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The so-called Sharpe Ratio became a cornerstone of modern finance, as investors used it to help select money managers and mutual funds. But at the Sonoma meeting, the use of the ratio was criticized by many prominent academics -- including Dr. Sharpe himself. The ratio is commonly used -- "misused," Dr. Sharpe says -- for promotional purposes by hedge funds. Bayou Management, the hedge-fund firm under investigation for what may have been a massive fraud, touted its Sharpe Ratio in marketing material. Investment consultants and companies that compile hedge-fund data also use it, as does a new annual contest for the best hedge funds in Asia, by a newsletter called AsiaHedge. "That is very disturbing," says Dr. Sharpe. Hedge funds often use complex strategies that are vulnerable to surprise events and elude any simple formula for measuring risk. "Past average experience may be a terrible predictor of future performance," Dr. Sharpe says. Dr. Sharpe designed the ratio to evaluate portfolios of stocks, bonds and mutual funds. It is derived from a simple equation: First, the rate of return of Treasury bills -- which are virtually risk-free -- is subtracted from the portfolio's rate of return. The average difference between those two figures over a given period of time is then divided by how much the portfolio strayed from that average. That standard deviation is a measure of volatility. The higher the Sharpe Ratio, the better a fund is expected to perform over the long term. A ratio of more than 1 is considered good because that means the portfolio is producing relatively high returns with relatively low volatility. At a time when smaller investors and pension funds are pouring money into hedge funds, the ratio can foster a false sense of security, some experts say. There are now 8,000 hedge funds world-wide handling nearly $1 trillion. "This is becoming more of a problem because there is a movement to offer retail versions of hedge funds," says Andrew Lo, a MIT finance professor and a partner in hedge fund AlphaSimplex Group. "The typical retail investor might very well be misled by amazing looking Sharpe Ratios." "Hedge funds can manipulate the ratio to misrepresent their performance," adds Dr. Sharpe. "Anybody can game this," he says. In a recent study, Dr. Lo found that the annual Sharpe Ratio for hedge funds can be overstated by as much as 65%. "You can legitimately generate very attractive Sharpe Ratios and still, in time, lose money," he says. "People should not take the Sharpe Ratio at face value." Even if it isn't manipulated, Dr. Sharpe says, it doesn't foreshadow hedge-fund woes because "no number can." The formula can't predict such troubles as the inability to sell off investments quickly if they start to head south, nor can it account for extreme unexpected events. Plus, hedge funds are generally secretive about their strategies, making it difficult for investors to get an accurate picture of risk. "For hedge funds, we have no standards to measure risk," says James Van Horne, a Stanford business-school professor who attended the Sonoma gathering. The quest for a new measure of risk is confounding experts around the world. At a popular virtual community for hedge-fund investors called Albourne Village, more than 2,000 members recently downloaded a document called "A Critique of the Sharpe Ratio," by a London-based money manager warning hedge-fund investors away from it. In Hong Kong, the government bars hedge funds from opening unless they can prove they aren't going to fail -- and yet there is no adequate measure, says Sally Wong, executive director of the Hong Kong Investment Funds Association. Her problem with the Sharpe Ratio is that it assumes that a fund's returns will remain even over time. "Many hedge-fund strategies have greater downside events," Ms. Wong says. She favors another measure, the Sortino Ratio. That is similar to the Sharpe Ratio, but instead of using the standard deviation as the denominator, it uses downside deviation -- the amount a portfolio strays from its average downturn -- to distinguish between "good" and "bad" volatility. But even the namesake of that ratio is troubled by its use for evaluating hedge funds. "I think it's used too much because it makes hedge funds look good," says Frank Sortino, who developed the ratio 20 years ago and is director of the Pension Research Institute. "It's misleading to say the least," he adds. "I hate that they're using my name." Dr. Sharpe feels similarly. "I never named it the Sharpe Ratio," he says of his formula. "I called it the Reward-to-Variability ratio."
All year, yields have been gravitating toward the flat line as steady Fed rate increases pushed two-year yields upward while low inflation and strong investor demand helped depress longer-dated yields. However, some bond investors now fear the Fed runs the risk of tightening too much, a stance that helped invert the yield curve in 2000. These observers say that as high energy prices push future inflation higher, the Fed could well keep raising rates despite the slowing of the economy caused from those same energy-price gains. Yesterday the yields of two-, and three-year notes converged and fell to lows of 3.933%, with the five-year yield not too far behind at 3.958%. Meanwhile, the 10-year yield fell to a session low around 4.088%, illustrating how cramped rates are getting across the curve and leaving the difference between the two- and 10-year yields at 0.16 percentage point. At 4 p.m., the benchmark 10-year note's yield fell to 4.105% from 4.174% Monday. The 30-year bond was yielding 4.321%, down from 4.366%. Against this backdrop, it isn't any surprise that bond investors have been confining their holdings of Treasurys to maturities below or near five years, as they stand to gain almost as much return as they would get from a 10-year note without taking on the time risk. As always in the Treasurys world, whether the yield curve actually inverts will depend on Fed policy, economic data and the influence of high energy prices upon consumer and business spending in the months ahead. At the start of the year, the difference between the two- and 10-year yields was around 1.16 percentage points. Steady rate increases from the Fed have pushed the two-year yield higher, while the 10-year yield has been capped by a still-benign inflation outlook and widespread support for long-dated Treasury debt from pension funds, foreign investors and central banks. The latest stage of the yield-curve compression reflects the market's growing belief that the Fed will be unable to lift the current 3.5% federal-funds rate above 4%. The market is concerned that the Fed will get ahead of the curve with its measured path of tightening, especially if it continues past 4.25% irrespective of where oil goes," said Gerald Lucas, senior agency and Treasury strategist at Banc of America Securities. Noting that "the Fed has had a better call than the market on the economy so far this year," he said the central bank faces "a difficult balancing act, as proper monetary policy needs to offset the inflationary, against the contractionary, effects of high energy prices." To date, Fed policy makers haven't given any indication that they will stop raising rates. For a bond market that looks at record oil prices as hurting the economy rather than as sparking inflation, Fed rate increases above 4% this year might smack of excessive tightening. Moreover, the curve implied by September 2006 and March 2007 three-month Eurodollar interest-rate futures has inverted, having closed at zero last week. That marks the bond market's first concrete step towards pricing in Fed rate cuts between the middle of 2006 and 2007. Hence the market's herding of yields just above the 4% level that is expected to spell the limit of the funds rate for this rate-increase cycle. Historically, once the central bank has completed its rate-increase cycle, yields converge across the spectrum of Treasury maturities. "Our view is the curve stays flat to slightly positive for some time," said Jason Graybill, portfolio manager at Abner, Hermann & Brock Asset Management.
Ratings of oil and gas and chemical companies, which are heavily concentrated along the Gulf coast, are expected to escape unscathed as well, partly because of the surging cost of energy. "High commodity prices throughout 2005 are expected to provide some financial cushion for affected companies to withstand the expected temporary service and production disruptions and restoration efforts," S&P analyst Jeffrey Morrison wrote in a research note.
The lesson here is not that analysts, strategists and financial reporters are often wrong. The lesson is that stumbles and recoveries are inevitable, and that means diversification is a very good idea. It increases the chance that something in your portfolio is going up when other portions are going down. Diversification has produced much better results than many investors may think. Diversification among asset classes also makes you put money where you may otherwise fear to go. And who knows? You may get a sweet surprise. Diversification also prevents stock mania from distracting you from the opportunities in other asset classes. Stocks are right for the long run, as Prof. Jeremy Siegel has argued for years. But stocks are not the be-all and end-all of a good portfolio. The recent big gains in commodities are the best example of that. Over the last 3, 5, 10 and 15 years - the usual investment horizons for measuring market performance - only stocks have had a down period. The average annual total return for the S&P500 was a loss of 2.3% in the five years ending in 2004, according to data calculated by Ibbotson Associates. Bonds had an average annual total return of 7.7% over the same period, as measured by the Lehman Brothers aggregate bond index. Commodities, as gauged by the total return of the Goldman Sachs Commodity index, produced returns of 13.8%, annualized. I am not anti-stocks, especially for the long run. Over the 10- and 15-year periods through 2004, equities returned 12.1%, annualized, over 10 years and 10.9% over 15 years. Bonds had annualized returns of 7.7% in both periods, while commodities brought home 9.1% a year, on average, over 10 years and 7.1% over 15 years. The average annual returns from money market funds were much smaller: 1.6% over three years, 2.8% over five years, 3.8% over 10 years and 4.4% over 15 years, according to iMoneyNet. What makes diversification unappetizing is that you would not have racked up the huge returns that stocks alone brought in the late 1990's - or the big gains that commodities brought in 2002 through 2004. But you would have done a lot better with a diversified portfolio than you might have expected. Over the three years through 2004, according to Ibbotson Associates, the average annual return from a portfolio containing all these asset classes was 7%, assuming that you held 55% stocks, 30% bonds, 10% commodities and 5% cash. That compares with a return of 3.6% for a portfolio containing only stocks. Over five years, the average annual return was 3.4% for the diversified portfolio, versus an average annual loss of 2.3% for stocks. Over a longer period, a stock-only portfolio fared better, but not by much. The annualized 10-year return for stocks was 12.1%, versus 11% for the diversified portfolio. Over 15 years, stocks won by only 10.9% to 10%. So you can live well, and a little less painfully, if you branch out. That's what makes diversification worth it.
