one can take.

"We got Greeced": Nicknames for the Crash

2011-08-09T08:38:00.021-05:00

Given that CNBC is going to be "all downgrade all the time", CNBC reached out to folks on Twitter for alternative words or phrases to replace "downgrade". It gets boring saying the same word over and over. They got a lot of replies, some not printable. Here are a few worthy suggestions:

"We got Greeced"
"Inverted upgrade"
"Negatively elevated"
"D-listed"
"Not Winning"
"Value challenged"
"The Fredo Corleone of sov debt"
"S&P to US: 'I will cut you!'"
"US downgraded from Hamlet to Horatio with negative Guildenstern watch (sorry, I'm watching Hamlet)"
"S&P has placed a 'Pitchy Dawg' rating on long term US Treasury Debt"
"Donkey punched, Dirty sanchez'd, Rusty tromboned"
"Deuce drop"
"Unfollow"
"Put in a time out"
"Un-friended"
"Type O Negative" (get it?)
"Kardashianed"
"US debt has gone from Rory McIlroy to Tiger Woods"
"We've gone from Moe to Larry"

Which is your favourite?

How Low Can the S&P Go?

2011-08-07T21:28:00.000-05:00

"(Squeaky Voice) How low can you go?! [8x]Luda!She could go lower than I ever really thought she could" - Ludacris How Low

The recent selloff in stocks has triggered a scary "head and shoulders" pattern in the S&P 500 chart, signaling that there may be more selling to come. Oh, and there is this little thing called a debt downgrade that has sent global markets down 7% (Middle East) and 3% (Asia). The so-called head and shoulders pattern is formed when the chart pattern shows three rallies, with the middle rally peaking higher than the first and second, thus creating a head. If the market breaks the "neckline," that is a trend reversal signal and can mean more selling ahead.

What we are in the midst of is a classical technical breakdown. When the S&P broke down through the 1248 to 1250 region, it violated the neckline on a head and shoulders formation. If it is a valid head and shoulders then you begin a countdown to where it occurred. That would take the market down to approximately 1120. To reverse itself, we would need to see the market go above the neckline at approximately 1248.

In the chart, the market first rallied, forming the top of the left shoulder in late February. It then rallied to a higher level, forming a head in May. It then dipped down to a neckline before rallying to form a right shoulder in July. Typically, the neckline is formed at an area of prior support. That would be the 1249 to 1280 zone.
Wednesday's move down through 1249 was the bottom end of the neckline which traders have been watching. That, combined with European debt issues, precipitated the further sharp selloffs. What a head and shoulders tries to do is it tries to measure the potential move of a correction and the way you do that is from the top of the head to the neckline. The high was 1370. The neckline would be an average of 1270. That gives you a measured move for technicians to pick an area to buy. That takes you down to a zone of 1150 to 1180. That correlates to a pretty big support level from last year. That will be the level traders are watching. Sometimes market's bounce back up after breaking the neck line, in a "kiss back" move, and that is what happened Wednesday when stocks recovered most of their losses to close slightly lower.
To short the market, I use ProShares UltraShort S&P500 (ETF: SDS). I have been in this for a few weeks now; however, as Mark Chan cautions, this investment is extremely volatile and is not for those that are not at least a little "insane in the membrane". Keep your stop loss tight and trailing.

8 Things Worth Teaching an MBA

2011-08-01T12:21:00.000-05:00

Listen up, budding Masters Of The Universe, and all those who dream of walking their path to wealth, power and spacious summer homes. At many business schools, boot-camp week–where the unwashed get a taste of debits, credits and such–starts in less than a month. After that, and just beneath the throb of your hangover (a B-school accessory), you will detect another inexorable rhythm–a faint ticking to be precise. This is the tell-tale heart to your two-year, $100,000 investment. The relentless reminder that you better get to learnin’ (or at least networking), lest you end up working for, and maybe getting laid off by, one of your classmates one day.

Now for the good–or totally vexing–news, depending how you take it: After all the spreadsheets and etch calculations, after all the case studies and Power Point presentations, after all the tuition money is gone and it is just you and your pedigree, contacts and gumption, guess what?
You get to start over again–in the real world.
As anyone who employs people and writes checks will confirm, turning $1 into a $1.10 is a real bitch. Turning that $1.10 into $1.25, even tougher. I had to laugh the other day when I saw on Google+: “Generating positive cash flow is one of the hardest f—ing things in the world.”
For all the wonderful instruction at places like Harvard, Wharton and my alma mater, DePaul University, b-schoolers should remember that making money involves so much more than columns in a spreadsheet and the ever-shifting assumptions behind them.
With that in mind, here’s a supplemental, 8-step curriculum:

If It Ain’t Broke, Still Fix It: One of the hardest decisions business owners have to make is turning their backs on cash when it is flowing. But that is exactly what you must have the courage to do sometimes to protect your franchise. Think about all those aggressive mortgage underwriters who scooped up fees by the shovelful during the housing bubble, when they should have been tightening their lending criteria. Or USA Inc., which ran deficits for years–because, well, our creditors did not seem to mind–and now faces a staggering $60 trillion fiscal hole (including the present value of all future obligations to its entitlement programs).
If You Don’t End Up Working At Goldman Sachs, Forget What You Learned About Finance: In my entire finance career with large respected companies, I can count on two hands the number of IRR (internal rate of return), DCF (discounted cash flow) and NPV (net present value) analyses I have completed, and I am pretty sure that I analyzed exponentially more balance sheets in a classroom than I ever have in a boardroom.
Take Your Financial Models With An Indiana-Jones-Sized Boulder Of Salt: Another biz-school mate, now a health care consultant, chimed in with this stern admonition: “Too often people in business rely upon a model demonstrating projections out 15 – 30 years.” I was astounded: Fifteen to thirty, I confirmed? In school we worked in more modest 3-to-5-year increments, with an understanding that anything beyond that was magical thinking. “Believe it or not,” he went on, “I have seen some done out that far for deals [acquisitions] and often for public-private partnerships.” Find me an industry (save for perhaps utilities) where the assumptions you make today apply for three years, let alone 30. No, really, find me one.
Overpromise And Try To Deliver: Under-promising and over-delivering may work on conference calls with Wall Street analysts who need earnings projections for their valuation models. (GE made an art out of that game for years under Jack Welch.) But that strategy will not always cut it when chasing new business to meet growth targets (or just payroll). Sometimes you will have to bite off more than your models–and your gut–say you can chew just to win the business. It’s an uncomfortable sensation at best, and a reputation-damaging maneuver at worst if you don’t come through. Get ready–and no tears.
If You Do Not Know Who The Sucker Is, It Is You: Yet another B-school colleague of mine, who probably plays too much poker, recalled this adage, a favorite of mine: “People are happy to take your money by pulling you off your home court,” he says. “Don’t let them. Deploy capital in ways that you understand not only intellectually, but also viscerally. Stick to home games–that’s where your instincts will flourish.”
If No One “Owns” A Project, It Will Not Get Done: Most people do not put in long hours for their health, or to make shareholders wealthy, or because their families drive them nuts and they would rather grind it out in the office. (Okay, sometimes that last part is true.) They do it because their job demands it, and with any luck they take a lot of pride in doing it well. Which is why all projects need champions. Not the kind who beats his chest and spews happy mission statements. The kind whose backside is on the line if things do not pan out. More importantly, the kind who has the authority and resources to make decisions that other people have to follow, else their backsides are on the line. It is not that people are lazy or incompetent (they may well be, but that’s a hiring issue). It is that, over time, you get what you incentivize–or do not.
Be Clear: They actually do tell you this one in b-school, but not in so many words and not vehemently enough. The clearer you are, the more thoroughly you probably understand what you are talking about, and the more capable and trustworthy you will seem to customers, colleagues and employees. Being clear has immense ramifications–on productivity, customer satisfaction and employee morale. If your Power Point deck contains the word “ideate,” cut, and do not paste. In fact, eliminate all jargon from everything you do. (If you think the word “utilize” is a smarter version of “use,” please, please read The Most Annoying Business Jargon.) This applies to electronic exchanges as well. The simplest, most straight forward emails can, and will, get twisted beyond meaningful comprehension. If the message is mission-critical, communicate face-to-face, or by phone, as best you can.
Business Involves People: People are a pain. They whine, mess up and have all sorts of problems. That is why every now and again you should ask how they are doing–and actually listen to the answer. It does not cost a cent and helps lift spirits and build trust.

Da Debt Ceiling Rap

2011-07-30T10:27:00.001-05:00

7 Logical Thoughts That Are Illogical

2011-07-28T12:13:00.014-05:00

The logical mind that has created most of the advancement we have seen as humankind is a detriment in the financial markets. While logic allows you to be a functional human being, having a firm grasp of what is illogical will be what allows you to profit consistently.

What do I mean? Let’s start with a simple premise. In order to survive in the financial markets over the long run, you must view the market as a thief. It wants what you have and uses manipulation of emotion to get it. The primary emotions are that of fear and greed. It is coded in your DNA to become greedy when all is going in your favor. Similarly, when you are dying a slow death at the hands of a blistering foul wind, you are programmed to flee the situation.
The market routinely manipulates the emotions of fear and greed, causing you to exit positions when the probability of achieving outstanding gains over the next 12, 18 or 24 months are at their best. Conversely, you are manipulated into buying situations that are inherently dangerous and have a high probability of working against you during periods of extraordinary comfort and joy.
Routinely, issues of seemingly logical importance make their way into your psyche during the most crucial times. As an example, during the depths of financial Armageddon in 2008, it was seen as perfectly logical that the financial system as we know could be finished. The phrase “end of capitalism” was being thrown around like we were talking about the end of a baseball game. Logical thinking told investors that safety was of the utmost importance. Anything tied to capitalism was to be abandoned in the favor of cash. Preferably cash in a foreign currency of a third world country that was not tied to capitalism.
It was thought of as illogical to recommend heavy allocation into equities. The thought of the Nasdaq being near ten year highs just three years later would have been seen as illogical thinking. It became logical to think that the financial markets were destined for a sideways range at best, with a continued bear market and deep depression being the logical outcome. The logical mind failed investors, as it always does. The illogical thinkers came out ahead, as they usually do. The logical mind can also betray investors in individual stocks.
The recent action in companies like Netflix (NFLX) and LinkedIn (LNKD) deceive the logical mind. In fact, the fuel for their fire is based on a logical dissection of a situation that cannot be logically understood. I have been very bearish about the prospects of NFLX for all of 2011. I have also been bearish on LNKD for the entirety of its public market existence.
If I were to attempt to logically dissect either of these companies, I would not only stay as a far away from them as possible, I would likely be looking to short them to my own detriment. Logical interpretation of these stocks fails. The numbers fails to justify the stock price. Just as the numbers during the bottom of 2008 failed to justify the historic rally that has taken place over the past three years. Just as logical thinkers failed to steer you clear of buying a home in 2005, and instead told you to buy a boat using equity from your home. Just as logical thinking said it was perfectly fine to be invested in Pets.com and Garden.com in 1999 and 2000.
It is easy to look at these events now and tell yourself that it was the illogical mind at work during these periods of euphoria and failed vision. In 2005, you could have been sitting at a table in the middle of Silicon Valley talking to a group of wealthy real estate investors. You would have brought up the question of real estate possibly being overvalued and not being able to sustain the gains of the past several years. You would then have been looked at as if you had just grown floppy ears and a tail. It was completely illogical to think of real estate–especially California real estate–ever going down. “Too many people want to live in California”. “The demand will always be there to support the price.” This was the logical argument of the time. Logic failed once again.
What is a FiPod investor to do? Realize that your logical mind is being stalked by the financial market. Come to terms with the fact that what you perceive as being an illogical trend taking place in the markets has roots far deeper than you suspect. Be suspicious of what you deem completely logical.
Where is the logical mind focused today?

The equity markets should be avoided. Logical thinkers feel that given all of the negative economic events we have experienced over the past 11 years and the bleak prospects for a sustainable future recovery, allocation to stocks is dangerous at best.
The housing market will come back eventually. Logical thinkers feel that real estate will continue to be a long-term outperformer.
Apple (AAPL) has the perfect mix of products, service, innovation and genius to continue until it is above $1,000 per share. AAPL is full of logically oriented investors. Doubting AAPL is thought of as highly illogical.
Oil prices can’t go above $150 per barrel. Logical thinkers feel that gasoline prices above $5.00 per gallon will destroy the U.S. economy. That number used to be above $4.00 per gallon. It has not destroyed the economy so logical thinkers simply raised the number to $5.
The Dow and S&P have been in the same place for more than 10 years, therefore a sideways trend is likely to persist. Logical thinking relies heavily on past events to close the mind to future events that defy the established trend. Dow 6,000 is much more likely than Dow 20,000 according to logic.
A company like Netflix should not be near $300 per share. It has too much competition. The business model is weak. Logical thinkers have been doubting NFLX for the last 200 points.
A company like LinkedIn should not have debuted above $50 per share. Let alone be sitting at its current price of $100 per share. Logical thinkers believe that their inability to comprehend such a steep premium for LNKD translates into an imminent, sustained drop in the share price.

The desire to deceive and surprise investors is tattooed across the markets forehead. For that reason you must allow your logical mind to remain what guides you through everyday life. However, when you enter the financial market arena, it is imperative to shut it off and allow your mind the creativity to imagine illogical pricing scenarios that only a person with floppy ears and a tail could dream of.

What Happens if the U.S. Defaults?

2011-07-26T12:07:00.002-05:00

Greece cannot solve a problem of too much debt by taking on even more. We will note, however, that by some measures, the United States is even more deeply in hock than Greece.

Greece’s debt-to-GDP ratio is 143%. America’s is officially 97%. But the $14.3 trillion national debt, stacked up against a $14.7 trillion economy, does not tell the whole story. Look at these numbers:

$14.3 trillion: “official” national debt
$5 trillion: Amount Uncle Sam is on the hook for Fannie Mae and Freddie Mac
$62 trillion: Total liabilities and unfunded obligations for Social Security and Medicare

That does not count the black box of bailouts.
We know how much the Federal Reserve doled out in emergency loans: $16.1 trillion between Dec. 1, 2007, and July 21, 2010. We know that because last week the Government Accountability Office completed its first-ever audit of the Fed, made possible largely through the persistence of Rep. Ron Paul (R.-Tex.) making that audit, however incomplete, the law.
What we do not know is how much of that has been paid back. “We have literally injected about $5.3 trillion,” said Dr. Paul earlier this month during his questioning of Fed chief Ben Bernanke, “and I don’t think we got very much for it. The national debt went up $5.1 trillion.”
Bernanke did not challenge those figures.
“To get our overall fiscal gap under control,” writes Boston University professor Laurence Kotlikoff in Bloomberg, “the U.S. must cut spending or raise tax revenue by $20 trillion over the next decade, far more than either the president wants or the House Republicans seek.”
Yep: The latest number we see bruited in Washington is $3 trillion. Whatever the final number — and there will be a last-minute deal; there always is — it will be substantially less than $20 trillion over 10 years. The can will be kicked as it keeps getting kicked in Greece. We note here that the total of outstanding credit default swaps on U.S. Treasuries crested $4.8 billion this week. Uncle Sam has now surpassed Greece in this category.
Measured in year-over-year change, America is number one: Net notional CDS outstanding grew 109%. That means there is double the bets out there on a U.S. default compared with a year ago.
“You may not know this, but the U.S. has actually defaulted a number of times already,” writes Chris Mayer. He cites five instances:

1779: The government was unable to redeem the continental currency issued during the Revolutionary War
1782: The colonies defaulted on the debt they took out to pay for the war
1862: During the Civil War, the Union failed to redeem dollars for gold at terms stated by the debt contracts
1934: FDR defaults on the debt issued to finance World War I, refusing to redeem it in gold. The dollar is devalued 40% against gold
1979: A bureaucratic snafu results in interest going unpaid on some small bills.

“With the exception of 1979,” Chris says, “which was mostly due to administrative confusion — the U.S. simply ran out of money each time. The end result was the dollar had to be devalued. Meaning it lost significant purchasing power.
“My guess is that the U.S. will default again. It may not technically be called that, but the only way for the U.S. to meet its financial obligations is to print a lot of money.”
What does that mean in practical terms? In Greece, professor Savas Robolis at Panteion University in Athens reckons that by 2015, the average Greek employee and pensioner’s standard of living will have fallen 40% compared with 2008. Even now, Americans are turning to their credit cards to pay for groceries and gas. According to First Data Corp., the volume of gasoline purchases put on credit cards jumped 39% over the last 12 months.
You do not want to be the average American in a default scenario, whenever it arrives. Ray Dalio, the head of Bridgewater Associates, the world’s biggest hedge fund, puts that day in “late 2012 or early 2013.”

Cash is King... Except Now?

2011-07-24T16:06:00.000-05:00

“Is it time for you to move to cash?” was a headline I saw on Reuters.com on Wednesday. Just two days earlier, I had spoken to a banker on a plane who was considering putting part of his portfolio into a money market fund.
This was likely just a coincidence, but both occurred as the U.S. debt ceiling debate remains unresolved (something that may or may not change by the time you read this) and Europe is dealing with its own problems. Plus, the economy is moving along at a sluggish pace.

In one of our first posts (Wild Goose Chases Rarely Produce Geese, Feb 09) we talked about the merits of holding large amounts of cash. This was during some pretty harsh economic times and we revised that statement during our first FiPod Winter Series post touting diversification (Preparing Your Portfolio for Winter: A New Weekly FiPod Series, Nov 09). It appears that the trend was captured adequately.
Despite the Reuters’ headline implication that investors are moving to cash, the data suggests otherwise. Retail money market funds held $919 billion in assets as of July 13, according to the Investment Company Institute (ICI). This is down from $947 billion at the start of the year. Institutional money market funds also hold fewer assets now than they did at the start of the year.
This is not to say that there are not some investors who have shifted to cash. Cash allocations were at 21.5% in Forbes' June Asset Allocation Survey, the highest levels since August 2010. They also retorted from some AAII members who have decided to increase their cash allocations. But there has not been a run to cash. In fact, cash allocations remain below their historical average, according to a recent survey.
Cash does have an allure when times are uncertain because its reported value is not impacted by the fluctuations of the market. Your purchasing power (what a dollar can buy) will eventually be eroded, and there are risks associated with where cash is stashed, but the account balance of cash is not impacted by the market’s ever-changing mood. I should add an asterisk to that last sentence because there have been discussions about letting a money market fund’s reported net asset value float daily. The result would be that a fund’s net asset value could drop below a $1 per share on a given day, the so-called “breaking of the buck.”
The problem with moving to cash when market conditions are considered to be unfavorable is knowing when to get back out of cash. Selling out of stocks during the summer of 2007 and getting back into stocks in March 2009 would have been a great strategy, but few people actually did that. Thus, while you may limit your downside risk, you also risk losing out on potential gains. One of the most common mistakes that investors make is moving into and getting out of cash too late, locking in big losses and missing out on big gains.
Over short periods, an allocation to cash is not a bad thing, especially if it accounts for a small portion of your portfolio. This is particularly the case if you sold a security or fund and are trying to decide where to reinvest the proceeds. Cash also makes sense if you know you are going to have an upcoming withdrawal from your account, such as a required minimum distribution (RMD) from an IRA.
You also need to look at what you have outside of your brokerage accounts. Financial planners recommend that employed individuals have cash savings equal to several months of expenses. Retirees should also have a certain amount of savings to cover unexpected events and emergencies. If there is a large expense that you expect to incur within the next couple of years, such as a new car, you should keep those funds in cash as well. I bring this up because all of your accounts contribute to your net worth, and anyone with a savings account already has an allocation to cash. Thus, you already have some protection against the market’s volatility.
The key to portfolio risk is to find a balance between what allows you to sleep at night and what allows you to achieve your financial goals. If you want to protect your wealth against the eroding effects of inflation, you will need some exposure to stocks. Cash can provide short-term safety, but it won’t protect you against the dual threats of inflation and the risk of outliving your money.
Moving into and out of cash is one method of managing your short-term risk exposure, but it does not address a long-term risk facing many investors: what happens to your estate after you pass. An estate plan helps to ensure that the wealth you have worked so hard to accumulate and grow will be properly distributed according to your wishes.

Who Owns America?

2011-07-22T15:05:00.000-05:00

Note: The following piece comes from Tom Mucha of Global Post, which provides excellent coverage of world news - important, moving and odd.

Truth is elusive. But it's a good thing we have math.
Our friends at Business Insider know this, and put those two principles to work today in this excellent and highly informative little slideshow, made even more timely by the ongoing talks in Washington, D.C. aimed at staving off a U.S. debt default.
Here's the big idea:
Many people — politicians and pundits alike — prattle on that China and, to a lesser extent Japan, own most of America's $14.3 trillion in government debt.
But there's one little problem with that conventional wisdom: it's just not true. While the Chinese, Japanese and plenty of other foreigners own substantial amounts, it's really Americans who hold most of America's debt.
Here's a quick and fascinating breakdown by total amount held and percentage of total U.S. debt, according to Business Insider:

Hong Kong: $121.9 billion (0.9 percent)
Caribbean banking centers: $148.3 (1 percent)
Taiwan: $153.4 billion (1.1 percent)
Brazil: $211.4 billion (1.5 percent)
Oil exporting countries: $229.8 billion (1.6 percent)
Mutual funds: $300.5 billion (2 percent)
Commercial banks: $301.8 billion (2.1 percent)
State, local and federal retirement funds: $320.9 billion (2.2 percent)
Money market mutual funds: $337.7 billion (2.4 percent)
United Kingdom: $346.5 billion (2.4 percent)
Private pension funds: $504.7 billion (3.5 percent)
State and local governments: $506.1 billion (3.5 percent)
Japan: $912.4 billion (6.4 percent)
U.S. households: $959.4 billion (6.6 percent)
China: $1.16 trillion (8 percent)
The U.S. Treasury: $1.63 trillion (11.3 percent)
Social Security trust fund: $2.67 trillion (19 percent)

So America owes foreigners about $4.5 trillion in debt. But America owes America $9.8 trillion.

Can't Handle a Double-Double? How About 100x100?

2011-07-17T15:44:00.000-05:00

As a continuance on our In-And-Out post... the largest burger ever ordered. A group of 4 (including the Zappo's CEO) sat down for a 100x100. Unfortunately, the treat is no longer available. For less than $1 per burger, it was one heck of a steal.

In-N-Out Burger "Meats" Texas

2011-07-15T15:43:00.000-05:00

I have been hanging around with a certain Californian for the past few weeks and naturally, when we heard that Texas opened its first In-N-Out Burger, we had to go. All it took was a little persuading in the form of "Do it; Do it; Dooooooo it; 5...4...3...2...1...Now!" After our journey (in which I got two single cheeseburgers instead of the double-double that I should have), I realized INO has its own language... and a bit of a religion.
A little background on the privately held business founded by the Snyder’s in 1948. INO was started east of downtown Los Angeles, as the first drive-through restaurant, with a basic business philosophy:

“Give customers the freshest, highest quality foods you can buy and provide them with friendly service in a sparkling clean environment.”

INO’s menu is still the same basic menu of burgers, fries and shakes that customers have enjoyed since the doors first opened. Everything is still made fresh to order and there are no microwaves or freezers. Customers may observe french fries being made from hand-diced, fresh, whole potatoes and shakes handcrafted from real ice cream. Esquire Magazine’s Chef Survey ranked it the Best Fast Food in America. Some even worship their food. In fact, you can worship with your food through the bible verses on their packaging. Here are some of the passages:

REVELATION 3:20 (burger and cheeseburger wrappers): Behold, I stand at the door, and knock: if any man hear my voice, and open the door, I will come in to him, and eat with him, and he with me.
JOHN 3:16 (soda cups): For God so loved the world that he gave his only Son, that whoever believes in him should not perish but have eternal life.
PROVERBS 3:15 (milkshake cups): She is more precious than rubies, and nothing you desire can compare with her.
NAHUM 1:7 (Double-Double wrapper): The Lord is good, a stronghold in the day of trouble; he knows those that trust in him.

