Market Evaluations and Advice
INTRODUCTION
In Money Smart I explain that the standard advice to "always invest for the long run" is nothing more than a highly destructive myth. All markets go through long periods where they are substantially over or under valued and it is critical to know the current valuation of any market you are invested in, or are considering investing in.
I update my evaluations as circumstances change and my advice shifts. You can sign up for Smart Alerts and get notified as my market advice changes.
This is not information you need to check on a daily basis, but rather should check
periodically to make sure your investments are safe. Check back especially when
you are considering making a new investment, or changing an investment in any of
these markets.
a high probability of success, gives you the best chance at being successful. For
example, if you select 5 investments with an 80%+ probability of success and only
4 succeed; the odds are still good that you will be a winner.
We all like to feel certain when we invest, but the reality is that it's a game
of probability, and that diversifying your investments into a series of high probability
situations is both the best that can be done and is also usually all we need to
do.
In this section of the website I provide my best evaluation, as well as evaluations
from others I respect, of the current status of:
Disclaimer: This website contains the opinions and ideas of the author. It
is intended to provide information to be used as a guide and a reference in making
personal financial management decisions. Presentation of performance data herein
does not imply that similar results will be achieved in the future, and past performance
is no indication of future results. Performance data is provided only for the purpose
of illustrating and discussing the underlying principles involved and not as the
basis for making any financial decision. The author will not be responsible for
any liability, loss or risk incurred as a result of the use and application of the
information provided on this website. While the author has used his best efforts
to insure the accuracy and completeness of the information on this site, no warranty
or other assurances are made with respect to such accuracy and completeness, and
it is specifically noted that information contained herein may and likely will change.
RIGHT NOW
Current Since: June 16, 2011
This is one of those times when there is almost no reliable way to invest money as the risk of losing is just too high. Unfortunately, no broad investment alternative (U.S. stocks, overseas stocks, real estate, commodities, bonds, etc) looks attractive at this time. That being the case, I believe the best place for your investment money is to park it for now in short term CDs or a money market offering a rate similar to a short term CD.
What I am recommending is unpleasant. I believe it is a lot better, however, than the losses you could sustain by taking excessive risk at this time. Like it or not, you sometimes have to be patient and wait for the next opportunity. Please understand that the wait could be a few more months or it could well be a few more years, but attractive opportunities will always eventually come. For now, I feel the best bet is to stay primarily in very short term fixed income investments, pay off any and all debts except a low rate real estate mortgage, and keep saving as much as you can.
Here is why I am currently recommending a very conservative position. (Find more detailed explanations in each of the market’s sections below):
- The supposed economic recovery was an illusion brought on by the actual and psychological impact of the waves of money thrown at the economy by the government. This stimulus is now over and it hasn’t improved things.
- Unemployment is a lot worse than the government numbers publicized by both Washington and the media suggest. To understand why I say this I recommend reading the following CNBC article: The 'Real' Jobless Rate: 17.5% Of Workers Are Unemployed . Although it's a bit dated it explains things well.
- Globalization will continue to have an adverse impact on the job picture for Americans as more and more American jobs (not just manufacturing but service jobs as well) continue to be outsourced to cheaper labor overseas.
- The true picture on the housing market is a lot worse than what has been spun in the media and it will continue to be a huge drag on the U.S. economy for years to come.
- The commercial real estate picture is also a lot worse than people are led to believe.
- The American consumer is tapped out and the stimulus created by our heavily credit driven economy of the last 20 years is coming to an end. According to the Federal Reserve, total U.S. debt – even excluding the financial sector – is basically twice what it was 10 years ago ($35 trillion compared to $18 trillion). Households have barely made a dent in their debt burden; it's fallen a mere 3% from last year's all-time peak, leaving it twice the level of a decade ago, inflation adjusted.
- 61% of Americans are now "always or usually" living paycheck to paycheck, up from 49% in 2008, and 43% in 2007.
- The Federal government and a substantial number of state and local governments must deal with drastic financial shortfalls. At least 10 states, mostly larger ones such as California, New York and Illinois have hit the wall and can no longer avoid making massive spending cuts.
- The probability is high that a period of significant inflation is around the corner, driven by a further drop in the US dollar.
- Lastly, given all of the above it has become likely that corporate earnings growth will begin to falter and that along with the other factors will cause the stock markets of the world to drop sharply.
In the meantime, don’t let the current situation get you down, and don't buy into the idea that the stock market is the "be-all" and "end-all” for your financial future because it isn’t. Just follow the Money Rules and the real-world game plan contained in Money Smart and I am confident you will find there is a lot you can do to insure a good financial future for yourself and those you care about.
