Smart401k Blog

In the headlines

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

• CIT Group arranged for emergency financing to allow it to avoid near-term bankruptcy, but more work is needed to stay out of Chapter 11 altogether
• New York Attorney General Andrew Cuomo is suing Charles Schwab over the firm’s handling of auction rate securities
• California lawmakers agreed on a budget proposal that will close the massive $24 billion gap
• TARP watchdogs continue to urge more transparency

(more…)

In the headlines

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

• Lender CIT Group found itself close to bankruptcy after the government refused to bail out the company
• Microsoft fired back in the escalating battle between it and Google
• Bank of America and the U.S. government clashed over fees for government asset guarantees
• Bullish commentary on Goldman from Meredith Whitney lifted banks early in the week

(more…)

In the headlines

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

• General Motors emerged from bankruptcy
• China continued its rhetoric around replacing the dollar as global currency
• Seven more banks joined the ranks of failed banks in 2009
• The U.S. Department of Justice began probing large telecom firms on antitrust concerns (more…)

Well, its finally here – a Bear Market.

As many of you know, two popular measures of U.S. stock market performance are the Dow Jones Industrial Average, and the NASDAQ Composite Index.  Wednesday, the Dow Jones Industrial Average closed at 11215.51, down 20.8% from its record close hit last October. A fall of 20% from the last market high is traditionally considered the definition of a Bear Market. The technology-focused Nasdaq Composite Index skidded 2.3% to end at 2251.46, also entering Bear territory.

From a historical perspective, no two Bear Markets have been alike.  But we can get some ideas of what to expect in the coming months by looking at the averages and extremes of market performance in the more recent Bear Markets.

First, a definition:  A Bear Market starts when stocks begin what turns out to be a 20% decline from its previous high point. It’s end is the bottom — seen only in retrospect after stocks have recovered by 20%.  So, the timer starts today, and we won’t know the end until we surpass the market highs hit last October. Now let’s look at some statistics for Bear Markets since 1960 (sources The Wall Street Journal/Ned Davis Research):

Number of Bear Markets since 1960:  9

Average length of time: 14 months

Shortest Bear Market Time Period: only a few months

Longest Bear Market Time Period:  A little more than 2 years

Average market decline: 31%

Smallest decline: 21% (remember it has to be at least 20%)

Largest decline: 45% (during the 1970s oil crisis)

With this wide variety of declines and timeframes, we want to point out three investing tips and reminders that our long-time readers have seen before:

1.  Don’t think about trying to time the market, or think you know when the market bottom will occur.  We don’t try to time the market and don’t know of anyone who consistently can.

And please don’t just move everything into money market funds because you are nervous about losing more.  Remember – what’s important is where your balance is when you are retired, not when you are building up your savings.   If the drops in your investments are causing you to lose sleep at night, consider changing the level of risk in your investments.  Smart401k clients can get recommendations for reduced risk portfolios by signing into their account and retaking the Risk Tolerance Questionnaire.

2.  Make sure you realign (rebalance) your investments to your target allocation percentages.  This is a very uneven market – growth funds are outperforming value funds, domestic funds have been outperforming international funds.  Emerging Markets funds have experienced wild swings (the average China stock is down 48% this year, while South American company stocks are up slightly).  Chances are some of your investments have moved up or down significantly more than others.  If you don’t rebalance to your target percentages, its likely that your overall investment risk has changed.

3.  Don’t stop putting money into your account.  Someone once said that stocks and mutual funds are the only things that people don’t like to buy “on-sale”.  If you have a reasonable time horizon, history shows that the markets and most likely your investments will rise over time (but, past performance is no guarantee of future results).

One way to look at the current situation:  the markets would decline by about 10% more to hit the average decline of a Bear Market.  If we assume that someday the markets will recover, as they always have in the past, the recovery will be at least 20% - actually 30% from the average market low.  By the averages, the upside is greater than the downside.  The always agonizing question is ‘when will all this occur?”  Based on history, the answer is, we won’t know until it’s already happened.

One last statistic:  Number of Bear Markets where a recovery never occurred:  zero.

Scott Revare

CEO, Smart401k

By now most people have received their stimulus checks.  Like many others, I felt it was my duty to spend the money as quickly as possible to help stimulate the economy.  After all, that was the Government’s intention when announcing the refund, right?  Well after dreaming of all the wonderful things I could use the money for, I started to realize there were better options than just spending it on material goods or a night out on the town.  More urgent day-to-day needs and my longer term retirement goals came to mind.

