|
|
More Factoids Mar 06 Feb 06 Jan 06 Dec 05 Nov 05 Oct 05 Sept 05 August 05 July 05 June 05 May 05 April 05 April 05 Bank Updates April March February January December November September September August July June May April March February MLP Updates April 06 March 06 February 06 January 06 December 05 November 05 October 05 September 05 August 05 July 05 June 05 May 05 April 05 March 05 February 05 REIT Updates Feb 05 Feb Off/Ind/Apt Feb Retail/Hlth Jan 05 Jan Off/Ind/Apt Jan Retail/Hlth Dec 05 Dec Off/Ind/Apt Dec Retail/Hlth Nov 05 Nov Off/Ind/Apt Nov Retail/Hlth Oct 05 Oct Off/Ind/Apt Oct Retail/Hlth Sept 05 Sept Off/Ind/Apt Sept Retail/Hlth Aug 05 Aug Off/Ind/Apt Aug Retail/Hlth July 05 July Off/Ind/Apt July Retail/Hlth June 05 June Off/Ind/Apt June Retail/Hlth May 05 May Off/Ind/Apt May Retail/Hlth April 05 April Off/Ind/Apt April Retail/Hlth |
Equally important is why long-term interest rates are rising. If they're climbing because of growing inflationary pressures — and the recent report on consumer prices showed a bigger-than-expected jump in core retail inflation — this could be even worse for equities because there is an inverse relationship between stock market valuations and inflation. Liz Ann Sonders, the chief investment strategist at Charles Schwab, recently studied market valuations in various inflation climates. When inflation has been running at an annual pace of less than 2%, Ms. Sonders found, the average price-to-earnings ratio for the S&P500 has been 23.4, dating back to 1960. But when inflation climbs to 3% to 4%, the average ratio falls to 17.6. And when inflation jumps to 4% to 5%, the ratio drops to 14.8, on average.
There is a tinge of sour grapes in Miller's tone. Commodities, and the stocks of the companies that produce them, have never been his style. Miller's Legg Mason Value Trust mutual fund currently has substantial stakes in Internet companies, including EBay and Amazon, and in blue chips such as Citigroup and Home Depot. The fund is down 1.3% year to date. By contrast, a Morgan Stanley index of 20 major commodity-related stocks is up nearly 19%. On Wall Street, as in Hollywood, it doesn't feel good to miss a big party. Since 1989, Miller's fund has risen 13.7% a year, on average, compared with a 10.6% average annual gain for the S&P500 index. He has beaten the S&P index every year for the last 15. So when he talks, people pay attention. His message on commodities is simple enough: It's probably too late to get in. Better to buy something that has been out of favor, like Citigroup stock, than a commodity or shares of a commodity producer, he says. "The excitement and enthusiasm surrounding commodities, and the belief that they will continue to rise, is not surprising," Miller says. "People want to buy today what they should have bought five or six years ago." No doubt the investor is reflecting the frustration of many who have sat out the bull run in raw materials and other hard assets since 2002. And it's hard to fault him for warning against buying into a panicked run-up, which describes metal prices, in particular, in recent weeks. But Miller could be way too early in calling the game over in commodities, says Bob Howard, who writes the Positive Patterns investment newsletter. He's been pounding the table for many raw-material stocks since 2004 or earlier. Prices in any free market ultimately are a function of supply and demand, Howard says. Look around the world at demand for oil and other commodities, he says. Then look at supplies. "Yes, at some point production will become such that it meets and exceeds demand, but for many commodities this may be years away," Howard says. The commodity bull market that began in 2002 has confounded plenty of veteran investors on Wall Street. It's fair to say that, over the last 25 years, most fund managers haven't been interested in commodities or the companies that produce them. These are dirty businesses, literally - pulling things out of the ground. They also have been prone to boom-and-bust cycles, with a couple of good years, then a crash. In the 1980s and 1990s, commodity investing was mostly a loser's game. An agile trader might have made money, but not a long-term investor. Buying and holding stocks, on the other hand, was spectacularly lucrative in that era. But for the last few years, the commodity market has been the buy-and-hold investor's dream. Oil is up 130% since the end of 2002. Copper is up 375%, sugar 129%, gold 87% and coffee 82%. Among stocks of commodity producers, Occidental Petroleum Corp. is up 261% since 2002. Copper miner Phelps Dodge Corp. is up 444% since then. Gold miner Goldcorp is up 176%. The S&P 500 index's return since 2002, including dividends: 58%. The thumbnail explanation: After mostly falling for 20 years, raw-material prices began to rebound in 2002 as demand soared in China, India and other emerging economies. Because there was little incentive for producers to hunt for new sources of those raw materials in the '80s and '90s, they weren't prepared to meet the sudden increase in demand. Now, even with prices up sharply, supply remains a problem, commodity bulls say. It is much more difficult worldwide to find and produce many raw materials than it was 20 years ago, they say. You don't snap your fingers and open a new copper mine overnight. But to be optimistic about commodities, you can't just assume that supplies will remain restricted. You also have to believe that demand will stay strong. And on that issue, in particular, Miller is skeptical. "It is undeniable that the demand picture is different this time," he says. "But the prices are different, too. What the commodity bulls implicitly assume is that higher prices will not curtail demand." China's government may be signaling unwillingness to enable further commodity inflation. The nation's central bank sent a shudder through commodity markets on Thursday, when policymakers raised their benchmark interest rates in an attempt to slow the economy's breakneck pace. Any deceleration in China's growth rate could send raw-material prices tumbling, if only because short-term speculators who have been riding the commodity bull market might decide they've had enough fun for now. In any hot market, it's impossible to know how many players are standing near the exit rather than settling in for the long haul. But the China scare lasted all of one day. By Friday, many commodity markets were rallying again. Near-term oil futures in New York rose 91 cents to $71.88 a barrel, although that was down from the all-time high of $75.17 set one week earlier. Copper futures rose 7.5 cents to $3.33 a pound. Gold surged $18.50 to a 25-year high of $651.80 an ounce. At these prices for raw materials, the earnings of many commodity-producing companies should be stellar, and they generally are. Witness the public outcry over the energy industry's record results. Those earnings don't attract Miller. If the laws of economics still work, he says, commodity prices can't continue at these levels. They're just too rich relative to the cost of production, he says. To put it another way, with the price of copper at $3.33 a pound, and the average mine production cost at 90 cents a pound, the reward for producing copper is just too great for a free market to sustain it, Miller says. Even so, he allows that when any bull market gets a head of steam up, it's hard to know where it will stop. In markets, he notes, "lots of things happen that never happened before." Investors worldwide have all sorts of reasons to bet on commodities now. Some see raw materials as the best way to play the economic ascent of the developing world. Some like the prospect of earning higher dividends from cash-flush commodity companies. Still others simply want something in their portfolio besides stocks, bonds and real estate. Some commodity bulls say one of the best arguments for keeping the faith is that many Wall Street pros are in Miller's camp, disbelieving that the raw-material rally has legs. Peter Schiff, president of money management firm Euro Pacific Capital, is a big fan of gold, even with the price at a 25-year high. He scoffs at the idea that the gold market is a bubble about to burst. That can't be true, Schiff contends, because popular culture has yet to embrace gold's bull market. "As has been the case for all real manias, if metals investing were a speculative bubble, it would have migrated from the financial and commodities spheres to make an impact on the broader culture," Schiff says. "In other words, taxi drivers would be offering tips on mining companies." Miller, however, believes that investors' fascination with the commodity story is far more intense than Schiff suggests. In any case, it's too intense for Miller, who has made his living as a fund manager finding undervalued investments and avoiding overvalued ones. "I can't help but be skeptical of the advice to start or increase a position in commodities after the biggest bull move in 50 years," he says.
