Smart401k Blog

In the headlines

A look at some of the market movers over the past week:

• Former Fed Chairman Alan Greenspan said that a US recovery may take longer than usual while booming oil prices may go on indefinitely
• The National Association for Business Economics didn’t have a much better outlook, but most still think the US will avoid recession
• Tough market or not, Visa is still planning to move forward with a potentially record-breaking IPO
• Ratings agency S&P revealed that a ratings downgrade on MBIA (NYSE: MBI) and Ambac (NYSE: ABK) isn’t as imminent as many expected
• The fall in US home resales in January was markedly better than what forecasters were expecting
• Take-Two Interactive (Nasdaq: TTWO) found itself battling off a hostile bit from video game giant Electronic Arts (Nasdaq: ERTS)
• Investors took some comfort in IBM‘s (NYSE: IBM) forecast and $15 billion stock repurchase
• A handful of economic data points all came in the wrong way
• Pilot seniority has put the chances of a Delta (NYSE: DAL) / Northwest (NYSE: NWA) merger on the rocks
• The OFHEO lifted the portfolio growth cap on mortgage financers Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE)
• Fed Chairman Ben Bernanke signaled that the Fed is ready to continue cutting interest rates, and this as economic data continues to come in on the downside
• GDP growth slowed considerably in the fourth quarter
• Computer giant Dell (NYSE: DELL) disappointed with its fourth quarter earnings
• Things just keep getting worse for insurer AIG (NYSE: AIG)
• Distressed investor Wilbur Ross announced a major stake in Assured Guaranty (NYSE: AGO), a bond insurer that hasn’t been in trouble lately

Commentary

The week started out on the upside with two straight days that put the S&P up over 2%. Continued concerns over the economy, inflation, and the financial services sector crept back into the picture towards midweek and drained the week’s early gains by week end.

Commentary from most economists continues to be relatively pessimistic. Though a majority of economists seem to still believe that a true recession will be avoided by the US, it is somewhat a question of semantics. A recession in technical terms is two straight quarters of negative economic growth, so consecutive quarters of -0.1% growth would be considered a recession, while back-to-back quarters of no growth would not. Regardless of whether we will apply “the r word” in retrospect, that the US is facing a major slowdown seems a sure thing.

With that in mind, the week played out similarly to many of the weeks preceding it — reactions to one-off news events, forecasts, and economic data releases tugged at the market in both directions. Sentiment during the week was split. During the first half of the week investors seemed to be considering whether stocks had sold off beyond what was needed, while economic data releases and comments from Chairman Bernanke had them revisiting pessimism in the second half.

Looking ahead

It’s important to note that recession is just a word, and the difference between the US economy actually heading into a recession and slightly avoiding it can be small. For that reason, it’s important to look beyond the coverage of whether or not what we’re experiencing is a recession — it’s just not that important.

From the standpoint of US investments, the important thing is whether the current problems will cause lasting damage to the functioning of the US financial systems or impair the country’s future growth prospects. There is an argument that the severity of the housing turndown and the erosion of credit confidence will have lasting impact. However, most economists believe that we are simply experiencing an economic cycle that will resolve itself within the next few quarters. There is likewise an argument for the current problems in the financial system leading to changes that will strengthen it in the long term.

As we’ve stressed in the past, for the vast majority of long-term investors saving for retirement, reacting to the short term fluctuations of the market can be difficult, if not detrimental. Investors that plan to hold their investments for at least five years and are properly diversified across asset classes will find the best results from investing on a consistent schedule. This will allow them to sleep better during up markets and down markets, while at the same time letting them capture long term gains.

In the headlines

A look at some of the market movers over the past week:

• Credit Suisse (NYSE: CS), which was thought to have avoided credit write-downs, joined the party

• Wal-Mart (NYSE: WMT) posted better-than-expected earnings, but didn’t provide a very optimistic outlook

• Toshiba conceded the next generation DVD war to Sony (NYSE: SNE) and its Blu-ray player

• Hewlett-Packard (NYSE: HPQ) came up roses with its quarterly release

• After a period of slightly lower oil prices, oil spiked back up to around $100

• Iconic retailer Sharper Image (Nasdaq: SHRP) filed for bankruptcy

• Fed minutes showed that the Fed is ready to keep on cutting rates… even though inflation was worse than expected

• Manufacturing activity showed deterioration and more is expected

• Microsoft (Nasdaq: MSFT) decided to get better about sharing

• Late news on Friday that a bailout could be in store for Ambac (NYSE: ABK) sent the markets shooting up to finish Friday in the black

Commentary 

It was a shortened week on Wall Street due to the Presidents’ Day holiday, and at the end of it we weren’t all that far from where we started. Volatility was somewhat lower this week, though you shouldn’t take that to mean that market participants have their minds made up on where we’re going.