While I was thinking through my own financial situation, I realized that it might be useful to share how I prioritized potential uses for my stimulus check.  At the top of my list are the day-to-day expenses that we all have such as food and gas.  With gas prices reaching all time highs and about to pass $4.00 per gallon, people have to pay more and more each time they go to the pump.  My co-workers and friends are now paying anywhere from $45 to $100 to fill up their car or truck, and as a result have far less for things like going out to dinner. 

After accounting for day-to-day living expenses, I turned my attention to high interest credit card debt.  If you consider the average household credit card debt is roughly $3,000 with an APR around 19%, it makes sense to try to pay it off as soon as possible.  In fact, a survey by the Harris Poll revealed that 38% of respondents said they will use a lump of their rebate checks to help pay off credit cards.  With such high interest rates, especially those with APR’s above 15-16%, it only makes sense to use this money to pay off credit cards.

Next on my list would be adding to an emergency fund or possibly funding an investment account.  In the Harris Poll mentioned above, over 35% said their rebate checks were going straight into their savings account. I think this is a great idea for those that are building an emergency fund and suggest six months of living expenses as a goal. If you have your day-to-day expenses accounted for, don’t have high interest credit card debt and have an emergency fund built already, you might want to consider investing it.

By using the stimulus check for these expenses, you will free up some money from each paycheck.  I’d suggest investing this portion and increasing your contributions to your 401k.  Unfortunately, I have seen a recent trend where people are doing the opposite, and are actually reducing their 401k contributions.  This trend will have long lasting effects. You might not see it now or in a year, but 10, 15, or 20 years from now, you will see the dramatic effects.  (To see how a change as small as 1% could affect your retirement plan try the “What May My 401k Be Worth?” calculator on the Calculate Your Progress page.)

There are many different options for how to use your stimulus check.  Instead of feeling obligated to spend the money on electronics or entertainment as I first did, I simply ask that you take a look at all of your options and decide what is best for you and your family.

Jeff Studebaker, Investment Advisor

Yesterday, both of traditional measures of the overall US Markets dropped to levels that fit the textbook definition of a correction.  The benchmark S&P 500 dropped 2.3% Monday, erasing its 2007 gains and leaving it 10.1% below its October 9th high (down .8% for the year).  The other key benchmark, the Dow Jones Industrial Average fell 237.44 points to show a 10% decline since its October 9th high. The Dow still shows a gain of 2.2% for the year.  The S&P 500 has been hit a little harder than the Dow primarily because it is more heavily weighted with financial stocks, which have declined more than the rest of the market.

Here are a few statistics and comments to put things into perspective (please refer to our prior blog on Corrections and Bear Markets):

• Historically, corrections are fairly common occurances -there have been 43 corrections since World War II.  Corrections have occured less frequently since the 1990’s. The last correction we had was in 2003.
• The average correction is a decline of 15% off of a market high.
• One in four corrections turn into Bear Markets (market declines of 20% or more) according to Ned Davis Research in Vinice, Florida.
• The length of time from the market high on October 9th to yesterday was less than 50 days. The last 16 corrections have averaged 148 days to the low point, and 111 days to recover back to the original high point in the market.

A final note: the label market correction is important to near term market performance because it is indicative of a broad drop in the market and it has a near-term impact on investor behavior.

By Scott Revare CEO, Smart401k.com

 What a ride we had this past quarter. Here are a few notable highlights:

• The US Stock Market (as measured by the S&P 500) hit a record historic high on July 19^th.
• From July 19^th to August 15^th 19 market days – the market dropped 9.4% – almost an official market correction.
• 36 market days later, on October 5^th the market recovers the 9.4% drop and hits a new historic high.
• USA Today noted that since 1950, the Standard & Poor’s 500-stock index has posted a daily loss of more than 2% on an average of four days a year. Yet in just the past nine months, the S&P 500 has posted daily losses of more than 2% six times.
• USA Today also noted that the Dow Jones industrial average gained or lost more than 1% on 24 days in the third quarter the same number of times it did for all of 2006.

In a few short weeks the market showed us both its resilience and its newfound increased volatility. So as retirement plan investors with a long-term viewpoint – what lessons can we learn from this wild ride of a third quarter?