The current housing bubble—prices have doubled in the last four years in hot markets like Boston, Washington, D.C., and parts of California—is breeding a lot of would-be Strausses. One seemingly obvious path to riches is to become a real-estate broker. For many decades, agents have successfully kept their payments steady as a fixed share of the value of the houses they sell. In most cities, the rate is around 6%, split between the buyer's and the seller's agents. The lack of price competition has attracted the notice of anti-trust authorities at the Justice Department who are planning to sue the National Association of Realtors over some of their anti-discounting policies. Economically speaking, it's hard to explain why the steady commissions have lasted so long—perhaps agents band together to blacklist competitors who undercut prices, or perhaps the NAR's extensive "education" program for realtors excels at indoctrination. Whatever the explanation, the realtors' reliable cut of 3% each means that the housing bubble should be all upside for them. If house prices double, then agents make twice as much. Sell a house for $500,000 and keep $15,000; sell the same house for $1 million and keep $30,000. The agents are Levi Strauss without the copper rivets. There is just one problem with this—a principle that economists term the "zero-profit condition." In a business with free entry, new participants will keep entering until no money remains. And becoming a real-estate agent is almost free. Most states require applicants to take a short class and a test to get a license. For $99, an online company will prepare you to pass. This kind of entry into the housing market is a lot cheaper than, say, building a steel mill. Every month, thousands of new brokers get certified—more than 8,000 in California in May alone. With all these new agents swarming onto the scene, the price they charge may remain constant, but the number of houses each sells will not. The zero-profit condition predicts that, in locales where housing prices rise, the number of agents will also rise, and acquiring new clients will become that much more difficult. The occasional star agent will always make a bundle. But the theory suggests that the average agent won't make much more in places where house prices have risen than in places where they haven't. A recently published study bears this out. Enrico Moretti and Chiang-Tai Hsieh of the University of California, Berkeley, studied the real-estate agent business in 282 metropolitan areas during a 10-year period. They compared agents in inflated markets to agents in flat-lining markets and found overwhelming evidence of the zero-profit condition in action. When housing prices rose, the number of agents did as well, and this, in turn, reduced the number of houses each agent sold by almost exactly the same proportion as the price increase. In Moretti and Hsiesh's data, for example, houses cost 5.9 times more on average in San Francisco than they do in Steubenville, Ohio. But the average full-time agent working in Steubenville sells more than 22 houses per year, whereas the same agent in San Francisco sells fewer than 4—5.7 times less. The average income for real-estate work in the two locales is virtually identical. Moretti and Hsieh found that the direct correlation between housing prices and agent productivity held true across all markets. A rise in housing prices in an area has no significant impact on the average wage of the brokers in that market. It's the oldest line in the economics book: No barriers to entry mean no big profits. So, you probably can't become the Levi Strauss of real estate by hanging out your broker shingle, no matter how high the housing prices climb where you live. If you want to make money off the housing bubble, you'll have to do it the old-fashioned way: Buy a place with a no-money-down mortgage and then flip it.
Thomas Helbling, deputy chief of the world economic studies division at the IMF, tracked the housing market histories of 14 industrialized nations for the period from 1970 to 2002, finding 75 home-price cycles. Bull markets typically lasted a bit less than three years, with prices climbing by a cumulative 11% when adjusted for inflation. Bear markets were about one year long and prices fell about 6%, the study found. In boom times, defined by Helbling as the top 25% of periods of rising prices, prices climbed for about four years with an average increase in house values of 32%. Housing market busts also persisted for about four years, with prices declining by an average of 27%. About two-thirds of all housing market booms ended in a bust, when booms are measured using cumulative house price gains in the eight quarters leading to prices peaking, Helbling found. That percentage dropped to about 40% when booms were calculated from peak-to-peak instead. In the past four years, the average price of a U.S. home resale has climbed by almost 38%, according to data compiled by the National Association of Realtors. After the Boom Slumping property values can wreck an economy. `Housing price busts in industrial countries were associated with substantial negative output gaps, as real GDP growth decreases noticeably,' Helbling wrote in his study. `On average, the output level three years after the beginning of a housing price bust was about 8% below the level that would have prevailed with the average growth rate during the three years up to the bust.' The IMF economist found that the U.S. had no booms and no busts from 1970 to 2002 based on his methodology, though he said the analysis only covered completed cycles and would miss any bull markets still under way since the 1990s. Helbling's definition means a quarter of all housing-market cycles are either booms or busts, a necessarily ``arbitrary'' classification, he wrote. Booms Elsewhere U.K. house prices are up 75% since 2001, according to the Nationwide Building Society, the U.K.'s third-biggest mortgage lender. In the four years to the end of 2003, Australian housing prices gained 70%; they've advanced less than 3% since then, according to the Australian Bureau of Statistics. `My hunch is that the booms in Australia and the U.K. have ended, but this is only a guess at this stage,' said Helbling in an e-mailed response to questions. He hasn't updated his study, which he presented at the IMF's October 2003 conference on ``Real Estate Indicators and Financial Stability,'' to include data for the past four years. Parts of the U.S. equity market indicate investors are starting to worry about the outlook for real estate. The S&P500 index of homebuilding shares has declined by almost 15% in the past month, paring its gain for this year to 23% and its 12-month climb to a bit more than 50%. Government figures yesterday showed the median price of a new home fell to $203,800 last month, the lowest since December 2003. `Affordability Erosion' Houses for first-time buyers are the least affordable since the third quarter of 1989, when rising energy prices and higher Federal Reserve interest rates last coincided with a bursting bubble, Rosenberg wrote in a research note this week. `New home sales plunged 20% in the ensuing year as demand responded to the affordability erosion,' he said. Yale University economist Robert Shiller, who updated his 2000 stock-market book ``Irrational Exuberance'' this year to include a section on the housing market, says U.S. house prices may decline by as much as 40% in the next generation, the New York Times reported Aug. 21. He's gone back to the late 1800s to show that a period of declining prices followed every boom, the paper said. `Bubbles usually end, not necessarily because of higher interest rates, but because you eventually reach a price point where the bids dry up,' wrote Rosenberg at Merrill. `When you treat your rising home price as a bonus to be spent every year, and that source of so-called income dries up, so does your economic activity.' U.S. homeowners used mortgage refinancing to suck more than $212 billion out of their houses in Q2, up 25% from the first three months of the year, Freddie Mac said earlier this month. Almost 75% of the refinancing in Q2 was to generate extra cash. Without that extra source of quasi-income to sustain the world's biggest economy, the Cassandras who see low bond yields as a harbinger of hard times to come may yet be proved right.