Tom Roseen, a senior research analyst at Lipper and author of the study, expects the average tax drag to approach fund-expense levels this year, or about 1% of assets, and exceed those levels next year, reaching about 1.5%. The average fund's expense ratio is about 1.24%, he says. Even though investors have enjoyed tax cuts on long-term capital gains and qualified dividends - both were reduced to a 15% tax rate - investors need to become more cognizant of the fact that taxes still have an impact, he says. "With most market pundits expecting returns to moderate over the next few years, investors need to become more vigilant in watching the little things that chip away at their funds' returns," he says in the report. Taxable investors own about half of the $8.39 trillion invested in mutual funds, according to the study. Over the past decade, they lost 1.6 to 2.4 percentage points of return because of taxes. Of the estimated $15.2 billion in taxes paid last year, $1.72 billion was tied to short-term capital gains and $6.34 billion was due to long-term capital gains, while the remaining $7.17 billion came from dividends. Those figures assume that only one-third of investors were subject to taxes and that they paid at the 28% tax bracket, Mr. Roseen says, adding that he believes those are very conservative assumptions. Total short-term capital gains -- which are taxed at ordinary income rates -- rose 57% to $18.5 billion last year from $11.8 billion. Long-term capital gains - taxed at the lower 15% rate - more than doubled, to $126.7 billion in 2005 from $50.22 billion in 2004. Investors can start to minimize the tax sting by maximizing the use of tax-sheltered retirement plans, Mr. Roseen says. For taxable accounts, investors should also take a fund's tax efficiency into consideration although, naturally, it shouldn't be your first or sole focus, he adds. Index funds, exchange-traded funds, tax-managed mutual funds and municipal bonds are tax-efficient alternatives to consider when creating an asset allocation, Mr. Roseen says. Another tip: Don't jump into a fund right before it is scheduled to make a distribution, which typically occurs near the end of each year.
Mutual fund management fees are the biggest expense. But they are prominently disclosed, have attracted wide publicity and have been declining as fund providers compete for customers. Administrative fees are another matter. They usually don't show up on quarterly or annual statements. Brochures touting the benefits of 401(k) investing rarely mention them. Employees have to work hard to find out how much they're paying — for instance, by scouring their plan's website for a record of all activity in their accounts. Plan consultants and providers collect their cut in varied ways. Some receive a fraction of each employee's savings. Others collect a commission from insurance companies that run 401(k) plans. When mutual fund companies manage 401(k)s, they often absorb overhead costs in return for the chance to give most of the "shelf space" to their own funds. They get their money back through fund management fees. But fund providers frequently offer 401(k) participants the same retail mutual funds they sell to the general public, not the low-fee alternatives designed for big groups of customers. Employees tenacious enough to demand information about fees from benefits departments or 401(k) administrators often complain that they can't get straight answers. Because of outdated federal disclosure rules, publicly available records on fees often reveal only a fraction of the money leaking out of retirement accounts. Workers who save conscientiously suffer a disproportionate hit because fees are typically taken as a percentage of their account balances. Someone with $100,000 pays 10 times as much as a co-worker with $10,000, even though it costs about the same to administer the two accounts. The structure of 401(k)s leaves employees with little or no voice. Employers sponsor the plans and hire the providers and administrators. But workers pay most of the fees. Employees can raise a stink about the charges — if they happen to learn about them. But they can't take their business elsewhere; they're stuck with whatever plan their company offers. The Fee Is Almost Invisible Benefits Sources & Solutions is a consulting firm that runs 401(k) plans. The consultant advises companies on which mutual funds to include, processes employees' payroll deductions and holds educational workshops, among other tasks. Benefits Sources does not bill a company for these services. It collects a percentage of employees' total savings every three months. In 2004, this fee averaged 0.51%. The payments do not appear as line items on employees' quarterly statements. Rather, Benefits Sources takes a cut of the mutual fund shares in each account. That makes the fee all but invisible. Most employees focus on their dollar balance, not the number of shares. The share balance changes constantly as fresh contributions are added and dividends are reinvested. To detect the deductions, an employee would have to track his or her shares rigorously enough to notice that the number isn't climbing as fast as it would otherwise. One way for employees to find out about these fees: they can ask their employer for a copy of its Form 5500, which employers must file annually with the Labor Department, listing certain expenses paid from retirement savings plans. A Little 401(k) History Although they have become the main retirement savings vehicle for millions of Americans, 401(k)s were not created as part of a grand plan. They were an accidental byproduct of a 1978 tax law. Shortly after the law took effect, a few benefits consultants realized that subsection 401(k) - intended to clarify the tax status of corporate profit-sharing plans - allowed workers to accumulate tax-deferred savings through payroll deductions. In the early days, employers picked up most of the administrative costs of the plans. That changed as mutual fund companies and insurers sought a larger share of 401(k) business. Those firms offered to handle every aspect of the retirement plans, including administration. In exchange, they would have a captive audience for their investment products. Employers liked the new arrangement because it greatly reduced their costs. The losers were employees. In 1988, 87% of U.S. employers paid all 401(k) administrative costs. Today, only about 25% do. The rest have shifted some or all of those expenses to workers, said Pam Hess, a 401(k) expert at Hewitt Associates, a benefits consulting firm that also administers retirement plans. As a result, employers have little incentive to hold down 401(k) costs. A 2004 Hewitt survey found that about half of employers haven't even tried to figure out what their workers are paying in fees. "If the company doesn't have to write a check, many times they're not interested in what the participants have to pay," said Ted Benna, a benefits consultant who created one of the first 401(k)s. Moreover, because fees are usually a percentage of employees' savings, providers and administrators get paid progressively more as a plan's assets grow — even if the amount of work they do remains the same. The net effect, retirement experts say, is that the fees paid by 401(k) investors have become divorced from the cost of the services provided. There are Wide Variations in Fees HR Investment Consultants surveyed about 80 401(k) providers, asking what they charge for plans of varying sizes. For a medium-sized plan with 500 participants and $20 million in assets, the fees ranged from $205 to $818 per employee each year. Investors should benefit from economies of scale as 401(k) plans grow, allowing overhead costs to be spread over a bigger pool. Yet the HR Investment survey, released in 2004, found that employees realized little savings. The average fee for a 500-employee plan was $482 per person. For a plan 10 times as large — 5,000 participants and $200 million in assets — it was $450 per person, just 6.6% less. The figures partly reflect the industry custom of charging fees as a fixed percentage of assets. Chris McNickle, a 401(k) specialist at Greenwich Associates, a consulting firm, says this is necessary because small accounts are unprofitable. The entire mutual fund industry