News for the week tipped in favor of the negative, keeping everyone firmly on recession watch. The financial sector continues to be the bearer of bad news as a parade of companies continues to report write-downs in the billions. Despite the Ambac bailout rumors, credit insurers are still hanging in the balance as well and keeping tensions high.

Meanwhile, economic releases are painting a picture of a slowing economy with yet increasing prices. Though the word stagflation was batted around after the week’s CPI report, the release of the Fed minutes suggested the Fed is still convinced that the moderating economy will place a drag on prices going forward. And though the Fed lowered its economic growth outlook, their expectation still appears to be a slowing, but not recessionary, economy.

Looking ahead

If you’ve been following this column in past weeks, you’ll know that the outlook doesn’t change a whole lot week to week. For long term investors, there’s no reason to get overly focused on the near-term economic picture — this is part of the economic cycle and not something to get too worried over. Long term investors should continue to invest on a regular schedule to take advantage of the current lower equity prices.

If there’s anything that long term investors should be doing on a daily basis, it’s avoiding looking at investment balances. As I’ve stressed previously, investors have a bad tendency of buying when prices are too high and selling when they’re too low — exactly the opposite of what they should be doing. Focusing on account balances on a daily (or even weekly) basis increases the chances that an investor will get too concerned about short term market movements and bail out at the wrong time.

On a bigger picture basis, now is a good time for investors to make sure they have the basics covered. Owning quality funds with relatively low expenses and being properly diversified is as important, if not more important, as the market goes through this tumultuous time.

In the headlines

A look at some of the market movers over the past week:

• With Microsoft (Nasdaq: MSFT) hot on its trail, Yahoo! (Nasdaq: YHOO) started turning any direction it could, including AOL and News Corp

• Venezuela’s bombastic leader Hugo Chavez threatened to cut off oil supplies to the U.S.

• Insurer AIG (NYSE: AIG) ran into a whole mess of trouble

• The Dow Jones Industrial Average did some shuffling

• Berkshire Hathaway‘s (NYSE: BRK-A) Warren Buffett offered to insure $800 million in municipal bonds

• Profits continue to be hard to come by for GM (NYSE: GM)

• With estimations on how long the mortgage and housing crisis will last, the US Treasury put a deal in place that will freeze foreclosures for 30 days

• Surprisingly, January posted a retail sales gain

• Remember the economic stimulus plan? Well now it’s law

• Swiss bank UBS (NYSE: UBS) took a massive write-down on US subprime exposure

• New York’s new attorney general is going after some health insurers

• Though not overly pessimistic, the market did not like what Fed Chairman Ben Bernanke had to say about the economy. Former Chairman Alan Greenspan isn’t quite as optimistic

Commentary

Market volatility calmed down somewhat this week, though you shouldn’t take that to mean that worry has subsided. Right now the financial markets and the broader economy are in a waiting game that has little solution but more time.

There are many slow moving variables that are currently in play. Interest rates, which are under the control of the Federal Reserve and were lowered drastically in January, typically work with a lag, so the recent cuts are going to take some time to work their way through the system. The recently enacted economic stimulus plan will similarly take time to take effect — checks aren’t expected to be sent out until mid spring and it will take some time after that for them to work through the economy. And, of course, the mortgage mess that caused all the fuss is continuing to unfold. Because of the timeframe over which adjustable mortgages reset, it will take yet more time to see how bad it gets.

The variables mentioned above could be considered first order variables, meaning they are happening at the top level. We still also have yet to see how variables further down in the chain — such as consumer and business spending — will move as the situation continues to unfold.

In the meantime, psychology and expectations have hold of the market. With little concrete evidence of how bad the situation will get (or how benign it will be), investors are left to make their best estimates and adjust those as more data comes to light.

Looking ahead

The outlook really hasn’t changed substantially since last week’s update. The near term picture (six months to one year) is very cloudy. However, equities still look like a great choice for investors with a sufficiently long investment horizon.

As noted last week, retirement savers should be encouraged to continue investing, if not invest more, while stock prices are down. The cyclical nature of the market has a way of fooling a great many investors. At market peaks there seems to be little reason anybody can think of that will make stocks decline, while at the bottom there seems to be little reason to ever invest in stocks again. To get the most out of your savings, it’s important that you keep on a steady investing path and don’t fall into the crowd psychology of either swing.