The CBOE created the VIX in 1993 to measure the expectations that options traders had about the volatility, or short-term price movements, of the stock market. The VIX options will trade for higher prices when expected volatility rises. The VIX currently stands at 13.42, which is lower than about 79% of the index's past readings. Its historical range extends from a low of 9.31 in December 1993, to a high of 45.74 in October 1998. The VIX quickly found a following among contrarians who believe that the stock market rarely moves in the direction that the majority expects; therefore, they are bullish for the overall market when the VIX is high and indicating widespread investor fear. They are bearish when the VIX is low and betraying investor complacency. Researchers, however, have been able to find only partial historical support at best for this interpretation of the VIX. According to a recent Hulbert Financial Digest study, the stock market has indeed tended to turn in an above-average performance following very high VIX readings - just as contrarians say. But contrary to what contrarians believe, the stock market has also produced above-average returns following very low readings. The stock market has tended to turn in some of its worst months after VIX readings were more or less in the middle of the pack. At the stock market's top in March 2000, for example, the VIX stood at 23.31, only moderately higher than its historical average of 19.7. During the 2000-2002 bear market, the average VIX level was 25.31, and never fell below 16. Even though above-average market returns tend to follow high VIX readings, it would be a mistake to credit the VIX for this, according to Samuel Eisenstadt, senior vice president and research director at Value Line. Eisenstadt argues that the root cause of the market's propensity to rise after high VIX readings has little to do with the index itself. Instead, he says, it is caused primarily by the market's tendency to reverse itself following sharp declines. Eisenstadt found that, once he controlled for those declines in his statistical tests, high VIX readings lost their apparent ability to forecast strong market action. Does the VIX, nevertheless, have a role to play as a contrarian market-timing tool? Some market timers think it does, provided they focus on its recent trend rather than its actual level. These contrarians consider fast rises in the VIX to be bullish, on the theory that investors are quickly becoming scared. By the same token, rapid declines are taken to be bearish, since it must mean that investors are becoming smugly confident. The Hulbert Financial Digest also failed to find support for this interpretation, however. On average, the stock market in the past has performed no differently after rapid rises in the VIX than it did after rapid falls. Even if this alternate interpretation of the VIX had statistical validity, however, it would not support the bearish conclusion that many contrarians currently have been drawing. That's because the VIX has been locked in a fairly narrow range for several months now and therefore has neither risen nor fallen sharply. The bottom line: Don't worry about a low VIX.
Crude-oil futures closed at a new high of $66.86 a barrel on Friday, which, even adjusting for inflation, is the highest level reached since 1982. Gasoline rose above $2.40 a gallon last week vs. $1.85 a year ago. But the recession hasn't come, and most of the economists in this month's Journal survey think economic growth will be running at an annual rate north of 4% in the current quarter and at better than 3% in the three quarters to follow. So why did the recession forecast go bust? In last year's poll, some economists commented that how the economy responded to rising oil prices would depend on whether the push higher was caused by rising demand or a drop-off in supply. That was an important distinction. Supply shocks, like those that followed the Arab oil embargo in 1973 and the 1979 Iranian revolution, caused sharp price rises that hampered the economy. The recent rise in prices has been mostly the result of increased world demand for oil. As a result, energy prices have gained gradually, rather than jumping higher. So the increase has been far easier for consumers to stomach. Still, it is somewhat surprising that the rise in energy prices has had such little effect on consumers' gasoline habits. One example: Total U.S. car sales rose 16% in July from the year-earlier period, while sales of trucks & SUV's -- generally less fuel-efficient -- jumped 25%. Lay it on Detroit's generous incentives, which are skewed toward its more-profitable trucks. Personal Finance
It's called the revised equivalence scale and is one of the many devices that have been used to sort out the differences in cost of living for households of different ages, sizes and composition. Academics continue to debate the best tools, but a revised equivalence scale that's 20 years old tells the story. Let's say that the cost of living for a young married couple without children gets an index number of 100. From there, the revised equivalence scale has an index to represent the cost of living for each size and age of family composition. A young single person, for instance, would get an index of 71. Marriage and the arrival of a first child takes the index to 127. The arrival of a second child moves the index to 147. The index continues to climb as the children age. It reaches 204 when the older child is 6 to15 years old and peaks at 231 when the older child is 16 to 17. (The index is apparently unaware that some children go to college.) From there the index starts to descend, going down to 186 when only one child is at home (assuming the other isn't at Stanford or Harvard). It reaches a mere 120 when the couple makes "Empty Nester" status. It hits 104 when the couple is retired and bottoms at 57 when a spouse dies and leaves a widow. Put all these index numbers together, and you have a life cycle. You also have an idea of how much your income needs to increase if you have the heartwarming and politically correct goal of having two children. Between the day we marry (index 100) and the day the index peaks at 231 – a period of about 17 to 19 years – real family income needs to grow at 4.5% to 5% a year to maintain our standard of living. So think about that. If your real family income needs to grow at 4.5 to 5% a year and inflation is 2.5 to 3.5%, the simple project of marrying and having a family requires income growth of 7 to 8.5% a year. Not for two or three years. Not for five years. It requires that size of annual income increases for nearly two decades. How often does that happen? Not very. According to the Web site salary.com, typical workers can expect a raise of 3.7% this year, after an average raise of 3.6% in 2004. At best, that's 1 percentage point over the rate of inflation, not the 4.5% to 5% a young family will need to avoid a declining standard of living. Averages, of course, can be misleading. Younger workers tend to get larger raises as they move into positions of more responsibility. More experienced workers tend to get smaller raises. How long you get real raises depends on the complexity of your job and whether your responsibilities increase. Whatever the job, it's tough to argue that you deserve a raise just because you're a parent and need the money. Many young couples, armed with visceral knowledge of this reality, decide to have fewer children. Some – an increasing number – decide to have none. What about the others? Are they dumb? No. They are heroes, real everyday heroes.
I was writing about "FICO scores" because a GMAC Mortgage consumer survey had found a wealth of misconceptions about the scores. GMAC stated flatly that a score of 620 is necessary to secure the most favorable rate. But that number will vary by lender. It's a number with a history: When the concept of "credit scoring" took off in the 1990s, consumers with scores of 620 or 630 qualified for standardized lending, according to Craig Watts, a spokesman for Fair Isaac. "If scores were above 620 or 630, mortgage lenders could use [Fannie Mae's or Freddie Mac's] standardized underwriting process" to make loans that Fannie and Freddie would be willing to buy and resell as securities, Watts said. "If they were below that, [Fannie Mae and Freddie Mac] encouraged lenders to take a deeper look at that borrower's risk level. That threshold has shifted over the decade, but it has stayed pretty firmly in the low-600s range," Watts said. But a score of 620 doesn't mean you're going to qualify for the best rate, he says. It means you "qualify for a standardized rate, or a prime rate. 'Prime' is a broad category, so lenders will have different loan products that classify as 'prime' rates." Lenders set their own credit-score benchmarks, depending on the level of risk they're willing to take, Watts says. The lesson here for consumers: It pays to shop around. "For the best borrowers, you're likely to get more points knocked off the loan fees [if you have the higher scores], or you're likely to pay a fraction of a percent less in overall interest." Then there's a whole other category of loans known as "subprime" for borrowers with spotty credit histories. These borrowers may qualify for mortgages, but they'll pay more for the privilege. How low can you go and still get a subprime loan? "When you get below 500, you're getting into tenuous territory," Watts says. "People who are below that may be qualified, but they might not want to pay the price for it. If you're in the 300 or 400 range, God help you in finding a loan."