relies on the largest 10% to 20% of accounts for all its profit, he said. Marcy Supovitz, a retirement plan consultant, suspects that people with large 401(k) holdings would object to this system — if they were aware of it. "What's made this acceptable historically," she said, "is that they simply don't know it." Leading 401(k) providers contend that their fees are reasonable and that competition holds costs in check. "If we take on a client and we were to charge fees that were too high, do you actually think that client is going to stay with us?" asked Stephen Malbasa, head of retirement-plan sales and marketing at American Funds. "Every 401(k) plan out there probably gets inundated at least once a week with calls from other providers who tell them they can bring their fees down." In addition to basic services such as staffing call centers and keeping account records, 401(k) firms shoulder the cost of complying with federal tax laws. For example, they must perform complex statistical analyses to ensure that highly paid employees do not benefit disproportionately from matching contributions and other plan features. Employees move money around in their 401(k) accounts more frequently than they do with outside investments. That adds to overhead costs. At American Funds, only 1 dollar in 10 is pulled out of a fund each year, compared with 1 dollar in 3 in 401(k) plans. "This isn't a business where everyone is making a lot of money," said Peter Demmer, chairman of Sterling Resources, a consultant to 401(k) providers. Demmer acknowledged that it could be hard for 401(k) participants to figure out what they pay in fees. But he questioned whether more disclosure would be beneficial. Employees might stop contributing to their 401(k)s if they knew too much about expenses, he said. "If you single out retirement plans to do that sort of detailed disclosure, you're doing providers of those plans a disservice. But at the end of the day, you might do the participants a disservice." The Amgen Example: A Generous Plan with High Fees Amgen, the biotech company, has been lauded for having one of the best 401(k) plans in the country. Amgen matches employees' contributions up to 10% of their pay. Even if an employee puts in nothing, the company kicks in 5%. The generous terms led Fortune magazine in 2005 to include Amgen on a list of nine companies with "the best match for 401(k)s." Fidelity Investments provides the mutual fund offerings. It also administers the plan. Because Fidelity's fund management fees are lower than the industry average, Amgen employees might assume they're getting a bargain. They're not. Most of the investment choices are the same funds that Fidelity retails to the public. The funds, including Fidelity's flagship Magellan Fund, have built-in expenses for marketing and advertising. Those charges are hard to justify for participants in a 401(k) plan, who can't shop around, said Dennis Lynch, vice president at Advisors Capital Resource. A plan of Amgen's size - with more than 13,000 participants and $1.2 billion in assets — has the clout to demand cheaper institutional funds. "For the average investor with small amounts to invest, Fidelity is an excellent choice," Lynch said. "On the other hand, a large retirement plan such as Amgen is in a position to negotiate for institutional prices, which on average might be 30% to 60% lower than some of the funds they are currently using." Fees for one of the offerings, the Fidelity Growth & Income Fund, total 0.69% per year. An institutional fund with a similar investment style charges 0.47% according to a survey by EVestment Alliance, a financial research firm. An Amgen employee with $100,000 in the Fidelity fund would pay $690 a year in fees, compared with $470 for the institutional alternative. Institutional funds have some drawbacks. They are not publicly traded, so their share prices are not readily available. They aren't required to send out prospectuses and aren't always rated by independent firms such as Morningstar. But a major advantage is that their fees are on a sliding scale: As assets grow, the percentage taken out for expenses declines. Fidelity says that about 19% of the assets in all the employee-funded retirement plans it runs are in institutional funds. Brent Glading, head of Glading Group, a 401(k) consulting firm, analyzed public records and other information about the Amgen plan for the Los Angeles Times. He estimated that employees paid total fees of more than $5.1 million in 2003, or an average of $410 each. Of that, he said, Fidelity received more than $4.7 million; the rest was paid to non-Fidelity funds included in the plan. Glading estimated Fidelity's cost of managing the investments and administering the 401(k) at $2.1 million. That would mean Fidelity cleared about $208 per employee — a profit margin of 55%. Amgen probably could lower the fees if it negotiated with Fidelity or solicited bids from other providers, Glading said. After The Times asked questions about the 401(k) plan, Amgen last year substituted lower-cost versions for three of the mutual funds. Chip Bell, Amgen's vice president of compensation and benefits, said the fees — a weighted average of 0.59% of assets — were cheaper than the average for 401(k)s. But they aren't as cheap as those at Alcon Laboratories, a maker of eye-care products. Alcon's 401(k) is similar in size to Amgen's but relies almost entirely on institutional funds. As a result, employees pay just 0.43% of their assets each year in fees. The institutional funds "are exceedingly inexpensive, which we really push for," said John Batton, the company's manager of investments. "Why give it to Wall Street when you can give it to your participants?" Weak Federal Oversight Federal law requires employers to evaluate 401(k) providers and investment choices and make sure that costs paid by participants are reasonable. But determining what's reasonable is subjective, and the law doesn't spell out what constitutes a fair fee. The Labor Department, which has oversight of 401(k) plans, concentrates on investigating wrongdoing, such as when employers take money from 401(k) accounts to pay unrelated business expenses, Assistant Labor Secretary Ann Combs said. Fees aren't a high priority. Combs said some employers "may not have done enough probing of their service providers and probably could negotiate those fees down." But the law does not require employers to get the best price. "This 'out-of-sight, out-of-mind' mentality of some [employers] is particularly dangerous," a Labor Department advisory panel said in a 2004 report, "because as the account balances grow so do the fees regardless of whether additional services are provided." One problem is obsolete disclosure rules. Form 5500, for example, often does not fully reflect the administrative costs paid from employees' accounts. When a mutual fund company runs a 401(k) plan, only a fraction of overhead expenses are disclosed. "The Form 5500 as currently structured is outdated and simply no longer reflects the way fee structures work in the industry," the Labor Department panel said. "Many explicit fees have all but disappeared and many very large plans have little or no explicit fees whatsoever." The Labor Department is expected to propose new disclosure rules this year. Cost Cutting Could Save 30% Brent Glading, a 401(k) consultant, used to sell retirement plans to employers. He switched sides in mid-2002 and now represents employers trying to reduce fees. He is paid either a flat fee or a percentage of any savings he obtains. He estimates that costs could be slashed at 30% of all companies. Playtex Products says it shaved annual fees for its 1,500 employees by $250,000 by switching providers in 2004 on Glading's advice. Employees with a $100,000 balance in their 401(k) and pension plans now pay an average of $370 in fees, compared with $580 before. As he negotiates for better terms, Glading has two weapons at his disposal: his knowledge of the industry and the ability to put an employer's plan out to bid. Despite the potential benefits to employees, Glading said, many employers spurn his services. "One [chief financial officer] told me, 'I don't care. Why should I care? I'm here to save my company money. I don't care about my employees.' I was flabbergasted."