In addition, I found that INO is made even better once you crack their "secret handshake" and learn the code words. What follows is a basic start-up guide for the new Texans:

“3-by-3″ = three meat patties and three slices of cheese.
“4-by-4″ = four meat patties and four slices of cheese.
“2-by-4″ = two meat patties and four slices of cheese.
“Animal Style” = the meat is grilled with mustard, then pickles, extra spread, and grilled onions are added.
“Whole Grilled” = onions are grilled whole and not chopped like animal style.
“Double Meat” = like a Double Double without cheese.
“3-by-Meat” = three meat patties and no cheese.
“Animal Style Fries” = fries with cheese, spread, grilled onions.
“Protein Style” = this is a burger with no bun, wrapped in lettuce.
“Grilled Cheese” = no meat, but everything else.
“Extra Toast” = buns are extra toasted giving them a crunchy texture.
“Veggie Burger” = aka “Wish Burger,” burger without patty or cheese.
“On the Sal” = this is just lettuce and dressing. Nothing else.
“Animal Fries” = fries with melted cheese, grilled onions, and dressing.
“Fries Well-Done” = extra crispy fries, even better than the regular!
“Fries Light” = opposite of fries well-done, more raw than usual.
“Flying Dutchman” = two meat patties, two slices of melted cheese–nothing else–not even a bun!
“Neopolitan Shake” = strawberry, vanilla and chocolate shake.
“Choco-Vanilla Swirl Shake” = chocolate and vanilla swirled together to perfection.
“Lemon-Up” = half lemonade and half 7-up drink.
“Root Beer Special” = half root beer and half Dr. Pepper
“Tea-Ade” = half iced tea and half lemonade.

On my second trip, I went with a double-double, no tomato, whole grilled, animal style and fries well-done animal style... though much better than the first trip, I am not sure I had the same reaction the person in this video did... I leave you with the Dallas store opening:

How to End the Deficit in 5 Minutes

2011-07-08T18:48:00.002-05:00

Buffett: “I could end the deficit in 5 minutes. You just pass a law that says that anytime there is a deficit of more than 3% of GDP all sitting members of congress are ineligible for reelection.”

Find a Home in Your Portfolio for Homex

2011-07-03T15:28:00.008-05:00

Mexico-based Homex Development (HXM), which was recently upgraded to a “buy” rating at Banco Santander, has recognized the importance of the Brazilian housing market, where it actively participates. The homebuilder’s CFO, Carlos Moctezuma stated recently that the Brazilian market has been “unattended for 20 years” and offers immense potential for growth.

Brazil is currently one of the most dynamic housing markets in the world. The property boom is being driven by the enormous explosion in the number of potential buyers. The nation’s middle class currently comprises about 50% of the total population, up from 37.5% in 2003. Higher personal incomes and a robust macroeconomic outlook add to the expectations. According to the Brazilian Association of Real Estate and Tourism, there is a shortage of 7.9 million homes in that nation, mostly in the northeastern part of the country.
The Brazilian government has ensured that the aspirations of the economically weaker sections of the society have not been ignored. The government’s biggest housing program (“Minha Casa Minha Vida”), which offers loan subsidies to the lower income segment of the population, has enabled the creation of 1.3 million new homes—30% more than its initial target—within a 22-month period.
Currently changing hands at 9.9 times earnings and with a market capitalization of $1.3 billion, Homex’s stock price advanced from $10 and change in early 2009 to the $40 level later that year. Since then it has eased back to the low to mid-$20s.
With sustainable demand and rising aspirations of a growing Latin American middle class, housing stocks serving that region are likely to prove more attractive than their U.S. counterparts for some time.

Bennie and the Feds

2011-07-01T15:21:00.014-05:00

In his June 7 speech, Fed Chairman Ben Bernanke stated, “the best way for the Federal Reserve to support the fundamental value of the dollar in the medium term is to pursue our dual mandate of maximum employment and price stability, and we will certainly do that.”

It is instructive to take a look at the actual Federal Reserve goals, as well Bernanke’s results in pursuing those goals. "The goals of monetary policy are spelled out in the Federal Reserve Act, which specifies that the Board of Governors and the Federal Open Market Committee should seek ‘to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates’. Stable prices in the long run are a precondition for maximum sustainable output growth and employment as well as moderate long-term interest rates.
When prices are stable and believed likely to remain so, the prices of goods, services, materials, and labor are undistorted by inflation and serve as clearer signals and guides to the efficient allocation of resources and thus contribute to higher standards of living. Moreover, stable prices foster saving and capital formation, because when the risk of erosion of asset values resulting from inflation—and the need to guard against such losses—are minimized, households are encouraged to save more and businesses are encouraged to invest more.”
Let’s look at the results of Bernanke’s economic “fine tuning” (using data from the St. Louis Fed’s database, starting in February, 2006, through April 2011), and see if he has successfully pursued this mandate. But first, the definition of STABLE (from the Mirriam-Webster dictionary):
a : firmly established : fixed, steadfast
b : not changing or fluctuating : unvarying
c : permanent, enduring
Stable prices are one of the Fed’s primary mandates. In the table below, take a look at what has happened to the prices of items in a typical U.S. consumer’s budget since Ben took the reins:

It is easy to play with the weightings of the above prices, and see how individual budgets would be impacted. Regardless of the method used to look at prices, it is clear that Bernanke has not been successful at maintaining price stability since taking over as Fed Chairman. Mandate not accomplished.
Finding a strict definition of maximum employment is impossible. Many economist give different estimates, ranging from 2%-7%. The standard unemployment rate most often used by the Fed is currently at 9.1%, up 90% since Bernanke started. The more inclusive (realistic) U6 number stands at 15.8%, up 75% in the same period. The Civilian Participation Rate has declined 2.87% to 64.2%.
This is the lowest level the U.S. has seen since March, 1984. The decline amounts to 8,946,844 fewer Americans in the labor force. Had they not dropped out because of a lack of jobs, the “official” unemployment rate would be significantly higher. While we can debate the meaning of the term maximum employment, it is clear that the jobs data has deteriorated considerably since Bernanke took the reins at the Fed. Mandate not accomplished.
While not stated in Bernanke’s recent address, the Fed’s website also posts “moderate interest rates” as a stated goal. While we cannot definitively say what constitutes “moderate”, we do know that both short and long-term interest rates are near all time lows. It is safe to assume that near record low rates are not “moderate”. Further, when interest rates are artificially held below the rate of economic growth,” financial repression” is occurring. Many bright folks have commented on how the zero interest rate policy (ZIRP) is destructive to savers and misallocates resources. It is safe to say that this mandate has not been accomplished.
In conclusion, it is evident that Ben Bernanke is failing his mandates. We believe it must come down to one of the following reasons:

Bernanke does not know how to achieve his mandates;
The policy tools employed do not work;
He does not have the ability to implement policies that would work;
He is not trying to achieve his mandates;
He has goals other than his legal mandates;
He does not look at the data, and believes he is succeeding.

We will leave it up to our readers to make their own conclusions.

Create your Own Deal

2011-06-29T15:11:00.000-05:00

There is a new front in the daily-deals battle: The fight to be the first to successfully blow up and reinvent the business model. Groupon got big fast as the field's most prominent pioneer, but its approach is now drawing fire from several angles. Businesses are questioning whether bargain-hunting buyers actually become loyal customers, customers are overwhelmed by a flood of offers, and literally hundreds of rivals -- not to mention Facebook and Google -- are plying the trade. As Groupon prepares to go public, all that emerging competition is a key risk.

The current model of the big daily deal is unsustainable for big businesses. So this week, several sites went live with new twists on the daily deal. Location-based networking service Loopt launched a personalized deal-creation service, U-Deals. U-Deals lets users create their own fantasy deals and share them with friends. As the user rallies a team around the deal, Loopt contacts the target business to see if it will play ball. The first u-Deal was a $100 voucher for Virgin America for $35. The airline approved the deal, which sold out within hours.
Fledgling startup Ringleadr launched a similar service on Thursday. Like Loopt's u-Deals, the site lets users to suggest their own deals for businesses they are interested in. The model could run into the same problem Groupon is hitting: Merchants that offer discounts do not necessarily get new customers in return for them. You are most likely to request deals from places you already go to. Businesses do not want to offer large discounts to existing customers. That is one of the biggest risks of running a Groupon.
Loopt CEO Sam Altman counters that one of the strongest ways for a brand to attract new customers is for existing fans to draw in their friends. Check-in service Foursquare is also relying on social-networking buzz to power a fresh approach to deals. On Thursday Foursquare rolled out a national partnership with American Express to offer card holders discounts when they check in with participating merchants. The pair road-tested the approach earlier this year at the South by Southwest festival in Austin, offering $5 credits for spending money at local businesses.
National retailers Sports Authority and H&M are Foursquare's launch partners; several restaurants in Foursquare's hometown, New York, are also offering deals. The deals are "pre-loaded" onto the shopper's Amex card through Foursquare's mobile app, sparing merchants from having to track stacks of coupons. But there is one way in which Foursquare's new deals approach is old-fashioned: It is a money-loser. Foursquare is not taking a cut. The company says its payoff will come later as it fine-tunes and expands the program.

Hot Women Don't Want to Pay for Dinner?

2011-06-27T14:59:00.000-05:00

It is a down economy. Men would rather go dutch on a date. Guys, I have bad news. The more attractive your date is (yes!), the less likely she is going to help cover the dinner bill (d'oh!). A British study — naturally — reveals that hot women do not think they should have to pay on a date. Less attractive women are more willing to chip in. Why?

But they are not worried about the expense - it is likely to be because they believe their date should pay for the pleasure of being with them, according to researchers at St Andrews University. The intriguing finding comes from a study of 416 men and women who were asked to rate themselves for attractiveness, ahead of going on a series of hypothetical dates. In each case, they were shown a picture of their ‘date’, told to imagine they had been for dinner together, and asked to decide who should pay for the meal. They could decide to pay for the entire meal, nominate their date to pay or choose to split the bill. The answers revealed that the good-looking women were less likely to want to contribute towards the costs. Handsome men were also reluctant to splash the cash.
Researcher Michael Stirrat said: ‘They quite literally bring more to the table, so they expect the other person to pick up the tab or expect to pay for the bill.’ Things, however, may change, if the man wants to impress. The study, published in the journal Evolutionary Psychology, showed that a man is more willing to pay for a good-looking woman. Dr Stirrat said: ‘When a man offers to pay for the meal he is to some extent saying “I’m interested, I’d like a second date, I’d like to see you again”.’

Who should really pay on a date? The article consulted etiquette experts who say the person who requested the date must cover the cost. I have a different question. If an attractive woman expects a man to pay for dinner, what does the man expect in return? Ah, my friends, they did not cover that in the survey, but I think we know the answer.

But with women, the opposite is true. The study found that a woman expects a good-looking man to pay for her, perhaps as a way of making him invest in their future. The researcher said: ‘When the woman lets the man pay for her, she is basically saying she’d like a second date.’ It also means that if a woman does insist on paying, or at least making a contribution, it may be a sign that the date has not gone well. Dr Stirrat said: ‘If he is less attractive, she’d rather split the bill.’

Overall, some 45 per cent of the women said they would expect their date to pick up the entire tab, compared with just 30 per cent of the men. The favoured scenario, with both sexes, was splitting the bill or ‘going Dutch’, something that goes against etiquette, according to Debrett’s. The authority on manners, style and taste says the task of paying the bill should fall to the person who set up the date – no matter what they look like. Debrett’s director David Miller said: ‘There is one abiding rule when it comes to it – the person who requests the pleasure, pays for the pleasure.

Which leads me to another shocking headline: Sex Can Kill You. Or at least give you a coronary. Tufts researchers found that sudden bursts of activity — like sex — make it 2.7 times more likely someone will have a heart attack. Exactly how did they monitor and measure that?? Still, frazzled housewives now have a better excuse for bowing out for the night than coming down with a headache. However, take heart. Your chances of avoiding a heart attack during sex improve if you get regular exercise.

Cops and Robbers... Now TSA and Taliban?

2011-06-25T14:59:00.001-05:00

As we hit the road for family vacations this summer to reunite with relatives and old friends, we brace ourselves. There is always someone we are forced to see whom we cannot stand. Maybe it is their politics, religion, lifestyle or hairstyle, but, inevitably, a heated debate blows up like lighter fluid around the backyard BBQ.
I fancy myself a peacemaker (which is a hollow lie, but whatever). What do I do to build bridges between opposing sides when everyone's supposed to be having a good time? I bring up the TSA. The TSA is one of those unifying forces, like bad gas or Anthony Weiner. Everyone can agree they do not like it. Which is not fair. I find 99 percent of TSA employees cheerful, vigilant, helpful; however, I also think urologists, proctologists, and oncologists are generally very good...but who wants to see one?

With that in mind, I am a little flummoxed at a toy being sold on Amazon.com called the Spy Gear Security Detector. For a mere $12.95 (on sale!), kids can finally stop playing cowboys and Indians and move on to TSA versus the Taliban. Or TSA versus the elderly grandmother with the walker who can't take off her shoes to go through the metal detector. "Protect your HQ with this handheld metal detector," the product pitch reads from manufacturer Wild Planet. "LED alarm alerts you when a metal object is found. Lightweight and portable."
This is what constitutes childlike fun?
I wonder if the toy is meant as a gag. Maybe a little. I might buy one for laughs. Amazon claims people who buy the Security Scanner often buy Wild Planet's Lie Detector Kit, too, a product I recommend to mothers wanting to "prove" their kids are lying—something they already know through their Mommy Super Powers of Lie Detection.
What's next? The Playskool Full Body Scanner cannot be far behind—the 21st century version of playing doctor. Maybe plastic bins from Mattel to put your kiddie laptop and belt in? A Leapfrog edition of The Patriot Act?

Dollar Store Renamed 75 Cent Store?

2011-06-16T02:41:00.000-05:00

This week's ad from discount retailer 99 Cents Only (NDN) takes a shot at Miami Heat star LeBron James. The offer, valid at Texas stores through Tuesday, calls for a discount to 75c "when you don't have a fourth quarter." James, who has faced intense criticism since leaving the Cleveland Cavaliers a year ago, failed to lead the Heat to an NBA title against the Dallas Mavericks and was derided by the media and fans for his lackluster 4Q performances.

Which Airports Have the Most Unfair Fares?

2011-06-14T08:21:00.001-05:00

What is a fair airfare?
Here is a hint: It is probably not the one you are paying if you are flying out of Newark, Cincinnati or Houston.

As I have been criss-crossing the country for work and for business, I am always intrigued as to how you can leverage airline market inefficiencies to your advantage. Thankfully others have done research on airlines, whose labyrinthine pricing schemes ensure that customers who are not prepared to exploit the pricing oddities will instead become the suckers.
Seasoned travelers know a few tricks — for instance, the best time to look for bargain airfares is often on the weekend — and I will aim to teach you a few more. But perhaps the most basic strategy is to know which airports tend to be relatively cheap or relatively expensive to fly to or from. For instance, while individual fares vary significantly, the average passenger flying out of Newark Liberty Airport pays about 25 percent more than someone flying out of John F. Kennedy International for an equivalent seat on an equivalent flight.
I am certainly not the first person to tackle this subject. Lists of the cheapest or most expensive airports usually appear a couple of times a year in major newspapers and magazines. The government also publishes extensive data on commercial airfares.
But some of these approaches suffer from flaws of various kinds. They may take a simple average of all fares at a given airport, for instance, which is problematic because each airport offers flights to a different mix of destinations. At LaGuardia Airport, for example, flights of over 1,500 miles are prohibited in most circumstances (that is why you can not find a nonstop flight from LaGuardia to Los Angeles), while Kennedy and Newark offer many long-haul flights. Conversely, the cities of the northwestern United States are relatively far apart, both from one another and from the rest of the country, so the average airfare into, say, Seattle is almost certainly going to be quite high. The question, then, is not where are the average fares highest, but where are they the most unfair.
I doubt anyone would dispute that it is fair for an airline to charge you more for traveling a longer distance, so distance is something we will need to control for. I would also argue that it is fair to charge you more for flying into or out of a smaller market where there is less demand for air travel. Fewer economies of scale are available in a place like that: the airline can run fewer profitable flights each day, so the costs of ground services like check-in and baggage handling will be spread over fewer passengers, and aircraft may be idle longer.
At the same time, smaller airports tend to be served by fewer airlines, and lack of competition can lead to higher prices; that isn’t fair to the traveler. Nor is it fair if your home airport is one like Memphis, where discount airlines like Southwest have had trouble breaking in to compete with full-fare carriers, despite years of trying. What we need is an approach that distinguishes airfares that are high because of monopoly pricing from those on routes that are legitimately expensive to fly.
The method that many have adopted to study this is a tiny bit involved — readers who are not statistically inclined may want to skip ahead to the charts of the results. The basis of the approach is data published by the Bureau of Transportation Statistics, which periodically releases a 10 percent sample of all domestic airline itineraries, including information on the fares paid. The particular files that were used come from the third quarter of 2010 and include data on, literally, millions of passengers.
The data required some cleanup. The reference study limited the analysis to round-trip tickets in which all segments were flown in coach (economy) class — the type of flights that most of us are interested in. They also eliminated itineraries where the passenger traveled outside the contiguous 48 states, had more than one stop (not counting layovers), or had different origin and departure airports. They removed fares that the bureau marked as being implausibly expensive (given the millions of records, these may have been data-entry errors) — or which were implausibly cheap. A big regression analysis was run that attempts to explain airfares based on several factors.
The first factor is the distance traveled — we use the distance from the origin airport to the destination as though it were a nonstop flight, whether or not there was a layover along the way (since the airline is not exactly doing the passenger a favor by routing her through, say, Baltimore on her way from Buffalo to Atlanta, increasing the number of miles flown).
Second is a variable representing the demand for travel at both the origin and destination airports. Demand is assumed to be a function of the number of origin-and-departure passengers that an airport handled (not counting passengers who passed through the airport on a layover), but with a modification for average ticket prices. In other words, if the average fare at an airport was high, the model assumed that more people would have wanted to fly there but were deterred by the cost, and if the average fare was low, that some passengers would not have flown if the fares had not been such a bargain. (Specifically, it assumes unitary elasticity — a 20 percent increase in fares results in a 20 percent reduction in travel — for which there is support in the empirical literature.) There are demand variables specific to both the airport and the metropolitan area; these variables are expressed as logarithms.
These two factors — distance to destination and size of market — are the ones we would propose can be fairly reflected in ticket prices.
The regression analysis also accounts for three other factors that have significant effects on pricing. These are, respectively:

The market share at the origin and destination airports held collectively by the five “legacy carriers” (United, American, Delta, Continental and US Air);
The market share held by Southwest Airlines; and
The market share held by the largest single carrier at that airport (for instance, Delta and its affiliates are responsible for about 66 percent of all traffic at Atlanta).

Prices are higher the more the legacy airlines dominate an airport, but they also tend to be a bit higher where Southwest has a large share as opposed to other low-cost carriers like AirTran and JetBlue. (Southwest is cheap, but it is not quite as cheap as some of these up-and-coming airlines and now represents something of a middle ground.) Also, prices tend to be higher when any one airline dominates an airport, regardless of whether it is a legacy carrier or a low-cost one.
These somewhat complex mechanics allow me to estimate what each airfare “should” have been assuming the airport had an average degree of competition between and among the legacy carriers, Southwest, and the other low-cost airlines. We can then compare these “should” fares to the average prices that passengers actually paid.
At Newark Airport, for example, it is estimated that the average fare should have been $382, given the itineraries that the passengers in the bureau sample traveled. However, the average round-trip fare that those passengers actually paid was $454 — a 19 percent markup above fair prices.
At LaGuardia Airport, by contrast, prices were more in line with market rates (the average ticket price was $338, as compared to a fair rate of $331). And prices were actually somewhat cheap at J.F.K. (average price $389; fair price $413). Passengers at Newark paid an average of 12 percent more than those at J.F.K. for their trips to Los Angeles, 49 percent more for those to Chicago, 65 percent more to Dallas, and 118 percent more to Washington, D.C.
The main reason for the discrepancy is probably that Continental Airlines dominates Newark Airport — it currently handles 63 percent of domestic passenger traffic there, not counting the 6 percent for United Airlines, with which it is in the process of merging. No one airline dominates either LaGuardia or J.F.K. to that extent.
Also, New York’s airports are somewhat inefficiently configured, with both J.F.K. and LaGuardia in the same general direction from Manhattan. Many passengers in north-central New Jersey face an unpleasant choice between commuting two hours in traffic to either J.F.K. or Philadelphia, where tickets are fairly priced, or paying the premium that the carriers in Newark are happy to extract.
Overpricing is not just a New York (or New Jersey) problem, though. Passengers in the middle of the country often bear the most burden, including many of those in the poorest parts of the United States:

The table above reflects the 15 most overpriced airports from among the 50 where the most passengers begin and end their air travel. Topping the list is George Bush Intercontinental Airport in Houston, where passengers paid a premium of $85 — about 24 percent — on the average round-trip coach ticket. (Flights to Houston’s older, smaller field, William P. Hobby Airport, were only $8 overpriced).
Next up was Newark. Then we see several other airports, like Minneapolis, Detroit, Cleveland, Dallas, and Washington Dulles, where one of the legacy carriers has a dominant share of traffic. O’Hare Airport in Chicago was expensive despite — or perhaps because of — two legacy carriers (American and United) having a hub there.
These, conversely, were the best airports for frequent fliers:

The unifying theme is vacation destinations, like Las Vegas and pretty much anywhere in Florida. It is important to keep in mind that the fares here reflect average prices. The legacy carriers often charge comparable fares to those of the discounters like Southwest when they have plenty of seats to fill, but when supply is short or the passenger books at the last minute, they may raise their prices several-fold. For instance, about 10 percent of economy-class round trips were sold at $750 or more by Continental, as compared to just 1 percent for Southwest.
This is a more viable strategy, however, for business destinations than for leisure ones. While a casual traveler can probably forgo a weekend in Las Vegas, a last-minute client meeting in Houston may be unavoidable (plus, someone else is probably paying for the ticket).
The most competitively priced destinations tended to be warm-weather cities. It’s hard to know whether this is because cities with nice weather attract a lot of price-sensitive leisure travelers, or perhaps because they entail less risk of delays and cancellations, which are as costly to the airline as to the passenger.

But there were some exceptions. General Mitchell International Airport in Milwaukee, for instance, was about $75 underpriced on average, the result of a fare war among several discount carriers. Buffalo — not known as a vacation haven, although it is close to Niagara Falls — is also a nice city for air travelers. While both Dulles and Reagan National Airports, dominated by legacy carriers, are overpriced, Baltimore/Washington International Airport, a Southwest hub, is more affordable.
Let’s take a quick look at the data for mid-size airports — those ranked between No. 51 and No. 100 in origin-and-departure traffic.

Perhaps the most unfairly priced airport in America is Northwest Arkansas Regional in Fayetteville. Economy-class round trip tickets cost an average of $527 there, $158 above fair rates.
The reason, no doubt, is because the traffic there is dominated by business travelers on their way to and from the headquarters of Wal-Mart in nearby Bentonville. Although Wal-Mart is famous for its sensitivity to prices, and has saved consumers billions of dollars over the years, its pricing power evidently does not extend to the air fares its executives and clients have to cough up.
Memphis, about 28 percent overpriced, is nearly as bad, because Delta controls about two-thirds of the passenger traffic and FedEx ties up a lot of the airport’s flight capacity with its shipping hub. (Memphis is the busiest cargo airport in the Western Hemisphere.)
Another overpriced airport is Cincinnati/Northern Kentucky International, a former Delta hub that no longer gets as much layover traffic, but where Delta still has a 75 percent market share.
Almost every airport in this part of the country, in fact — Little Rock, Knoxville, Huntsville, Oklahoma City — is significantly overpriced. This is also the United States’s poorest region; in their own small way, expensive airfares are probably hampering the area’s economic development.
The cheapest midsize airports, meanwhile, are again those associated with leisure travel. Atlantic City, with an average round-trip fare of just $157, will leave you with plenty of money to blow at the craps table.

Finally, the research reports has tracked the data for all 230 airports that serve more than about 100 origin-and-departure passengers a day. If you are flying out of an airport smaller than the top 100, you are probably paying a premium to do so. Even accounting for the fact that these are small markets with low demand, they still tend to be overpriced, as they are usually dominated by one or two legacy carriers who will charge you a premium to fly you to their nearest hub.
Passengers in areas far from large cities — like La Crosse, Wis., or Minot, N.D. — tend to be the worst affected. But even airports like the one nearest to where I grew up in Lansing, Michigan (about $117 overpriced) can go through a death spiral of sorts.
Lansing is within a reasonable driving distance of Wayne County Airport outside Detroit, so relatively few people will choose to fly from Lansing unless its fares are competitive with Detroit’s. The airlines, rightly or wrongly, may take that trend to signify a lack of demand, and may cut service, with further price increases on the remaining flights. Before long, the only passengers who regularly fly out of an airport like Lansing are those who are extremely insensitive to price, creating a semi-stable equilibrium of limited but very expensive service.