The three-digit number from 300 to 850 is used by mortgage brokers, credit card companies, retailers and auto dealers to determine how much you can borrow and at what interest rate. The higher the score, the better. You need to know that number, but you should not obsess about it. That can be hard, though, because the credit agencies and Fair Isaac would very much like you to monitor it closely. Andy Jolls, a vice president for Fair Isaac, said, "The more people who know about it the better." Fair Isaac last year sold $706.2 million worth of financial data to companies that want to sort out the deadbeats. Over the last four and a half years, it has sold more than 10 million scores to consumers at $45 each. Revenue generated from the company's MyFico.com Web site jumped 33%, to $32 million last year. The FICO score, invented in 1988, has in a very short time become the single most important indicator used by lenders to predict whether you will repay your debt. The score is largely based on just two factors: history of paying off debt and "credit utilization," or the amount of debt you have in relation to your credit limits. Fair Isaac measures this, along with three other factors, applies an algorithm to compare that data with the payment patterns of millions of other Americans and generates the FICO score. Any number below 500 and you are a financial pariah. Get above 750, where 40% of Americans are, and the credit card companies will never stop plying you with offers. So, of course, you want to know what your score is. It is human nature to want to know. If your mortgage broker does not share it with you free of charge, by all means, buy it. Fair Isaac and each of the credit bureaus will be glad to sell versions of it to you. (It does not come with any credit report, free or otherwise.) Here's the first rub: the credit score you get is not really the score that a lender will use. Fair Isaac sells a variety of scores aimed at various markets. Its computers slice the data it purchases from credit bureaus any number of ways for clients. Some scores calculate the odds of a bankruptcy filing, while others help a collection agency predict the likeliness one will make good on a debt. Some lenders even have their own algorithm to generate a proprietary score. "There are thousands of options and creditors choose which one they want," says Maxine Sweet, vice president for consumer education at Experian, one of the three major credit agencies. In fact, FICO uses Experian data to generate the score that is very similar to what the majority of mortgage lenders ask for, but Experian also sells a version to consumers called Score Plus. You can also obtain a credit score called Empirica from TransUnion, and one called Beacon from Equifax, that closely approximate the FICO score. All the numbers are different, but are not supposed to vary much. You really only need to look at one score. But MyFico.com and each of the credit agencies not so subtly urge you to buy more with a variety of products, including some that will give you constant updates of your score. If you are checking your credit report three times a year as you should, watching your score change every few weeks is complete overkill. They also urge you to buy products to improve your scores. But does everyone need to obsess over this score? If you have excellent credit, you already know it. If you have bad credit, you also know that, too, and you should know what to do about it: pay your bills. It is everyone else who could benefit by knowing the score. The people with scores in the 600's could profit the most by nudging it into the 700's. In that lower range, a difference of only a few points can mean paying thousands of dollars more in interest. In some regions like California and the Northeast, where home loans of more than $350,000 are the norm, anyone with a score below 660 will have trouble qualifying for a mortgage. The credit score is determined by five factors, some weighted more than others. If your score is anywhere above 700, do not sweat it. Keep doing what you are doing. For everyone else, here's where to apply a little discipline so you look less like a credit risk: Payment History (35%) Pay your bills on time. The longer you do that, the faster your score goes up. It is that simple. Amounts Owed (30%) If you have balances, start paying them down to zero starting with the cards carrying the highest interest rate. Consolidating debt onto one card can lower your score because a high ratio of debt to your credit limit, what the industry calls "credit utilization," looks like you are about tapped out. Widening the gap between your credit card limits and what you owe will pay off. A score can be raised 10 to 15 points in only a few months with a little discipline. Length of Credit History (15%) This category trips up people who think they are improving their credit by tearing up their credit cards. Do not close any accounts. It does not hurt to let them sit there, because the longer you have accounts open - assuming you pay on time - the better your score gets. New Credit (10%) Ignore the come-ons from stores offering a discount if you open a charge account. Taking out more credit makes you look short of cash. But do not worry about shopping around for a loan. Inquiries from potential lenders hitting credit bureaus within a 30-day period aren't harmful. Types of Credit Used (10%) Crazy as it sounds, if you have some debt you look better than someone who has none. If you have some small amount of installment debt - as dumb as that is to do - it can help to raise your score a bit. Related How to Rasie Your FICO - Kadet, WSJ / Kristof, LA Times, Credit Score Simulators - J Bayot, NY Times Mutual Fund Update
The Energy Select Sector SPDR Fund holds 29 large oil and gas companies in the S&P 500 -- far fewer than the other funds. Its holdings don't include small- and mid-cap securities, but underweights some large-cap companies relative to the S&P500 index. The energy SPDR is considered the purest play on large-cap energy stocks. The fund is also the least expensive of the bunch. The shares trade at about 12.5 times prospective earnings of the underlying stocks, weighted by their representation, according to Morningstar. The fund deducts 0.25% of assets to cover expenses each year. The SPDR is also the oldest and most popular. More than 13.26 million shares trade hands each day, according to Morgan Stanley. The iShares DJ U.S. Energy Index Fund by Barclays holds just over 50 stocks and is designed to track the performance of the Dow Jones U.S. Energy Sector Index. The fund, which includes stocks with a variety of market caps, doesn't hold all of the stocks in the index but instead invests in a representative sampling to produce returns that closely track the index. The iShares ETF trades at about 12.4 times prospective earnings of the underlying shares, according to Morningstar. Shareholders in this fund spend the most on fees -- 0.60% of assets. The Vanguard Energy VIPERs, which came to the market last September, holds about 130 stocks and consists of all the stocks in the broader Morgan Stanley Capital International, or MSCI, Investable Market Index. While large energy companies account for a big portion of the portfolio, the large pool of stocks gives this fund exposure to more small- and mid-cap names. Generally, the fund holds all of the stocks in the index. The VIPERs trade at about 14.2 times prospective earnings of the underlying shares and carry the same 0.25% fee for expenses as the energy SPDR. Morgan Stanley analyst Paul Mazzilli suggests that investors considering an energy ETF look at the composition of the index, the trading liquidity of the ETF and the fees. Short-term traders tend to be more interested in liquidity while those investing for the long haul tend to be more interested in fees. Other ETFs are designed to track different parts of the energy market. The iShares S&P Global Energy ETF tracks the global energy market, and iShares Goldman Sachs Natural Resources ETF follows natural resources in the U.S. and abroad. Powershares Capital Management has the WilderHill Clean Energy Portfolio, and Merrill Lynch manages the Oil Service HOLDR, which is constructed slightly differently than an ETF but also is designed to track oil and gas drilling and equipment and services. Other ETFs are in the works. Barclays's commodity ETF, which is in registration with the SEC, will put more than 75% of its dollar weighting in some form of oil or gas. However, because the fund is a broader play on commodities, it will be less correlated to oil than the other options.
Financial firms are not required by law to offer transfer-on-death registration. Many New York-based firms heretofore have held out offering transfer-on-death to accountholders nationwide, trying to avoid potential legal headaches that might have come from allowing the registration to customers who weren't eligible for it. Now, with transfer-on-death available in New York effective Jan. 1, that situation is likely to change. Even if it doesn't, however, investors would be well-advised to review precisely how they have registered their fund accounts to make sure their money goes where they want in the end. Registration is an estate-planning issue, showing where you intend for your accounts to go after you die. Typically, the idea is to maximize what goes to your heirs and avoid probate. Probate is the state judicial process that determines the value of a dead person's estate. Mutual-fund holdings typically are subject to probate, though laws vary by state. For anyone with serious estate-planning needs, transfer-on-death options are no big deal. To minimize taxes, these high net-worth individuals or couples should be hiring an adviser to set up trusts that will preserve as much of the savings as possible. In those situations, mutual-fund accounts will be registered in the name of the trust. But for smaller savers, people whose estates aren't likely to threaten the estate-tax limits, transfer-on-death rules are worth examining. Transfer on death is self-explanatory. Name a beneficiary, and that's who gets the money, without probate. The account owner maintains control of the assets until they die, and has the right to change the beneficiary designation at any time. When the owner dies, the beneficiary can manage the money right away, rather than having it subject to market whims while the estate potentially is tied up in court.
About a quarter of the $12.9 trillion U.S. retirement market was in mutual funds at the end of 2004, a record amount, and about a percentage point higher than a year earlier. Mutual funds managed a record $1.5 trillion in IRAs in 2004, though their share of total IRA assets has dipped since the late 1990s with the rise of securities held in brokerage and separately managed accounts. To estimate the size and contours of the U.S. retirement market for its annual survey, the ICI combined its own data with statistics from the U.S. Department of Labor, Federal Reserve Board, the IRS and a number of trade organizations. ICI said in its survey that the biggest slice of the retirement market is composed of IRAs, which held $3.5 trillion at the end of 2004. Traditional IRAs are most popular, funded with rollovers from employer-sponsored retirement plans and contributions. Roth IRAs and employer-sponsored vehicles including SEP, SAR-SEP, and Simple IRA accounts also have grown, though they comprise only a small portion of the overall market. Second to IRAs are defined-contribution plans, which held $3.2 trillion in assets at the end of 2004, according to ICI. Assets in 401(k)s, the most prevalent, increased 13% in 2004, ending the year at $2.1 trillion. Other kinds of defined-contribution plans held $1.1 trillion at the end of 2004, 12% more than they had a year earlier.
But in roughly the past 1.5 years, 32 actively managed small-stock mutual funds closed to new investors, bringing the total number of small-cap funds shuttered to new investors to 79, according to Lipper. That means roughly 14% of all small-cap funds are now closed to new investors, compared with 3% of large-cap and 7% of midcap, a recent Merrill Lynch report noted. With small-cap funds, the concern is that many small stocks can be relatively illiquid. If a fund manager needs to get out of a large position, it may be difficult to unload if there isn't enough volume. It can also be costly to start new positions in a stock, because a thinly traded stock means less availability, enabling those that are on the other side of the trade to demand higher prices. Bill McVail, portfolio manager of Turner Small-Cap Growth Fund, shut his doors to new investors after it became apparent that returns could begin suffering. "You close a fund after you've had great performance, great assets come in," said Mr. McVail, who made his move after reaching $250 million in assets. "It's not like you're buying a General Electric, or another large company, because small stocks just don't trade that way," Mr. McVail said. Mr. McVail said he has no second thoughts about closing the door to new investors, even as small stocks have continued to climb. "We want to make sure we can perform for our clients," Mr. McVail said. "If we left it open, it would have compromised our ability to provide value." Satya Pradhuman, chief small-stock strategist at Merrill Lynch, said of the closure to new investors, "It's a growing phenomenon." Mr. Pradhuman, who expects the trend to continue, noted that "it doesn't pay for them [small-cap funds] to take in new investors." David Klaskin, chairman of Oak Ridge Investments, also decided it would be best to shutter his firm's Pioneer Oak Ridge Small-Cap Growth Fund, when it hit $265 million in assets. "As a manager you want to have enough maneuverability," Mr. Klaskin said. "I became concerned that selection was going to be influenced by liquidity issues." There can be a drawback, though. "You don't want to be too small that you lose access to company management," Mr. Klaskin said. But a number of money managers who are watching funds turn away new investors are deciding to launch their own. Because so many funds are so full, "investors have to go down the totem pole," said Brandi Allen, portfolio manager of River Oak Discovery Fund that started June 29. Mr. Allen's fund has roughly $3 million in assets under management, "which gives up plenty of room to maneuver." Andrew Beck, president of River Road Asset Management, is another new entrant as the manager of ABN Amro/River Road Small-Cap Value Fund, which opened to investors on June 27. "Many small-cap funds are either closing or should be closed because they are bloated," Mr. Beck said. But at the same time, there remains room for smaller funds "to leverage the unbelievable demand for small-cap products, which is still out there," Mr. Beck said. ABN Amro/River Road Small-Cap Value Fund has $40 million in assets.