A subtler instance of total return's limitations turns up on the Web site of Capital Group's American Funds. In a simple comparison of total returns from the 1970s, '80s and '90s between its American Mutual Fund and the Standard & Poor's 500-stock index, Capital Group says the S&P 500 came out ahead. A $100,000 investment on Dec. 31, 1970, would have grown to more than $4.7 million in the S&P 500, compared with a shade less than $4.4 million for the same sum over the same 30-year stretch in American Mutual. Suppose instead, Capital says, that our investor was living off his nest egg and made regular monthly withdrawals from his account. He took out $5,000 the first year and increased that amount by 5% each year to keep pace with inflation. After 30 years, Capital says, the investor would have had a balance of slightly less than $1.3 million in American Mutual, against only $555,561 in the S&P 500-stock index. The reasons for the difference: "AMF provided more dividend income and, more importantly, it had less volatility (i.e., fewer and smaller ups and downs in share value) than the S&P 500," Capital says. "When you regularly withdraw a fixed dollar amount from an investment that has gone down in value, you end up withdrawing more of your principal (i.e., a larger number of shares), leaving you with fewer shares left to participate in any subsequent stock market recovery." It makes sense that stability would favor the steady withdrawer. This is the flip side of a principle that has long intrigued me -- that volatility favors the steady contributor. When people invest similar amounts at regular intervals, they engage, wittingly or not, in dollar-cost averaging. They buy more shares when prices are low, and over a given period accumulate their position at a cost below the average price of the security during that time. The bigger the variations in the price, the more pronounced this effect. So whatever their emotions may have to say on the subject, those who dollar-cost average have a mathematical reason to prefer volatile investments. The result they achieve in a high-volatility fund may turn out better than what they would get from a less changeable fund, even if the two post similar results in their nominal total returns. Millions of individual investors invest via this method of similar amounts at regular intervals. That is how their money for investment becomes available to them, in dribs and drabs. It is also the basic way employer-sponsored retirement plans operate, with regular contributions from paycheck to paycheck. A smaller number of investors take regular withdrawals from their fund accounts. That group promises to grow as the baby-boom generation reaches retirement age, which will be soon. For both regular savers and regular withdrawers, a similar conclusion applies: Total return isn't everything.
[1] Our standard of living has climbed. That raises the bar for retirement, because we now need a larger nest egg to maintain our standard of living. [2] According to the Federal Reserve's 2004 Survey of Consumer Finances, the typical household's net worth, adjusted for inflation, grew 1.5% between 2001 and 2004. But the gain in our wealth was driven largely by rising home prices. While we are free to sell our stocks and our mutual funds, selling a home is more problematic, because we need to live somewhere. [3] We are increasingly on our own in retirement. Among workers covered by employer retirement plans, just 37% had a traditional "defined benefit" pension in 2004, down from 86% in 1983, according to the Center for Retirement Research. More of us are saving for retirement through 401(k) and similar "defined contribution" plans, where the onus is on us to save diligently and invest intelligently. The risk: Our nest-egg building could be slowed by our own financial mistakes. That puts us at the mercy of both our bad investment decisions and bad markets. To give ourselves some room for error, we should probably settle for modest portfolio withdrawals - and that means we will need a supersized nest egg. [4] We can expect to get less from our investments. At year-end 1981, 10-year Treasury notes yielded 14%, far above 1981's 8.9% inflation rate. At year-end 2005, 10-year Treasurys were paying 4.4%, not much above 2005's 3.4% inflation rate. Similarly, at year-end 2005, the stocks in the S&P500 were trading at 18 times 2005's reported earnings, versus eight times reported earnings at year-end 1981. The implication? We are likely to see lower stock and bond returns in the years ahead. That means we will need to save more to compensate. [5] We can expect higher taxes and lower government benefits. As the baby boomers retire, they will leave the economy with too few workers and too many dependents. This economic imbalance will be reflected in a soaring government budget deficit. We will probably see some mix of rising taxes, renewed inflation and cuts in Social Security retirement benefits and Medicare, all of which will make it more costly to retire. Many folks in their 60s will be forced by these financial pressures to delay retirement, thus ensuring a more reasonable balance between workers and dependents. [6] Life expectancies are rising - and that's making retirement more expensive. Sixty years ago, a 65-year-old woman was expected to live another 15 years, on average. Today, a woman age 65 is expected to live almost 20 more years - and, by 2040, that is projected to increase to almost 22 years. Similarly, 60 years ago, a man age 65 could expect to live another 13 years. Today, a 65-year-old man can expect to live 17 more years and, by 2040, a 65-year-old man will be looking at 19 more years. [7] As we live longer, we face steeper health-care costs. To be sure, a big chunk of these costs will be picked up by Medicare and Medicaid. Still, seniors could get hit with hefty out-of-pocket expenses, further boosting the cost of retirement. Consider long-term care, possibly retirement's most alarming cost. According to a study by academics Peter Kemper and Harriet Komisar and consultant Lisa Alecxih that appeared in the winter 2005/2006 issue of Inquiry, 69% of today's 65-year-olds will need some sort of long-term care, either at home or in a facility. While the cost will be relatively modest for most of these folks, an estimated 16% of today's 65-year-olds will incur expenses of $100,000 or more, figured in today's dollars. Medicaid and Medicare may cover part of this cost. But we shouldn't kid ourselves: The potential financial hit is huge - and we need to be prepared.
Perhaps sales work well for valuation purposes because they're less subject than earnings to sharp swings from quarter to quarter. Sales, or revenue, appear on the top of companies' income statements (thus the term "top-line income") before a long list of expenses have been deducted and accounting adjustments have been applied. A company that pays a large legal settlement in a particular quarter, for example, might see its earnings temporarily depressed, and its P/E ratio inflated. But its price/sales ratio would go right on reflecting how much business is coming in relative to the stock's price.