Still, there are bargains to be found at a handful of small airports, and those airports tend to have something in common: the legacy carriers want nothing to do with them.

Among the 10 airports listed above, the legacy airlines accounted on average for just 12 percent of passenger traffic. In many cases the alternative is Allegiant Air, a small carrier that has a dominant presence in 8 of these 10 airports and which sells many tickets at what amounts to a 50 percent discount below prevailing rates.
Allegiant Air, despite this, is significantly profitable, which suggests that the small-airport death spiral can be avoided. Surprisingly to no one but the legacy carriers, far more customers may be willing to use your service when you are willing to charge them a fair price.
Note that airfares have risen since this data was collected. However, the relative fares charged to fly to or from different airports are usually quite stable in comparison with one another.

The Airport Checkpoint of the Future?

2011-06-12T08:18:00.008-05:00

IATA unveiled a mock-up of an airport checkpoint of the future—designed to enhance security while reducing queues and intrusive searches—that relies on intelligence-driven, risk-based measures. Speaking at IATA's AGM in Singapore, DG and CEO Giovanni Bisignani said the concepts behind the checkpoint are based around focusing resources where risk is greatest. IATA envisions supporting this risk-based approach by integrating passenger information into the checkpoint process, and maximizing throughput for the vast majority of travelers who are deemed to be low risk with no compromise on security levels.
“Today’s checkpoint was designed four decades ago to stop hijackers carrying metal weapons,” said Bisignani. “Since then we have grafted on more complex procedures to meet emerging threats. We are more secure but it is time to rethink everything. We need a process that responds to today’s threat. It must amalgamate intelligence based on passenger information and new technology. That means moving from a system that looks for bad objects to one that can find bad people.”
The checkpoint of the future will have three lanes—known traveler, normal and enhanced security. Which lane the passenger uses is determined by a biometric identifier in the passport or other travel document that triggers the results of a risk assessment conducted by the government before the passenger arrives at the airport.
The primary identification check will be an iris scan of all passengers. Those who are categorized as a “known traveler,” who have registered and completed background checks with government authorities, will simply walk through the tunnel that uses x-ray and conducts metal and liquid scans. A “normal traveler” will also get a shoe and explosive trace scan while those who require an “enhanced” screening will get an advanced x-ray and full body scan.
ICAO and 19 governments, including the U.S., are now working to define standards for a checkpoint of the future (ATW Airport's Today, March 7). “We have the ability to move to the biometric scanning and three-lane concept right now. And while some of the technology still needs to be developed, even by just re-purposing what we have today we could see major changes in two or three years’ time,” said Bisignani.

The Hidden Cost of Airport Security

2011-06-10T08:09:00.000-05:00

I recognize that the outcry over the T.S.A.’s new security procedures — which has been both broad and deep in technology, travel and political blogs, but which has been less acute elsewhere in the country — has a bit of a Brooks Brothers Riot quality to it. That is because its effects are felt most manifestly among those relatively few Americans who have the means to travel (and the wherewithal to write about it). Nevertheless, this is more than just some sort of wedge issue for yuppies with wanderlust: there are real and quite tangible consequences stemming from the procedures that the T.S.A. chooses to implement.
Consider what happens, for instance, when travelers are inconvenienced by a new security procedure. Yes, most of them will simply pass through the new body-scanners without incident, buy a snack at the Cinnabon, and go on their merry way. But others will do something different: they will be sufficiently annoyed by the procedures that they will decide not to travel by air the next time they have the choice.
In the past, more cumbersome security procedures have had deleterious effects on passenger demand. A study by three professors at Cornell University found, for instance, that when the T.S.A. began to require checked baggage to be screened in late 2002, it reduced overall passenger traffic by about 6 percent. (You can actually see these effects a bit when looking at the air traffic statistics: passenger traffic on U.S.-based airlines dropped by about 6 percent from the fourth quarter of 2002 to the first quarter of 2003 — greater than the usual seasonal variance — even though the economy was recovering and travelers were starting to get over the fear brought on by the Sept. 11 attacks.)
More stringent security procedures, in essence, function as a tax upon air travel, and produce a corresponding deadweight loss. Teleconferences are often a poor substitute for person-to-person interaction, and when people are reluctant to travel, some business deals do not get done that otherwise would have. Recreational travelers, meanwhile, may skip out on vacations that otherwise would have brought them pleasure and stress-relief (while improving revenues for tourism-dependent economies). The tenuous profits of the airline industry are also affected, of course. Revenue losses from the new bag-checking procedures may have measured in the billions, according to the Cornell study.
Other passengers may substitute car travel for air travel. But this too has its consequences, since car travel is much more dangerous than air travel over all. According to the Cornell study, roughly 130 inconvenienced travelers died every three months as a result of additional traffic fatalities brought on by substituting ground transit for air transit. That is the equivalent of four fully-loaded Boeing 737s crashing each year.
The effects could run in the opposite direction, of course, if new security procedures made passengers feel more secure about air travel — and therefore more willing to fly. As Anil Dash points out, even if one takes the cynical view that full-body scans are a type of “security theater”, and have little tangible effect on deterring terrorism, the mere act of making travelers feel safer may in and of itself be beneficial.
The Cornell data suggest, however, that travelers may tell pollsters one thing, and behave in a different way. Polls in 2002 and 2003 found that most people thought the new procedures were indeed making air travel safer — just as most people now say they favor the full-body scans. Despite this, there was a material reduction in air travel: inconvenience outweighed security for quite a few passengers when push came to shove.
The new full-body scans could have similar effects. In addition to making some travelers feel as though their privacy has been compromised, they require more time per traveler than traditional metal detectors to do, which could have unpredictable effects at check-in points that are already stretched to capacity at many airports. At the home airports that I have traveled out of for the last several years — Dallas Fort-Worth and Washington D.C.'s two airports — the T.S.A. really seemed to have gotten the hang of the “old” procedures, processing the security lines efficiently and usually getting everyone through after just a few minutes of waiting. (Although I would not recommend this behavior, I have fairly often arrived at the airport no more than 30-50 minutes in advance of a domestic flight, and have never missed one flight.) Now, that balance may be upset.
Finally, one should consider the implicit message that the full-body scans conveys to travelers. The explicit message is that the T.S.A. is doing everything in its power to keep us safe — something which might increase confidence in air travel. Many travelers, however, might read between the lines in the following way: the T.S.A. is making us go through all this rigmarole because otherwise air travel would be very, very dangerous; terrorists might be hiding explosives in their underpants! (Among other places.) One can draw an analogy, for instance, to the new security cameras that the city of Chicago has been installing: they are deliberately designed to be conspicuous, since the cameras are accompanied by extremely vibrant blue police lights — and they may well decrease crime. But they only appear in marginal neighborhoods that were susceptible to high crime rates to begin with. The explicit message is that the Chicago Police Department is doing what it can to keep everyone safe. The implicit message is that it is doing so because this is a really dangerous neighborhood — and perhaps you should be buying your condo, or planning your wedding reception, somewhere else.
How the new security procedures affect demand for air travel overall is hard to gauge. And of course, if they indeed prevent another terrorist attack, the upside would be quite significant, since few events would do more to reduce air travel than another 9/11.
But there is an argument that the T.S.A. deliberately ought to be instituting the new procedures slowly and selectively in order to provide for a sort of natural experiment. It is one thing to cite the polls, which indeed show most Americans in favor of full-body scans. But if, for instance, Chicago O’Hare installs new machines and Chicago Midway does not, and passenger traffic at O’Hare drops by 9 percent while traffic at Midway holds steady, that would provide considerably more tangible evidence of how travelers are reacting to the new protocols than polls ever could.

It's Mapnificent!

2011-06-08T07:46:00.002-05:00

STEFAN WEHRMEYER, a 23-year-old German programmer, has developed a Google Maps application called Mapnificent (harhar). It's pretty cool: it shows you the places in your city that you can reach in a given amount of time using public transport. This, for example, is a map of the places you can get to from the White House within 15 minutes:

Barack Obama, of course, gets around quicker (via motorcade) or a lot slower (if he ever decided to take the Metro). But Mapnificent has some even cooler features—including some that are genuinely useful for planning business meetings or social events. I especially like the feature that lets you look at two intersecting time-based-maps and find coffee shops (or bars, or restaurants, or whatever) within, say, 15 minutes of two different locations. I'll let Mr Wehrmeyer explain:

Mapnificent from Stefan Wehrmeyer on Vimeo.
More transport agencies should make their data available openly online so that programmers like Mr Wehrmeyer can develop these sorts of useful tools. And down the road, it'd be great to see public transport agencies really embracing the digital age and hiring smart young programmers and information technology experts to continually improve and expand their online and mobile reach. The easier it is to get information about public transportation, the more people will use it. That's better for the environment, keeps cars off the streets, and encourages denser, more pedestrian-friendly development—and shorter commutes. Huzzah! Check out Mapnificent (it's in public beta for most major American cities and a handful of others around the world) and let us know what you think in the comments.

Don't Know Which Bottle to Pop? There's an App for That!

2011-05-16T12:17:00.000-05:00

A new mobile application allows less-savvy wine consumers to scan bottle bar codes to get instant tasting notes, scores and food pairings. The free app, called Natalie MacLean Wine Picks & Pairings, works by snapping a picture of any bottle label's bar code to access a database of 150,000 wines at liquor stores across the United States and Canada.
The app is the first of its kind that actually scans bar codes to search wines, instead of having to type in various descriptors. The new scanning capability of the wine app is currently only available on iPhones but the company expects that BlackBerry users will be able to upgrade to the new version within a couple weeks.
Older versions of the app -- which also feature a virtual cellar, journal, and Facebook and Twitter integration -- have been out for more than a year. The app's popularity has surged since it launched. Currently there are over 100,000 users, a number MacLean anticipates will rise.

Retooling America

2011-05-09T08:15:00.002-05:00

Here's some interesting facts that support we as Americans really do need to focus on our "Thought Skills" in order to be competitive in the global economy. We really don't produce tangible goods here in the States. I always joke, that we really only produce J.D.'s and M.B.A.'s. HA! The fact is, the quality of these guys aren't even THAT good. :-\. If we Americans do not step up our game as a thought leader, we will continue to lose our global competitive edge.

Rock On,
- Mark

(From: http://equedia.com/blog/view.php/view.php/Age-of-America-Over)

19 Facts About The Deindustrialization Of America That Will Blow Your Mind

#1 The United States has lost approximately 42,400 factories since 2001.

#2 Dell Inc., one of America's largest manufacturers of computers, has announced plans to dramatically expand its operations in China with an investment of over $100 billion over the next decade.

#3 Dell has announced that it will be closing its last large U.S. manufacturing facility in Winston-Salem, North Carolina in November. Approximately 900 jobs will be lost.

#4 In 2008, 1.2 billion cellphones were sold worldwide. So how many of them were manufactured inside the United States? Zero.

#5 According to a new study conducted by the Economic Policy Institute, if the U.S. trade deficit with China continues to increase at its current rate, the U.S. economy will lose over half a million jobs this year alone.

#6 As of the end of July, the U.S. trade deficit with China had risen 18 percent compared to the same time period a year ago.

#7 The United States has lost a total of about 5.5 million manufacturing jobs since October 2000.

#8 According to Tax Notes, between 1999 and 2008 employment at the foreign affiliates of U.S. parent companies increased an astounding 30 percent to 10.1 million. During that exact same time period, U.S. employment at American multinational corporations declined 8 percent to 21.1 million.

#9 In 1959, manufacturing represented 28 percent of U.S. economic output. In 2008, it represented 11.5 percent.

#10 Ford Motor Company recently announced the closure of a factory that produces the Ford Ranger in St. Paul, Minnesota. Approximately 750 good paying middle class jobs are going to be lost because making Ford Rangers in Minnesota does not fit in with Ford's new "global" manufacturing strategy.

#11 As of the end of 2009, less than 12 million Americans worked in manufacturing. The last time less than 12 million Americans were employed in manufacturing was in 1941.

#12 In the United States today, consumption accounts for 70 percent of GDP. Of this 70 percent, over half is spent on services.

#13 The United States has lost a whopping 32 percent of its manufacturing jobs since the year 2000.

#14 In 2001, the United States ranked fourth in the world in per capita broadband Internet use. Today it ranks 15th.

#15 Manufacturing employment in the U.S. computer industry is actually lower in 2010 than it was in 1975.

#16 Printed circuit boards are used in tens of thousands of different products. Asia now produces 84 percent of them worldwide.

#17 The United States spends approximately $3.90 on Chinese goods for every $1 that the Chinese spend on goods from the United States.

#18 One prominent economist is projecting that the Chinese economy will be three times larger than the U.S. economy by the year 2040.

#19 The U.S. Census Bureau says that 43.6 million Americans are now living in poverty and according to them that is the highest number of poor Americans in the 51 years that records have been kept.

A Solution to NFL Negotiations

2011-05-07T13:29:00.000-05:00

I saw this recently on another blog that I frequent and thought it too interesting an idea to not re-post.

When two sides are negotiating over something that spoils forever if it doesn't get shipped, there's a straightforward way to increase the value of a settlement. Think of it as the net present value of a stream of football...Any Sunday the NFL doesn't play, the money is gone forever. You can't make up for it later by selling more football--that money is gone. The owners don't get it, the players don't get it, the networks don't get it, no one gets it.The solution: While the lockout/strike/dispute is going on, keep playing. And put all the profit/pay in an escrow account. Week after week, the billions and billions of dollars pile up. The owners see it, the players see it, no one gets it until there's a deal.Seeing and counting money you don't get to touch is a very different story than merely imagining the money you didn't get to touch, money that's gone forever... Change the story, change behavior.The alternative (if you don't do this) is that down the road, instead of announcing a deal where everyone gets a windfall, you are forced to announce a deal where everyone already starts way behind where they would have been in the first place. That money is gone forever, no one gets it back. The problem with the game of chicken is that someone has to lose.I'm not even a football fan, but this seems like a clear way to both maximize value and minimize the damage to all those involved. Especially players with short careers and those fans with nothing to do on Sunday afternoons.

Sell in May and Walk Away?

2011-04-29T04:46:00.028-05:00

A wobbly stock market facing pressure from numerous sides could be setting itself up as a victim of one of the oldest market dangers: Sell in May and Go Away. The trend, in which early gains start evaporating as investors leave for summer vacation and shed their positions, poses danger especially when the market has a fast start to the year. That has been the case for 2011 and its sizzling first quarter.

Combine that with the recent threat of a debt downgrade from Standard & Poor's, a parabolic surge in commodity prices, and the imminent exit of the Federal Reserve from its liquidity policies — and the inclination to subscribe to the old maxim becomes hard to resist.
There is almost an embarrassment of riches for potential things to go wrong, a "perfect storm" of market danger: High stock valuations compared to book value, unrest in the Middle East, and overheated market sentiment further amplify the risks of the other aforementioned factors.
The fears are shared among market bears who feel the flat market of the past seven weeks will become a down market as the sell-in-May trend takes hold. For the summer, we recommend investors be extremely picky, in most cases turn to cash and cash-equivalent assets such as short-term Treasurys until the selling passes.
May historically has been a tricky month for stock market investors, market cliches aside.
Since World War II the month has brought seven pullbacks—more than any other—with a modest return of 0.3 percent, which ranks it eighth out of the year's 12 months, according to Standard & Poor's.
The threat of a rating cut is likely to fuel more concern that May could be a rough month.
There have been a lot of headwinds that the market has been able to withstand and continue forward progress. But now that we have the downgrade of the outlook for the U.S. and earnings that are not exactly knocking the cover off the ball, investors are probably thinking that maybe we have overanticipated good things to occur during this first half.
What's more, the market has not seemed to price in the end of the Fed's Treasury-buying program, often referred to as quantitative easing. The second leg of QE, which has entailed another $600 billion in government debt purchases, wraps up in June and will take a sizeable chunk of liquidity out of the market. Also, the Federal Reserve delivers its next policy decision April 27, which will coincide with the first post-Open Market Committee news conference from Chairman Ben Bernanke, an event that journalists are looking forward to but some investors are dreading.
We the market heading for some crucial tests of support and resistance levels that may coincide with the historical May selling period. Key levels for the Standard & Poor's 500 will be about 1,370 on the topside and then around 1,200 on the way down. A breach would signal longer-term movements in that direction. The prospect of a difficult May could prove a boost to Treasury prices and provide another leg up for commodities, where gold briefly topped $1,500 an ounce Tuesday. Markets these days are so driven by high-frequency momentum trading that any sustained slide in the market could snowball and accelerate the sell-in-May trend. An unexpected event when everything is priced to perfection could be something that really triggers quite a big fall and we keep going. These are computer programs going here, but those guys are not long-term buyers. They are not buy-and-hold candidates. You have a lot of nervous money in here.

Buy The Heck Out of Citi

2011-04-27T04:42:00.012-05:00

Although Citigroup (C) posted a quarterly profit narrowly beating Wall Street forecasts last week, I am bullish on the stock. The bottom line is this was a very encouraging quarter, if you are looking for accelerating future revenue growth.
I think this stock will be one of the best performers going forward for the remainder of the year. While the big positive in JPMorgan (JPM) and Bank of America (BAC) earnings was commercial loan growth, Citi enjoyed strong retail loan growth. Total retail loans grew 11 percent, and 22 percent in Latin America and 16 percent in Asia.

$70,000 Can Buy You A Country... For A Night

2011-04-25T16:35:00.000-05:00

Being FiPod readers, you have rented palaces, mega yachts, even an island. How about renting a country? For $70,000 a night with a two-night minimum and a very strict cancellation policy, you can rent Liechtenstein. Yes, the entire country. You can rent the country for a conference, a party - whatever you drum up for you and your 900 closest friends.
Now, if you are forgetting your high school geography, Liechtenstein is a tiny Alpine country - population 35,000 - tucked between Austria and Switzerland. So what to do with your own nation? Well, how about starting with a wine tasting at the prince's estate while watching your own fireworks show. You want to make this a very personal experience? You can rename the city streets and town squares as you wish and even print your own temporary currency with your face on it. Now, if you do decide Liechtenstein is the perfect place for your party, please do not cause too much of a ruckus. The nation has only a handful of police officers and no military.

10 Deadly Sins of Inflation

2011-04-12T12:27:00.004-05:00

While my comments last month focused on the positives of inflation, at least from the governments perspective, its long term and overall effects are always negative. The only reason it gains any traction in government is because it has various positives in the short term for bureaucrats and politicians, which I detailed last month. Aside from the fact that last month’s inflation positives are negatives for other than government and debtors, let’s review some more negatives:

It discourages investment and erodes savings thereby making planning and budgeting by individuals and industry hesitant and uncertain.
It causes an allocation of more capital into non-productive assets such as gold, collectibles, land, etc.
It causes hoarding and speculation which leads to price distortions, i.e. it is self- perpetuating.
It erodes peoples’ pensions and retirement savings so they cannot afford to retire. Those already retired face a reduced quality of life or becoming Wal-Mart greeters.
It leads to tax bracket creep for individuals increasing their tax rates in addition to the total tax amount.
It increases labor strife and disruptions as wage negotiations make unions more importance to workers.
It causes an inefficient allocation of resources resulting from the constant need to raise prices, which is also costly, e.g. restaurant menus.
It leads to speculative borrowing which increases investors’ risk as well as overall systemic risk for the financial system.
It invariably leads to an economic contraction when government decides the negatives outweigh the positives. They do this through raising interest rates and shrinking the money supply.
As inflation drives up interest rates, the cost to the federal government of financing a $14 trillion debt at say 6% becomes $840 billion a year – the amount of the entire budget not so long ago. This alone would be a $350 billion increase in federal spending over the cost today, which shows just how marginal is the current debate over getting $100 billion in annual budget cuts.

The consequences of inflation for the federal government are a host of new problems, usually involving the spending of more money to counter the economic contraction they caused in the first place. But then, this is the history of government actions, a high percentage of which are directed at remedying past policy mistakes. Individual investors need be pro-active if they wish to avoid the consequences of inflation.
Our recommendations for asset allocations are:

25% in adjustable interest rate debt securities
30% in stock market sensitive issues, i.e. convertible stocks and high dividend paying blue chip stocks
20% in energy securities and master limited partnerships
15% in high dividend paying special purpose closed end funds, i.e. commodities, energy, adjustable rate debt and stocks
10% in gold, silver and platinum ETFs

As this plays out monetary velocity, i.e. the frequency money turns over, will increase giving us the moderate inflation Ben is hoping to induce. The problem with this hopeful scenario is that the rate of inflation will likely be much higher than desired. The Fed’s plan would be that once the desired inflation level is reached, they will begin selling off the $600 billion in treasuries they acquired under QE2. Such sales will decrease the money supply, the first shoe to the inflation equation. This will also have the effect of driving long term interest rates even higher in the search for buyers. It will also have little effect on the velocity of money, which should actually increase even more as the increase in interest rates fuels even more inflation angst.
The Fed has little or no influence on the velocity of money short of raising short-term interest rates to a level that causes an economic slowdown or recession. Even then, if they don’t play it right, they can get their economic slowdown and still have inflation (better known by the term ‘stagflation’.)
Even those who try to protect themselves against inflation by buying TIPS and other adjustable rate securities find their refuge is limited by the fact that government decides how much inflation to report. By excluding such essentials as food and fuel from the CPI (called core CPI) they miss much of the real cost of living. This is especially so since housing is 42% of the overall CPI index, but becomes 51% of the core index when food and energy is stripped out. Given this distorted percentage for housing which continues to decline, don’t expect core CPI to give a realistic reading anytime soon. It has been reported that if inflation today was measured as it was in the 1980’s we would be reporting a rate of 9% rather than 1.4%. Hint, you may want to avoid treasury TIPS, which are tied to core CPI.
To make matters worse, through what is termed hedonic adjustments, the government makes subjective judgments about product equivalents (i.e. a computer today may cost more but, is 4 times better than one sold five years ago; ergo in their calculation, the price actually declines! The fact that you don’t use or need the snazzy new features is irrelevant.) It is such data manipulation which allows politicians to have inflation while by-passing mandated budget cost increases tied to the CPI.

Coming Soon to Theaters: Double-Digit Rent Hikes

2011-04-10T12:03:00.011-05:00

Renters beware: Double-digit rent hikes may be coming soon.

Already, rental vacancy rates have dipped below the 10% mark, where they had been lodged for most of the past three years. The demand for rental housing has already started to increase as young people are starting to get rid of their roommates and move out of their parent's basements. By 2012, we predict the vacancy rate will hover at a mere 5%. And with fewer units on the market, prices will explode.
Rent hikes have averaged less than 1% a year over the past decade, according to Commerce Department statistics, adjusted for inflation. Now, rents are expected to spike 7% or so in each of the next two years -- to a national average that will top $800 per month. In the hottest rental markets, the increases will likely top the 10% mark annually for the next couple of years. In San Diego, rents are anticipated to rise more than 31% by 2015. In Seattle rents will climb 29% over that period; and in Boston, they may jump between 25% and 30%.
This is a sharp change from the recession, when many Americans could not afford to live on their own. More than 1.2 million young adults moved back in with their parents from 2005 to 2010. Many others doubled up together. As a result, landlords had to reduce prices and offer big incentives to snag renters. Now that the recession is easing, many of these young people are ready to find new digs, mostly as renters, not owners. Plus, the foreclosure crisis continues unabated, and the millions losing their homes are looking for new places to live.
Apartment developers many not be able to keep up with this heightened demand, which will force prices upwards. There will be an envelope of two or three years when the rise in demand for rentals will exceed the industry's ability to meet it. Plus, there has been a shift in the American Dream. We are learning from surveys that a huge proportion of people are choosing to rent. They have experienced the downsides of homeownership -- or seen friends and family suffer -- and do not want to take the risks or pay the higher costs of homeownership.
Where homeownership costs are particularly high, there are many more renters than owners. In Manhattan, for example, only about 20% own their homes; in San Francisco, about of third of the population does; in Los Angeles, less than 40%; and in Chicago, about 44%. There is one factor that could rein in rent increases: the huge number of foreclosed homes that could hit the market over the next few years. In many markets, like Phoenix and Las Vegas, there are neighborhoods filled with recently built, single-family homes going for fire-sale prices. When the cost of owning homes falls well below the costs of renting them, more people will buy. That has always been the biggest competition for rentals.