Over a 10-year stretch, between 60% and 90% of U.S. stock funds in any one category will typically fall behind their category's benchmark index. There are 126 stock funds with $1 billion or more in assets that have suffered an even more ignoble fate. They have fared worse than most funds in their category, according to Morningstar. These 126 funds collectively manage $438 billion, equal to 9% of all money invested in stock funds. These funds are run by some of the country's best-known fund companies, including AIM Investments, Alliance Capital, Dreyfus, Fidelity, Franklin Templeton, Janus, MFS, Morgan Stanley, OppenheimerFunds, T. Rowe Price, Putnam and Vanguard. Included in the 126 are some balanced funds, which own both stocks and bonds, and even some index funds. Among our laggards are 48 funds that have also trailed their category average over three and five years -- and yet they collectively manage $192 billion. The three-strikes camp includes Fidelity Magellan. Magellan has fallen behind the S&P 500 in seven of the past 10 years, but it continues to boast $55 billion in assets. Arguably, Magellan is so big that no manager could generate stellar long-run results. But that isn't true for most of the other laggards. A big asset base can be a disadvantage, partly because it's tougher to trade in and out of stocks, and partly because managers have so much to invest that they can no longer stick with just their best investment ideas. Still, $1 billion isn't a huge amount to be managing, especially with the U.S. stock market [the Dow Jones Wilshire 5000 "total stock market" index] now valued at more than $15 trillion. "It would be insane to own a micro-cap fund with a $1 billion in assets," says Minneapolis financial planner Ross Levin. "But I wouldn't think twice about buying a large-cap fund with $1 billion in assets." In fact, funds that outpace their category average tend to have more in assets than those that underperform. That is no surprise: Investors flock to funds with good performance. What is surprising is the patience of investors in large funds with dreadful results. A Matter of Taxes? One possible explanation is shareholders may be reluctant to cash out because they don't want to pay the resulting tax bill. But I am not buying this argument because, according to ICI, almost 40% of mutual-fund assets are in tax-sheltered retirement accounts. Meanwhile, even if shareholders held these laggard funds in their taxable account, they probably wouldn't pay a big tax price for selling. Once they figure in the fund income and capital-gains distributions that they have received over the years and reinvested in additional fund shares, these investors may find their cost basis for tax purposes is surprisingly high -- and the unrealized gain is fairly modest. A Matter of Psychology? To understand why these shareholders don't sell, I think we need to look to investor psychology. That brings me to a new study by Woodrow Johnson, a finance professor at the University of Oregon. According to his study, if a fund performs poorly, new investors stay away and existing shareholders don't add to their holdings. Poor performance, however, doesn't prompt existing shareholders to rush to sell. "My guess is that most investors are unsophisticated and they are going to hang on until they need the cash or they meet their goal," Prof. Johnson says. Meir Statman, a finance professor at Santa Clara University in California, suspects this tenacity is driven by our reluctance to sell bad investments. Selling means admitting we made a mistake and giving up all hope of better performance. "The reluctance to realize losses affects everyone" he says. "The difference is, professionals have a sell discipline." Got a rotten fund you can't bring yourself to sell? Prof. Statman's advice: You may find it easier to bail out if you first identify another fund that you really want to own. "Instead of getting rid of a loser, think of it as finding a winner," he suggests.
[1] How has the fund done compared to its peers? Losses -- or unexpectedly slow returns -- are the biggest concern for investors, but a losing fund may be at the top of an ailing asset class. The investor who bailed when the funds were down missed out on the benefits of diversification. If poor returns make you realize that the asset class is wrong for you, dump the shares in favor of something different. It makes no sense to stay in an investment category you can't stomach. Experts differ on how long to give a fund that lags its pack, but waiting forever is a mistake; management owes you a chance at good performance, and if they can't deliver for, say, two years, they deserve to see you leave. [2] Has the fund changed strategies or missions? If a fund stops buying the things you bought it for -- maybe it has grown and is now investing in mid- or large-cap stocks instead of small ones -- you may want to look for the exit. By keeping an eye on the portfolio, the fund's paperwork and the category that the ratings agencies apply, it's easy to see if it has strayed. [3] Has management changed? There are plenty of cases where a star manager has left and the fund has barely missed a beat. Still, if performance declines after a change -- or if you are hoping that a new manager will get things back on track and you don't see improvement -- it's a reason for concern. [4] Would you buy the fund again today? If a fund can't meet the same criteria applied when you bought it -- and no longer looks so attractive -- start shopping.
The trend toward lower transaction costs has been driven by investors' growing yen for funds run by managers who are less trigger-happy when it comes to buying and selling stocks in their portfolios, as well as the continuing drop in trading commissions. "Funds' trading costs are coming down, but not necessarily in every corner of the market," says Don Cassidy, a senior analyst with Lipper. In some cases, investors are losing as much to trading costs as they are to expenses that are disclosed as a percentage of assets -- management, administrative and related costs. This yardstick, known as the expense ratio, is easy for investors to understand: If expenses total 1%, earnings are reduced by one percentage point. But trading costs are disclosed separately, typically in a fund's obscure statement of additional information, where they are listed as a dollar figure, making it difficult for many investors to calculate the true cost of owning a fund. At The Wall Street Journal's request, Lipper calculated trading commissions as a percentage of assets at funds larger than $100 million. Credit Suisse Capital Appreciation Fund had the highest costs -- 1.95% for the year ended last October. That's on top of the fund's other expenses, which range from 1.16% to 2.16%, depending on the share class. At the AIM Opportunities I Fund, trading costs amounted to 1.23% of assets, according to Lipper. That's on top of the fund's expenses of 1.01%. The average fund investor nowadays pays 0.87% in other, nontrading expenses, plus an additional 0.15% in trading commissions, based on Lipper's calculations. But more than 250 funds have trading costs that add up to more than 0.5% of their assets, including roughly 45 with more than $100 million portfolios, Lipper says. Industry watchers frequently complain that funds trade too much, pointing to figures that show that over the past five years, the average U.S. stock fund bought and sold stocks valued at more than 100% of its portfolio each year, according to Lipper. But other statistics show that turnover is falling. In the year ended July 31, just 46% of the value of all fund portfolios taken together was bought and sold, down from 70% five years ago, by Lipper's dollar-weighted tally. That suggests that investors are pouring more money into funds that trade less frequently and is heartening to critics who have long said money managers who buy and sell frequently are confusing motion with progress. Mutual funds today pay less than they have in the past to trade each share of stock. The average commission for stocks listed on the NYSE now stands at around four cents a share, though many funds pay less due to the advent of electronic trading systems that operate without a broker and often charge a penny or two a share. Ten years ago, the average commission on NYSE-listed stocks was nearly six cents a share. While the percentages may seem small, they can significantly ding returns over time. Consider two hypothetical $10,000 investments over 20 years in different funds with nontrading expenses of 1%, one with trading costs of 0.5% and the other with trading costs of 1%. Assuming annual growth of 8%, an investor would wind up with a little less than $34,500 in the first fund and about $31,100 in the second, according to a calculator on the SEC's Web site. Many high-turnover funds are growth funds. Small-cap value funds typically have a turnover rate of 49%, compared with 91% for small-cap growth funds, based on Lipper's dollar-weighted tally.