A number of analysts say Mr. Jakowsky may have taken the right approach. Although there's often a rush of new money into hot funds that are closing, performance following a fund closure often falls off from the years preceding it. A closure is often a tip-off that the fund has already reached an unwieldy size, and that the manager is having difficulty taking positions in attractive stocks that are large enough to improve performance, says Russel Kinnel, director of mutual-fund research at Morningstar. A fund's unwieldiness can worsen because many funds can continue to grow in size after a closure. That's partly because often, as with the Contrafund action, the closure is only partial. New investors can't get in through the front door after April 28. But Contrafund, Fidelity's largest portfolio, will continue to accept new investments via retirement plans, such as 401(k)s, that already have the fund among their menu of investment choices. In a study a few years ago, Morningstar found that after hot mutual funds close, their performance versus similar funds - that is, those with comparable investment objectives - declines. Looking at 38 funds that closed, Morningstar found that the closers, on average, beat 80% of their peers in the three years prior to closing. Afterward, they fell behind more than half of their peers. Overall total return slipped to 15.4% a year from 19.6%. The study didn't provide average returns versus benchmarks. But Mr. Kinnel said the funds were typically trouncing their benchmarks prior to closing, and after closing, many were often hovering closer to their benchmarks. More than 30 funds have closed to new investors so far this year, largely a reflection of the popularity of funds that invest in small companies, which have enjoyed a run on the stock market. In just the past few months, Fidelity Japan Smaller Companies and Royce Funds' Royce Micro-Cap funds closed. One of the more well-known funds to close was the Vanguard Capital Opportunity Fund, which closed in March 2005. But some funds perform better after closing. Vanguard Health Care fund, which closed last year, returned 9.5% in the 12 months before closure, and gained 17.3% in the 12 months following the move. Morningstar says some closing funds are worth considering as buys if they close when still of a modest size, and the portfolio manager has a good track record. Morningstar defines moderate as $800 million for a fund that invests in small companies; $3 billion for a midsize-company fund; and $18 billion for a large-company fund. Contrafund, which has 3.7 million shareholders, has more than doubled in size since 1998. The fund beat the performance of the S&P500 index last year by 16.2% to 4.9%. Fidelity announced the closure of Contrafund on March 31. The advance notice was intended to give new investors a chance to get in, says Mr. Loporchio. But some investors question the advance notice. A closing can generate a flood of new money that is exactly the opposite of what a closure is meant to accomplish. By contrast, when Vanguard Group announced on Feb. 2 that it was closing its popular Vanguard Explorer and Vanguard Precious Metals and Mining funds, the closures were effective immediately.
These findings are contained in a study entitled "Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds," which has been circulating in academic circles since last fall. Its authors are James J. Choi, an assistant professor of finance at the Yale School of Management; David Laibson, an economics professor at Harvard; and Brigitte C. Madrian, a professor of business and public policy at the Wharton School. A copy is at http://www.som.yale.edu/faculty/jjc83/fees.pdf. The researchers wanted to find out whether the students would be able to assess how returns are affected by funds' fees. In the first simulation, the professors asked undergraduates and M.B.A. students to allocate a hypothetical $10,000 among four S&P500 index funds that would be held for one year. All four funds invested in the same 500 companies, and matched the index's allocation for each stock, so the only significant difference in the funds' returns would come from their fees — their front-end loads, or sales charges, and their management expenses. And because of the way the professors designed the experiment, these four funds had relatively high fees, ranging from 3.09% to 5.89%. Each student received copies of the four index funds' prospectuses, which varied from 26 to 116 pages long. The prospectuses provided detailed descriptions of the funds' loads and expenses, along with a great deal of other information. To encourage the students to take the exercise seriously, each was paid a small amount and was told that one student at each school, picked at random, would receive any profit that the $10,000 portfolio produced over the 12 months. The rational response, the professors argue, would have been to allocate all the money to the fund with the lowest fees. Yet fewer than 20% of either group of students did so. As a result, the hypothetical portfolios built by most of the students paid much higher fees than were necessary: 1.22 percentage points more, on average, among the undergraduates and 1.12 points higher among the M.B.A. students. What could account for the students' choices? One possibility is that the students were diverted by extraneous material in the prospectuses, and couldn't focus on the relevant information on fees. This is a disturbing prospect. After all, if a sampling of elite students can't separate the wheat from the chaff in assessing mutual fund reports, most investors probably can't do so, either. (All the study participants were high academic achievers who had scored above average on a financial literacy test administered by the professors.) To test whether the students were being distracted, the professors designed two additional simulations. In one of them, another group of 112 students was given, in addition to the prospectus, a one-page sheet listing the date of inception for each of the four index funds, as well as its performance since then. Because the funds had different inception dates, comparing funds on this basis of their lifetime performance would shed no light on which one should be chosen. To make matters worse, the funds that had the higher returns since their inception also had higher fees. So if the students chose these funds, they would be giving more weight to irrelevant data than they were to the fees. But that is precisely what they did. On average, both the undergraduates and the M.B.A. students in the second experiment made significantly higher portfolio allocations to the higher-cost funds than did the students who didn't receive the additional page of information. In the other additional test, another group of 114 students was given a one-page sheet that, instead of reporting returns since inception, specifically compared the funds' fees. Students in this final group did, on average, construct portfolios with lower fees. Nevertheless, even this group came nowhere close to allocating its entire portfolio to the low-cost fund. More than half of these students, in fact, continued to allocate some money to the higher-cost index funds. What conclusions emerge from all these tests? Over all, the study said, the results do "not inspire optimism about the financial choices made by most households." The professors also concluded that the presentation of data could have a big effect on investors' decisions. And they argued that this offered a particularly important lesson for policy makers who are thinking about establishing personal investment accounts for workers in the Social Security system. Without careful guidance, the study said, most people won't be able to invest their money intelligently.