U.S. STOCK MARKET
Current Since: May 1, 2012
Note: If you haven't already done so, please first read the Introduction and Right Now sections.
U.S. stocks have on average been valued at (bought and sold at) about 15 times trailing company earnings over the last 100+ years, although the market goes through long periods of emotionally driven under and over-pricing. Most importantly, while the market has fluctuated a great deal over time, it has continued to fluctuate around 15 times the average price. For this reason it is logical to consider it a good approximation of fair market value.
Normally, my advice on when to buy and sell is based on fair market value. The key word here is normally, as you must always take into consideration what the economic situation is like going forward. In 1997-1998 the picture was so favorable that you could allow prices to become a lot more expensive than normal before selling. Unfortunately, the situation we are facing right now is quite the opposite.
Since 1999, I have continued advising not to invest in the U.S. Stock market, or any stock market for that matter. The Financial Services Industry is always trying to spin the idea of always investing in the stock, real estate and even the fixed income market (bonds, etc) for the long run and using select time periods to "prove" their point. Well here are some facts to think about.
The stock market is up 2.5% in the last 12 months vs. an inflation rate of at least that much and more. But what about "investing for the long run"? The 12 year return has been a total of about 18%, one and a half percent per year. After factoring in inflation, the return becomes minus 1% per year.
For the 85% of Americans who depended on the advice of the experts, the underperformance of 95% of all managed mutual funds by about 2.5% per year, on average, has greatly added to that loss. The bottom line for that 85% of people is a staggering loss of over 40% of their money, inflation adjusted. You are not going to hear these facts from the "experts", as it's just not in their best interest to tell you these things.
So what about now? For the reasons laid out in my Right Now section, above, the risk of substantial loss should you choose to invest in the stock market now is just too high. The same goes for any type of fixed income investment where the length of time to maturity for the loans/bonds involved is other than very short term (see Fixed Income Market, below).
The financial services industry’s strategy for convincing you to keep putting money into their funds is to always say that things are looking good going forward. Their favorite spin is that earnings will grow very nicely so stay on board and win. To understand the truth behind this spin, take a look at the chart below by Mckinsey & Co. Every year it’s the same story: fabulous earnings are coming! But most years reality is far from that optimistic projection.
By the way, have you noticed that the financial media never measures these "experts" against the forecasts made in advance? They are only judged against their forecasts at the end of the year where estimates are adjusted down to just under reality. This is typically also used as an opportunity to spin the wonderful news that the companies are beating the estimates and how great things are going. "Hey we forecasted (at the end of the year) growth of 2% and its 4%! What more do you need to tell you to keep on investing?"
I know I’ve become cynical, but I’ve also avoided losing money throughout the last decade. I hope you recognize the reality of the situation and act accordingly. Now is not the time to have your money in the stock market—not even “for the long run”.
I hope by now you see the truth, and act accordingly.
Critical information Alert: Provided below are links to the results of two monumental studies of how the public has fared when investing in the stock market. This information is critically important to the financial future of most adults and I urge you in the strongest possible terms to read this information if you haven't already done so.
Morningstar article on the Harvard study- http://trendfollowing.com/whitepaper/The%20Study%20of%20the%20Decade.pdf
The actual Harvard study- http://www.people.hbs.edu/dbergstresser/dbjchpt.pdf
Article on Dalbar study of 1984-2004- http://www.profutures.com/article.php/184/
Dalbar Study for 1984-2005- See page 31 for results of both 2004 and 2005 http://www.timothyross.com/letters/QAIB_2006_Dalbar.pdf
(Company Research, Market Commentary, Research Trends) by Ockham Research Staff on 17-05-2010
The analyst community has never been known for their pinpoint accuracy, but no one can reasonably expect them to be able to perfectly forecast a corporations performance down to the penny. However, the latest study on the analyst community by McKinsey & Company (commentary in the McKinsey Quarterly) shows that they have not even been remotely close to the actual results over the last twenty-five years.
As you can see from the graphic above, analysts have forecasted far better earnings growth than was actually the case. This may seem surprising to some as analysts have undershot earnings over the past four quarters, but the longer term view it is undeniable that analysts are too bullish. To be sure, earnings have rebounded nicely since the spring of 2008, but we have warned investors that a quick return to peak earnings levels may be a bit optimistic. After all, we would expect analysts to revert to their clear historical pattern of overestimating rather than underestimating earnings.