Reaching 7 Figures: Part 3

2011-04-08T12:54:00.031-05:00

By now, you are almost up to speed on all three levers that it takes to become a millionaire. In fact, you can probably smell it from where you are at. The third lever, investing, is much more difficult to forecast. Always save the most difficult for last.

Say your goal is to have a million in less than 20 years, that you have $250,000 put away and that you are taking great pains to save $30,000 a year. Even at that aggressive pace, you would not hit your deadline if your portfolio simply kept up with inflation. However, if you earned a modest 1% a year after inflation, you would get to the equivalent of $1 million today in 18 years ($1.7 million in nominal dollars). Every percentage point shaves off a little more time. Of course, the strategies that promise the greatest potential returns also present the greatest potential for loss so you will want to avoid serious long shots like buying manganese futures or trading the Thai baht. A few saner strategies, in ascending order of risk:
SAFE BET: Cut your costs.

The returns you collect from mutual funds will always be hampered by the expenses you pay. Do not think reducing costs makes much of a difference? Vanguard ran a series of simulations to see how various asset mixes are likely to perform over the next 20 years. Turns out, a typical 60% stock/40% bond portfolio, charging 1.25% a year, has a great probability of generating at least 5% annually over the next two decades. At that rate -- assuming 3% inflation, current savings of $250,000 and additional contributions of $15,000 a year -- you would get to a million in 23 years. But if you were able to boost those returns to 6%, which you could do by reducing portfolio costs to 0.25%, you would make it in 20 years.
You can easily create a 60/40 portfolio with an overall expense ratio under 0.25%. For example, put 40% in Schwab Total Stock Market Index (SWTSX) (expense ratio: 0.09%), 20% in Vanguard Total International Stock (VGTSX) (0.26%) and 40% in Vanguard Total Bond Market (VBMFX) (0.22%). All three are recommended mutual funds and ETFs.
Wondering if you could not achieve similarly positive results simply by picking better funds? Good luck consistently finding managers that will consistently outperform the market.
LESS SAFE BET: Tilt toward small bargains.
In this strategy, you would keep your overall stock-to-bond split the same. You would just move some of your equity allocation out of big blue chips and into small-cap value stocks -- shares of small companies that are being overlooked or once-larger companies that have fallen on hard times and are selling at attractive prices. Between July 1927 and the end of last year, the average small-cap value stock gained more than 14% annually vs. 9.8% for the S&P 500.
It is not all roses, however: Such stocks tend to be more volatile than your garden-variety blue chip because they have either been battered or lack competitive advantage. Also, there have been long stretches when they have been out of favor, such as the mid- to late 1990s. Finally, since these shares have returned nearly three times as much as the broad market over the past decade, it is hard to imagine they can keep churning out outsize gains -- at least in the short run. But in the long term there is no reason to believe small-cap values will not sustain their advantage.
So if you have at least two decades to invest, gradually shift small amounts from large-caps into small value through a fund like T. Rowe Price Small Cap Value (PRSVX). Do so until the shares are a quarter of your equity allocation, and history says you will see a real impact. Since the late 1920s, a 60% stock/40% bond portfolio with this small-cap value tilt returned 9.7% a year, while a traditional 60/40 index portfolio returned 8.7%. With that edge, in 25 years you would turn $200,000 into $970,000 in today's purchasing power vs. $770,000 without the small-cap bent.
RISKIER BET: Step up your stock stake.
History shows that the simplest thing you can do to boost long-term investment performance is to dial up your equity exposure. Since 1926, the average 50% stock/50% bond portfolio gained 8.2%. Raising the stock stake just a bit, to 60%, would have resulted in annualized gains of 8.7%.
There is a trade-off, of course: The more you tilt toward stocks, the higher your chances of losing money in a single year. A 50/50 portfolio has lost value in 17 calendar years since 1926; a 60/40 has fallen 21 times; a 70/30 sank in 22 years; and an 80/20 dipped in 23. You will suffer the most if the market dives near the end of your time horizon, since you will not have a chance to recover. For example, if you entered 2008 the last year the market suffered losses -- with $1 million, you'd have had $798,000 at the end of the year with a 60/40 mix. Were your portfolio instead invested at 50/50, your million would have ended up at $840,000. So even if you think you can handle a greater stock exposure now, be sure to reduce the percentage as you approach your goal date.
RISKIEST BET: Leverage your equities.
Yale professors Ian Ayres and Barry Nalebuff think there is a problem with how we invest. When you are young and can tolerate being all in equities, you do not have much money. When you are older, you may want to be only 50% in stocks, but in dollar terms that dwarfs how much you had in the market in your youth.
Therefore, the duo have controversially posited that young investors -- those in their twenties and thirties -- should leverage their equity positions, sometimes by as much as 2 to 1. In other words, if you have $20,000 to invest, not only should all of that go into stocks, but you should borrow an additional $20,000 so you have $40,000 in equity exposure. Ayres and Nalebuff crunched the numbers going back to 1871 and found that over a lifetime this strategy consistently beat the traditional 110-minus rule (where you subtract your age from 110 and put the resulting percentage in stocks). Their method resulted in accounts 14% larger, on average. Even in the worst case, their approach came out ahead by 3%.
These professors are not talking about taking a flier on a single stock. They recommend investing in the broad market, which you can do using a margin account at your brokerage to buy an index fund or ETF. Or you can leverage your bets through options contracts that give you the right to buy or sell an index, such as the S&P, in the future. You would reduce your stock exposure as you age. In fact, the extra risk you take in your twenties and thirties would allow you to be even more conservative -- possibly keeping as little as 20% in equities -- toward the end of your career.
There are, of course, caveats: While the profs say that someone in his forties could still benefit by leveraging -- say, 1.2 to 1 -- older folks or those with a time horizon of less than 20 years should think twice about trying this strategy. Leverage will magnify any losses you suffer in equities. And that could put you in dire straits if your brokerage issues a margin call, meaning it requires you to sell some of your holdings because your account value is too low. (This is also a risk for young people, but less dire.)
Finally, if you work in a volatile industry where your future income looks shaky, you cannot afford this type of risk. But if you have got a stable job and decades to invest? It may just make you a million bucks.

Reaching 7 Figures: Part 2

2011-04-06T12:47:00.000-05:00

Two days ago we began the first in the three part series of describing the levers that you need to pull in order to become a millionaire. Today we delve into how much you actually save. Now we know that saving, like exercising, is not really fun at first. However, you can view them as very good analogies. In exercise, you can devise the most optimal splits between cardio and weight training. But if you only go to the gym for six minutes, it will not really help you that much. The same holds true for saving.

Let's say you have 20 years to invest and $250,000 already amassed. You can see from the table at right that boosting your annual savings from a modest $5,000 to an aggressive $20,000 could increase your chances of hitting $1 million in today's dollars -- $1.8 million nominally in 2031 -- from 31% to 67%, assuming a 60% stock/40% bond portfolio. If instead you kept your savings rate the same but upped your stock allocation to 80%, your chances of success would be less than fifty-fifty.
Savings may be the safer bet, but it is often the tougher task. Here are four ways to crank up the amount you're banking per year, in ascending order of difficulty.
EASY: Use other people's money.
You have heard this before, but it bears repeating: The simplest way to boost your savings is to max out your 401(k) match, since that's a hand-out from your employer. Say you make $100,000 and save 3% of pay. If you are eligible to receive 50¢ on the dollar for the first 6% of salary deferred a common match you would be leaving $1,500 a year on the table.
Tax-advantaged accounts like 401(k)s and IRAs also allow you to build wealth faster, in that case by putting Uncle Sam's money to work for you. On the same salary, by contributing $10,000 annually to a 401(k), you would immediately reduce your income taxes by $2,800, assuming you are single and in the 28% bracket.
For now you can think of it as saving the equivalent of $10,000 while ponying up only $7,200. But even after paying taxes at withdrawal, you would still come out ahead in most cases thanks to tax-deferred compounding at a 6% annual return, you would be up by $1,600 a year if you had been socking away $10,000 for 15 years. (This is why we assume that you will use tax-deferred accounts as well as tax-efficient investments such as index funds to avoid the drag of taxes on your returns.)
A LITTLE HARDER: Bump up savings systematically.
The easiest way to save is to put as much of your savings on autopilot as you can. A decade ago University of Chicago economist Richard Thaler devised a 401(k) plan feature that allows workers to preset future contribution hikes -- that is, it lets them specify in advance how much they want to ratchet up savings. A 2007 study found that those who used this option boosted contribution rates from less than 4% to nearly 14% in about 3½ years' time. Those who did not barely changed their deferrals. Today half of large employers offer this type of feature, reports Hewitt Associates. If your company is among them, use the tool to step up contributions.
A $2,000 bump will feel like only $55 more per biweekly paycheck thanks to the tax benefit. And with the money tucked into savings, you will be forced to adjust your spending. Your plan does not offer this option? Partner up with a co-worker, put a date on your calendars, and remind each other to call HR that day.
HARDER STILL: Live on last year's budget.
After the market crashed in 2008, retirees were commonly advised to forgo inflation-adjusting withdrawals on their nest eggs for a few years, to give their accounts time to heal. People who are working can adopt the same strategy with savings rates.
Say you earn $90,000 a year and save $9,000 of it. That means you "spend" $81,000 a year on discretionary items (such as entertainment and travel), non-discretionary items (mortgage, utilities), and taxes. Let's also assume your pay climbs 2% annually for the next five years. Your $90,000 salary will rise to more than $99,000. But if you were to increase your "spending" each year only enough to cover the additional taxes you would owe, you would be able to save an increasing amount every year -- for a total of $15,000 by year five.
The challenge here, and the reason this falls under "harder still," is that if inflation rises faster than the long-term historical average of 3% -- as some economists fear -- you would really have to trim your spending. This plan may not be feasible in any case if you have a medical condition, what with health care costs expected to continue outpacing income growth for the next several years.
HARDEST: Boost your income.
There is only so much you can save on a given salary. At some point, the limits of austerity (you have to buy new clothes sometime!) and the impact of inflation will make it impossible to squeeze more out of your budget. When that happens, your only option is to increase your income.
Landing a higher-paying job would be one way to up your income. But since that promises to be challenging in today's tight labor market, bringing in income beyond your full-time job may be a more optimal choice. If you have the capacity to do consulting work in the evenings or on weekends, even a small project could help you boost yearly savings by $10,000 or so. Plus, this would allow you to save more tax-deferred: You could contribute 25% of freelance pay up to $49,000 to a SEP IRA.
You might go further by taking steps toward starting a small business while still employed a path about half of entrepreneurs have taken. Or, with housing prices down in most markets and mortgage rates near historic lows, you could take a calculated risk on real estate, investing in rental properties to boost income. True, improving your investment results may not speed you to $1 million as quickly as jacking up your savings rate. But it can help.

Reaching 7 Figures: Part 1

2011-04-04T12:40:00.023-05:00

Remember that old Steve Martin joke about the secret formula for becoming a millionaire?
"First, get a million dollars ..."
Okay, getting the odometer on your investment portfolio to click over into seven digits is not quite that easy. Only 7% of American households ever manage it, according to research firm Spectrem Group -- though it is certainly not for lack of desire.
While $1 million may not be worth what it was back when Martin was a wild and crazy guy in the late '70s, achieving that iconic number still has profound allure. It means that you are ahead of the game. You are assured a baseline retirement security. You have arrived.
Martin may have oversimplified, but the reality is that getting your portfolio to the $1 million mark is not nearly as difficult as you may think, even if you have managed to put away only a fraction of that amount so far. You just have to understand how to operate the three basic levers of wealth building: how much time you have to work with, how much you save, and how you invest that savings. The slightest tug on one or two of these levers can dramatically affect your path to $1 million.
In this three part FiPod series, we will take you through each of the three levers to pull to get to the 7-figure goal. Today, we start with...
Lever 1: How Much Time You Allow
When you think about getting rich, what jumps to mind? Saving more money? Getting that money to work harder for you? Sure, those are critical elements. But they're not nearly as important as time: How long you allow dictates how you pull the other two levers -- which is why you want to estimate your schedule before going on to the next sections. Sometimes you cannot play with the time lever -- your kids will go to college when your kids go to college. But in certain cases, it's possible to control the clock.
Say you are now 45, want to retire at 62 with a million bucks, and have $250,000 saved. You have got 17 years. If you were saving $15,000 a year, adjusting for 3% inflation (meaning you put away $15,000 in year one, $15,450 in year two, and so on), and were able to earn 4% a year in real terms (7% before inflation), you would not get there.
But if you delayed retirement by just two years, you would hit the mark. In part, how long it will take to become a millionaire depends on where you are now. If you already have $500,000 saved, it might take only 10 to 15 years, in inflation-adjusted terms, provided you sock away $10,000 to $15,000 a year and your investments outpace inflation modestly.

But even if you are only a tenth of the way there -- like the typical worker who has been investing in a 401(k) for 10 to 20 years, according to the Employee Benefit Research Institute -- you can make it in two decades or less, if you save a good chunk of income or earn a decent return. Of course, that is the dilemma. While the ability to save more is within your control, the ability to generate a certain return is not 100% in your hands. And as your time horizon shrinks, so too will your ability to accurately predict how your investments are likely to perform. So let time determine which of the two other levers -- savings or investing- -- you pull harder.
If you want to get to seven figures in 10 years or less: Seriously ramp up savings. With only a few years to invest, there is a significant risk that even a seemingly safe investment strategy could fall short of your expectations, because of the wide range of possible outcomes.
For example, according to computer models run by Ibbotson Associates, a moderate 60% stock/40% bond strategy could result in annualized returns of as much as 16% over the next 10 years, but it could also result in worst-case losses of nearly 1% a year. While that gain would certainly speed things up, a sustained loss -- even a modest one -- could be devastating given your time frame. So if your self-imposed deadline for achieving $1 million (or any financial goal) is tight, instead of banking on optimistic returns, you're better off trying to boost your savings as much as possible. Then invest in a balanced mix of 50% stocks and 50% bonds that can be expected to beat inflation by a modest two or three percentage points a year.
If you are willing to wait more than ten years: Invest more aggressively. The longer you have to invest, the greater chance you give the market to smooth out any ups and downs. Back to that 60%/40% portfolio: Over 20 years, the annualized spread could narrow to gains between 2% and 14%. So you could even take on a little more risk -- increasing your equity exposure, say -- for the possibility of better returns.
The single most important thing you need to know about building wealth: You are far better off being a dogged saver who's a mediocre investor than being a below-average saver who can knock the socks off the S&P 500.

A Milli, A Milli, A Milli

2011-04-02T12:27:00.002-05:00

I'm a millionaire
I'm a young money millionaire, tougher than Nigerian hair
My criteria compared to your career just isn't fair

Warren Buffet became one at 31 years old; now $1M only amounts to 0.002% of his fortune. Assuming that he is an outlier, who are all of these millionaires in the U.S.? What characteristics do they share? Of the millionaires polled by millionairecorner.com...

14% of had wealthy parents
42% do not feel wealthy
95% say they got there through hard work

83% credit smart investing
81% pinch pennies
67% take risks
41% feel lucky

90% are college grads

5% have law degrees
3% have medical degrees

17% are single.

The median price of a millionaire's car is $31,400.

Most live in Alaska, Hawai'i, California, Virginia, D.C., Maryland, New Jersey, Connecticut, Massachusetts, or New Hampshire.

The average millionaire saves/invests $39,300 and donates $13,000 per year.

April Showers Bring Retirement Savings Deadlines

2011-03-31T12:19:00.000-05:00

Two deadlines for retirement savings are approaching. The first is tomorrow, April 1. Investors who turned 70-1/2 in 2010 must take a required minimum distribution (RMD) from their qualified retirement plans (e.g., a traditional IRA) if they have not already done so. The IRS has a helpful page on its Web site explaining RMDs.

The second is April 18. This is the last day a contribution can be made to a tax-deferred retirement account–including a traditional IRA, or a Keogh or SEP plan–for the 2010 tax year. Contributions to Keogh and SEP plans can be postponed if a tax extension is filed. IRS Publication 590 covers IRAs and IRS Publication 560 covers Keogh plans.
Changes to retirement savings, whether they take the form of a distribution from or a contribution to an account, require coordinated planning with other accounts. Though it is human nature to put various banking and brokerage accounts into buckets, your net worth is calculated by totaling everything you own. In other words, an outside auditor will not split your savings into a vacation fund, a grandchild’s college fund, a home purchase fund, etc., but rather will look at the total sum you have saved.
Coordinating all of your savings accounts has two major advantages.

The first centers on diversification. When an amount is withdrawn from or added to your retirement account, your overall allocations can be shifted. A withdrawal or contribution gives you the opportunity to review how all of your accounts are allocated and make the appropriate changes. For example, if you hold too much in stocks, you could use the RMD as a reason to sell certain stocks or stock funds. Conversely, if you are underweighted in bonds, you put the new contribution to work by purchasing fixed-income securities or funds.
The second advantage centers on reducing your tax exposure. Individual retirement accounts allow investments to grow tax-free. (Savings held in a traditional IRA are only taxed when a withdrawal is made.) Therefore, you should use them to hold the least tax-efficient investments, while placing your most tax-efficient investments in your taxable brokerage accounts. For example, holding dividend-paying stocks or funds in your traditional IRA shelters the income from the IRS. (As an added bonus, they’ll generate cash to help facilitate the RMD.) Similarly, municipal bonds are most beneficial when held in a taxable brokerage account. It reduces your tax bill, and it is completely legal.

Be Careful What Your Put In Your IRA
The IRS is picky about what you can and cannot put into an IRA. For example, you can buy an exchange-traded fund that invests in gold, such as SPDR Gold Shares (GLD), but physical gold must meet specific requirements. Alternatively, you can hold an annuity that has incidental life insurance benefits, but you cannot use IRA funds to purchase a life insurance policy.
These may sound like subtle differences, but violating any rule regarding prohibited IRA investments can result in potentially significant tax consequences. Robert Carlson, publisher of the Retirement Watch newsletter, provides some guidance in this AAII Journal article.

3 Stock Picks for Japan Reconstruction

2011-03-29T12:15:00.000-05:00

Earlier this week, Japan estimated that post-earthquake rebuilding costs could total upwards of $300 billion. However, hopes for a massive restructuring effort have been a boon for material-related equities, which led stocks out of the ashes on Wednesday. In particular, Wisconsin-based Manitowoc Company, Inc. (MTW), farming and construction equipment concern Deere & Company (DE), and engine manufacturer Cummins Inc. (CMI) piqued our curiosity.
Should you buy into the hype? Let’s take a closer look at each stock’s fundamental, technical, and – most importantly – sentiment backdrops to find out.
Manitowoc Company (MTW)
The task of rebuilding Japan is likely to offer business opportunities to certain firms including heavy equipment manufacturers. From a broader sentiment standpoint, though, the encouraging brokerage note is relatively rare for the equity, which boasts just six “buy” or better ratings, compared to nine “hold” or worse recommendations, Zacks reports. In the same vein, Thomson Reuters pegs the consensus 12-month price target on the security at only $21.23 – representing a slight discount to MTW’s settlement price of $21.37 on Thursday.
On the charts, the shares of MTW have been on fire in recent weeks, outpacing the broader S&P 500 Index (SPX) by about 59% during the past 60 sessions. From a longer-term perspective, the stock has advanced more than 62% since the start of the year, ushered higher atop its 10-week and 20-week moving averages – a duo that has not been breached on a weekly closing basis since late August. Additionally, MTW is now on pace to log its first weekly finish north of the $20 level since September 2008. This round-number region has acted as a technical ceiling for the stock over the past month, but could now switch roles to serve as support.
As the stock continues its quest for multi-year highs, the bearish holdouts among the brokerage community could abandon ship. A wave of upgrades or a round of upwardly revised price targets should add fuel to the outperformer’s fire. Traders looking to capitalize on an extended run higher for MTW may want to consider the stock’s April 18 call.
Deere & Company (DE)
Similar to MTW, the aforementioned analysts at UBS also named DE – the world’s largest manufacturer of farm equipment by sales – as a potential benefactor from Japan’s looming reconstruction efforts.
Separately, the company is also hoping to establish a bigger presence in Russia, which boasts 9% of the world’s arable land and is one of the top wheat producers around the globe. In similar fashion, CEO Samuel Allen has outlined plans to grow business in China and India, where rapid expansion of public infrastructure is driving demand for earthmoving equipment like bulldozers and excavators. Against this backdrop, the firm said it hopes to nearly double sales over the next eight years – a goal Allen called “realistic” in a recent interview with Dow Jones.
Technically speaking, DE has more than tripled since March 2009, led into the black atop its 10-week, 20-week, and 32-week moving averages. After a recent test of support at its 20-week trendline, the stock is now poised to resume its longer-term uptrend. Plus, the security’s Schaeffer’s Volatility Index (SVI) of 24% stands just nine percentage points shy of a 52-week nadir, suggesting short-term options are relatively inexpensive at the moment.
Cummins Inc. (CMI)
Unlike sector peers MTW and DE, the shares of CMI have underperformed the broader SPX by 10% over the past 60 sessions. In additional, the security has run into a speed bump at its formerly supportive 10-week and 20-week moving averages, which are on the verge of a bearish cross – often suggestive of lackluster price action in the intermediate term. In addition, these trendlines have congregated in the $105 neighborhood, which acted as a technical backstop in late 2010 and early 2011, but could now reverse roles to serve as resistance.
Nevertheless, options speculators remain devoted to CMI’s bullish bandwagon. In fact, the stock sports a 10-day call/put volume ratio of 2.00 on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), implying that traders have bought to open twice as many CMI calls as puts during the past couple of weeks. Furthermore, this ratio ranks in the 69th annual percentile, indicating a greater-than-usual appetite for bullish bets over bearish.
In the same vein, the security’s Schaeffer’s put/call open interest ratio (SOIR) sits at 0.88, suggesting calls outnumber puts among options slated to expire within three months. What’s more, this ratio registers in the 17th percentile of its annual range, meaning near-term speculators have been more optimistically positioned just 17% of the time during the past year.
It is worth noting, also, that peak call open interest in the front-month series rests at the overhead April 105 strike, with almost 3,000 contracts outstanding. This notable accumulation of bullish bets could translate into additional options-related resistance for CMI in the short term.

Why Kindles Should Be Free

2011-03-27T15:11:00.000-05:00

E-books are revolutionizing the publishing industry and reader preferences, and Amazon might be in a unique position to hasten that change -- if they decide to start giving away their popular Kindle e-reader for free. Here is why they might want to do that.