Index funds now account for 15% of total foreign stock fund assets, compared with only 5% at the end of 2001. Index funds attracted more than 21 cents of every new dollar invested in international funds in the first two months this year, according to AMG Data Services. To be sure, in some foreign fund categories, like European stock funds, the average active manager has done slightly better in recent years. And in others, like Asia Pacific funds that don't invest in Japan, there simply aren't enough index funds to make a good comparison. But even among highly volatile emerging-market stock funds, indexed portfolios are proving their worth. The average index fund that invests in the emerging markets gained 47.8%, annualized, over the last three years. That is more than three percentage points better than the average active manager. These results would seem to belie the notion, often espoused in the 1990's, that indexing simply doesn't work in foreign markets. "Some folks aren't big fans of indexing overseas because of the generally held belief that foreign markets aren't as efficient" as the broad domestic stock market, said Michael Iachini, senior research analyst at the Schwab Center for Investment Research. In other words, some people think that foreign stock prices don't fully reflect all the available information concerning publicly traded companies abroad. This means that "there may be more opportunity for active managers to beat the indexes overseas," Mr. Iachini said. But as stock markets around the world have become more global in nature - attracting more foreign dollars - international stock markets have become more efficient than they were a decade ago. And many of the problems that investors had with foreign index funds in the late 1990's had as much to do with one country [Japan] as with arguments over market efficiency. Paul Lohrey, a principal in the quantitative equity unit of the Vanguard Group, noted that at the end of the 1980's, Japanese stocks made up more than 50% of the Morgan Stanley Capital International EAFE index of foreign equities, thanks to spectacular gains they enjoyed in that decade. But by the early 1990's, the Japanese stock market had slipped into a severe bear market, which meant that investors who indexed the broad foreign markets were hammered by an asset class that accounted for more than half of their holdings. Active stock fund managers, meanwhile, were able to beat the EAFE index simply by being underweight in Japan. But times have changed. Because of a long bear market in Japanese equities — along with a change in the way MSCI builds its index — Japanese stocks now make up only about one-quarter of the EAFE index. What's more, Japanese stocks are staging a comeback. Though Japanese stock funds trailed their foreign counterparts in Q1 [returning 4.2%] they were up more than 42% over the last year. J. Lisa Chen, a senior portfolio manager at Barclays Global Investors - which runs dozens of ETFs that track global indexes - said the change in MSCI's method should not be overlooked. Before 2002, a country's weight in the EAFE index was based on the total market capitalization of companies domiciled in that country. But four years ago, MSCI began to weight country exposure not on total market capitalization, but on the market capitalization of stocks that are open to foreign investment. "In effect, they've made it more of an accurate reflection of the true investable universe," Ms. Chen said. And this has leveled the playing field between active and index funds, she said. Of course, the rise of ETFs has also had a hand in the greater acceptance of indexing. In recent years, companies like Barclays, State Street Global Advisors and Vanguard have started dozens of ETF's that track foreign stock indexes. While ETF's are popular among institutional investors, individuals have begun to embrace them as well, because of low costs and ease of use. Barclay's iShares MSCI EAFE Index fund, for example, is now one of the biggest international portfolios, with $27.5 billion in assets. Market watchers expect foreign indexing to become more popular as investors embrace foreign stocks and as more broad-based international indexes are created. Paul Merriman, the president of Merriman Capital Management, an investment advisory firm, said it did take a certain attitude to embrace indexing overseas. Mr. Merriman, for instance, says he doesn't feel it necessary to swing for the fences in the foreign markets. "I know that the market return, based on the history of international equities, is a return that will meet the general needs of my clients," he said. "And if I try to get better than that, I know there's a high probability of doing worse than that." Why? Part of it has to do with costs. In theory, an active manager can avoid certain countries that are underperforming. But in an attempt to beat the market indexes, active managers need to research the global markets thoroughly. And that costs money. The average actively managed international stock fund has an expense ratio of 1.73%, according to Morningstar. By comparison, index funds that invest abroad charge 0.88%, on average. Because expenses come directly out of a fund's total returns, that means active managers must find a way to beat the indexes by 0.85 percentage points annually just to break even with foreign index funds. That's similar to the challenge that domestic portfolio managers face. The average expense ratio for actively managed domestic stock funds is 1.53%, versus 0.71% for domestic index funds — a gap of 0.82 of a point. Active managers trade stocks more often than index funds do. So brokerage and other trading costs that are not included in a fund's reported total expense ratio must also be considered. And because many foreign markets are still less efficient than the domestic market, the indirect trading costs associated with jumping into and out of various holdings are likely to be even more than they would be in the United States. That is why Mr. Merriman argued that "indexing or passive investing becomes more important when you're dealing with relatively less efficient or illiquid markets."
Google jumped from about $342 a share March 23 to about $399 by March 29 as the stock was added to the S&P500, making it a must-have for every index fund that tracks that index. Then on March 30, the price declined to as low as about $384 on word that the company planned to sell 5.3 million additional shares to help meet the demand from index funds. The stock finished the week at $390. What makes this more than a few passing wriggles in a stock famous for its volatility? For starters, the sale of additional shares brings a lasting change in the capital structure of the company. From here on, existing investors in Google stock will have to share their claim on each dollar of the company's profits with the indexers, who pay little heed to matters such as changing prospects for earnings. It's called dilution: More shares per dollar of earnings equals lower earnings per share. Now, I recognize there are counter-arguments to be made. Putting the extra capital from indexers to work, Google may be able to increase its earnings, offsetting the dilutive effect. And it's true that the indexers in this story remain passive in the sense that they have made no judgment about the merits or demerits of Google as a company. They bought the shares simply to keep in step with the S&P500 as its makeup changed. Operating the way they do, index funds save on the substantial costs of researching a company, in this case Google, or of trying to decide when is a good time to buy and sell its stock. This gives them an abiding edge in competition with actively managed funds as a group. As a sometime critic of indexing, I never dispute this point. But I part company with indexing's acolytes when they present it as a blanket answer to every investing problem, a neat and tidy package that can be bought and owned on blind faith. As long as gaps persist between the theory and practice of indexing - and they do - the whole story hasn't been told. As this latest Google tale demonstrates, it's naive to speak of index funds as mere bystanders, passively mimicking what transpires in the markets. To resort to metaphor, they step into the river in order to travel along with it, and in so doing, they change how it flows. The bigger indexing gets, the greater the splash the indexers may make. Between those splashes, the indexers and their clientele may themselves get wet. One estimate, from Citigroup, said managers of S&P 500 funds needed to buy more than $7 billion of Google's stock as it joined the index. All this extra demand arose from no apparent change in the company's underlying fundamentals. Whenever the supply-demand balance for a security gets artificially influenced this way, experienced investors may prefer to be on the other side of the trade. It's apparent that indexers played a big part in the bidding up of the largest S&P 500 component stocks in the late 1990s. In those days, investors were positively pouring money into S&P 500 funds, which had little choice about where to invest it. And lo, from the end of the 1990s through the next six years and three months, the S&P 500 went nowhere while smaller stocks, far removed from the epicenter of indexing, fared much better. According to Bloomberg, the S&P 500 posted a decline of 0.4% a year, including dividends, from December 1999 through last month. In the same stretch, the small-stock Russell 2000 gained 8.3% a year. Let's stipulate that indexing is an approach to investing that enjoys some solid natural advantages. Let's also stipulate that indexers' need to buy a stock such as Google en masse, at a price that had quadrupled in the past year and a half, probably isn't one of them.