Scams and Investment Traps Alert: See my blog post The ETF Scam: Beware of Misleading Financial Advice)
FOREIGN STOCK MARKETS
Current Since: May 1, 2012
Note: If you haven't already done so, please first read the Introduction and Right Now sections.
Although I do not believe most overseas stock markets to be noticeably overpriced, I continue to be cautious at this time about investing in them. I say this because of their high volatility and also because they are likely to drop a lot should the U.S. Stock Market pull back. Should both the U.S. and overseas markets pull back significantly, I would then invest overseas quite aggressively. I say this as I believe the future growth of the U.S. market will be slower than most overseas markets for a number of reasons. Our economy has matured and, for years to come, we will continue to deal with some heavy problems. In contrast, the future of non-U.S. /non-European markets (primarily Asia and South America, especially Brazil) looks much brighter, given the likely continued emergence of a huge middle-class and the consumption society. As for Europe, with the exception of Germany and possibly Scandinavia, I expect serious problems to continue to unfold and would definitely not invest there.
An additional factor that should play out in favor of overseas markets during the next 10 years or so is the high probability the dollar will continue to erode versus most other currencies. This is primarily driven by excessive printing of money by our government during the past several years and the unsustainable level of debt we are now carrying. Personally, I intend to see that the majority of my market investments end up either denominated in other than U.S. dollars, in commodity based investments or in U.S. companies that have the majority of their business growth coming from overseas markets. My intent is to do this should we get the market correction I see as likely.
Bottom line, when the time is right to invest in stocks again I believe that the majority of most people's money should be invested overseas primarily via broad-based no-load index funds.
FIXED INCOME MARKET
Current Since: May 1, 2012
Note: If you haven't already done so, please first read the Introduction and Right Now sections.
I believe we are about to enter a period of high inflation, perhaps very high inflation.
This forecast is by no means a certainty, especially on the exact timing, but a very high probability, and high enough that I will act on it. It's been 30 years since we've had to face very high inflation. I lived through it, and I remember it well.
I'm going to lay out all the reasons why I believe we will soon enter a period of high inflation and what you need to do about it. But first and foremost, let's take a look at why this is important to you.
Things are going to cost a lot more. Everyone will be affected by increased costs for food, gas, rent, cars, services...pretty much everything you buy now. It may seem pretty minor at first, but as it continues the effect of compounding makes it a lot worse. Let’s say it's 5% per year increase. 5% becomes 10% more in another year. If its 7%, and it's very likely to get to that at some point, that's 20% more in 36 months. Imagine paying 20% more for most of the things you buy now.
Are we looking at increases of this magnitude? Yes, I believe we are. It may start small but I believe it will accelerate. If your income doesn't rise to match inflation it can end up being a very serious problem.
On the plus side, if you have a long term fixed mortgage you'll end up paying it back 70 cents, or maybe even 50 cents on the dollar. If, on the other hand, you have a short term fixed or adjustable mortgage—then imagine what it would be like to pay 20% more. Obviously, one of the steps I recommend is if you own a home and don't have a long term fixed interest mortgage run out and get one right away. The current rate of 4% is very unlikely to last.
If you're like most people and you've been saving money each month, likely half or more is sitting in some sort of fixed income investment such as treasuries, bond funds, CDs, etc. and this is going to cost you. You will incur big losses if you don't understand what will happen and do something to prevent it. When interest rates rise, the value of all fixed income investments, other than those with a very short time until they come due, will drop by a lot.
For example, let’s say you invest $10,000 in Treasuries (loans to the federal government) that have a maturity (when the loan comes due) of 20 years. Now let’s say that rates then rise to 6% on new 20 year Treasury loans. In that instance your $10,000 is now worth $7,300, and keep in mind that rates are likely to rise quite a bit more than just 2% as they're over 2% below historic average rates right now.
The government can't pay its obligations. It has no choice but to either cheat or flat out renege on its commitments. I'm talking Social Security, Medicare, Obamacare, you name it. If you work for the government this also includes your pension. And I'm not just talking about the federal government. Also look at the state of California and other states who are struggling to balance their budgets.
The fact that our federal government and probably our state government cannot meet its obligations and do nothing about it, just kick the can down the road until there is no more road may or may not be a problem for you in the near future, but eventually it will be.
So why do I believe inflation is coming?
We can only keep an extremely unrealistic situation going for so long. For the last 10 years inflation has averaged 2.4%, and the 30-40 years before that 4.7%. Look at the rates being paid to you on your money. Under 1% for 1 yr CDs, 20 year loans at 3%. Look at the lending rates. Car loans and mortgages at under 4%. How can that be sustained?