Last year, nearly $1 billion in e-books were sold, according to Forrester. By 2015, this is expected to jump to $3 billion. That is an awful lot of money to be made selling e-books.
At that point, selling e-readers at any price might just become an obstacle to selling more e-books. So why not just give away some e-readers for free? Back in October 2009, blogger John Walkenbach noticed that the Kindle price -- currently $139 -- was falling steadily. By June 2010 this rate was so consistent that he projected that by November 2011 the Kindle price should be $0. Last summer, author Kevin Kelly asked Amazon CEO Jeff Bezos about this projection. According to Kelly, Bezos "merely smiled and said, 'Oh, you noticed that!' And then smiled again."
In a way, Amazon has already been giving away Kindles for awhile -- in the form of the free Kindle smartphone, tablet, and computer apps. Right now, about 6 million U.S. adults own e-readers -- but this field is getting much more crowded. According to recent research from Changewave, Kindle currently holds 47% of the e-reader market. Apple's iPad (which is much more than an e-reader, so I am not sure that's a fair comparison) holds only 32% of this market. Sony's Reader, at 5%, is just barely leading the Barnes & Noble Nook, at 4%. Plus, Google recently acquired eBook Technologies, Inc., so it will be interesting to see what that yields on the e-reader front.
The Kindle's core business model has always been to sell books, not devices. So a free Kindle seems like a potentially savvy business move. Forrester analyst James McQuivey recently noted: "Just 7% of online adults who read books read e-books. But that 7% happens to be a very attractive bunch: they read the most books and spend the most money on books. And here's the kicker: the average e-book reader already consumes 41% of books in digital form. Oh, and that includes the people who don't have an e-reader yet, which is nearly half of them. For those that have a Kindle or other e-reader, they read 66% of their books digitally."
The e-book market has plenty of room for growth and will, by conservative estimates, reach $3 billion by the middle of the decade. All e-readers, including the Kindle, have their pros and cons -- not the least of which are concerns about digital rights management, and whether you can loan or sell your used e-books. But if Amazon does not offer free e-readers, someone certainly will. I am sure Amazon wishes to maintain its market lead. Here are three ways they might do that:
1. Buy X number of Kindle books, get a Kindle free
And maybe the Kindle books you h've already bought to read on your phone, tablet, or computer might count toward that benchmark.
2. Free Kindles for Amazon Prime members
Millions of Amazon.com customers already pay $79/year to get free two-day shipping on many items, plus (now) free video streaming.
3. Partner Kindle giveaways
Already some banks have started giving away Kindles to customers. But here is a more intriguing option, from the London Review of Books: "The New York Times, if it stopped printing a physical edition of the paper, could afford to give every subscriber a free Kindle. Not the standard Kindle, but the one with free global data access. And not just one Kindle, but four Kindles. And not just once, but every year. And that is using the low estimate for the costs of [their] printing."
Personally, I think free e-reader devices, if they worked with library e-book lending programs (like the one in Oakland, California) and open e-book formats (like .mobi and .pdf) -- could help increase access to books for youths, seniors and low-income communities. For many in these groups, smartphones and tablets are too expensive or complicated, and it is not always easy to get to the public library. Like in most libraries today, students now search the library catalog from computer terminals. But they still must go to the shelves to get their books. With free e-readers, maybe libraries could be everywhere, and open all the time.
Hmm, maybe Amazon would not like that so much. But if their e-book market was big enough, they probably would not care.

Using Twitter to Make Stock Picks

2011-03-21T12:51:00.002-05:00

Last fall, Indiana University informatics professor Johan Bollen stumbled upon an astonishing connection: The social network Twitter could predict swings in the Dow Jones Industrial Average with 87 percent accuracy. Six months, numerous inquiries, and one Caribbean brainstorming session later, Bollen is a consultant to a soon-to-be-opened U.K. hedge fund betting that 25 million sterling and one killer app will be enough to generate double-digit investment returns.
The fund, Derwent Capital, is scheduled to open for trading in early April. Run by a young entrepreneur with a background in foreign-exchange trading, the fund will use quantitative models to comb through millions of daily tweets and look for sentiment threads that could prove leading indicators of how stocks trade several days later. Derwent's founder, Paul Hawtin, said in an interview he is “confident” Derwent can achieve 15- to- 20 percent returns, given how accurate the trading models have appeared so far.
Hawtin’s is one of the boldest attempts to crack human market psychology in recent memory, and it could well have disappointing results. How to predict the behavior of irrational human investors has been one of the most nettlesome dilemmas in market history—contributing, among many other examples, to the collapse of the hedge fund Long-Term Capital Management in 1998. Still, even some veteran traders acknowledge that if any information source can track emotion on a real-time basis, it may be Twitter, where the users of more than 200 million accounts publicly share their thoughts and feelings on a minute-to-minute basis—in no more than 140 characters.
The apparent connection between tweets and stocks was a revelation even to Bollen, who had been working with a doctoral student to find connections between Twitter and more scientific public sentiment polls for months. “We thought that changes in the markets would induce changes in the public mood state,” said Bollen, 39, in a recent interview. “We found the exact opposite.”
Bollen and his student, Huina Mao, published their findings on an academic site Oct. 14. Within days, the paper had received 70,000 hits from Internet users, and Bollen’s phone was ringing off the hook with interested entrepreneurs, investors and fellow academics. One query came from Hawtin, a British entrepreneur who was looking to start a hedge fund. Hawtin, 28, had dropped out of college to work on a hair product business that he later sold. Since then, he had worked on and off as a trader in London. Now, he and his 23-year-old brother, Simon, had plans to open a quant fund. Introduced by mutual contacts, Bollen and Hawtin met over the Christmas holidays in St. Lucia, near where both happened to be vacationing. There, they hammered out a plan: Bollen would sell his model for searching Twitter to Hawtin, and come on board the hedge fund, Derwent Capital, as a consultant.
Boiled down, their strategy is straightforward. Throughout the day, Derwent’s technology will scan Twitter and select about 10 percent of the available tweets at random. Those messages will then be sorted in to one of a dozen mood states: calm, alert, sure, vital, kind, and happy. (The other six states are their opposites.) Based on how many users fall into each state, the software will make predictions about where stocks are headed three or four days later—and then make trades.
Hawtin acknowledged that in an online universe where the flamboyant actor Charlie Sheen is now one of the most popular contributors, not every tweet may appear to have market relevance. “But you’ve got to remember there’s 100 million tweets a day,” he said. “Compile them all together, they give a general [sense] of how people are feeling.” (On an average day, Twitter now posts more than 130 million tweets.)

Twitter itself takes no position on the planned hedge fund. “We’ve got our hands full trying to make a business out of the ad side of the business,” said Matt Graves, a Twitter spokesman. “We have some guidelines for how we’d like people to work with Twitter, but we don’t really have thoughts on how to use it.” The social media company, which is privately held, requires anyone who plans to use tweets for commercial purposes to secure a license, and Hawtin is in the process of trying to secure such an agreement. Negotiations with Gnip, the sole sublicensor of Twitter data, are ongoing, say both Hawtin and a spokeswoman for Gnip.

Dollars Driving Unease in the Middle East

2011-03-19T08:22:00.020-05:00

Who is responsible for the commodity and food inflation? Chairman Ben Bernanke denies that it is the Fed. Of course, the cause of inflation is hard enough to prove in a domestic economy, much less from the monetary policy followed by a central bank in a different country.

There is, however, a very unique circumstance for the U.S. central bank. That circumstance revolves around the fact that the U.S. dollar is the world’s reserve currency. Almost all international transactions are done in U.S. dollars. Nearly all of the world’s commodities are priced in U.S dollars. So, an auto manufacturer in Korea importing steel from Japan must first convert Korean won into U.S. dollars, pay for the transaction in dollars, and the Japanese exporter, once receiving the payment, must convert the dollars into Japanese yen. So, the Dollar is key to much of the world’s trade.
In 2009, the Fed embarked upon quantitative easing (QE1), using a tool that the central bank had never used before, massive buying of securities in the open market and a near asymptotic explosion in the Fed’s balance sheet. Last August, the Fed announced a second round. QE creates liquidity, but because of the sheer volume of easing over the past two years, “excess” liquidity–more liquidity than is needed for the smooth flow of business–is clearly in abundance.
The “excess” liquidity looks for the best return it can get in those places offering such opportunity, and it finds its way into those asset markets. Bernanke points to the 25% increase in U.S. equity prices from the announcement of QE2 in August, 2010, to the end of February, 2011, as evidence of QE2’s success. So, clearly, the Fed intended for the “excess” liquidity to push up asset prices, probably hoping that the “wealth effect” of higher asset prices would spur economic activity in the U.S. Equity markets are not the only markets impacted by the “excess” liquidity.
The commodity, bond and even the property markets have been impacted. Yes, property! Believe it or not, the property market in Australia took off with the implementation of QE1 in the U.S. (see John Mauldin’s new book, Endgame). This blog is not about the equity, bond, or property asset markets. It is about the impact of QE on commodities and the food and energy inflation that it may have inadvertently, or perhaps purposefully, engendered.
At the end of February, corn and wheat prices were up 80% from year earlier prices. Soybeans were up 40%. Hog and cattle prices are at all time highs. Some of this, of course, is due to weather conditions and rising worldwide demand. As I write, WTI (West Texas) oil is over $104/bbl and Brent crude is more than $115/bbl. (I suspect the glut at the Cushing, Okla., oil terminal is responsible for the large price discrepancy.) Gasoline prices are rising daily.
Bernanke has argued that there is no “core” inflation. Originally, the concept of “core” occurred because the Fed didn’t believe that, through monetary policy, it could influence food prices (weather) and energy prices (oil politics), and that these were too volatile to deal with on a monthly basis. But, now, “core” has morphed into a political concept to insure the American voter that inflation is not an issue. Be that as it may, America still spends a significant percentage of its income on these items. Of more importance, third world and emerging nations spend more than 50% of their incomes on food and energy.
So, let’s not fool ourselves. The unrest in the Middle East has a lot to do with food and commodity prices, and Fed QE policies may have a lot to do with those prices. Here is how the “Excess Liquidity Theorem” works:

The Fed lowers interest rates to 0% and embarks upon QE;
Institutions and investors, holding the “excess” liquidity, look for and find higher yields in emerging and other “opportunity” markets;
That capital inflow fuels those economies and drives up the demand for resources and commodity inputs;
Speculation in commodities adds to the demand and prices continue to rise;

The emerging economies have two choices – they can peg their currencies to the Dollar (like China) to protect their export markets and suffer inflation in their economies, or they can try to neutralize the Dollar inflows via higher interest rates, thus slowing their own expansions and, perhaps, impacting their employment levels.
Let’s look at what happens when a country, like China, pegs its currency to the dollar. Bernanke is correct when he claims that China wouldn’t have the inflation problem they have today if they allowed their currency to float. Here is the logic: Because the dollar is the world’s reserve currency, Chinese exporters receive dollars for their export products. Since they are not allowed to exchange those dollars for their local currency (renminbi) in an open market, they sell it to the People’s Bank of China at the pegged exchange rate.
The Chinese central bank has to print renminbi to purchase the dollars. So, the China nds up with dollars, but has printed an equal value amount of domestic currency. It is likely that, if the Chinese currency were allowed to freely float in the forex markets, inflation in China would subside. So would their exports and their GDP – and probably their employment levels.
Now let’s look at what has happened in countries with freely floating exchange rates, especially with regard to commodity prices. The first table show the changes in the price of commodities in the home currencies (i.e., the cost of commodities in the local currency), of 7 selected freely floating currencies for 2009 and 2010 as measured by the price of RJI, an ETN that mirrors the movement in the price of the Rogers Commodity Index.
The second table shows the Expense/Revenue ratios of the governments sponsoring those currencies as measured by data found in the IMF World Outlook database, October, 2010. Each table also shows the rank from best to worst in the change in commodity prices in the home currency in the first table, and in the Expense/Revenue ratio in the second table.

Note that, except for Switzerland and Australia, the ranks between changes in commodity prices and government deficits show high correlations. In those countries following excessively stimulative economic policies, as measured by the Expense/Revenue ratio, including the U.S., the U.K. and Japan, commodity inflation appears to be explained by internal policies.
Commodity inflation in the other four countries, especially Switzerland and Brazil, appears to be much higher than internal policy would imply. For example, commodity inflation in Switzerland is more than 40% over the two year period while their budget was nearly balanced. Brazil has complained about the explosion of U.S.dollars since the Fed began QE. Yet, Brazil’s relatively low deficit levels were still associated with much higher commodity prices, especially in 2010. The same appears to be true in 2010 for Canada, and to a lesser extent, in Australia.
The data backs up the “Excess Liquidity Theorem” that the “excess” liquidity of U.S. Dollars, as manufactured by QE, seeks opportunity elsewhere in the world. Since, the economies of the U.S., the U.K., and Japan offered little opportunity, commodity inflation in those economies could be explained by internal extremely stimulative economic policies. The “opportunities” for investment of the “excess” liquidity existed in the other four economies shown.
While the data here do not directly implicate the Fed for commodity inflation in those countries, they do back up the notion that when the world’s reserve currency central bank generates “excess” liquidity, those excesses have unintended consequences – in this case, a high probability of contributing to commodity inflation.

Emerging Markets: Which Are Cheap?

2011-03-17T08:17:00.013-05:00

“One question,” the gentleman asked, “why Colombia?”
We believe the market is unnecessarily maligned by lingering fears over the drug war, and therefore less expensive than the market will bear when the real Colombian story gets out. We expect to find opportunity here.
With price-to-earnings in the 18 range, we would not exactly call Colombia cheap. Seated at the table with us was a gentleman who makes his living running a fund in Cambodia and who would just returned from investment tours of Haiti and Cuba. Those places are most assuredly cheaper and possess deeper “value” plays than anything we will find here.

Still we think, as with Nicaragua, we believe there is a unique opportunity here. And it is right in our wheelhouse. The security issues are a thing of the past. Colombia’s future is food and energy – two things the world needs and will be buying forever.

Gambling on Flight Prices

2011-03-15T08:02:00.003-05:00

Allegiant has quietly slipped a note into a federal filing that says it wants people to be able to pay for fuel price fluctuations after a plane ticket has already been bought. And I like it. I know, you think I am insane for saying such a thing, but there are some very good reasons why I like this. It really is good for the gambler, er, traveler.
Let me start by saying that the idea that you can buy a ticket and then be forced to pay more if fuel goes up sounds awful in theory. I mean, people save up for their trips over time, and not having certainty around how much that would cost would really destroy a lot of plans. Had that really been Allegiant’s goal, then this probably would have earned a Cranky Jackass Award. But that’s not what they are doing. Let me take a snippet from the filing with the DOT itself.

"Allegiant is considering a new pricing option for use on its website: when making a purchase, consumers would be able to choose between a traditional “locked in” fare that would not fluctuate, and a lower fare that could change before the date of travel. That lower fare could be reduced further or could increase (up to a set maximum that would be clearly disclosed) depending on changes in fuel price between the booking and travel dates. This would be a non-compulsory alternative for consumers; it would provide them another option for potential substantial savings on their trip costs and would be clearly disclosed and explained prior to any purchase."

In other words, there would be two pricing options. Let’s just throw some numbers around for the heck of it. You could pay $100 for your flight to Middle of Nowhere and never have to worry about the price changing. Or you could pay $90 and then have the price fluctuate with the price of oil after. So if oil goes down from when you bought, presumably the price would go down and you’d save money. If oil goes up, the price would go up and you would lose money. This is perfect for an airline based in Vegas, because it is a gambler’s dream. (I wonder if they will hand out those sad pamphlets about gambling addiction with the sun setting on the cover?)
So why is Allegiant talking about this in a federal filing? Well there is a proposal that would make it illegal to have post-purchase price changes. Allegiant is arguing that it would be a good thing for consumers and that one of the alternative ways to deal with this issue that has been proposed should be accepted instead. That alternative would not just allow blanket price changes, but it would have three main requirements.

The potential for the increase needs to be “conspicuously” disclosed to the buyer.
The maximum potential amount of the increase must be shown.
The customer would have to proactively agree to the arrangement before purchase.

Why does Allegiant want to do this? Because it allows the airline to sell a lower fare. And lower fares mean more people are willing to fly. As long as the disclosure is clear, then why not have this as an alternative? I cannot imagine myself ever wanting to take advantage of this option, but if others want to, then great. It lets Allegiant better match revenues with costs, and it gives customers the chance to decide if they want to play the game or not.

Beating Inflation: Buffett Style

2011-03-13T07:17:00.000-05:00

As the U.S. government undertook more and more drastic measures to combat the financial crisis and Great Recession in 2008 and 2009, many top strategists–including the great Warren Buffett–said we woud put ourselves on a path to significant inflation. You cannot, after all, deluge the economy with close to a trillion dollars to rescue banks, throw in nearly a trillion more to stimulate demand, and keep interest rates near record lows for two-plus years and expect to escape inflation’s wrath, right?
Well, more than two years after the stimulus flood started, we are still waiting, with much of the funding having gotten stuck on corporate balance sheets. But that may be changing. Over the last year, inflation has already hit commodities hard, with food prices eclipsing record highs. Part of that is due to extreme weather, but part is simply due to rising demand as the global economic recovery continues. Corporations have also been digging into their cash stockpiles to up dividends and hire new workers. Banks have begun increasing commercial lending.
At some point–perhaps sooner than the consensus–I think we will see the broader inflation that Buffett and others have predicted. The Federal Reserve will not, regardless of what Ben Bernanke says, be able to perfectly time the withdrawal of its huge stimulus efforts. Given the potentially paralyzing effects of deflation, it seems likely that the Fed will err on the side of caution–that is, the side of inflation–when the time comes to mop up all that extra liquidity.
For fixed-income investments like bonds and Treasury bills, inflation is of course a huge threat. But what about stocks? For companies that are unable to pass costs along to consumers, it can be a serious hazard. But, according to Buffett, those that do have the ability to pass along those costs can not only handle inflationary climates; they can actually benefitfrom them.
That is what Mary Buffett–who worked closely with Warren and is his former daughter-in-law–wrote in Buffettology. She said Warren Buffett “developed a theory that investments in companies that benefited from a strong consumer monopoly and required nominal incremental amounts of capital to continue operations actually benefited from the effects of inflation.” They are able both to pass costs on to consumers, and avoid big capital expenditures that become even more costly when inflation is sending equipment and facility replacement costs through the roof. “Invest in these businesses and inflation helps you as an investor,” Mary Buffett wrote. “It makes you richer.”
Finding companies that don’t have to spend a lot on capital expenditures is easy enough. But what about identifying firms that have the “consumer monopoly” (also known as an “enduring moat” or “durable competitive advantage”) that Buffett is known to look for? Is that not subject to interpretation?
To some degree, yes. But, according to Mary Buffett, Warren Buffett has used some quantitative measures to find companies with those enduring moats. Among them: return on equity (ROE), and return on total capital (ROTC). The strategy also looks for companies with positive free cash flows per share (a sign the firm is not bogged down with capital expenditures), and a number of other “Buffett-esque” qualities, such as manageable debt and a lengthy history of increasing annual earnings per share. Given the warnings about inflation that many, including Buffett himself, have offered, we used the principles in the Buffett model to uncover some top inflation-fighting picks.
Coca-Cola Company (KO): One of the best examples of a company with a “moat,” Coca-Cola ($150 billion market cap) has long been a staple in Buffett’s Berkshire Hathaway portfolio. Its moat comes from its size and incredible brand recognition.
Coca-Cola is planning to up capital expenditures a bit this year as it incorporates into its fold the North American operations of bottler Coca-Cola Enterprises. But that should not be a big problem–it has $1.39 in free cash flow per share and a number of other qualities my Buffett-based model likes, including a 10-year average return on equity of 30.8%, and just one EPS dip in the past decade.
C.H. Robinson Worldwide (CHRW): This 106-year-old Minnesota-based firm works with close to 50,000 companies around the world to provide transportation services to its clients. It is a third-party logistics company, meaning that it doesn’t own the equipment used to transport customers’ freight–and thus does not have to shell out all of the cash needed to maintain and upgrade those fleets.
Robinson’s size–annual sales are more than 50% greater than its largest competitor–would appear to give it a Buffett-esque “moat,” and its 10-year average return on equity of 26.8% bears that out. My model also likes Robinson’s lack of any long-term debt, and the fact that it has upped EPS in each year of the past decade.
Alcon (ACL): Majority-owned by Novartis AG (NVS), incorporated in Switzerland, and having a U.S. base in Texas, Alcon is the largest specialized eye care company in the world. It offers a variety of surgical products, pharmaceuticals, and consumer products designed to help with eye problems.
Alcon’s size and market position should give it an “enduring moat”, and, indeed, over the past decade, it has averaged an exceptional 38.2% ROE. It also doesn’t need to shell out a ton of cash on capital expenditures, part of why it has a healthy free cash flow per share of $2.93. Alcon also has no long-term debt and just one dip in EPS over the past decade.

Cheering for Inflation: Bring It On Style

2011-03-11T07:11:00.000-06:00

Under ordinary circumstances, accelerating inflation is bad for stock prices. Present circumstances, however, create a rare exception. Investors who aim to increase their wealth by owning stocks over the next decade should hope Federal Reserve Chairman Ben Bernanke fails in his stated goal of holding inflation to 2% or less.
The 1970s discredited the previous belief that equities represent an effective hedge against inflation. As measured by the Consumer Price Index (CPI), annual inflation averaged 7.1% for the decade 1970-1979, while the Standard & Poor’s 500 advanced by just 1.60% per annum. Instead of preserving their wealth by owning stocks, investors lost ground, in real terms, at a rate of 5.50% a year.
Edifying as this experience was, investors should not leap to the conclusion that inflation is the key to determining whether to own stocks. For example, Exhibit 1 shows that the inflation rate was essentially the same in the 1940s and the 1980s, yet stock prices advanced at meager 3.02% annual rate in the former decade but a robust 12.59% in the latter. In the same vein, the 1950s and 1960s had very similar inflation rates but the rates of stock price appreciation were vastly different, at 13.55% and 4.39%, respectively.

This seeming inconsistency is resolved, at least for the six-decade stretch of the 1940s to the 1990s, by substituting for the inflation rate the change in the inflation rate. (See Exhibit 2.) For those decades, Exhibit 3 shows a clear, negative correlation between stock price appreciation and the change in the average annual inflation rate versus the preceding decade: For each one-percentage-point decline (rise) in inflation, the rate of appreciation in stock prices rose (fell) by 1.20 percentage points. This relationship explains 76% of the variance in decennial stock market appreciation during the period 1940-1999.

For example, in the 1950s the rate of increase in the Consumer Price Index declined by 3.5 percentage points versus the 1940s. The S&P responded by climbing at a rate of 13.55% a year during the decade. At the opposite extreme on Exhibit 3’s horizontal scale, the 1940s registered a 7.6-percentage-point rise in the average annual inflation rate versus the 1930s. In the 1940s, the S&P advanced by just 3.02 percentage points per annum.
This relationship is consistent with the view now generally held by economists, that stock prices are affected by inflation expectations, rather than inflation. For instance, a 1999 study by Steven A. Sharpe of the Federal Reserve Board finds that an increase in expected inflation adversely affects stock prices by:

Lowering expected real earnings growth
Raising investors’ required real returns. It seems reasonable to conjecture the following link: A decade-over-decade drop in inflation reduces expectations of future inflation, causing stock price appreciation to accelerate.

Exhibit 3 demonstrates that from the 1940s to the 1990s, the stock market consistently liked disinflation. Bookending that 60-year period, however, are two renegade decades. In the 1930s and the 2000s, the inflation rate declined versus the preceding decade. The stock market did not merely rise slowly, as it did when inflation spiked in the 1940s and 1970s, but declined in nominal terms over a full decade. The outlier positioning of the 1930s and 2000s plot points in Exhibit 3 underscores the anomalous results for the first and last decades of the full study period.
An explanation of these anomalies emerges from Exhibit 2. The two renegades are the decades in which the inflation rate fell from already low levels, i.e., 0.1% in the 1920s and 3.0% in the 1990s. (Inflation was less than 3.0% annually in the 1950s and 1960s, but both of those decades were followed by increases, rather than decreases, in inflation.)
Based on these observations, an amended statement of the relationship between inflation and stock prices reads as follows:

A decline from a high rate of inflation is associated with a high rate of stock price appreciation.
A decline from a low rate of inflation is associated with a low rate of stock price appreciation.