This has already been a rough decade for stocks. It started with calendar-year losses in 2000, 2001 and 2002, the first three-year losing streak in six decades. After that drubbing, the S&P500 rallied 28.7% [including dividends] in 2003. In 2004 the S&P500 climbed 10.9%, and in 2005 it gained 4.9%. Where does that leave us? Over the past six calendar years, the S&P500 fell a cumulative 15%. On a total-return basis, the S&P500 has lost a cumulative 6.6% over the six-year stretch. There has been some good news. While stocks have gone nowhere, dividends and earnings are now significantly higher. Reported per-share earnings are up a cumulative 46% over the past six years, while dividends per share have grown 33%. Moreover, Standard & Poor's market analysts are forecasting that earnings will jump an additional 16% in 2006 and that dividends will increase 13%. At year-end 2005, the S&P500 was trading at less than 18 times that year's reported earnings. The average price/earnings multiple for the past 80 years is a little under 16 times earnings. To make matters worse, there is a risk that we could see a slowdown in the economy, which would damp down profit growth. Stocks are also facing stiffer competition for investors' attention, as rising interest rates make bonds more appealing. So are stocks worth buying? Over the past 50 years, per-share earnings have grown two percentage points a year faster than inflation. If that pattern holds and we get 2.5% annual inflation during the next decade, per-share earnings would notch 4.5% a year. Assuming shares climb along with earnings, that would give us 4.5% a year in stock-price appreciation. Add a 2% average yield to the 4.5% annual capital gain and we are looking at an average total return of 6.5% a year. Sound grim? Conceivably, we could do slightly better. The companies in the S&P 500 are paying out less of their earnings as dividends than they have historically. Let's presume companies put that extra cash to good use, which helps nudge up the long-run return to 7%. Even then, we are making a big assumption, which is that the market maintains its current p/e multiple. If, instead, the market's earnings multiple slid back toward the long-run average, that would knock more than a percentage point a year off the market's return. What if the market's price/earnings multiple fell below its long-run average? Clearly, results would be a whole lot worse. I am not trying to scare you away from stocks. But don't kid yourself: Stock returns over the next decade will probably be modest and you need to factor that into your savings and investment strategy. Suppose that the S&P 500 does indeed score 7% a year - and you own stock mutual funds that charge 1.5% of assets in annual expenses and rack up 1% a year in trading costs. Unless your fund managers are truly talented, you could end up pocketing less than 5% before taxes. "If you own the typical stock fund and stock returns come in at 6% or 7% a year, you'd be far better off in Treasury bonds," reckons William Bernstein, an investment adviser. "And if the stock market reverts to more normal valuations, you might even do better investing the money inside your mattress." The lesson: If you're going to invest in stocks over the next decade, you need to be extraordinarily tightfisted about investment costs. While you are at it, make sure you diversify beyond the big blue-chip stocks in the S&P500, by investing in both smaller U.S. companies and foreign markets. I suspect small stocks and foreign shares will outperform the S&P 500 over the next 10 years - though there are, of course, no guarantees. And, as always, save regularly. Whatever mix of stocks and bonds you own, your returns over the next 10 years will likely be uninspiring and certainly far below those available in the 1980s and 1990s. Want to make sure your portfolio keeps growing, no matter how the market fares? Saving diligently is your best bet.
These are confusing times for the shareholders of America's biggest corporations. GE has boosted its earnings by 22% since Chief Executive Jeffrey Immelt took the reins on Sept. 7, 2001. But GE's once vaunted stock price has languished during his tenure. Home Depot, the second-biggest U.S. retailer, has more than doubled its profits since 2001, a feat rewarded with a measly 1.5% bump in its stock price. Intel's prize for boosting its earnings by 173% in five years? A 30% plunge in its shares. A similar malaise afflicts Walt Disney, Microsoft, Pfizer, Wal-Mart, and others across many sectors and industries. What exasperates the leaders of these corporations is that it seems there's little they can do about it. They're delivering the earnings growth, but investors aren't responding. At work are forces largely beyond their control. Welcome to the blue chip blues. The S&P 500 is near a five-year high. But don't celebrate: It has returned just 4.3% annually during that span, far less than its long-term average of 10%. The S&P 100-stock index -- the bluest of the blue chips, with $6.5 trillion in market capitalization and a huge share of U.S. corporate profits - has returned just 2.03% annually to investors during that span, chiefly from dividends. Without dividends, it's just 0.94% overall, or 0.19% annually. In any event, after taxes and inflation, that pretty much boils down to zilch. Things have gotten so bad that ISI Group strategist Jason R. Trennert has said blue chips could be "the cheapest asset class in the developed world." There's no law that says stock prices must track corporate earnings perfectly. But the degree of the disconnect and its long duration pose serious questions for CEOs, managers, and shareholders alike. Is this a temporary phenomenon or a permanent structural change? Should America's investor class continue to hold these stocks as dearly as they did a few years ago? What would it take to get big U.S. stocks moving again? Just about everything is crushing blue chips: real estate, commodities, precious metals, international stocks, and smaller U.S. stocks. And investors haven't had to be geniuses to take part in those gains. They've merely had to dust off some old ideas. Basic finance theory says that investors can get the best balance of risk and reward by owning pieces of as many of the world's asset classes as they can, from stocks to gold. For years, the S&P 500-stock index of the biggest U.S. companies was the best approximation of that ideal available to investors -- and they flocked to it. But in the past decade, the world's financial markets have changed in unexpected ways. The proliferation of hedge funds has allowed pension fund managers and other institutional investors to venture beyond U.S. shores and seek high returns wherever. And the explosion of ETFs has opened up the world to individual investors in ways that were never before possible. A decade ago, they were available chiefly through clunky, high-fee mutual funds, if at all. With more choices, investors are diversifying their portfolios as textbooks say they should. Emerging-market shares, small U.S. stocks, gold, and even commodities are taking up sizable chunks. When Big-Caps Were The Only Game In Town Some market strategists think this global rebalancing act could be a 10- or 20-year process. But skeptics point out that an overseas financial crisis could erupt at any time and send investors fleeing to the relative safety of the U.S. markets - not unlike what happened during the 1997 and 1998 Asian and Russian sell-offs. Who's right? Before we can sort out the possibilities, we must understand how the blue chips got so popular in the first place. The biggest U.S. stocks returned an average of 16% a year during the 1982-2000 bull market, gains that far outpaced the underlying corporate profit growth. In 1981 the average P/E ratio for these stocks was around 8. By 2000 it had swelled to 35. Even a conglomerate such as GE sported a ratio nearly double its current 18. Blue chips "are coming off the biggest p/e expansion in history," says James O'Shaughnessy, at Bear Stearns Asset Management. "In 2000 it was as if there was nothing else worth investing in." The bull market resulted from a dearth of alternative opportunities. Long-term interest rates fell throughout the period, making bond yields less attractive to investors. Prices of oil, other commodities, and precious metals fell, too. Two housing busts soured investors on real estate by the mid-1990s. Stocks were the only game in town. The p-e ratios of companies with growing but stable earnings soared, with blue chips enjoying unprecedented popularity. Then the profit growth stopped - and with it, blue chip supremacy. According to GoldmanSachs, reported earnings per share of the companies in the S&P 500 fell from $50 in 2000 to $17.50 by 2002. The largest 100 stocks lost 53%, peak to trough. Assuming an 8% average annual return, it would still take Cisco 17 years to hit its 2000 level; Microsoft, 10 years; GE, 8; and Disney, 6. A Return to the Historical Trend - Small Caps Do Better Smaller stocks have fared much better. For one thing, their valuations hadn't run up so much in the first