It's simple. The federal government has been loaning the banks all the money they want at 0% interest. 0%! How can they do that? Again, it's simple. Just keep printing as much new money as you can. Does this qualify as an extremely unrealistic situation that can't just go on and on? I sure think so.
And now for the biggest factor of all: At some point the dollar is going to be worth a lot less to the rest of the world and it's going to buy less. Why? Our government is printing money in the order of a trillion dollars a year for each of the last 4 years. History has shown that you can't print as much money as we have without devaluing it and creating inflation.
It comes down to just how much the dollar ends up getting devalued. This is the biggest wild card of them all.
The government wants inflation. As I said earlier, the government cannot meet its obligations to Social Security, Medicare, and pensions. Inflation is the only way out because it allows the government to pay what it owes in cheaper dollars (just like you'll get to do, if I'm right, on your long term fixed mortgage).
So what do you do?
Given the likelihood that we are facing rising inflation, I believe the best bet is to go out no more than 12 months with your fixed investments and avoid any form of long term bond investment. If you own such investments, either via a bond fund or as individual investments, I strongly suggest you sell them now. What I am recommending isn't very pleasant, but I believe it's better to take a lower risk position for now. Like it or not, it's sometimes best to be patient and wait for the next opportunity.
COMMODITIES MARKET
Current Since: March 10, 2011
Note: If you haven't already done so, please first read the
Introduction and Right Now sections.
Commodity based stocks are a good place to invest a decent percent of your money at some point, but not right now. These markets have moved up a lot since last summer and I believe the risk of a significant pullback now outweighs the probability of a significant further upside. I also see commodity investments as likely to drop a lot more than the stock market if a correction occurs. Bottom line, I would hold off in this area right now, but should there be a sizeable pullback I see commodity stocks, especially in the areas of agriculture and energy as very desirable mid-term investments. I say this because I believe that emerging markets, and related rising consumption, especially in Asia, will cause supply shortages and pressures on most commodities. However, the odds favor a significant stock market drop in the near term which gives us a good reason to wait.
Scams and Investment Traps Alert: See my blog post The ETF Scam: Beware of Misleading Financial Advice)
RESIDENTIAL REAL ESTATE MARKET
Current Since: June 16, 2011
Note: If you haven't already done so, please first read the
Introduction and Right Now sections.
I expect that the majority of our housing markets will drop a little further and remain bottomed for at least several years, and possibly quite a bit longer, as they slowly address the inventory of unsold homes and those not yet on the market.
Should I be a buyer? At this point I continue to advise that it's best to wait. If your reason for buying is that a home is always a good investment, do not buy into that idea. History shows a home is a great savings bank, great forced savings, but that the value of homes generally tracks the rate of inflation and nothing more.
If you feel strongly you wish to have your own personal residence, here some questions to ask yourself:
- Have you've saved at least 20% down
- Assuming 20% down, is the total annual carrying cost no more than 30-33% of your gross salary (If you make a lot more than the average family this can be a little higher)
- Are you're planning to stay in the home for at least 5 years?
- Is it important enough to you that you are willing to accept a further drop in the values in your market of another 10% followed by no increase for at least an additional 3-4 years, even though inflation keeps rising?
If the answer to all of the above questions is yes, then go ahead, but do your very best to get a really good deal, as foreclosures are going to keep on coming. So wait for that deal, and don't go locking in on a single home and tell yourself this is the one and only home. Even if your market has bottomed, you are still likely to have a flat market for at least several years, giving you plenty of time to act. In the meantime, use your waiting period to eliminate any remaining debt you may have and to increase your down payment and savings. Lastly, do not assume you'll win because you're buying a foreclosed property. I'd like a nickel for everyone who did just that during the past 3 years and is now underwater.
I will admit there is another positive in favor of home ownership that is likely to begin unfolding over the next few years---the probability of paying back an existing fixed rate mortgage with cheaper dollars due to the likelihood we will be facing significantly higher inflation for years to come. This is indeed a significant positive once it begins to unfold, but I still advise being very cautious and patent right now, as you're likely to have the time to do so. What this also means is that it's a bad idea to get an adjustable rate mortgage. Stay with fixed rates.
Should I be a seller? If I had a home I wanted or needed to sell for some reason (relocation, financial issues, etc.), I would do so, as you are unlikely to win by waiting. If your goal is just to make money by selling now and re-buying at a later time, I believe you're too late. We've reached a point where the costs, the risks, and the loss of quality of life involved in selling now and buying later is probably not worth it.