Investor advocates like Russel Kinnel, director of research at Morningstar, say that fund managements have spent the money to promote more sales, helping their own bottom lines at the expense of their customers. Mutual funds say the industry average distorts the true picture, which sees most investors enjoying lower fees. The overall industry number is higher than in 1987, they argue because it reflects the start-up costs of thousands of new funds launched since that date. At the end of 1989, there were 2,935 funds with $981 million in assets. At the end of 2004, the number of funds had swelled to 8,044 and they were overseeing $8.1 trillion in assets. This year, through June 30, the number of funds had dropped by 92, to 7,952, according to ICI. Expense ratios can significantly reduce an investor's total return. One Morningstar study says expenses are a better predictor of fund performance than historical returns. In a piece last April for "FundInvestor," Kinnel asserted that an investor who randomly selects a fund with expenses in the lowest 25% and five-year returns in the worst 25% probably will have better future returns than the investor who buys a fund with five-year returns in the top 25% and expenses in that same quartile. If this is the case, investors should ignore those lists of last year's best-performing mutual funds, Kinnel argued recently. If anything, he said, the previous year's top funds probably are near their apex in both share price and performance. Kinnel contends that the industry's rapid growth in the number of funds and assets under management since 1989 should have resulted in lower expenses, given the possible economies of scale. Why have expense ratios moved up? Kinnel says that middlemen have captured the money saved from running more money more efficiently. Simply put, fund companies are encouraging brokerage houses to sell their products by giving them a small piece of the action. Kinnel He also points an accusing finger at mutual-fund supermarkets, such as Schwab's One Source. These offer investors the convenience of being able to buy funds from a number of companies in one place and having one statement each month, instead of one per fund. But such convenience comes at a cost. Funds are charged 20 to 40 basis points a year for their listing, and the charge is passed through to investors, including those who aren't investing in them through a supermarket. Sean Collins, an economist with ICI, argues that Kinnel's conclusions are wrong. Most individual investors have seen expenses fall, he contends, even though the average expense ratio for the mutual-fund universe is up. Collins resolves this paradox by claiming that many of funds created since 1989 have attributes that skew the overall number. For example, many of the newcomers are small and thus lack economies of scale. In addition, the new funds are unfamiliar to investors and so must spend more on advertising and distribution to attract assets. And, some incur higher expenses by virtue of their focus. International funds, for example, are more expensive to run because it costs more to buy and sell non-U.S. stocks. In 1989, there were 128 international funds, according to the ICI. As of June, there were 824. Collins also cites the fund supermarkets as contributing to higher costs, but adds that people want the extra services they afford, which weren't readily available in the 1970s and the 1980s. Kinnel doesn't deny that some individual funds are reducing their fees. In fact, he says, investors are flocking to the funds that are. He also finds that advisers and retirement-plan sponsors are providing cheaper funds in their lineups more frequently than in the past. Kinnel points out that fund groups like Fidelity and T. Rowe Price had expense ratios below average in 1989 and that they've continued to lower them. "Conversely, Aim and Franklin Templeton are now charging more than 40 basis points above what they charged 15 years ago," he adds. Economic Update
Reports in recent weeks have shown that even after nine rate increases since June 2004, with a 10th expected tomorrow, the Fed hasn't been able to slow the economy. The 10-year note yields less now than it did when the central bank began raising interest rates. The government reported that house prices in June jumped by the most on record and inflation is running at the high end of the central bank's estimates. Yields will rise ``just on the mere fact that the Fed will be moving more than the market is currently pricing in,'' said Stephen Stanley, chief economist at RBS Greenwich Capital. ``The inflation picture won't look as good'' as it has based on current economic growth, he said. RBS expects the 10-year Treasury to yield 5%, the highest since June 2002. The benchmark 10-year Treasury has fallen for six straight weeks, the longest slide this year. The yield is up from 3.92% at the end of June. The yield peaked this year at 4.69% on 3-23. Twenty said the Fed will increase the so-called federal funds rate to at least 4% by year-end. A month ago, just 11 expected the rate to reach that level. By July, the rate will be at least 4.25%, 14 firms said. ``The Fed is going to have to raise rates however high as necessary to get an effect on the housing market,'' said Jan Hatzius, a senior economist at Goldman Sachs. Goldman forecast a year-end 10-year yield of 4.90%. Robert DiClemente, the chief U.S. economist at Citigroup, estimates the 10-year note will yield 4.35 percent at year-end, down from his estimate of 4.9% in January. Drew Matus, a senior economist at Lehman Brothers, raised its forecast for the 10-year yield to 4.70% at year-end from 4.50%. Matus and his colleague, Chief Economist Ethan Harris, said growth in the second half of the year may accelerate beyond 4% as companies restock inventories. Merrill Lynch Chief U.S. Economist David Rosenberg on Aug. 3 changed his year-end fed funds forecast to 4% from 3.50%. ``Growth in the second half of the year and inflation will pick up modestly and that will keep the Fed moving rates higher at a measured pace,'' said Conrad DeQuadros, a senior economist at Bear Stearns. The firm had a 5.75% year-end yield for the 10-year note in January, then lowered its estimate to 5.5% in the first quarter and to 5%, its current prediction, in June.
People say offshoring's effects may be less dire than feared. Specifically, it seems the job market for American technology workers has been improving for people who can program and manage computer networks and other information systems. According to Foote Partners, a consulting firm that regularly surveys about 50,000 information-technology professionals, demand for qualified tech workers is rising in the United States. This is reflected in the salaries and bonuses being offered for network technicians, database administrators, and managers of specialized computer applications. It's a big turnaround from only 18 months ago, when information-technology salaries were falling at rates close to 10 percent per year, said David Foote, the firm's founder and head of research. In the last 12 months, by contrast, pay for tech workers in the United States rose between 3 percent and 5 percent, depending on the type of skills they have. What has changed? Foote thinks many technology firms have discovered the limits of offshoring. Companies that rushed to cut costs by shifting work to India or other places got results that were less than they had hoped. Some found it hard to manage workers situated many time zones away. Others ran into security issues, or discovered language and cultural barriers created more problems than they were worth. Companies "were dazzled by these comic-book numbers" showing huge labor-cost savings overseas, and rushed to shift work without understanding the risks involved, Foote told me. "Outsourcing halfway round the world is really difficult," he said. When Foote Partners surveyed firms last year about their offshore projects, "65 percent of these things were not going according to plan." That doesn't mean employers won't continue to take advantage of lower labor costs in other parts of the world, according to Foote. But he thinks U.S. firms will be more cautious and selective about the work they send offshore. The ups and downs of offshoring aren't the only explanation for rising tech salaries. It's worth keeping in mind that high-tech job growth fell generally when the economy went into recession in 2001. Now that the economic cycle is turning again, with companies investing more in new equipment, it's logical to see tech hiring picking up across the board. Offshoring may be here to stay. But it no longer looks like a major threat to American jobs - if it ever was.
That's not the sense one gets from listening to the imprudent bears, who keep predicting Armageddon at every bend in the road; from Democratic politicians, carping about the lack of job growth; or from protectionists of all persuasions, complaining that the good jobs are going overseas. ``It's hard to explain the lack of volatility in GDP,'' Carson says. ``Maybe it's due to better information flow and few surprises on the policy front. But it also shows you that all the talk about soft patches and slowdowns makes for good press but poor analysis.'' Back in the 1980s, which wasn't exactly the Dark Ages, it was common to see a quarter of 1.6% growth sandwiched in between two quarters of 4% growth. Part of the volatility owed to the fact that the inflation genie had yet to be stuffed back into his bottle. Most central banks have come around to the view that the best way to achieve maximum sustainable growth is through price stability. ``The Federal Reserve's preferred reason (for low economic volatility) would be that 20 years of anti-inflationary monetary policy leads to stable economic growth,'' says Neal Soss, chief economist at Credit Suisse First Boston. ``And they would be right.'' Secondly, two decades of globalization have produced a more stable domestic economy. ``We're off-shoring some of the volatility because we import a lot,'' Soss says. In the old days, domestic industries would have to slam on the brakes when final demand ebbed, causing sharp quarterly fluctuations in output. Nowadays, when businesses and consumers cut back on their spending, it translates into reduced imports from abroad. Countries that export to the U.S. have to do the adjusting. Our stability is their volatility. Deregulation is another phenomenon that has forced companies to become more flexible, Soss says. Otherwise, they won't survive. ``But the real biggie is the proliferation of credit innovation,'' he says. ``Credit cards, home equity loans, mortgage innovations all allow consumers to smooth activity through time. They aren't constrained by cash in their pocket.'' Economic stability seems to have translated to stability in long-term interest rates. One component of long-term rates is inflation expectations. With inflation low and confidence high the Fed will keep it that way, long-term rates have defied the Fed's initiative of normalizing overnight rates. Take the volatility out of growth and inflation, and long rates have nowhere to go.