1. Hanging on for the ride can pay off.

It really came back, didn’t it? It seems like human nature leads us to want to do something to defend ourselves when confronted with bad events. We also seem to think that when the market drops, it will just keep going down. Whenever the markets drop significantly in one day, or over a few days, our customer call and email volume increases over 30% at Smart401k. People inevitably ask our advisors what they should do they seem to expect us to tell them to quickly sell – bail out before it’s too late! But the best prescription for long term investors is to do nothing – just hang on for the ride. Historically, the markets have always gone up over time. As long as you are properly invested (i.e. diversified) and have the luxury of 5 or more years to wait, history says time is on your side.

2. Prepare yourself for market volatility.

There are two important things to keep in mind during times of market volatility.  First, be mentally prepared. The worst thing you can do is let emotions take over and start making decisions that are not consistent with your long term investment approach. Take a deep breath and make sure you are approaching any investing decisions with a long-term perspective. Second, if market volatility keeps you from sleeping at night, consider changing your long-term investing strategy. By increasing your fixed income (e.g. bond) holdings, and decreasing your equity holdings (stock mutual funds), your overall investments will experience less ups and downs. This most likely means your investment returns will be less over time, but your health and well being is more important.

3. Keep investing.

The funny thing about market drops is that they usually are accompanied by large-scale pullbacks from investors. Many investors sell what they have, and even more stop their contributions to their retirement accounts. Investors withdrew $12.3 Billion dollars from stock funds in August. Yes, that’s the month that the S&P hit its quarterly low. In the months since, the market hit a new high. When you know you are going to be investing in the market over many years, isn’t it better to be investing when the market is lower?

4. Stay properly diversified.

It’s easy for market movements to put your investment allocations out of whack. Different types of investments grow at different rates over time. For example, international funds have grown faster than most US based funds this year. By getting your investments back to your target allocation percentages, you are in effect selling investments that are relatively higher priced, and putting your money in investments that are relatively lower priced, since they haven’t grown as fast. This seems counter-intuitive, as you would naturally think you should keep investing in something that has been going up. But this approach ensures that you are moving money out of investments that have already experienced higher than market-average growth before those investments inevitably experience a drop back to market averages. You are in effect œselling high and buying low.

If you stick to your long-term investing strategy and ride out any market gyrations, you put time on your side working to your advantage. Historically speaking, that’s a good thing.

Value funds have not had nearly the year so far that growth funds have, though with a gain of 7% large cap growth has been able to outpace both small and mid-cap value funds. Since many of the traditional defensive stocks fall in the large cap value category, the market volatility and the threat of recession has helped buoy this group.

With continued high oil prices, it’s not surprising that the oil majors in the group such as ExxonMobil, Chevron, and ConocoPhillips have bolstered the year-to-date performance of the large cap value funds. These stocks are up 23%, 30%, and 24%, respectively. Companies related to oil production such as Halliburton have also had a strong year so far.

Though technology names typically make less of a showing in value funds than growth funds, large cap value has seen some spillover from the strength in technology this year. Year to date IBM and AT&T are both up 22%, while Texas Instruments has gained 28%.

On the downside, large cap value funds do have significant exposure to the weakness that has hit the financial sector due to the housing and credit market problems. American International Group, JPMorgan, and Bank of America are all down single digits for the year, and Citigroup has lost 13%.

By: Matt Koppenheffer for Smart401k.com

Having already discussed what the Federal Reserve and Federal Open Markets Committee (FOMC) are and what they do, let’s take a look back at what the FOMC did this week and what it means for the financial markets.

The Federal Reserve’s Take

In short, the FOMC decided to cut its Federal Funds Rate target 50 basis points (0.5%) from 5.25% to 4.75%. Not only is it significant that the FOMC cut rates, but the size of the cut is also meaningful. But first, let’s take the FOMC’s statement in parts (the text of the FOMC’s statement will appear in italics).

Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

If you’re anything like me, when you start feeling sick, you don’t wait for a full-blown flu to set in before you start guzzling water and upping your vitamin C intake. In other words, you try to head off the sickness before things get too bad.

This is exactly what the FOMC has said here. Economic growth was still OK through the beginning of the year, but they saw the potential of tight credit markets (a fever) to intensify the housing correction (bad chest congestion). They hope that a rate cut (a lozenge) will help ease the situation enough that the housing correction can take place without causing a recession.

Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

As I discussed in the overview of the FOMC, when the FOMC lowers its targeted Federal Funds Rate, it buys government securities in the open market to pump more money into the system. A potential side effect of this action is an increase in inflation, as measured by indexes of consumer and business prices that the Fed watches. Here, the FOMC is asserting that so far this year inflation has been kept under control, and so there is not an imminent worry of prices getting out of control.

Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

The final paragraph of the release more or less reiterates what the FOMC’s stance is and underscores the fact that it is ready to do more should the situation continue to deteriorate.

The Market’s Take

Though there was a reasonable-sized minority of market participants that were expecting a 50 basis point rate cut, the majority of the market was taken by surprise. Some people were expecting the Fed to continue to hold rates steady at 5.25%, while many others saw a 25 basis point cut — the typical “moderate” move for the Fed — as the most likely move.

The larger than expected rate cut was very well received by the market, as measured by the one day rise of nearly 3% in the S&P 500 index, and similar gains in the Nasdaq and the Dow. The reason for the jubilant reaction is that many believe the lower rates will do exactly what the FOMC said in its statement and ward off further economic disturbances. Some may even see this as a near-term solution to the trouble in the housing market.

But the rate cut was not without controversy. While many saw good logic in the Fed’s move, many others believed that the decision to cut rates created a “moral hazard” and would encourage speculators to take increasingly larger risks with the thought that the Fed would bail them out if things went poorly. On the extreme side of this argument are those that believe if anything the FOMC should have raised its target rate to further shake out the speculators.

The Long Term Investor

As a long term investor, the rate cut may be interesting to follow, but it should not have a major impact on your continued, steady investing. The last time the FOMC went from raising rates to cutting them was in 2001 when the Internet bubble was bursting. However, this does not necessarily mean that the markets are headed for a major tumble similar to then — in the mid and late 90’s the Fed also cut rates a few times, and that was in the middle of one of the greatest bull markets one could hope to see.

The worst case scenario for the long term investor would be for the Fed to take an extreme tactic of either cutting rates to the point where inflation became a major problem, or raising rates to the point where deflation actually became a risk. The ideal for us is for the Fed to take a cautious and measured approach to the situation that will steady the economy while keeping it on a sustainable long term growth path.

One of the top business headlines from the Associated Press at the end of the day on Friday read “Stocks Flat Ahead of Fed Meeting.” If you read any business news coverage over the past week, you may have noticed that many headlines were some variation on the theme of the approaching Federal Reserve meeting. Based on the amount of attention that the Fed gets in the news it’s obviously important, but let’s take a step back for a minute and take a look at what exactly the Fed does and why it’s important.

The Federal Reserve was established in 1913 to direct US monetary policy and helps keep the economy stable and running like a well oiled machine. Monetary policy refers specifically to the amount of money in the economy, and is important because the amount of the money available has a major impact on the interest rates that lenders charge.

Low interest rates tend to encourage borrowing and stimulate economic activity. While this is often a positive, low interest rates can also stimulate activity above the economy’s capacity and drive inflation. Inflation is a whole topic in and of itself, but when it is high and unpredictable it can have destabilizing effect on the economy and discourage economic growth.

So the challenge for the Fed is to adjust the US money supply so that the economy expands smoothly and at the same time maintains a low and stable rate of inflation. To do this, the Fed has three tools at its disposal: the discount rate, reserve requirements, and open market operations. Each of these tools allows the Fed to either increase or decrease the supply of money.

The most widely used and best known of these tools, open market operations, is controlled by the Federal Reserve entity known as the Federal Open Market Committee (FOMC). The FOMC has the ability to either buy government securities to increase the money supply or sell securities to decrease the money supply. The current policy of the FOMC is to set a target for the Federal Funds Rate and then buy and sell securities to try to pinpoint that rate.

Which brings us back to the news headlines and the importance of the upcoming Federal Reserve meeting. Typically, these stories refer to a meeting of the FOMC (there are eight at least eight FOMC meetings per year). At the FOMC’s meetings, the members, led by the Chairman of the Federal Reserve, discuss current economic conditions and decide whether there should be a change in the Federal Funds Rate target.

The current Federal Funds Rate target is 5.25% and it has been there since the FOMC’s meeting in July of 2006. The next Fed meeting is scheduled for tomorrow, and the turmoil that’s sprouted from the housing and credit markets have many expecting that the Fed will cut rates by a quarter or half percentage point to try to relieve some of the pressure.

Interpretations of what a rate cut would mean varies. Some believe that a rate cut would go a long way to help prevent the situation in the credit markets from escalating further and view a potential rate cut as a positive development. Others, though, focus on the fact that a rate cut — particularly one of a half percentage point — suggests that the Fed sees the problems as major threats to economic growth.

Of course, following tomorrow’s meeting we’ll have much more to analyze. So stay tuned for a look back at what the Fed had to say and what it means for the stock market.