If you are trading up, the equation becomes quite tricky-- getting enough for your house and paying as little as possible for the higher priced ore. If you're confident you can pull that off, sell first and be prepared to rent for a while. You do not want to be under pressure to buy right away.
Should you feel that I'm being too negative regarding my caution about buying, here are some things to consider:
- Although we are now at or close to fair market value in many of our real estate markets most of the time markets overreact, taking prices to below fair value. Given the overall situation in the housing market I believe the odds of prices going substantially below fair value are very high.
- There is a large volume of homes that haven't been repossessed yet, but soon will be. 27% of U.S. homes are now underwater and 11% of all U.S. homes(18.4 million homes) are currently vacant.
- Many homeowners have wanted to sell but are waiting for a better market. The following is some interesting information on this group from a March 24, 2010 post by Aaron Trask: (Although this information is almost a year old, the picture it paints really hasn't changed that much.)
“A recent Zillow.com survey shows 8% of homeowners, or about 10 million Americans, are "very likely" to sell if and as local conditions improve. Humphries doesn't expect anywhere near 10 million more homes to come on the market in the near term. But this "pent-up supply" combined with foreclosures already in the pipeline and those yet to come because of negative equity and job losses means it will take three-to-five years ‘before we see more normal appreciation rates return to the market,’ the economist predicts."
- As baby boomers move to retirement, their downsizing, increasing mortality, and retirement cash shortfalls are likely to add to housing inventory. Worse yet, due to all that's happened, over 10 million baby-boomers will have a lot of trouble retiring and their situation will be made worse by the inevitable nasty cuts in both Social Security and Medicare in the years to come, and by significant increases in taxes necessary to reduce existing government deficits. These factors, like the others, are likely to increase the number of sellers and reduce the number of buyers.
- As I explained in the Right Now section, unemployment and the economy in general are a lot worse than the numbers reported by both Washington and the media and are likely to continue causing additional forced sale of both primary residences and second homes, especially those purchased for investment.
- As the impact of the huge financial shortfalls on federal, state, and local governments continues to hit home, it will have an additional negative effect on unemployment and, therefore, on the housing market. This isn't a small thing, as about 30% of the workers in the U.S are now employed by government.
- The banks have no choice but to continue the conservative (realistic) lending position they've been forced into.
INVESTMENT REAL ESTATE MARKET
Current Since: March 10, 2011
Note: If you haven't already done so, please first read the
Introduction and Right Now sections.
The investment real estate market covers a wide range of properties: commercial properties, residential properties purchased for investment, industrial properties, raw land, and so on. I see this market as continuing to be a very risky place to invest at this time, despite the big hit that it has taken.
Here are some reasons why I say this:
- I believe the odds are high that we are looking at a weak economy for years to come. To understand my thoughts on this point, read what I have to say under Residential Real Estate Market and also under Right Now section.
- During the debt driven boom of the last 15 years or so, we built too much commercial real estate capacity.
- The banks are still carrying a very large inventory of underwater commercial properties that will continue to hit the market for years to come. . : Here is some food for thought on that subject:
WASHINGTON (AP) -- Feb 23, 2011. "The number of banks at risk of failing made up nearly 12 percent of all federally insured banks in the final three months of 2010, the highest level in 18 years." "Last year, 157 U.S. banks were brought down by the soured economy and mounting loan defaults. That was the most in one year since 1992, the height of the savings and loan crisis. They were mostly smaller or regional banks. Smaller and regional banks depend heavily on making loans for commercial property and development -- sectors that have suffered huge losses. Companies shut down in the recession, vacating shopping malls and office buildings financed by the loans."
- Should I be a buyer? I would only be a buyer if I was certain I was able to buy something at a price so low that I was convinced I could re-sell it immediately at a profit. Even if you think you are looking at such a transaction, you better be extremely thorough in doing your homework as "steals" are often not what they appear to be. If you are unsure what that homework should be, read the explanation provided by Money Smart in the section on ‘Investing in Real Estate’.
Do not underestimate the risks involved. I also caution you to remain very conservative on your assumptions on rents and vacancy percentages going forward, as the current high vacancy rate will insure that the game remains in favor of the tenant for quite a while to come.
Should I be a seller? Assuming you don't use the property for a business you own, it depends on your level of confidence in keeping your tenants and being satisfied with the significantly depressed rent levels of the moment for at least several years to come. If you do decide to sell, the trick will be to avoid selling at a fire-sale price, something not so easy to do right now.