Monthly Employment Stats
The factory sector, which shed 4,000 workers, was one of the only weak spots last month. However, the Labor Department noted that an 11,000-job drop in auto manufacturing reflected larger-than-normal temporary plant shutdowns for annual retooling. The service-providing industry added 203,000, the biggest increase since April. Within that category, the retail-trade industry added 50,000 jobs. The professional-and-business-services industry, which includes temporary-help jobs, added 33,000 jobs. Government jobs increased by 26,000 -- the biggest increase so far this year. The construction industry slowed the pace of hiring, adding 7,000 jobs after a 15,000 increase in June. Retail trade employment rose by 50,000 in July, and have gained 197,000 jobs over the year. In July, retail employment gains were widespread, including growth in clothing stores (13,000), motor vehicle and parts dealers (10,000), and building material and garden supply stores (7,000). Employment in professional and technical services increased by 23,000 in July, and have added 211,000 jobs this year. Management and technical consulting services, as well as architectural and engineering services, rose by 21,000 in July. Since July 2004, employment in credit intermediation has grown by 93,000, while real estate has added 54,000 jobs. Employment in food services and drinking places rose by 30,000 in July and 262,000 jobs over the year. The health care industry added 29,000 jobs. Temporary help services employment was flat in July. Construction employment has averaged 21,000 per month. The strong job growth came with increased inflationary pressures: Average hourly earnings rose six cents, or 0.4%, to $16.13 -- the biggest rise in a year. The average work week was unchanged at 33.7 hours for a third month in a row.
So what's happened to the U.S. economy to make tepid job growth the norm? Labor force growth, or the lack of it, says Mike Englund, chief economist at Action Economics. `Labor force growth is slowing, and you can't have job growth diverging from labor force growth over the long run,' Englund says. From 1970 to 2000, annual labor force growth averaged 1.9%, driven by the influx of women and baby boomers into the labor force, he says. Payroll growth averaged 2 percent. After rising for 30 years, female participation rates have leveled off -- `now they're similar to men's,' Englund says, just as the baby boomers are preparing to head for the exit. At the same time, `increased surveillance after 9/11 may have slowed illegal immigration,' he says. In this environment, labor force growth slowed to less than 1% last year (2004 versus 2003). Job growth tracked that with its 1.1% increase. `You can't look at the numeric increase; you have to look at the percentage increase,' Englund says. The decline in the unemployment rate to 5% from a peak of 6.3% two years ago is a sign that job growth is outpacing the number of new entrants to the labor force. Another theory for the tepid job growth is tepid capital investment. Companies are investing, but given their strong profits and positive cash flow, they aren't investing at a pace one would expect. Capital spending `consistently has undershot that implied by fundamentals, such as corporate cash flow, financing costs, tax incentives and output,' economists at Citigroup write in the latest issue of ``Comments on Credit.'' `Internally generated funding continues to point to better capital expenditures,' says Citigroup economist Steven Wieting. `There's more potential than actual.' From this observation, economists have deduced a hypothetical risk aversion on the part of corporations, which is easier to describe than document. Possible reasons include the added cost of compliance associated with the enactment of the 2002 Sarbanes-Oxley corporate governance law; over-compensation for the over-investment in technology and telecommunications equipment in the late 1990s and the bust that followed; and the reality of a world where terrorism is an ever-present danger. The revisions to GDP for 2002-2004, which had the effect of lowering capital spending's share of GDP as well as its contribution to growth, widened the gap between potential and actual investment. `The trough (in capital spending) was lower and the rebound less robust' than previously reported, Wieting says. Investment in equipment and software as a share of GDP bottomed at 7.3% in Q1-03 and inched its way up to 8% in Q2-05, he says. At its peak, in the second and third quarters of 2000, the share was 9.4%. To summarize: The labor force isn't growing as fast as it used to for demographic reasons. And businesses aren't investing the way they used to. Somehow these answers, along with the frequent refrain that all the jobs are going overseas, aren't completely satisfying. While we've moved from the jobless recovery in 2002 to job growth, one doesn't get the sense of a rip-roaring job market. I'd be tempted to call the sub-standard job growth a conundrum. As such, it goes a long way toward explaining that other conundrum: Why long-term interest rates have failed to follow the federal funds rate higher. Both the equilibrium funds rate -- the rate that will keep the economy expanding at its non-inflationary potential -- and the economy's potential growth rate may be lower than policy makers think. Just the Facts Amazon Selling Digital 'Shorts' AP 8-21 Amazon.com has started selling new works of short literature and nonfiction Friday from authors who write them exclusively for the Internet retailer. It won't be offering printed editions, just digital copies of short stories that can be e-mailed, downloaded or printed from a Web site for 49 cents a pop. ''Publishers have always had a hard time selling and marketing the single, short-form work,'' author Daniel Wallace said in a statement released by the Seattle-based e-commerce titan. ''Amazon.com has created a new way for authors to get that kind of work out there, which is incredibly exciting.'' About 60 authors have signed up so far. A Simple Change in a Complex World Messes Up Many Things Anick Jesdanun, AP 8-08 An energy bill President Bush is to sign Monday would start daylight time three weeks earlier and end it a week later as an energy-saving measure. And that has technologists worried about software and gadgets that now compensate for daylight time based on a schedule unchanged since 1987. Cell phone companies could give you an extra hour of free weekend calls, and people who depend on online calendars may find themselves late for appointments. Newer VCRs and DVD recorders have built-in calendars to automatically adjust for daylight time. Users would have to override them, switching to "manual" to ensure shows continue to record correctly. Computers with Microsoft's Windows operating systems would need to obtain updates. Some electric utilities have advanced meters to adjust rates based on peak and non-peak hours, and studies would be required to determine if any modifications are needed. The telecommunications industry, meanwhile, must ensure that its clocks are properly adjusted to bill customers properly. Lexus to Sell In Japan Jathon Sapsford, WSJ 8-03 Toyota is launching the Lexus in its home country for the first time this month. Toyota's rivals [Nissan's Infiniti and Honda's Acura] still market luxury brands in the U.S. but not in Japan. Toyota officials concede that Lexus won't be an easy sell. In Japan, wealthy consumers tend to favor German engineering -- Volkswagen AG's Audi, BMW AG and Mercedes-Benz from DaimlerChrysler AG. Last year, industry officials say imports accounted for 90% of the Japanese market for cars that retail at $50,000 and up. But Europe's car makers charge far more for luxury cars in Japan than elsewhere, tapping into a long-held Japanese association between high prices and quality. According to brokerage CLSA Asia Pacific Markets, a BMW 545i that lists for about $56,000 in the U.S. sells in Japan for $84,000; an E500 Mercedes sells for $57,000 in the U.S. but is more than $85,000 in Japan. Quick Facts, Stats & Opinions Homeowners took $59 billion in cash out of their houses in Q2, double the amount in Q2-04 and 16 times the average rate of the mid-1990s, according to Freddie Mac. People are cashing out so quickly that the term "homeowner" may soon be inaccurate. Fifty years ago, Americans owned, on average, three-quarters of their house and the lender owned the rest. These days, it's approaching an even split. One reason for the 69% rise in mortgage debt over the last five years is the exploding cost of homes, which has far outstripped wage growth. The proportion of buyers whose down payment was less than 5% of the purchase price rose from 30.6% in 2000 to 38.1% this year, according to a new study by SMR Research. In 1997, the median length of time remaining on an older homeowner's mortgage was a decade, according to Census figures. By 2003, the median was 14 years. During that time, the number of older homeowners who owed more than $300,000 on their home went up tenfold. (David Streitfeld, LA Times 8-28) The gap between a movie's opening weekend in theaters and its debut on home video has been narrowing from about six months in 1994 to about four months in 2004. (Gary Gentile, AP 8-28) Higher energy prices have started to seep into the costs paid by manufacturers. The producer price index climbed 1% in July as energy prices surged 4.4%. But core CPI, which excludes food and energy, rose only 0.1% in July and was up only 2.1% on an annual basis, indicating that high fuel prices haven't yet materially affected most consumer items. The more volatile headline CPI, including food and energy, was up 0.5% last month and 3.2% year over year. That annualized CPI figure has some traders worried that consumer spending will take a hit in coming months. We don't expect that to be a major problem. During the 19-year bull market that began in 1982, the average annual CPI change was 3.3%. (Joseph Lisanti, BusinessWeek 