I’m sure it would surprise nobody if we said that recessions aren’t good for stocks and mutual funds. After all, a stock represents an ownership interest in a company and if that company is going to see less business during a recession, then investors will expect lower profits and put a lower value on the stock. For companies that are in precarious positions because of high levels of debt or the like, a recession can even spell the end if they are no longer able to keep up with their debt obligations.

Even investors with broad exposure to a number of stocks through mutual funds see declines during recessions as the market simply ends up pricing nearly everything down to compensate for additional risk in the environment. The big question, though, is how long-term investors should look at this situation.

Milking the downturn

For long-term fund investors, the fall in stock prices creates opportunity. Lower stock prices give good mutual fund managers the opportunity to buy more of the stocks that are down temporarily but will outperform over the longer term. Investors that add money, rather than pull money out, during a downturn are in a much better position to see outsized gains when the market eventually recovers. In fact, research has shown that the actual performance for most individual investors tends to fall below the performance of the funds that they invest in because they add money during “good times” and pull money out during the “bad times” — exactly the opposite of what they should do.

When to make your move

So the dilemma for many investors, then, is when to start putting in extra money. Shouldn’t they wait until the recession is over and try to get in right at the bottom as the economy is recovering? Well, actually, the answer is no, because the stock market anticipates turns in the economy and is quite good at it. Finance professor and author Jeremy Siegel notes:

The major determinants of stock prices are corporate earnings and interest rates. The stock market almost always falls before recessions. In fact, out of the forty-one recessions from 1802 through 1990, thirty-eight of them, or 93 percent, have been preceded or accompanied by declines of 8 percent or more in the stock returns index (the only exceptions were the 1829-30, 1945, and 1953 recessions). In the postwar period the peak of the stock market preceded the peak of the business cycle by between six and seven months.

Recent research by management firm Northern Trust paints a similar picture. Their numbers show that peaks in the stock market precede peaks in the economic cycle by anywhere from one to ten months. Similarly, troughs in the stock market precede troughs in a recession by two to eight months. In other words, by the time you realize that we’re in a recession, the market has already fallen, and if you wait for the “go ahead” that the recession is over and everything is peachy again, the stock market will already be well into its upswing.

The plan

The solution to this is two-fold. The first part is to make sure that you have a good investment strategy. This means making sure that you are adequately diversified and have put your money with high quality funds. Being overly reliant on a single fund or sector of the economy, or investing with low-quality funds can lead to trouble even without a recession — with one, it can be even worse.

The second part is to be aware of the fact that at the times when there’s the strongest urge to pull your money out of the market, it’s really the best time to be putting more money into the market — and vice versa. This, of course, can be easier said than done. While many people know this intellectually, it’s very easy to get overwhelmed by the fears du jour and not follow it when it counts. If you find adding extra money during down times to be overwhelmingly stomach churning and adding extra money during boom times very inviting, then the best solution is to simply have a steady amount that you put in on a regular basis, come rain or shine.

Downturns are a normal part of the long term cycles of the stock market, and are welcomed by many investors for the opportunities that they create. Investors that are able to keep a long term view in mind during downturns stand the best chance of bolstering, rather than harming, their portfolios during these periods.

In the headlines

A look at some of the market movers over the past week:

• Google (Nasdaq: GOOG) came out definitively against the Yahoo! (Nasdaq: YHOO) / Microsoft (Nasdaq: MSFT) tie-up
• Private equity backed off from the bond insurers, though the extent of the overall fall-out was questioned
• Job cuts grew in January, but factory orders have been strong and worker productivity was a positive
• Consumer confidence continued to dive and most Americans now think that we’re already in a recession
• The service sector hasn’t been so hot either Disney (NYSE: DIS) surprised many investors by beating estimates
• Toll Brothers (NYSE: TOL) reminded us that the housing slowdown isn’t done yet
• The Fed reiterates its focus on inflation fighting, but not all Fed governors have a bleak outlook
• Poor guidance from Cisco (Nasdaq: CSCO) didn’t help the market’s mood much
• Airline merger chatter has been heating up
• Macy’s (NYSE: M) and other major retailers delivered weak numbers
• Congress said “yes” to President Bush’s economic stimulus plan.