A possible explanation of this bifurcation is that below a certain level of inflation, a further decline reflects economic weakness more than it reflects a salutary reining in of excessive monetary expansion.
Judging by the experience of the 1930s and 2000s, equity investors should be hoping for stabilization of inflation or, to be on the safe side, reinflation from the present level. If it is true, however, that steady to higher inflation is a precondition for rising stock prices in the current decade, the signals from the Federal Reserve are not encouraging. Chairman Ben Bernanke has not instituted an explicit inflation target, something he advocated before joining the Fed, but he has suggested that inflation of “about 2% or a bit below” would be consistent with the monetary authority’s mandate. Achieving that objective would represent disinflation from an already low rate (2.6% in the 2000s), something that has been associated historically with declining stock prices.
Even more discouraging to anyone rooting for reinflation is January’s year-over-year CPI rise of only 1.6%. If inflation were to average that low a level throughout the 2010s, stocks would be expected to suffer their second consecutive, decade-long decline. On the other hand, an acceleration in the inflation rate to just 3.0% would be expected to boost the level of the index by 8.92% annually through 2019. The estimate is derived from the trend line shown in Exhibit 3. Subtracting a 3.0% inflation rate would net a respectable 5.92% annual rate of real wealth increase.
This bullish scenario does not seem improbable, at least in the short run. The Fed justified its second round of quantitative easing partly on grounds that the wealth effect of rising stock prices would stimulate consumer spending and, by extension, boost output and reduce unemployment. To be sure, it is unlikely that this policy will remain in place through the end of the decade. Long before then the U.S. economy should be expanding vigorously enough to permit the termination of monetary stimulus.
Some caution is warranted regarding the optimistic scenario. First, as noted above, the change in the inflation rate explains 76% of the variance in the rate of stock price appreciation, but that leaves 24% to be determined by assorted other factors. The scatter around the trend in Exhibit 2 is instructive. By formula, stocks should have advanced at a rate of 9.04% per annum in the 1960s, but the actual rate was only 4.39%. A second caveat is that this report’s focus on ten-year chunks of time limits the analysis to a very small sample size. Moreover, two of the eight available observations are deemed to be outliers. On the other side, there is no precedent for stocks advancing during a decade in which inflation declined from a level of less than 5.5%.
Nothing in the preceding discussion is intended as a prescription for Federal Reserve policy. It is by no means clear that promoting long-run appreciation in stock prices ought to be an objective of the Open Market Committee. Furthermore, there is no assurance that the Fed can push the inflation rate up to, say 3.0%, without triggering a substantially steeper escalation. That could lead to a replay of the 1970s, when inflation jumped by 4.7 percentage points from 2.4% in the preceding decade. The result was the lowest annual stock price appreciation of the 1940-1999 span, a paltry 1.60%. For that matter, it is fair to ask whether the Fed should be promoting inflation at all, given its dual mandate of price stability and full employment.
Whatever stance one might wish the Fed to take, a purely descriptive approach to the relationships examined in this study indicates that equity investors should be rooting for reinflation. The record suggests that further disinflation from the comparatively low level of the 2000s will push stock prices lower over the next decade. A modest acceleration in inflation, on the other hand, should head off the negative real returns experienced in both the high-inflation 1970s and the low-inflation 2000s.

How to Make the Now Network the Now Stock

2011-03-09T06:57:00.051-06:00

Sprint has struggled with growing its subscriber base in recent years, but we believe it is righting itself after launching many new initiatives. Sprint recorded overall positive postpaid net additions for the first time in a few years during the most recent quarter as theCDMA platform added about 453,000 subscribers in the quarter while iDEN lost about 395,000.
Sprint competes primarily with AT&T and Verizon in the mobile business, which makes ups almost 80% of our $5.15 price estimate for Sprint. This is about 18% ahead of the market price.
Here are four areas in which Sprint can improve its fortunes and win a higher stock valuation from investors.
1. Make a Decision – WiMax or LTE?
Sprint has pumped a significant amount of money into Clearwire which has built out coverage of WiMax 4G technology in the U.S., thus giving Sprint an early market entry advantage. However, given that LTE has more global support and Verizon and AT&T are closing in on Sprint in terms of 4G coverage with their LTE network, Sprint may have to decide whether to continue with WiMax or shift gears to LTE entirely.
2. Impact of Network Modernization Initiative
Sprint is investing significant capital in modernizing and improving its network. The company is looking to add flexibility to add LTE services in the future, migrate iDEN subscriber base to CDMA network and improve in-building coverage. Additionally the company also plans to decrease the number of its cell sites from around 66,000 to 46,000 in the U.S.
If successful, not only will the network modernization improve its service and help Sprint improve subscriber trends, but it will also result in cost savings that can impact the company’s value positively.
3. Expanding Customer Type
Sprint has been pushing beyond mobile service in order to continue to grow. The company has been investing in technology that would add wireless connectivity to cars, a market that Sprint believes could bring revenues of over $1 billion within a few years. Sprint has also partnered with ECOtality, an electric car charging company, to connect its electric car chargers throughout the country. New developments will help drivers locate charging facilities through GPS, enable data tracking on charging habits, and facilitate other processes like billing and digital content delivery.
This is a relatively new arena for the company but does present a potential market for the company to tap in and better diversify itself.
4. Reducing Leverage
Sprint is loaded with debt currently. The company has net debt of close to $14.7 billion compared to a valuation of close to $15.4 billion. This makes it a highly leveraged company leaving its stock quite sensitive to driver changes like market share, margins, capital expenditures, etc. and this debt profile can ward off many investors. If Sprint can manage to reduce its debt in the coming years, this will help build investor confidence and reduce its cost of capital thus improving its intrinsic value.
Each of these four areas deserve focus as they can help reshape Sprint’s future.

Why There is No White iPhone

2011-03-07T06:40:00.000-06:00

How is it that a company that is been making electronics in white for at least a decade cannot produce an iPhone 4 in that color?
Apple added another layer to that puzzle Wednesday, when it announced that the iPad 2 would come in both white and black models. Sure enough, in a demonstration room after the announcement, attendees at Apple's event found a feast of test units in both colors. Flash back to June 2010, when Apple escorted reporters into a room, nary a block from here, filled with iPhone 4s fashioned in both black and white.
Needless to say, Apple has yet to sell the most recent iPhone model in a color that is not black. The older 3G and 3GS iPhones came in models with white backsides. Apple CEO Steve Jobs, who unveiled both products, made a nod to the iPhone flub at Wednesday's event. "We'll be shipping white from Day One," he said with emphasis, to laughs from the audience.
At least two key factors have prevented Apple from shipping a white version of the newest iPhone on Day One and even still on Day 251, Apple employees said. Apple co-founder Steve Wozniak uses a white iPhone 4, which he says he assembled from parts made by a Chinese supplier and deemed to be defective by Apple. The device takes poor-quality photos when the camera's flash is used, and the white materials make the proximity sensor less reliable, he said. "The early parts Apple made were defective. So Apple decided not to put them out," Wozniak said in an interview with Engadget. "I took a picture with flash and without; the one with flash was ... like I took it through cellophane."
These design obstacles affect the latest version of the iPhone. The iPad 2 has a camera on the back, but its backside is made of aluminum, not of the white casing used on the front, and doesn't have a flash. The new tablet computer also lacks a proximity sensor. That mechanism in the iPhone is used to detect when, say, it is pressed against an object, usually your head, to tell the display to turn off during a call. (Previous iPhones were not affected because every version had a black-colored front.)
Instead of a proximity detector, the iPad 2 uses magnets embedded within the hardware to determine when Apple's Smart Case has been applied to the screen, thus telling the screen when to turn on and off. Ambient light sensors, which are also in iPhones, tell the device to adjust the screen's brightness.

Apple first announced a delay for the white iPhone on the day before the product's launch in June, saying it would be available in the second half of July. Then in July, Apple said the elusive white phone was coming later that year. Then in October, Apple again pushed its release to spring 2011. Despite its mythical nature, the white model has not only become a grail for geeks, like Wozniak, willing to void their warranties and screw in some foreign parts. It is also a sort of status symbol around Apple's Cupertino, California, campus. Jony Ive, the company's principal hardware designer, was seen tapping away on his white iPhone 4 in the product demonstration room after Wednesday's iPad 2 unveiling.

Managing Your Retirement in a Bear Market

2011-03-05T18:40:00.000-06:00

What follows is an excerpt from a very good book called Probable Outcomes: Secular Stock Market Insights, in which the author takes on the mostly silly research, done by so many analysts, that purports to show what an investor can expect to make from his retirement portfolio over time. We cannot tell you how disastrous this simplistic analysis can be for retirees.
Stay Out of the ROOM
An Excerpt from Probable Outcomes: Secular Stock Market Insights
By Ed Easterling (Copyright 2010, Crestmont Research)
Al Pacino, Dionne Warwick, Fran Tarkenton, Jack Nicklaus, Mario Andretti, Peter Fonda, Raquel Welch, Ringo Starr, and Smokey Robinson—what do they have in common with secular stock market cycles?
They were all born in 1940 and were subsequently impacted by secular bull markets. The choice of that year, which is not precise but was chosen for illustration, is that people born around 1940 aged into their forties by 1980. Most people and families accumulate savings slowly, if at all, during their twenties and thirties. By their forties, and certainly fifties, they begin to build retirement nest eggs. Therefore those born around 1940 had the opportunity to build sizable retirement savings during the 1980s and ’90s if they invested well as they reached their prime saving period.
David Brinkley, Shelley Winters, Walter Matthau, and others born in 1920 were saving during the secular bear market of the 1960s and ’70s. With little stock market gain over that period, their savings would be filled with contributions that earned little additional investment income. That modest capital base, however, then encountered the secular bull market of the 1980s and ’90s, and though the nest was small, the eggs from it were abundant.
Chunks, Not Streams
This walk down memory lane illustrates several points. First, secular stock market cycles deliver returns in chunks, not streams. Second, most investors live long enough to have the relevant investment period extend across both secular bulls and secular bears. Third, investors do not get to pick which type of cycle comes first. Fourth, investors need to be aware that they will likely encounter both types of cycles. Those who experience secular bears during accumulation are generally better prepared than investors who are spoiled by a secular bull. A secular bull market is a pleasant surprise to retirees who endured a secular bear on the way to retirement. For retirees who grew to expect a secular bull during accumulation, the unexpected secular bear can be considerably disruptive.
Given where the stock market and valuations are today, the circumstances are quite different for people across different age groups.
Distribution
A retiree today has a relatively long-term horizon, with an average retirement age near sixty and an expected lifespan for the last surviving spouse of almost thirty years. Relatively healthy retirees today can expect one or both spouses to live well past ninety. Whether you are retired now or on the cusp of retirement, your savings has been built over many years of toil and saving to provide or supplement your income during retirement. For pre-retirees who are still building the nest egg, this analysis can provide insights about what to expect in the future. The objective is to determine a safe assumption for investment returns, and a safe level of income or withdrawals from savings each year to sustain a desired lifestyle—the rate at which it is safe to withdraw golden eggs from the goose.
Safe Withdrawal Rate (SWR) is the term that investment advisors, financial planners, and do-it-yourself investors use to represent the acceptable rate at which funds can be withdrawn from an investment portfolio while still providing a high confidence of income for the balance of a retiree’s lifetime. In effect, this is the rate of withdrawal to avoid the ROOM, where you Run Out Of Money!
SWR is often stated as the percentage of an investor’s initial portfolio that can be safely withdrawn annually after retirement to cover life’s expenses. The main variables are: (1) success rate, as reflected in the percentage likelihood of not running out of money; (2) portfolio mix and return assumptions for investment income; (3) how long the retiree assumes that he or she will live; and (4) a variety of other variables including tax rates, investment expenses, etc.
Some advisors or planners will go so far as to advocate that today’s long-term retirees invest heavily in the stock market. Those pundits say, “A market that has never lost money over thirty-year periods won’t let you down in the future.” It’s true that there has never been a thirty-year period when stock market investors overall have lost money, yet there have been quite a few thirty-year periods that have bankrupted senior citizens who were relying upon their stock portfolios for retirement income.
Most analysts and models suggest that a retiree can withdraw 4% to 5% of the original balance each year, increased annually to cover inflation, and still have a very good chance of not running out of money. The models, however, often do not use reasonable assumptions and do not sufficiently consider risk. Generally, such high withdrawal rates relate to investment portfolios that are significantly weighted toward stocks, especially during the current and recent environment of low bond returns.
For illustration, assume that a retired couple invests exclusively in the stock market because they “need” the extra return and should feel “safe” that the stock market will not let them down over a thirty-year period. Further, assume no income taxes, investment fees, commissions, or other charges. Admittedly, these assumptions probably deliver the best-case scenario and conclusions.
For the analysis, the portfolio includes a diversified stock market portfolio using the S&P 500 index including dividends. The time horizon is thirty years, which assumes that the last surviving spouse will need money for at least thirty years after the retirement date. What, therefore, are the chances of success, of not running out of money, and avoiding a job search after age eighty?
Many models use historical average rates of return. As previously reflected across multi-decade periods in the stock market, average rarely happens. Most often, returns from the market are either well above average or well below average. Regardless, as far as retirement success is concerned, each retiree’s results will be binary—the retiree either will be successful or will run out of money. It doesn’t matter whether the retiree—on average—has a 75% chance of success. The reality for each retiree is that success will be either 100% or 0%. Though probabilities are interesting, retirees should thus be keenly focused on the implications of the assumptions and their likely impact on the outcome.
Using history since 1900 as the laboratory to assess the likelihood of success, a retiring couple who start with withdrawals of 4% have a 95% chance of success. In other words, they have a 95% chance of not running out of money before the last surviving spouse no longer needs withdrawals. For example, this represents an initial annual withdrawal of $40,000 for a retiree with $1 million, increasing the $40,000 at the start of each year by the inflation rate. By the way, about half of retirees will live past the expected average lifespan; thus the success rates are actually lower for the half of retirees in the lucky group.
A 95% chance of success sounds pretty good—on average. The 95% success rate, however, means that you have a 1-in-20 chance of having to find a job at age eighty. If you have enough money to be thinking about SWR, you likely have a lifestyle that you don’t want to compromise. When you think about last-to-survive issues, it has even greater significance.
To further emphasize the concept of success rate, assume that the doctor comes into your hospital room and says that your upcoming surgery has a good success rate: a 95% chance of success. The doctor performs this procedure five times a day. Since that’s twenty per week, how many of you will immediately hope that you will not be the one that week who does not make it.
A 95% success rate sounds good to all those who are standing around the operating table, but it is quite different for the one who is actually on the table. The patient will be thinking about his or her particular circumstances—whether the odds are more likely to be above or below the 95%. A high success rate may still represent a significant risk.
Before digging into the details, what does the overall average look like? Over the 81 thirty-year periods since 1900, on average across all periods, the retiree who started with $1 million could have withdrawn 4% plus the inflation rate each year and still ended with $7.0 million. The average retiree accumulated seven times his initial savings, even after withdrawing 4% plus inflation every year for thirty years. As for the failure rate, only 4 of the 81 periods resulted in the retiree running out of money.
What are the implications for investors, especially at this stage of a secular bear market? For retirees who are primarily invested in the stock market, the most significant factor determining future returns is the level of valuation at the time of initial investment, as measured by the P/E ratio. So the level of the P/E at retirement has a significant impact on the individual investor’s chances of success in retirement.
To better understand the potential success rate for a couple entering retirement, stock market history can be dissected into five ranked sets called quintiles. These sets are organized from the highest to the lowest P/E ratio at the start of the respective thirty-year periods. The result is that the highest quintile (the top 20% of all periods) includes the thirty-year periods since 1900 that started with P/Es of 18.7 and higher. The second set (the next 20%) cuts off at a P/E of 15.1, the third at 12.2, the fourth at 10.4, and the last at 5.3.
Why does this matter? While the success rate for the entire group was 95%, for a retiree who enters retirement with a portfolio dedicated to stocks when P/E is 18.7 or higher, the expected success rate based upon history is 76%—analogous to more than one loss per day for the surgeon, rather than one per week using the overall average.
When P/E started at relatively high levels historically, thereby fundamentally positioning the stock market for below-average returns, there was a significant adverse impact on future success. When P/E started at relatively lower levels, returns were always sufficient for 4% withdrawals—100% success from periods that started with a low P/E.
As figure 11.2 reflects, the starting level of P/E has a direct impact on retirement success and on ending capital. The implication for today’s investor is that the likelihood of financial success in retirement is considerably less than most pundits advocate. Twenty years from now, a response of “who knew?” won’t be much comfort for retirees in the employment line at the local job fair. This is especially true since a rational understanding of history and the drivers of longer-term stock market returns can help today’s retiree avoid that surprise.
Figure 11.2. SWR Profile By P/E Quintile: 4% SWR, 30-Year Periods Since 1900

As presented in figure 11.2, covering the 81 thirty-year periods since 1900, the top 20% of the periods based upon the beginning P/E started with P/E at 18.7 or higher. Within that 20% of the periods, about 1 in 4 (24%) of the thirty-year periods resulted in the retiree running out of money before the end of the period. When that occurred, the retiree was out of money on average during the 27th year and as early as the 23rd year. For those 76% who were fortunate enough to not run out of money, the average retiree that started with $1.0 million ended the thirty years with almost $2.8 million.
Keep in mind that success provides a wide path, but failure is a thin line: those who succeed will end with a little or a lot; those who fail get to zero, or start counting pennies as their savings dwindle. Further, in reality, for retirees who invest during top quintile periods, the chance of suffering the painful effects of failure is even higher than 24%. Since a few of the periods ended relatively close to zero, fear forced some retirees to drastically reduce spending as their portfolios dwindled toward the end. For most retiree investors over the past century, those fortunate enough to have retired when stock valuations and P/Es were lower, the results were much better. As reflected in figure 11.2, the benefits were directly and inversely related to the starting level of valuation. As the starting valuation declines, returns increase, and the resulting average balance in the portfolio at the end of the thirty years increases. This is another tangible example of the way that starting valuation significantly impacts future results.
A number of advocates and studies promote initial withdrawal rates of 5% or more of the starting portfolio: “You can have $50,000 a year from your million dollars, and have it increase annually by inflation and still last thirty years.” The calculated success rate historically is 75% for retirees using a 5% initial withdrawal rate from stock market portfolio. For many retirees, that probability of success would be marginally acceptable. When the impact of starting P/E is included in the analysis, however, the odds change significantly for most of the quintiles.
As figure 11.3 shows, though the average may have been 75%, one of the sets reflects success as low as 41% while another had everyone making it safely through the thirty years. As you reflect upon the figure to assess the likely odds of either financial success or failure during your retirement, it is crucial to recognize the importance and impact of the starting level of P/E. Most important, it does not matter how many of the scenarios provide your heirs with multimillions; you will likely be most concerned about reducing the chances of being forced to work again at eighty. Risk management is not just about enhancing success; it is about avoiding the unacceptable failures.
Figure 11.3. SWR Profile By P/E Quintile: 5% SWR, 30-Year Periods Since 1900

Though a statistical analysis of history provides averages across a wide variety of market conditions, the relevant periods for analysis are those with similar characteristics. Given the significant impact of P/E on returns, that factor will be a major driver for retirees over this decade and beyond. When individuals or couples retire with P/E in the upper quintiles, thereby driving below-average returns, their expected results will be below average. In some instances the risks will be so great that they may need to adjust their expectations, or they may need portfolio management to enhance potential success.
Retirees during secular bear markets may be limited to withdrawal rates that are less than 3%, or in some scenarios as much as 4%, to sustain their desired lifestyle successfully throughout retirement. Retirees who want to withdraw 5% or more will need a more consistent and higher return profile for their investments than passive investments in the stock market or bond market can provide when starting valuations are high. For those retirees, it will require a more actively managed and value-added approach to their portfolios, including investments in the stock market, even then with no guarantees of success.
There is no magic solution, no one way to achieve success. Given that retirees over this decade and longer are confronting the conditions of a secular bear market, it is important to start with a reasonable expectation about future returns and market conditions, then to apply appropriate investment strategies and approaches. Early personal planning and ongoing investment discipline can help toward avoiding the ROOM.
Winston Churchill could have been talking about this decade in the stock market when he said, “Let our advance worrying become advance thinking and planning.” The practical implications of another secular bear market decade should be a call to action rather than a call for retreat. Churchill offers wisdom that acknowledges challenging conditions and provides a solution toward success. His advice encourages investors to seek the benefits of preparation and risk management, the essential elements for investing through this secular bear toward the next secular bull market.

Market Poised for Selling

2011-02-26T13:52:00.000-06:00

As in any field of work or study, a lot of people provide sizzle without much steak. Armed with the most basic tools, technical analysts can be their own worst enemies. Just like owning a hammer does not mean you can build a house, using charts does not guarantee you will get rich even though you can make a of of noise using both.
I hear a lot of talk about patterns, trends, momentum and dozens of other indicators but most chartists do not really understand the market. Technical indicators have been funky ever since the financial crisis and the more computers trade with other computers the less reliable they become—if used as they have always been used. After all, they are meant to measure the psychology of the masses and computers are cold, unemotional beasts.
One way to cope is to step back a bit to really understand the ebb and flow of the market today. As you are no doubt aware, the stock market took a big tumble on the Libya news. We can cook up all sorts of reasons why it did not do the same on Egypt news or Tunisia or any one of a handful of Mid-East uprisings but as a technical analyst I believe it was because the market was ripe. Sure, Egypt does not produce much oil and Libya does. Argue amongst yourselves what it means to oil and then to the economy and then to the stock market and on and on.
I am a bit more convinced that the market has reached a place where the forces of correction are ready to emerge. The Nasdaq hit its 2007 peak. The S&P 500 came within 1% of a major price level that, when broken, knelled for the end of the bull and the start of the bear market of 2007-2009 (see chart).

For chart heads like me, that would be the neckline of the giant head-and-shoulders top seen at that time.

Another bit of the ebb and flow thing is understanding how different parts of the rally fit together. Without invoking the esoterica of Elliott Wave analysis (see chart to the right), the rally from March 2009 to April 2010 was followed by a correction to June. The rally from June to this month came within 1% of measuring 61.8% of the first leg up. Again, for chart geeks, that is a Fibonacci number and it is not unusual to see this relationship between legs of a rally or decline.
With frothy sentiment, momentum indicators way too high, resistance from 2007 and a nice relationship within the structure of the bull market, it does seem that we have reached a place where bad news would indeed be perceived as bad. So, when we get bad news—such as an oil squeeze—the bears start to call the shots.

Five Myths About Interest Rates

2011-02-16T08:00:00.018-06:00

Interest rates, which have been so low for so long that US consumers and businesses have come to consider it an entitlement, are starting to creep upward, prompting new concerns and debates. Will higher rates undercut the economic recovery? Should the Federal Reserve do more to hold rates down, or did the central bank already err by leaving them low for too long, feeding the housing and credit bubbles of recent years? It is worth dispelling some of the most common misconceptions about interest rates.
The Fed controls interest rates.
Yes, the Federal Reserve can change its federal funds rate—the overnight rate charged on loans between banks—and those shifts affect short-term rates on business loans and consumer loans. But long-term interest rates, such as those on a ten-year Treasury bond or a 30-year mortgage, are determined by the markets and influenced by inflation trends, government budget deficits, and the overall demand for and supply of capital over time.
The limits of the Fed’s powers were apparent recently when it began its second round of “quantitative easing,” an effort to lower long-term rates by pumping more money into the economy. Those rates did fall in the weeks leading up to the program’s launch in November, but they rose sharply soon afterward. Why?
First, signs of a strengthening economy prompted many analysts to raise their growth forecasts for this year, implying that the demand for capital will rise as well—and greater demand for capital translates into higher rates. Second, the tax-cut deal that the White House and congressional leaders struck in December will boost government borrowing this year, adding to the demand for capital. Finally, some investors worry that, as the economy gains momentum, the Fed’s program could lead to rising inflation, and such fears could lead to higher interest rates.
Low interest rates are here to stay.
Not so. Interest rates are headed higher, and not just because the Fed will eventually raise short-term rates once the economy speeds up. Recent research shows that the global demand for capital is rising fast as emerging markets embark on one of the biggest building booms in history. Rapid economic growth and urbanization in developing nations, particularly China, is fueling demand for housing, roads, ports, water and power systems, machinery, and equipment. Global investment demand could rise to $24 trillion per year by 2030, from $11 trillion today.
Meanwhile, global saving is unlikely to rise as quickly, as countries around the world spend more on pensions, health care, and other needs of their aging populations. In some forecasts, global saving will fall short of investment demand by as much as $2.4 trillion in 2030. And because, by definition, savings and investment must equal each other, the gap will push interest rates up.
U.S. policy makers should keep rates low so consumers will spend more and boost the economy.
American households are now saving more than they were during the recent credit bubble; the personal savings rate increased to nearly 6 percent in 2010, from 2 percent in 2007. Not only does this help people save for retirement, it is also good for the nation’s long-term economic health: higher national savings will help fund more national investment. If anything, policy makers should encourage consumers to save even more.
But wouldn’t more personal saving dampen economic growth? Not if corporations and the government increase investments that expand the nation’s capacity to produce more and better goods and services. We have invested too little in the past, particularly in infrastructure. The American Society of Civil Engineers estimates that the United States needs to spend an additional $2.2 trillion over five years—on top of our current $400 billion annual investment—on transportation, water, energy, schools, waste disposal, and public parks, to renew the nation’s crumbling infrastructure and help meet growing demand.
These kinds of investments would provide additional fuel for economic growth, offsetting slower gains in consumer spending. And now is the time to start, while interest rates are still near historically low levels.
The mortgage interest deduction is necessary to support the housing market and the economy.
Hardly. The deduction is a favorite among homeowners, real-estate agents, and lenders, but its broader economic benefits are debatable.
Under current law, US taxpayers can deduct their interest payments on up to $1 million in mortgage debt on both their primary residences and their second homes, and can also deduct their interest payments on up to $100,000 in home-equity loans. The law thus lowers the cost of homeownership and creates incentives to take on extra mortgage debt—spurring the real-estate and finance industries as well as consumer spending.
But these gains come at a cost: The deduction lowers federal revenues (by a projected $104 billion in 2011), thereby adding to the budget deficit. It also encourages households to take on more debt than they would otherwise and thus helped feed the housing bubble that led to the financial crisis. Canada, by contrast, has no such mortgage tax deduction, and its housing market is healthier and less leveraged, avoiding U.S.-style booms and busts. The proposal by President Obama’s fiscal commission to sharply limit the mortgage interest deduction was a step in the right direction.
Higher interest rates are bad for the economy.
Actually, in several ways, somewhat higher interest rates would be better for the economy than the extremely low rates of recent years. They would benefit savers (particularly retirees and pension funds) and therefore encourage greater household saving.
They would also limit financial bubbles, restraining speculative and heavily leveraged investment while encouraging more investment that would actually raise the economy’s potential growth rate, such as expanding the country’s broadband network, developing new green technologies, and rebuilding aging infrastructure.
Higher rates would also focus executives’ attention on the return that companies earn on their capital, prodding them to make sure they get more bang for each buck. This could boost the nation’s productivity, which is the key to raising standards of living over time.