8-26) The average American household with at least one credit card had $9,312 of credit-card debt last year, according to industry-tracker CardWeb.com. Now that the prime rate stands at 6.5%, variable rate cards, which account for nearly three-quarters of all credit cards, are charging more than 14% interest on average. On a $9,312 balance, that's more than $110 a month. Looking for money to pay off this debt? Most Americans will find at least some in the taxes unnecessarily withheld from their paychecks. With most taxpayers getting refunds averaging $2,113 as of last count, lowering their withholding to match their actual tax liability could add $176 a month to their take-home pay. (Humberto Cruz, South Florida Sun-Sentinel 8-24) A survey this spring by Bankrate.com estimated that consumers waste nearly $4 billion a year making withdrawals from automated teller machines at the "wrong" bank (in other words, not where they have their accounts). More than 90 percent of banks assess surcharges, typically $1.50 a pop, when a noncustomer uses their ATM. That doesn't seem like much until you add it all up. (Humberto Cruz, South Florida Sun-Sentinel 8-24) ComScore Media Metrix is out with its monthly qSearch analysis of the Web's top search engines. In July Google maintained its market share lead in the United States with 36.5% of all searches submitted. Yahoo! checked in at 30.5%. MSN got 15.5%. Time Warner Network (AOL) was next at 9.9%. And Ask Jeeves completed the top five at 6.1%. The sixth-place search engine, InfoSpace, was far behind at 0.9%. (Washington Business Journal 8-19) Although Wall Street firms long have been lambasted for collecting fees of 7% for every initial public offering of stock they manage, the percentage of U.S. IPOs with fees below 7% has risen in recent years. Through August, 33% of U.S.-registered IPOs have generated underwriting fees below 7%, according to Thomson Financial, up from 27.5% in 2004. In 2000, just 14% of deals fell under the 7% fee mark. That could be cause for celebration both for companies seeking to go public and for Wall Street itself, because investment banks have been criticized for years after a study published in 2000 by Jay Ritter and Hsuan-Chi Chen revealed there was a 7% underwriting fee associated with the majority of moderate-sized IPOs from 1995 to 1998. The study led to allegations of price-fixing and a formal Justice Department investigation that found no evidence of wrongdoing, but the grumbling about 7% fees has persisted. (Lynn Cowan, Dow Jones Newswires 8-22) Since 1980, for example, money invested in the Standard & Poor's 500 has delivered a return of 10% a year on average. Including dividends, the return on the S.& P. 500 rises to 12% a year. Even in New York and San Francisco, homes have risen in value only about 7% a year over the same span. (Motoko Rich & David Leonhardt, NY Times 8-19) Last year, for the first time since the National Association of Realtors started tracking the data, the national median price of a condo was higher than that of a single-family home. In June, the median price of a condo was $223,500, compared with $218,600 for a traditional house. Between 2001 and 2004, condo values appreciated 57%, while those of single-family homes rose 25%. In the past, the highest uses of land were commercial, but now with condos getting such high prices, the demand for land that would have been used for commercial is being shifted to residential. The shift towards condos also says a lot about Americans' changing lifestyles. Between 1970 and 2000, the percentage of nuclear families among U.S. households declined to 24% from 40%, according to the Census Bureau. (Kemba Dunham & Ray Smith, WSJ 8-18) The interests of executives in most mergers are not necessarily aligned with those of their company's shareholders. Executives of the companies being acquired hit the jackpot in these deals because their stock option grants, restricted shares and retirement plans turn into instant cash. If their companies remained independent, this largess would be accessible only over longer periods. When directors have received restricted shares and options for their board service, they stand to receive payouts, albeit smaller ones, in a takeover as well. (Gretchen Morgenson, NY Times 8-14) Of the $96.1 billion, on a net basis, that has poured into stock mutual funds so far this year, $44.4 billion, or 46.2%, has gone into international funds. Of the $33.8 billion that has gone into taxable bond funds, $8.3 billion has flowed into international or global funds. (Jonathan Fuergringer, NY Times 8-14) 384 stocks in the Standard & Poor's 500-stock index pay dividends, a number that has increased in each of the past four years. These stocks are besting their cash-hoarding rivals: Dividend-payers in the index are up 6.5% since Jan. 1, compared with 3.6% for nonpayers. Since 1980, dividend-payers averaged a 15.1% annualized total return, compared with 12.8% for nonpayers. Thanks to the lowered tax on dividends -- set at 15% in 2003 -- more than one in 10 stocks in the index boast bigger after-tax yields than the 10-year Treasury, which yielded 4.394% late Friday. (Ian McDonald, WSJ 8-08) A recent study by Hewitt found that only 15% of 401(k) investors who hold an asset allocation fund put all of their money in that portfolio. Typical investors who use such funds in their 401(k) plans put only 36% of their money into them, according to Hewitt. They invest an additional 48% or so in a variety of equity investments; the remaining 16% goes to fixed-income or cash instruments. A typical investor in an asset allocation fund may have upwards of 70% invested in stocks. (Paul Lim, NY Times 8-07) Money market mutual funds, which buy short-term corporate and government IOUs, have an average yield of 2.73%, according to fund tracker ImoneyNet.com. That's up from 2.3% at the beginning of May and 1.6% at the start of the year. the average six-month Bank CD yield has risen from 1.25% a year ago to more than 2.4% as of last week, according to Informa Research Services. (Tom Petruno, LA Times 8-07) Folks have flocked to socially responsible mutual funds in recent years, with assets up 137% since year-end 2000, easily outpacing the 24% asset growth for all stock and bond mutual funds, according to data from Chicago's Morningstar Inc. and Washington's Investment Company Institute. These funds have returned an average 9.1% a year over the past decade, only slightly behind the 9.4% average for all U.S. stock funds. (Jonathan Clements, WSJ 8-03) In 2000, average household credit card balances stood at $7,842, according to Cardweb.com. That figure rose to $8,940 by 2002 and $9,312 last year. Low interest rates have helped Americans mamage higher debt. In 2001, for example, debt payments represented 18.3% of disposable income. Today, the percentage has barely budged, to 18.45%. But interest rates are now rising. The average credit card interest rate is nearing 17%, up from 15.7% in the past year. (Paul Lim, US News 8-02) Deep Facts Victor Niederhoffer and Patrick J. Regan in "Earnings changes, analysts’ forecasts and stock prices", Financial Analysts Journal 1972 and JG Cragg and Burton G Malkiel in "The consensus and accuracy of some predictions of the growth of corporate earnings", Journal of Finance 1968 suggest that reported earnings are better forecasters of future earnings than analysts forecasts. Indeed, Richard Harris in "The accuracy, bias and efficiency of analysts’ long run earnings growth forecasts", Journal of Business Finance & Accounting 1999 concludes that analyst forecasting accuracy is extremely poor, biased and inefficient. The inaccuracy is mostly the result of random error and the performance of forecasts vary with both the company characteristics and the forecast itself. (Charles Kirkpatrick in "Stock Selection: A Test of Relative Stock Values Reported over 17.5 Years") The entire concept of past price returns having an effect on future price returns has academia in quandary since it tends to cast severe doubt on the efficient market hypothesis. Over periods of a month or less, Kenneth R French and Richard Roll in "Stock return variances: The arrival of information and the reaction of traders", Journal of Financial Economics 1986 and Bruce N Lehmann "Fads, martingales, and market efficiency", Quarterly Journal of Economics 1990 found negative returns in individual stocks weekly and daily; Lo and MacKinlay (1990) found positive returns weekly in indices and portfolios but negative returns for individual stocks. (Charles Kirkpatrick in "Stock Selection: A Test of Relative Stock Values Reported over 17.5 Years") Investor ostensibly receive no- or low-cost liquidity from open-end mutual funds. However, their trades in fund shares may force the fund to make costly transactions in its portfolio. Because the fund pays these expenses, shareholders who trade implicitly impose the financial burden of their liquidity demands onto others in the fund. If shareholders differentially generate fund-level costs, there will be a wealth transfer from the low-cost shareholders to the high-cost shareholders. (Predictable Investment Horizons and Wealth Transfers among Mutual Fund Shareholders, Woodrow T. Johnson) Evidence presented in William Goetzmann and Massimo Massa, "Daily momentum and contrarian behavior of index fund investors", Journal of Financial and Quantitative Analysis 2002 and John Ameriks and Stephen P. Zeldes "How do household portfolio shares vary with age?" Working paper 2001, and elsewhere shows that mutual fund investors trade very little. Woodrow T Johnson in "Shareholder heterogeneity in mutual funds", unpublished doctoral thesis 2002 documents that most of these shareholders make no transaction between account opening and closing. (Predictable Investment Horizons and Wealth Transfers among Mutual Fund Shareholders, Woodrow T. Johnson) Home Page Previous Factoid Top Sites
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