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: June 16, 2011
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:
Buying: Buy 1/3rd of what would be your full stock market allocation when the market hits 15% underpriced, the 2nd 1/3rd at 25% underpriced and the last 1/3rd at 35% underpriced or if it has bottomed and traded in a relatively stable range or steadily trended up for at least 6 months.
Selling: Sell the first 1/3rd of your holdings when the market hits 20% overpriced, the 2nd 1/3rd at 30% overpriced and the last 1/3rd at 40% overpriced. If you have a lot of years until your target date for retirement/financial freedom or you have a lot of assets, you can push these sell points by another 10-15% or so.
The key word here is normally, as you must always take into consideration what the economic situation like, going forward. In 1997-1998 the picture was so favorable that you could go for a lot more on the upside. Unfortunately, the situation we are facing right now is quite the opposite. Since March I have been advising investing no more than 30% in stocks, as its best to be less invested than you normally would be at this point. As I continue to watch things unfold I see the risk level continue to rise and now advise that it’s best not to be significantly invested in stocks for the time being.
The U.S. Stock Market is currently selling at about 16-17 times trailing earnings, or about 10% over fair value and it is possible that both the U.S. and overseas stock markets may still go higher for awhile. Given the factors outlined earlier in Right Now, however, the risk is far too high that corporate earnings growth will begin to falter and that the stock markets of the world will drop sharply in the not too distant future. (Should this happen there is a bright spot in that the dollar is likely to stop its fall and strengthen temporarily as it will be seen as a safe haven in the short haul)
For now, the allocation with the highest probability of success is to invest between 0 and 20% of your money in stocks. Keep the rest of your liquid assets in money markets or short-term CDs.
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
Scams and Investment Traps Alert: See my blog post The ETF Scam: Beware of Misleading Financial Advice)
FOREIGN STOCK MARKETS
Current Since: March 10, 2010
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 am cautious at the moment 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 the overseas markets pull back significantly, I would then invest in them 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 below average economic growth and would 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 verses 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. In the meantime the very modest percentage of my assets currently invested in the stock market meets those criteria.
Bottom line, when the time is right to invest in the stock market I believe that the majority of most people's money should be invested overseas primarily via broad-based no-load indexed funds.
FIXED INCOME MARKET
Current Since: March 10, 2011
Note: If you haven't already done so, please first read the Introduction and Right Now sections.
What can I say? Fixed income returns are minimal and yet, as explained in the Right Now section, I feel this is the place to park any new or newly freed up money for now despite the very low rate of return.
The return on fixed income is currently at or less than the rate of inflation and a lot of such investments are often taxable, so you make nothing in real dollars-- you actually lose a bit. Further, as covered in the Right Now section, we have come through a period of unusually low inflation and are likely entering a period of significantly higher inflation. I see this being driven by two factors-- higher commodity prices caused by emerging market demand and our government intentionally allowing/using inflation to pay back some of the literally un-payable level of debt they have created in cheaper dollars.
Given the likelihood that we are facing rising inflation, and probably starting right now, 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. 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.