Google Chrome OS and the Cr-48

2011-02-14T10:31:00.060-06:00

Once upon a time, a few decades ago, computers were extraordinarily expensive, room-filling machines — the kind decked out with whirring tape reels, flashing lights, and banks of switches. You did not pull up a chair up to use one; instead, using a process called timesharing, you accessed it via a remote terminal at the same time as a bunch of other folks.
The PC revolution changed all that, but only for a while. Today, we are all dependent on distant computers all over again — namely the phalanxes of potent servers that power the Web. More and more, we are using browser-based services instead of traditional software, and storing documents, photos, and other data online rather than on our own hard disks. It is a red-hot trend known as cloud computing. (The "cloud" in "cloud computing," incidentally, is a pointless synonym for the perfectly good term "Internet.")
Cloud computing does not need to prove its worth: You engage in it every time you post a status update to Facebook, upload a photo to Flickr, or check your inbox in Gmail. But the question is, is it ready to replace — rather than supplement — the old-school, PC-centric computing we know?
Google thinks so. And it is trying to hurry things along with a piece of software called Chrome OS. Based on the company's increasingly popular two-year-old Chrome Web browser (and distinctly different from its Android operating system), Chrome OS has emerged from the primordial browser ooze and sprouted stubby little operating-system legs — ones just muscular enough to let it boot up on its own. It is nowhere near as elaborate and feature-rich as Microsoft's Windows or Apple's OS X, but that is the point. Google wants to reduce or eliminate the headaches that come with full-scale personal computing, from maintenance hassles to security threats to data-destroying hard-disk meltdowns.
The original timetable had Chrome OS laptops going on sale for this holiday season. Google admits that the project turned out to be a more sizable challenge than it expected, so the first commercial systems — from Acer and Samsung — will not hit store shelves until the first half of 2011, at prices yet to be announced. In the meantime, Google has come up with the Cr-48, an unbranded test notebook running a rough draft of the new operating system. It is doling units out at no charge to selected interested parties in return for feedback.

That is exactly how I happened upon one last week. After months gone by since I first applied, I returned from a late night flight to DC to a Cr-48 sitting in my home.
The Chrome OS experience is nearly identical to using the Chrome browser (or, for that matter, Internet Explorer, Firefox, Safari, or any modern browser). Everything runs in full-screen mode, and there is no conventional desktop or folders. And while even the lowliest netbook can run Windows programs, there are no such things as Chrome OS applications: Google has launched something called the Chrome Web Store, but it is just a way to find and bookmark nifty Web sites and services, not a source of apps you can download and install (with the exception of a hybrid GoogleTalk and Notepad).
In theory, all this should feel underpowered and dumbed-down. In practice, it can be surprisingly agreeable, like exchanging a creaky, aging car for a nimble, lightweight road bike. Chrome OS starts up in seconds and snaps out of suspend mode by the time you have fully lifted its lid. There is none of the white noise that degrades the PC experience — the operating system notifying you that it is downloading updates, the security software crowing that it has deflected an attack, the random other programs telling you things you do not really care to know.
If something does go catastrophically wrong with a Chrome OS system, it should be less, well, catastrophic. Your data and settings are stored safely on the Web, not on a hard disk-in fact, there is no hard disk. You can get to them instantly on any Chrome OS computer simply by entering your Google user name and password, eliminating the risk of treasured family photos or videos going bye-bye because you failed to keep a backup. Upgrading from one Chrome machine to another should also be a snap: You will not need to figure out a way to transfer your programs and files.
Still, the time I have spent with a Cr-48 has not convinced me that pure cloud computing beats the blend of Web services and PC-based software that most of us rely on. True, I spend around 90% of my time in the browser even when I am on a Windows PC or a Mac. But some of the remaining 10% is with very specific applications. I would be thrilled, for instance, if a free Web suite such as Google's Google Docs could completely replace Microsoft Office or if my AmazonMP3s could be synced wirelessly from the web to my iPod or Android phone. For now, they cannot — serious number-crunching and dull runs on the treadmill still call for full-bodied Excel and iTunes.
I fret even more about Chrome OS's dependence on a reliable Internet connection. Google uses the tagline "Nothing but the Web" to promote Chrome OS, but "Nothing without the Web" would be almost as appropriate. Except for certain services that retain limited functionality even when the Internet is unavailable, such as Google Docs, this operating system is designed for an era of truly pervasive Net access — not the real world where connectivity can be pricey, spotty, or just plain unavailable.

Google is doing what it can: Every Chrome computer will have a built-in wireless 3G modem as well as Wi-Fi capability, and the company is partnering up with Verizon Wireless to provide buyers with 100MB of free data access for the first two years. A hundred megs is just enough to get you hooked, though — if you need more, you will pay anywhere from $9.99 for a day pass to $50 for up to 5GB of data per month. And it will not help in places where Verizon is unavailable, such as airplanes (where wi-fi is not cheap), for example.
Just to test my assumptions about what I could and could not live without, I used the Cr-48 exclusively for a week (outside of work). I was able to accomplish everything I absolutely needed to do, including writing this FiPod post — in part because I have good Wi-Fi. But when I booted up my Vaio to look up a recipe that was on an external hard drive, my Sony felt like an upgrade that delivered most of what I liked about the Cr-48, plus more.
Even if I have a tough time imagining myself recommending Chrome computers to typical consumers as soon as the first half of 2011, I am glad that they exist. The very existence of Chrome OS should encourage the development of sophisticated next-generation Web services that are better able to replace traditional software. By 2012 or 2013, pure cloud computing could feel far more tenable than it does right now — and if it does, the experiment known as Cr-48 will deserve some of the credit.

How to Save $1M by Age 65

2011-02-12T15:54:00.000-06:00

We at FiPod recently received the following question and believed it to be a great post.

Question: I'm 28 and would like to have $1 million by the time I retire at 65. What are some of the investing options I should consider? --Joshua Sin, Fresno, Calif.

I am all for savvy investing, and I will get to what I think you should do on that front in a minute. But let's not forget that when it comes to building wealth,won' investing alone will not do it. You also need to save.
I do not care how brilliant an investor you are. If you are not putting away a decent amount of money on a regular basis throughout your career, your chances of accumulating a million bucks are lower than LeBron's chances of getting elected mayor of Cleveland.
To understand what I am talking about, let's look at a few numbers.

If you begin putting away $100 a month starting now and continue doing so until 2047, the year you'll turn 65, you would need an annual return of roughly 13.5% a year to turn that monthly hundred dollars into a million bucks.

What investment options can deliver a 13.5% annual return for almost 40 years?

None that I know of. A 13.5% long-term annual return is nearly 40% higher than the 9.8% annualized that stocks have gained over the past 80-plus years, and that near-10% figure includes some pretty dramatic run-ups in the '80s and '90s that we may not see again for a long time.

Suffice it to say that it would be wishful thinking to expect anything close to 13.5% over the long run. If you increase the amount you save, however, you will see that the return you need to reach your goal becomes more manageable. Save $250 a month until you are 65, for example, and you would need a 10% annualized return to hit that $1 million target. I still consider that overly optimistic even for an all-stock portfolio, given the prices stocks are selling at today and the uncertainly surrounding the growth prospects here and abroad.
Boost your monthly savings to $400, and the return you need falls to about 8% annually. Possible? I suppose. But perhaps still ambitious. At any rate, it's higher than the 7.8% that companies in the Standard & Poor's 500 index are estimating for their pension plans, according to S&P.
At roughly $500 a month, however, the required return drops to 7% and if you can sock away just under $650 a month, you would need an annual return of about 6% a year. That seems reasonably achievable with a portfolio that contains both stocks and bonds, although not certain.
The idea behind this exercise, however, is not to make predictions about the long-term returns for stocks and bonds. Rather, my point is to show that the more you save, the less you have to count on lofty returns. It is important to keep that in mind because ultimately we have more control over how much we save than the investment returns we earn.
That said, you do not want to invest so conservatively that you end up having to save so much that you live like an ascetic. You should be willing to take prudent risks, especially when you're young, in hopes of earning a higher rate of return and making your savings burden manageable. But you do not want to invest so aggressively that you're left in the lurch late in life if you don't get the rosy investment performance you'd hoped for.
As for translating that trade off into specific investment options, someone your age who wants a reasonable shot at a seven-figure nest egg at retirement should be investing primarily in stocks. The exact percentage will depend on a number of factors, including how much you are willing to see the value of your investments decline from time to time.
Generally, though, you are probably talking somewhere between 70% and 90% in stocks with the rest in bonds (by which I mean a diversified portfolio of stocks and bonds, along the lines of what you might get combining the total stock market and total bond market funds in our Money 70 list of recommended funds.) The more anxious you get during market downturns, the closer you will probably want to be to the low point of that range. Of course, you could go even more conservative, even to the point of not investing in stocks. But such a cautious approach means you will have to pump up your savings effort quite a bit.
If you would like to see how your chances of accumulating a million bucks changes with different savings amounts and varying mixes of stocks and bonds, check out Morningstar's Asset Allocator tool.
I am not sure how Joshua arrived at $1 million as his goal. Maybe it is just a nice big round number. Remember, though, having a million bucks 37 years from now is not like having that sum today. In fact, assuming a modest 2.5% inflation rate, $1 million in 2047 would be the equivalent of having about $400,000 now. Or, viewed another way, you would need about $2.5 million in 2047 to have the purchasing power of $1 million today.
Finally, rather than shooting for a big lump sum, I think Joshua is better off thinking about how much income he will eventually have to replace to maintain his standard of living in retirement, and then figuring out what combination of saving and investing, along with other resources like Social Security, gives him a reasonable shot at hitting his goal. T. Rowe Price's Retirement Income Calculator can help all of you on that score.
Granted, at his current age any estimates he arrives at are going to be rough. After all, a lot can change over the course of 37 years. But if you save diligently, invest reasonably, monitor your progress regularly and make adjustments as you go along, you will improve your chances of hitting 65 with the level of savings you need, whatever amount that turns out to be.

Is Ford Stock "Found on Road Dead"

2011-02-10T08:09:00.000-06:00

The charts continue to be the number one key to any trader or investor finding the correct entry point for a long or short trade. The best example yet can be found on the daily chart of Ford Motor Company (F). Ever since last Friday, Ford has floundered and collapsed lower, sales numbers disappointing Wall Street. The stock was trading at $19.00 last week, only to fall into the $15.00 range. So the big question was on the lips of every trader and investor. Where is the proper entry on Ford? At what price will the stock bounce? The answer could be found in the charts.
By looking closely, it was noted that there was a major gap fill level at $15.18. This dated back to November 4th, 2010. The stock was already down over 20% and this looked to be the point where reward would outweigh risk to the maximum. Sure enough, the stop hit this level, crossing it by a few pennies. No sooner had it done this, Ford rebounded, shot higher, turned positive and jumped all the way back to $15.70, the high of the day. The gap fill entry level was nailed perfectly by using the charts. Any trader or investor that took the trade is in the money nicely and is having a stress free trade.

FiPod Fund: February 2011

2011-02-08T11:40:00.000-06:00

And The Superbowl Winner Will Be... Google?

2011-02-06T15:16:00.000-06:00

The Super Bowl is not just the biggest TV advertising event of the year, it is also one of YouTube's biggest events of the year. Advertisers are determined to eke out the biggest possible bang for their Super Bowl ad buck, so they are increasingly going online to support their TV ad spend. That means a massive spike in traffic for YouTube, with dozens of millions of visitors and a huge boost in ad revenue for Google (GOOG).

YouTube is hosting its fourth annual 'Super Bowl Ad Blitz' — posting Super Bowl ads online for viewers to view and vote as soon as the game ends. The voting continues for about a week and the winning ad is featured prominently on YouTube's home page, valuable free ad placement.
For the first time AdBlitz will be available on mobile devices, which should send traffic through the roof. People socializing after the game at Super Bowl parties will be able to pull up ads without the hassle of finding a laptop. Plus, YouTube's mobile views have tripled in the past year — which means people are now getting used to watching video on their phones. There is no doubt, YouTube will surpass last year's 42 million video views.
Google does not charge marketers to post their ads on AdBlitz, but there are a number of other ways this initiative generates revenue. YouTube cashes in on the spike in traffic. Once people go to the site to check out one video, they usually stick around and watch many more. The more videos YouTube streams, the more ads the company displays.
And Google sells ads supporting 'AdBlitz' — directing people already on YouTube to watch certain spots. And Google's ad push goes beyond just YouTube. A huge range of Super Bowl advertisers, from Budweiser to VW, are buying regular Google search ads to direct web surfers to watch their ads. (Search for funny Super Bowl ads and a rotating selection of ads from major marketers will pop up.)
Google also sells YouTube Brand Channels for $500,000. Companies like eTrade and Bridgestone have ponied up for dedicated, branded pages both on YouTube and the mobile platform. Jim Lecinski, Google's Managing Director of U.S. Sales will not tell how many of the Super Bowl advertisers have committed to these pages, but he did say that they are continuing to strike deals right now and will post many more pages before Sunday.
The Super Bowl has had an important impact on the way marketers approach an ad campaign. It has been effective to extent Super Bowl ad campaigns online, so marketers are starting to do that with other events — like the Oscars, or product launches. And all that ads up to more revenue for Google

Why An AAPL May Cost $500

2011-02-05T08:41:00.000-06:00

Apple recently announced its FY Q1 2011 earnings results, which were mixed though results did beat consensus estimates with $6.43 in EPS on revenues of $26.7 billion for this quarter against the consensus estimate of $5.38 in EPS on revenue of $24.42 billion. Most investments shops nudged their price estimate higher by $2 to $420, which is about 20% higher than the current market price. Apple competes with phone makers like Research in Motion, Motorola, Nokia, and Google.

As we look at 2011, the story is largely still about the iPhone and iPad. The iPhone now accounts for 52% of AAPL's price estimate while the iPad has risen to just over 7%.

iPhone 4 on Verizon could make a bigger splash
A few days back, Apple announced that iPhone 4 will be coming on Verizon network from February 2011. This could be a big trigger for Apple in terms of iPhone market share if Verizon’s network and subscriber base embrace the coveted smartphone in earnest. Verizon has over 90 million subscribers in the U.S. with 30% market share. Apple iPhone has increased its market share from 0.3% in 2007 to 3.1% in 2010, and most expect it to continue to increase to around 6.5% by 2013. Equivalently, we estimate that Apple sold 47.5 million iPhones for the calendar year 2010, thus increasing to around 116 million by 2013, at an average stated annual growth rate of 27%.
Additionally, enterprise support for iPhone has continually increased with 88 of the Fortune 100 companies and almost 60% of the Financial Times Europe 100 companies now testing or deploying iPhones. These are encouraging signs for iPhone and if Apple is able to increase iPhone’s market share at a faster rate to reach 10% by 2013, this raises our price estimate squarely to $500.

Can iPad remain king of the tablet jungle?
Although Apple has been able to rapidly increase the iPad sales from 3.3 million in CY Q2 2010 to 7.3 million in CY Q4 2010, it does face competitive threats from players like Samsung, RIM, Dell and HP in the future. However given its popularity and the adoption of the enterprise market, the iPad will not be easy to beat.
Apple management claims that iPad’s design is far superior to Microsoft OS or Google Android OS for tablets – why wouldn’t they? According to Apple, Windows-based operating system is heavy, expensive, has a weak battery life and requires a keyboard for the input. With regards to Android, Apple claims that Android and so does not provide the ideal tablet experience.
Based on the releases, we estimate that Apple sold just under 15 million iPads in 2010, and we expect its sales to increase to around 35 million by 2013, a 35% CAGR. According to Gartner, the tablet market is expected to grow from 19.5 million in 2010 to 208 million in 2014. If Apple is able to sell around 60 million by 2013 instead this would add just under 5% to our price estimate.

Why Sprint's Stock No Longer Sucks

2011-02-03T08:30:00.000-06:00

Sprint primarily competes with AT&T and Verizon in the mobile phone business. The company has been looking to rebuild its once shoddy image with multiple initiatives like improving customer service, network modernization, moving iDEN subscribers to a CDMA platform, investing in WiMax 4G, and expanding smartphone offerings. While these moves could lift core mobile phone operations and improve brand perception, Sprint can also benefit from strategic efforts to tap new markets.

My price estimate for Sprint’s stock stands at $4.35, in line with market price. Upside stemming from a push into markets like smart cars and smart grids could present a buying opportunity for investors.

Sprint’s Push Beyond Mobile Phones
Sprint is investing in technology that would add wireless connectivity to cars, a market that Sprint believes could bring revenues of over $1 billion within a few years. (Gartner anticipates that more than half of all premium vehicles in the U.S. will support apps by 2013, with half of all mass market cars supporting the technology within 3 years thereafter.) The technology would link mobile devices and applications to cars in order to enhance communication, navigation, and entertainment features. The move could create substantial upside for Sprint, as it positions its operations to tap a market with large growth potential. According to research from Gartner, roughly 4% of U.S. cars currently feature wireless connectivity.
Comparatively, mobile phones boast roughly 90% penetration in the U.S., so the opportunity for connected automobiles to close the gap is large.
Sprint has also partnered with ECOtality, an electric car charging company, to connect its electric car chargers throughout the country. New developments will help drivers locate charging facilities through GPS, enable data tracking on charging habits, and facilitate other processes like billing and digital content delivery. The move represents a foray for Sprint into the smart-grid arena, a next-generation network concept to monitor electricity consumption of households and businesses.
Sprint’s effort to expand its operations could present an interesting opportunity for investors, as the company increases its mix of revenues beyond core mobile phone segments. The trend could effectively expand the base of U.S. mobile internet subscribers, a metric to which Sprint’s stock value is particularly sensitive.

Happy Groundhog Day

2011-02-02T06:00:00.004-06:00

F5 Got Cloud-Slapped

2011-02-01T08:37:00.000-06:00

Last week, NetApp dipped on F5 earnings as revenues came in a little below expectations. While profit for F5 surged by 69% in Q1 year over year beating analyst expectations, the stock fell as investors had become accustomed to cloud players beating and raising expectations. In addition to NetApp, other cloud EMC, Salesforce.com and Riverbed saw profit taking as a result of F5’s earnings.

While we are bullish on storage and cloud networking stocks, we felt it was worth reviewing NetApp’s position in the industry. In an earlier note, we highlighted how cloud computing is resulting in a transition in the data storage space and all major players are making significant investments to grab the cloud opportunity. NetApp, a large player in the cloud computing space, competes primarily with EMC, VMware, Hewlett-Packard & IBM in the data storage market, and we currently have a $64.48 Trefis price estimate for NetApp’s stock, about 15% ahead of the current market price.

F5 a Niche Player in Cloud Space
F5 provides network optimization solutions and is a niche player in the cloud space. The firm is the market leader in application delivery controllers which helps network managers control traffic and improve software performance. With the increasing adoption of cloud computing and virtualization, a large amount of work is shared between virtualized infrastructures. As such optimization has become increasingly important in a cloud environment and firms are making significant investments to acquire or develop optimization solutions. Recently NetApp also acquired Akorri Networks, a storage optimization firm that helps companies use their storage capacity more efficiently in virtualized environments.

NetApp Need Not Worry
Less than expected growth in F5’s Q1 revenues indicates that analysts’ forecasts for the cloud computing firms might have been a little too aggressive or investors were looking for a reason to take some profit. Total data storage has seen tremendous growth in the past growing at an average rate of more than 50%, and we estimate that total data storage will continue to observe meteoric growth going forward driven by increased personal consumption as internet penetration grows rapidly.
We believe the earnings miss for F5 is a firm specific event and was due to, as the firm says, “certain sales deals not closing in late October”. We remain optimistic for NetApp as cloud as a concept gains increasing popularity and foresee its large scale adoption and believe a few surprises (like F5’s) do not indicate any long term threat to the cloud industry on the whole; however, a slightly lower growth in total data storage due to slower adoption of cloud and virtualized storage solutions could result in noticeable downside to our $64.50 price estimate for NetApp’s stock.

Harness The Power Of Passive Investing

2011-01-30T08:21:00.023-06:00

A few years ago it was not possible to build a passive portfolio of index funds and exchange-traded funds that covered all asset classes because most funds did not exist. That is no longer the case. This successful investment experience hinges on three key elements: the development of a prudent investment policy, full implementation of the policy, and the discipline to adhere to the plan in good times and bad.

In the following paragraphs I will run through the steps it takes to build a passive portfolio. At the end of this post you will find my specific recommendations for what I call a Core Four portfolio of mutual funds and exchange-traded funds.

Step 1: Understanding and Defining Needs
Investment strategy differs among investors depending on their needs. Individual investors are different from institutions. Individuals invest for themselves and their loved ones. The choices and actions that individual investors make have a direct bearing on their wealth and the wealth they will transfer to heirs. In contrast, institutional investors manage money for other people, therefore the choices made and actions taken by trustees will affect the lives of others.

Step 2: Study Market Risk and Estimate Returns
The asset allocation begins with a risk and return assessment. Successful investors study all asset classes and their components to understand the differences. They estimate the long-term expectations of risk and return, and study how the returns on one asset class may move in relation to the returns of other classes. Then they weigh the advantages and disadvantages of including each investment in their portfolio.
Investors expect to be paid for taking financial risks. Consequently, all financial assets are priced based on their perceived risk. The greater the perceived risk, the greater the expected return. Investors should consider the potential correlations among asset classes going forward and also be aware of which asset classes, styles, and sectors are better placed in tax-advantaged accounts such as a tax-sheltered retirement account and those that are suitable for taxable accounts.

Step 3: Select an Asset Allocation
The backbone of an investment plan is its asset allocation. At the 50,000-foot level, asset allocation is all about developing overall return goals while controlling risk. At the 5,000-foot level, it is about the expected risk and return of major asset classes and the correlations between those risks and returns. At the 500-foot level, asset allocation is about tweaking a portfolio using sub-asset classes to enhance the expected return of a portfolio.
Risk and return go hand in hand. Without risk, there is no expected portfolio return after taxes and inflation. The only way to distribute money and maintain portfolio value net of taxes and inflation is to accept some financial risk.
James Tobin, a pioneer in the area of risk budgeting, stated that investors should first determine their appetite for risk. In a sense, Tobin was saying that there are two portfolios, safe and risky, and each investor should own some risky assets, but only after taking care of their liquidity needs with no risk assets. He believed that there are optimal allocations within the safe portfolio and the risky portfolio and they are same for everyone. The only thing that changes is the amount allocated to each bucket.