Commentary 

After a brisk week last week when the S&P 500 gained 4.9%, the markets got back to being gloomy this week. By the end of the week, the S&P had given up all of the prior week’s gains, losing 4.6% overall. There was no real focal point to the week, as we had last week with the Federal Reserve meeting. Instead, the market was moved bit by bit by earnings reports and economic news releases that hit the wires throughout the week. The majority of the news was dour — though December earnings seemed to hold up for many companies, the outlook that many business leaders gave confirmed the slowdown that many investors have been expecting. Economic reports painted a similar picture, with the big drop in consumer confidence sounding a particularly worrisome note.

Looking Ahead

Meanwhile, the major interest rate cuts that the Federal Reserve put into place recently will continue to slowly work their way through the system. Credit markets are still sluggish right now, but the hope is that the lower Federal Funds Rate will provide some support to liquefy that market again.

The situation for investors saving for retirement hasn’t been changing much. If anything, the now widespread talk about excessive consumer debt in our economy should encourage retirement savers to redouble their efforts and make sure they are ready for the big day. For those that still have five or more years before retirement, the down markets continue to present a great opportunity to continue to add funds and do what most investors say, but few actually do — buy low.

A couple of quick notes on future blog content:

First, I hope you enjoy the “A Week in the Rearview” entry just posted below.  The purpose of this entry is to provide our blog subscribers with a weekly summary of the economic or market related events from the week that we believe are most likely to have an impact in some way (short-term or longer-term) on the markets and your retirement account.  We hope it becomes a quick way for you to cut through the clutter and get a quick synopsis of major company and economic events that can have an impact on you. 

Second, we want to start making our blog more interactive by addressing the questions you have – right in the blog.  In this spirit, we are going to select from the hundreds (thousands?) of email questions we get a week from customers or people just interested in our opinions.  We also want to invite you, our blog readers to submit any comments or questions you’d like answered – whether it be through this blog or directly to you in private via email.  Please send us your questions regarding the markets, the economy, or your specific investments or situations.  We’ll answer you one way or another. 

If you have any other suggestions for us on what you’d like to see in the blog – please let us know by dropping us a line at info@smart401k.com.

Scott

In the headlines

A look at some of the market movers over the past week:

• Countrywide‘s (NYSE: CFC) CEO, Angelo Mozilo, announced that he will forgo a chunk of the pay due to him when he retires.

• Analysts cut fourth quarter earnings projections further

• The housing picture continued to deteriorate

• American Express (NYSE: AXP) saw net income drop 10% in the fourth quarter

• The Federal Reserve cut interest rates an additional 50 basis points

• More question marks raised around bond insurers MBIA (NYSE: MBI) and Ambac (NYSE: ABK)

• Starbucks (Nasdaq: SBUX) growth in the fourth quarter was sluggish and the company announced some big changes

• Microsoft (Nasdaq: MSFT) launched a $45 billion hostile takeover bid for Yahoo! (Nasdaq: YHOO)

• New economic data has not been so pretty 

Commentary

The spotlight this week was on the US Federal Reserve. The Fed took a lot of heat last week after it decided to make an unusually large intermeeting rate cut of three quarters of a percent, and it followed up this week by whacking another half percent off its target rate, bringing it down to 3%.

In its policy statement, the Fed stressed the turmoil in financial markets, noting the tightening credit markets in particular. It also noted that it appears the malaise in the housing market is seeping into the broader economy and “softening” labor markets.

The move gives us a pretty mixed picture. On the one hand, the aggressive cuts that the Fed has been making suggest that it sees considerable risk to economic growth. The upshot, though, is that the Fed is moving quickly and decisively to try and head off major distress. Though interest rate cuts may not be able to prevent the economy from heading into a recession — if that’s the direction we’re headed — it can help cushion the blow and stave off complications that would deepen a downturn.

After a horrific start to 2008, stocks recovered to some extent after the interest rate cuts. Though the economic picture doesn’t necessarily look pretty over the next six to 12 months, many sectors of the market, notably financials and consumer-related, have already shed considerable value. So the question now is less of whether there will be headwinds (there will), but whether stocks have dropped too far given the likely strength of the headwinds.

Looking ahead

The eventful week passed hasn’t left investors with any clear direction in the near term, and this has manifested in some wild volatility in the markets. It’s not likely that this will abate any time soon either.

Though the near term picture is cloudy, the current down market could present a good opportunity for those investing for longer-term goals like retirement (more on this in an upcoming blog). Though the stock market has historically gone higher over longer periods of time, it has had significant ups and downs in shorter time frames. Investors that continue to consistently invest through these down periods in the market stand to benefit the most when the market starts rising again.