Step 4: Investment Selection
The first criterion for asset class inclusion is that an investment under consideration be quantifiably different from all other investments. Stocks and bonds are different as they have different obligations from the issuer, have different income streams, and are even taxed differently. Differentiating between categories within an asset class can also be straightforward. By definition, European stocks and U.S. stocks are mutually exclusive. Membership in one index precludes membership in the other.
Finding unique investments among category styles is more complicated. For instance, there is not much fundamental difference between large U.S. stocks and small U.S. stocks. Nonetheless, U.S. stocks can be divided so that a large stock index is quite different than a small stock index. Then the two indexes can be analyzed to discover different risk-and-return characteristics.
The second criterion for asset class inclusion is that the expected return must be higher than the inflation rate. All investments have an inflation expectation built into the price. Bonds pay interest based on the expected inflation rate until maturity, plus a fair risk premium over inflation based on the riskiness of the bond. Stock prices have an inflation expectation built in and also grow above inflation as real earnings growth occurs and dividends are paid by the companies.
Finally, the asset class should be investible with low-cost index funds and ETFs, or a least a near-index type, broadly diversified actively managed fund. Most asset classes are available in an index fund or ETF so there is no need for active funds. Some segments of the market are not as easy to invest in using index funds or ETFs because the indexes are difficult to replicate in a real portfolio. Municipal bonds are a good example. Funds that attempt to track municipal bond indexes don’t have the diversification that’s the hallmark of a good index fund investment.
Be very selective when analyzing indexes and the funds that track them. Morningstar Principia lists nearly 2,000 index funds but only a few dozen funds are truly of interest to a purely passive fund investor. These low-cost funds, coupled with a fixed strategic asset allocation based on needs, create a high probability solution for nearly every investor.

Step 5: Implementation and Maintenance
The best laid plans are useless if not implemented in full. I estimate less than 50 percent of investment plans are actually fully put into practice, and less than 10 percent of all investment plans are fully implemented and maintained for more than five years.
Regular maintenance is required after an investment plan is implemented in full. At a minimum, the owners or trustees should ensure that cash is invested when it is deposited and that dividends and interest are reinvested unless they are needed for withdrawals. In addition, asset allocation should be checked periodically to ensure that the portfolio is allocated close to the fixed allocation. If the allocations are off by more than a certain percentage, then rebalancing should take place.
A good plan has long legs and should last several years without major modifications. Annual reviews and adjustments are appropriate, with major changes occurring only when something has changed in the personal lives of the owner or beneficiaries of the account. Aside from rebalancing, portfolio changes should never be made in reaction to poor market conditions.

Conclusion
This short introduction to portfolio management processes works for all portfolios, including individual accounts, trust accounts, pension funds, endowments, and foundations. It is the highest probability solution to investment management. This model portfolio is called “Core Four” using both mutual funds and ETFs. For someone with a 60% stock allocation and a 40% bond holding the components would be:
Mutual Funds:

36% Vanguard Total Stock Market Index (VTSMX)
18% Vanguard FTSE All-World Ex-U.S. (VFWIX)
6% Vanguard REIT (VGSIX)
40% Vanguard Total Bond Market (VBMFX)

ETFs:

36% Vanguard Total Stock Market ETF (VTI)
18% Vanguard FTSE All World Ex-U.S. ETF (VEU)
6% Vanguard REIT ETF (VNQ)
40% Vanguard Total Bond Market ETF (BND)

FiPod warns that anyone interested in this kind of portfolio has to have a long time horizon.

7 Habits of...A Slow U.S. Economy

2011-01-28T06:24:00.003-06:00

Hoisington Investment Management Company (www.hoisingtonmgt.com) is a registered investment advisor specializing in fixed-income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $4 billion under management, composed of corporate and public funds, foundations, endowments, Taft-Hartley funds, and insurance companies. This is their regular quarterly report, where they outline seven things that are likely to retard US growth. An easy read, but take the time to think this through.

Growth Recession Continues
Factoring in a 4% Q4 growth rate, the U.S. economy expanded by 3% in real terms from the 4th quarter of 2009 through the 4th quarter of 2010. Despite this rise in GDP, the unemployment rate remained stubbornly high at 9.6% in the last quarter of 2010, only slightly lower than the 10% rate it averaged in the same quarter one year ago. Positive real GDP growth with high unemployment is the definition of a growth recession. An even slower growth rate of real GDP should be recorded over the next four quarters, suggesting the unemployment rate will be essentially unchanged a year from now. As we have noted previously, this modest expansion is due to the significant over-indebtedness of the U.S. economy. We see seven main impediments to economic progress in 2011 that will slow real GDP expansion to the 1.5%-2.5% range.
First, fiscal policy actions are neutral for 2011. Second, state and local sectors will continue to be a drag on the economy and labor markets in 2011. Third, Quantitative Easing round 2 (QE2) will likely produce only a slight economic benefit as the Fed continues to encourage additional leverage in an already over-indebted economy. Fourth, while consumers boosted economic growth in the second half of 2010 by sharply reducing their personal saving rate, such actions are not sustainable. Fifth, expanding inventory investment, the main driver of economic growth since the end of the recession in mid-2009, will be absent in 2011. Sixth, housing will continue to be a persistent drag on growth. Seventh, external economic conditions are likely to retard U.S. exports.

Fiscal Policy in Neutral
The recent tax compromise between the President and Congress merely extended existing tax rates for another two years and provided a transitory 2% reduction in social security tax withholding. Personal taxes, including federal and non-federal, rose to 9.44% of personal income in November, up from a low of 9.1% in the second quarter of 2009 (Chart 1). Even with the tax compromise this effective tax rate will continue moving higher as a result of higher state and local taxes. Economic research has documented that temporary changes in tax rates are far less beneficial than permanent ones since consumers spend on the basis of permanent income. Higher outlays for unemployment insurance were also legislated, but these were negated by cuts in other types of spending. Federal spending through early March will mirror its pace in fiscal 2010, and the rest of the 2011 budget will decline slightly in real terms. Therefore, total real federal expenditures are likely to contract in real terms this year.

If fiscal policy becomes focused on long-run considerations (e.g. deficit reduction) economic conditions will improve over time. But, if fiscal policy remains focused on short-term stimulus, the economy’s prolonged under-performance will persist since the government expenditure multiplier is less than one, and possibly close to zero.
The recent scientific work on the expenditure multiplier is aligned with the Ricardian equivalence theorem as well as the views of the Austrian economists who continued to follow Ricardo even when the Keynesian revolution was ascendant. Economist Gary Shilling made this point very well in his outstanding new book, The Age of Deleveraging – Investment Strategies for a Decade of Slow Growth and Deflation.
Dr. Shilling’s analysis of the simplified and unsubstantiated Keynesian multiplier (p.216) still taught in many colleges and universities is extremely insightful. “But the Austrian School of economists like Friedrich Hayek and Ludwig von Mises believed that the economy is much more complicated; The Austrian view suggests that the government spending multiplier may be only 1.0 and that there are not any follow-on effects. More recent academic studies indicate that the multiplier is less than 1.0, and perhaps much less.”
After recognizing the difficulty of calculating the multiplier, Dr. Shilling writes, “Also, the inherent inefficiencies of government reduce the effects of deficit spending and lower the multiplier.” Thus, if steps are taken to reduce deficit spending, the economy’s growth rate will recover after the initial transitory negative impact as additional resources are provided to the private sector.

State and Local Governments Drag
Municipal governments face substantial cyclical deficits and significant underfunding of their employee pension plans. In addition, municipal bond yields rose sharply in the second half of 2010, increasing borrowing costs, probably an unintended consequence of QE2. The municipal bond market proceeds are used primarily for funding capital projects, which suggests that such projects will be delayed. State and local governments typically do not undertake capital projects freely when they have large cyclical deficits.
To reign in these financial imbalances, state and local governments have five choices: (1) cut personnel; (2) reduce expenditures including retirement benefits; (3) raise taxes; (4) borrow to fund operating deficits; or (5) declare bankruptcy. All retard economic growth. Any trend toward increased bankruptcy would raise caution in the broader municipal market and add to higher borrowing costs. Raising taxes may give bondholders more confidence, but such actions can fail to raise new revenue as slower economic conditions retard spending. The demographic trends in the decennial census also show that people are increasingly moving to low tax regions, contributing to worsening fiscal imbalances from the exited areas.

QE2’s Problems
Clearly, Fed actions have affected stock and commodity prices. The benefits from higher stock prices accrue very slowly, are small, and are slanted to a limited number of households. Conversely, higher commodity prices serve to raise the cost of many basic necessities that play a major role in the budget of virtually all low and moderate income households.
For example, in late 2010 consumer fuel expenditures amounted to 9.1% of wage and salary income (Chart 2). In the past year, the S&P GSCI Energy Index advanced by 14.6%. Since energy demand is highly price inelastic, it seems there is little alternative to purchasing these energy items. Thus, with median family income at approximately $50,000, annual fuel expenditures rose by about $660 for the typical family. In late 2010, consumer food expenditures were 12.6% of wage and salary income. In the past year, the S&P GSCI Agricultural and Livestock Commodity Price Index rose by 40%. If we conservatively assume that just one quarter of these raw material costs are ultimately passed through to consumers, higher priced foods will have added another roughly $626 per year of essential costs to the median household budget. These increased costs could be considered inflationary, however, with wage income stagnant, higher food and fuel prices will act like a tax increase. Indeed, the approximately $1300 increase in food and fuel prices is equal to 2.6% of median family income, an amount that more than offsets the 2% reduction in the social security tax for 2011.

Reflecting the inflationary psychology of the higher stock and commodity prices, mortgage rates and municipal bond yields have risen significantly since QE2 was first proposed by the Fed chairman, increasing the cost and decreasing the availability of credit for two sectors with serious underlying problems. Also, Fed policy has pushed most consumer time, money market, and saving deposit rates to 1% or less, thereby reducing the principal source of investment income for most households. Clearly the early read on QE2 is negative for the economy.

Substitution Effects
In a November speech in Frankfurt, Germany, Dr. Bernanke said that the use of the term “quantitative easing” to refer to the Federal Reserve’s policies is inappropriate. He stated that quantitative easing typically refers to policies that seek to have effects by changing the quantity of bank reserves. These are channels that the Chairman considers relatively weak, at least in the U.S. context. Dr. Bernanke goes on to argue that securities purchases work by affecting yields on the acquired securities in investors’ portfolios, via substitution effects in investors’ portfolios on a wider range of assets. This may well be true, but the substitution effects are just as likely to be detrimental (i.e. the adverse implications of increasing commodity prices and rising borrowing costs for some and reducing interest income for others). Importantly, the Fed has no control over these substitution effects.
In his reputation-establishing 2000 book, Essays on the Great Depression, Dr. Bernanke argues that “some borrowers (especially households, farmers and small firms) found credit to be expensive and difficult to obtain. The effects of this credit squeeze on aggregate demand helped convert the severe, but not unprecedented downturn of 1929-30 into a protracted depression.” Interestingly, when QE2 drives up borrowing costs for homeowners and municipalities, thereby restricting credit, the Fed is creating (according to Dr. Bernanke’s book) the exact same circumstance, albeit on a reduced scale, that helped cause the great depression—rather bizarre!

Liquidity Mistakes
For the past twelve years the Fed’s policy response to economic problems has been to pump more liquidity. These problems included: (1) the failure of Long Term Capital Management in 1998; (2) the high tech bust in 2000; (3) the mild recession that began with a decline in real GDP in the fall of 2000; (4) 9/11; (5) the mild deflation of 2002-3; (6) the market crisis and massive recession and housing implosion of 2007-9; and now, (7) the lack of a private-sector, self-sustaining recovery.
The Fed diagnosed each of these events as being caused by insufficient liquidity. Actually, the lack of liquidity was symptomatic of much deeper problems caused by their own previous actions. The liquidity injected during these events led to a series of asset bubbles as the economy utilized the Fed’s largesse to increase aggregate indebtedness to record levels. The liquidity problems arose as the asset bubbles burst when debt extensions could not be repaid and generally became unmanageable. Each succeeding calamity or bust reflected reverberations from prior Fed actions.
While governmental directives to Fannie and Freddie to increase home ownership clearly also played a role, the Fed supported this process by providing excessive liquidity to fund the housing bubble as well as other unprecedented forms of leveraging of the U.S. economy. The heavy leveraging and the associated asset bubbles, however, produced only transitory and below trend economic growth. Similarly, like its predecessors, QE2 is designed to cure an over-indebtedness problem by creating more debt.
In addition to failing to revive the economy permanently, major unintended consequences have arisen. The LTCM bankruptcy created a $3 billion loss, a very modest amount in view of the sums required by subsequent bailouts. The Fed’s reaction to LTCM served to give market participants a signal that the Fed would back-stop those regardless of whether they engaged in or enabled bad behavior. Also, Fed actions have conditioned Wall Street to seek Fed support whenever stock prices come under downward pressure. In fact, the process of leaking out QE2 began in the midst of a stock market sell off.
Well-intentioned actions to promote growth and fine tune the economy by micromanagement have instead produced failure. Although the Fed had little choice in massively supporting financial markets in 2007/8, no Fed intervention would have been a more long-term productive stance in the previous economic events. QE2 is another example of flawed Fed policy operations.

The Saving Rate Decline
In the second half of 2010, real GDP grew at an estimated 3.3% annual rate (assuming the fourth quarter growth rate was 4%), up from 2.7% in the first half of the year. Transitory developments in two of the most erratic and unpredictable components of the economy—the personal saving rate and inventory investment—accounted for all of this acceleration.
From 6.3% in June 2010, the personal saving fell by a significant 1%, to 5.3% in November (Table 1). Consumer spending is slightly in excess of 70% of real GDP. Without the one percentage point reduction in the personal saving rate, the second half growth rate would have been 2.6%, a shade slower than the first half growth pace, and materially less than the presumed second half growth rate.

When job insecurity is high, and defaults, delinquencies and bankruptcies are at or near record levels, a drawdown in the saving rate would seem to be an unlikely event. This development is certainly viewed favorably by retailers but the issue is whether the economy’s future is better served by using the funds to make mortgages current, pay other debts and prepare consumers for potential emergency needs. Thus, the lowering of the saving rate is similar to running monetary and fiscal policy to meet short-run needs while ignoring long-term consequences.

Inventory Reversal
Inventory investment was the main driver of economic growth since the recession ended in mid-2009. Based on published data, real GDP grew at a 2.9% annual rate over this span. However, real final sales, which excludes inventory investment from GDP, increased at a paltry 1.1% pace. In the third quarter, inventory investment surged to 3.7% of GDP while preliminary fourth quarter figures on retail, wholesale and manufacturing inventories indicate this figure might have reached 4% (Chart 3). In the final quarter of the recession, inventory investment was -5.1% of GDP. Since 1990, the period of modern inventory control mechanisms, inventory investment averaged only 1.1%. At a minimum, the dominant source of aggregate economic strength will not repeat in 2011.

Housing Drag Persists
Housing will remain a drag on economic activity in 2011. Prices have re-accelerated to the downside over the past four months, as mortgage yields have risen and the housing overhang has increased. The housing overhang, as explained by Laurie Goodman writing in the Amherst Mortgage Insight, “is not caused solely by the number of non-performing loans that exist in the market. The problem also includes the high rates at which re-performing loans are re-defaulting, along with the relatively high rates at which deeply underwater loans that have never been delinquent are running two payments behind for the first time.”
Another major problem is that home prices are still too high. An excellent and well-researched study by Danielle DiMartino Booth and David Luttrell in the December 2010 Economic Letter from the Dallas Fed documents this issue very authoritatively. Booth and Luttrell write, “As gauged by an aggregate of housing indexes dating to 1890, real home prices rose 85% to their highest level in August 2006. They have since declined 33 percent. In fact, home prices still must fall 23% if they are to revert to their long-term mean.”
From the standpoint of most households, the home is the main component of wealth, not stock market investments. The continuing drop in housing prices serves to underscore the ill advised and likely temporary drop in the personal saving rate that was so critical to economic performance late last year.

Adverse Global Considerations
The global economy since 2009 may be referred to as a two-speed recovery, with China, India, Brazil, and other emerging economies at the high speed and the U.S. and Europe at the slow speed. That pattern is likely to continue, but with an important difference. China, India, and Brazil are likely to slow adversely affecting the U.S. and Europe. Thus, the two-speed recovery will continue, but with the entire world growing at a much more modest pace. Two major considerations point to this outcome. First, the higher food and fuel prices discussed earlier will serve to significantly depress growth in countries like China, India and Brazil where food and fuel are known to be a much higher percentage of household budgets. Already reports have surfaced from international agencies on the growing adverse consequences of higher food prices, and social unrest has also been witnessed on a limited basis.
Second, Chinese economic policy is designed to slow growth and reduce inflationary pressures. Although the People’s Bank of China (PBoC) has already taken several actions to contain surging inflation, more steps may be needed. In China, as elsewhere, inflation is a lagging indicator. It is worth considering that the PBoC has never been able to engineer a soft landing, which suggests that ultimately a downturn in China may be greater than the prevailing consensus.
Thus, changing global conditions should serve to moderate U.S. exports. Ironically, the U.S. current account deficit still may continue to improve. A stabilization of the saving rate will reduce U.S. imports, while a higher saving rate will cut imports significantly. Already this two-speed global economy has resulted in a reduction in the U.S. current account deficit of approximately 3% of GDP (Chart 4). A continuation of this trend will serve to underpin the value of the dollar, which rose in 2010. The firm dollar, in turn, will serve to keep U.S. disinflationary trends intact.

Bond Market Conditions
In spite of the adverse psychological reaction to the QE2, long Treasury bond yields dropped to 4.3% at the end of 2010, down 30 basis points from the close of 2009, producing a total return of slightly more than 10% for a portfolio of long Treasury and zero coupon bonds. The problematic economic environment and its depressive effect on inflation suggests long Treasury bond yields could easily decrease another 30 basis points in 2011, which would produce another double-digit rate of return for a similar portfolio. The probabilities of even lower yields are significant.

The U.S. Government and Commodities

2011-01-26T05:58:00.002-06:00

The U.S. military is gearing up to become a more active player in the global scramble for raw materials, as competition from China and other countries raises concerns about the cost and availability of resources deemed vital to national security.

The Defense Department holds in government warehouses a limited number of critical materials--such as cobalt, tin and zinc--worth about $1.6 billion as of late 2008. The Pentagon is in the process of overhauling its stockpiling program. The new plan, dubbed the Strategic Materials Security Program, would give the military greater power to decide what it stockpiles and how it goes about buying the materials. It would also speed up decision making at a time when military technology evolves rapidly, commodity markets swing widely and countries around the world fight to secure access to natural resources.
Right now, the military cannot add to the stockpile list without congressional approval, a process that can take as long as two years. The military wants to remove that restriction. It also wants the authority to strike long-term deals with companies or allied nations to provide emergency supplies of materials that the military says are irreplaceable for making weapons, jet engines, high-powered magnets and other gear.
U.S. allies are also increasingly alert to possible supply threats. Last year, Australia blocked a Chinese firm's bid for control of a company that was developing a mine for rare-earth elements, which are used in products such as alloys, electronics and computer monitors. China controls more than 90% of global production of rare-earth elements, which the U.S. military uses in lasers and high-powered magnets. The U.S. in October added several of these elements to its list of materials that it might warehouse.
The proposed changes to the stockpile system are part of a broader overhaul of the way the Pentagon buys raw materials. The military currently uses hundreds of millions of dollars worth of raw materials annually, for building weapons and equipment, among other things. The military has recently tested a system of bulk-buying commodities--by putting in joint orders across the armed services--which could cut purchasing costs. The military also wants the latitude to have private companies stockpile materials in "buffer stocks" that the military can tap if other supplies dry up.
Critics argue the current stockpiling system--set up in 1939 for World War II and shaped by the Cold War--is outdated and leaves the U.S. vulnerable to a shortage of critical supplies. That could weaken the military's negotiating position or leave it at the mercy of wild price swings in the market, or unable to get the material it needs for key weapons. The huge purchasing power of other nations such as China and India makes this even more critical,
according to a Department of Defense report given to Congress last year. Worries about potential shortages of strategic materials escalated in 2007 and 2008, as commodity prices jumped and demand from emerging economies soared. At a hearing on the stockpile last July, a Defense Department official told Congress that the price of rhenium, whose heat-resistant qualities help jet engines operate at higher speeds, at one point shot up 1,000%. Rhenium is one of many materials the department already screens for stockpiling.
China looms large in the debate. In addition to dominating production of rare-earth elements, China is an aggressive deal maker with countries and companies that produce raw materials. The Chinese government also stockpiles a range of natural resources. The rising competition for raw materials has sparked fears in the U.S. military that some materials that once seemed abundant could suddenly become hard to get at any price. In 2008 the military suspended or limited sales of 13 commodities it had previously considered excess. Last year it added 14 materials to its list of resources it considers for stockpiling, including specialty steels, lithium and some rare-earth elements, taking the total to 68. More additions are expected, said the Defense National Stockpile Center.
The changes being proposed by the military have the potential to move prices, especially on materials for which the market is small. If the military decides to add a commodity to the stockpile, it could cause some upward pressure on price. The Defense Department is also a major buyer of raw materials for immediate consumption, as opposed to stockpiling. It purchases about three-quarters of a million tons of raw materials a year for immediate consumption, and it uses almost 1% of U.S. steel production and nearly 5% of its aluminum.
The stockpiling system evolved over the past few decades into a network of warehouses containing material that, after the Cold War, the military largely concluded it no longer needed. Much of what was stored has since been sold off, shrinking the hoard and netting about $7 billion. In 1995, the stockpile held 90 different commodities at 85 different locations. Today, it holds 20 commodities in 10 locations.
The military has been caught flat-footed in the past. A special type of steel was needed early in the Iraq war to reinforce Humvees to protect soldiers from powerful explosives used by insurgents. The Defense Department did not have the steel in its stockpile, and couldn't find a domestic firm to produce all it needed. The rules were changed to allow the military to use material from Mexico, according to testimony to Congress last year. At the same time, the military has also adapted to emergencies. When it was racing to build bomb resistant trucks to use in Iraq, the Pentagon invoked authority it had not used in decades to force contractors to give key projects top priority access to essential material, because it feared shortages of ballistic glass and other components.

Rare Earth Minerals and Molycorp (MCP)

2011-01-24T06:06:00.000-06:00

The mineral trade has been one for the ages. Stocks like Molycorp, Inc. (MCP) doubled in value in the month of December, soaring to an all time high of $62.80. Rare earth metals and minerals were the place to be as rumors surfaced out of China that they may lower the amount allowed for export. A rocket ship move was an understatement for stocks like MCP and Rare Element Resources Ltd. (REE). In addition, small cap China mineral plays soared, moving hundreds of percentage points. China Shen Zhou Mining & Resources Inc. (SHZ), China GengSheng Minerals, Inc. (CHGS) and Qiao Xing Universal Resources, Inc. (XING), just to name a few.
These stocks topped out at the end of December and have since sold sharply. MCP has fallen from its high of $62.80 to a low of $44.74. This massive drop may seem like a real buying opportunity but a true investors and trader must use the charts. The charts allow for exact entries and exits. This maximizes profits. Let's analyze MCP to discover the ideal entry.
The chart of MCP is getting attractive from the buy side but has yet to hit the key support that a true investor would want to see. That price is clearly the $39.50 to $40.00 level. Why? There are two technical levels at that same price. These two signals confirm a major support and a huge bounce opportunity. First, the daily 50 moving average sits at $40.00. In addition, the last pivot high was made in late October at $40.00 as well. These two major levels coincide and signal a buy. Note the chart below.

The stock is attracting attention for another reason - IPO lock-up expiration. Molycorp confirmed that the IPO lock-up is expiring on Tuesday January 25, 2010. After the lock-up agreements expires, an additional 53,125,000 shares will be eligible for sale in the public market. Total shares outstanding currently sit at 82.3 million. How much will the lock-up expiration impact shares of Molycorp? That remain to be seen, but shares of another hot stock Tesla Motors (TSLA) saw its stock drop 15 percent the day its lock-up expired.

Over the longer-term, Molycorp's fortunes will likely be more closely tied to rare earth prices and the situation in China, but if the latest pullback in the shares of rare earth stocks tells you anything it is that the sector has gotten frothy and was due for a correction. Maybe the lock-up expiration will be a blessing in disguise for Molycorp shareholders, as weak-hands will exit the stock making way for larger, longer-term shareholders who have the patience to wait for the company to gets its new rare earth facility online.