place. And smaller companies are nimbler than big ones, and can adapt to changing economic conditions faster. As blue chip profits cratered in 2002, the earnings of the S&P 600-stock index of small capitalization companies rocketed 20%, then 15% and 28% the following two years. Investors sought out the relative value of small and midsize companies, which have returned an average of 15% and 13% a year, respectively, since March, 2001. Small caps once were considered much riskier than big ones. The big-company earnings crash showed that even the celebrated blue chips are risky, too. The question is, which period was the aberration: 1982-2000 or 2001-06? History seems to argue for the former. According to Ibbotson Associates, small caps have returned 11.7% annually since 1926, vs. large caps' 9.8%. As Herb Stein, chairman of the Council of Economic Advisers under President Nixon, once quipped, "if something cannot go on forever, it will stop." Hedge funds exacerbated the shift to small stocks. In 1982 they were minor players. But they took off in the late '90s and especially during this decade. Their superior information-gathering allows them to spot profit opportunities in small companies that aren't widely followed. The ability of so-called activist hedge funds to transform small companies by taking big positions and agitating for change has been another lure. Perhaps most important, hedge fund traders are trend followers, traveling in packs into and out of asset classes. Right now the trend favors small stocks. "If you were to stick a gun to my head," says Bear Stearns' O'Shaughnessy, "I'd say small caps will keep beating for 20 years." Another Trend - International Investing Blue chips are also getting crushed by just about everything overseas. South Korea was up 54% last year; Latin America, 55%; and Saudi Arabia, 108%. Russia and a resurgent Japan returned 87% and 42%, respectively. In the past five years, the S&P Citigroup Emerging Market Index has returned about 17% a year, slightly better than the annual returns U.S. blue chips posted from 1982 to 2000. Could emerging markets pull off a similar 18-year run? Time was, investors looking for exposure to international and emerging markets would buy shares of a huge U.S. multinational, which supposedly offered transparency and sound governance and none of the crony capitalism found in emerging markets. Then the corporate scandals hit, and big U.S. companies were seen in a different light. Nowadays, foreign pure plays are getting the benefit of the doubt over U.S. giants. For example, shares of Brazil's Banco Bradesco, which trade in the U.S. as ADRs, have soared more than 370% since 2001. Citigroup's shares have gained only 12%, despite the bank's presence not only in Brazil but also China, India, Korea, Mexico, the Philippines, Poland, Russia, and almost 100 other countries. In all, Citigroup derived 41% of its 2005 net income from foreign markets. Yet investors clearly favor the Brazilian pure play. It's difficult to argue with the growth these nations are posting. According to statistics from the International Monetary Fund, Brazil, China, India, and Russia drove 30% of the overall growth in global demand in 2005, more than double the figure five years earlier. And so the hunger for international stocks is huge. Since 2003, net flows to international-stock mutual funds have more than tripled, to $150 billion, while flows into U.S. funds have plunged from $154 billion to $64 billion. In January, foreign equity funds' inflows almost doubled those of December. The explosion of low-cost ETFs made it easier for ordinary investors to jump into and out of emerging markets. Barclays Global Investors offers 37 international and global ETFs holding $72 billion in assets, up from 24 and $2 billion in January, 2001. Some argue that emerging markets have emerged for good. "The structural story has changed," says Thomas Melendez, associate portfolio manager at MFS Emerging Markets Equity fund. Emerging markets, he says, will keep growing, diversifying, and cleaning up their fiscal houses. Consider the emergence of red chips, the biggest and best companies in China. They don't have the stability of their Western counterparts, and they carry the risk of major government intervention. But over the next several years, red chips should turn bluer. Demand for the IPO later this year of Industrial & Commercial Bank of China, one of China's largest financial institutions, is expected to be strong. Already, Goldman Sachs has ponied up $2.58 billion for a 7% stake, ahead of a potentially $12 billion IPO that's on track to be one of the biggest ever. Yet despite the long rally, emerging-markets companies still trade below their historical averages based on p-e and price-cash flow ratios. "The (emerging-markets) story has legs for the next 10 years," says Melendez. In fact, legendary value investor Warren Buffett recently disclosed that he had made big bets on four major stock indexes, three of which are outside the U.S. With Nearly Everything Else Working, Why Bother with Blue Chips? Predicting the major turning points for markets has proved perilous for investors, academics, and business publications alike. But asset classes move in discernible cycles, rising and falling over long periods of time. Commodities, for instance, ruled the 1970s, slumped for two decades, and then resurged recently. Strategists citing the cyclical argument have been predicting a blue chip comeback for 18 months. It hasn't happened yet. "Clients gripe: 'We listened to blue chip bulls last year, and it did not work,"' says Tobias Levkovich, chief U.S. equity strategist at Citigroup. "'(The bulls are) saying the same thing this year, and it's still not working."' The degree to which blue chips have fallen out of favor is remarkable. "When we buy a large cap, we hear: 'How can you buy that dog? It has done nothing for five years,"' says Ron Muhlenkamp, manager of the $3.2 billion Muhlenkamp Fund, which has big positions in several blue chips. But betting against fund flows, prevailing sentiment, and trend lines has made contrarian investors rich over the years. "The time to make money," said Lord Rothschild, "is when there is blood on the streets." Big stocks are clearly wounded. "It actually hurts to say this again," wrote ISI's Trennert in a Feb. 27 research note to clients, "but we believe large caps are due." Some of the signs that blue chips were overvalued in the 1990s are showing up in small caps now. The Russell 2000 index sports an estimated P/E of 25, a 10-point premium to the S&P 100's 15. "What ultimately wins in financial markets is valuation," says Trennert. If valuation is king, cash is its queen. According to Moody's Investors Service, U.S. nonfinancial companies now hold a record $1.5 trillion of cash - double the kitty of just seven years ago, with blue chips sitting on the most. Sooner or later, activist hedge funds will come a-calling. "The real (opportunity) is now untapped shareholder value," says Trennert. "As in: 'Give the money back - or else."' Attacks on a few big companies might send their stocks up. And other big-company CEOs might start spending on share buybacks, dividends, and acquisitions, to nip potential activist challenges in the bud. Dividends, of course, can be a powerful component of total return. DuPont's shares, for example, rose just 0.5% during the past five years. But adding and reinvesting dividends jack up the total return to 18.5%. For Microsoft, the numbers are 0.8% and 15.2%. Rising interest rates would make those cash hoards all the more enticing. "If bond yields creep up, companies will be pressured to do more with their cash," says Marc Freed, managing director of Lyster Watson, a hedge fund-of-funds shop. Investors would no longer tolerate idle cash languishing on balance sheets if it could be put to good use. At the same time, rising rates would hurt smaller companies, which are more dependent on short-term borrowing. So while blue chips would be spending cash in ways to benefit shareholders, small companies could see their earnings decrease as their financing costs rise. That would change the perception of small caps as can't-miss investments, and prompt a shift back to blue chips - the long-awaited flight to quality. Trend-following hedge funds would spot the turn faster than most, pile in, and speed things up even more. Trennert takes the argument a step further. "The single biggest reason that large caps have lagged is that the economy hasn't slowed. A slowdown would get people thinking about safe, sustainable earnings growth again" says Trennert. But what of the international funds and ETFs sucking so many tens of billions away from U.S. blue chips? Levkovich says the trend simply can't last. While the relative valuation of the 25 largest S&P 500 companies is near a 20-year low, flows into emerging-market funds as a percentage of all equity flows is twice the previous peak. The last time he saw flows so disparate was during the last call for tech and growth stocks in 2000. "You can see the fad, and know it's just a matter of time until it blows up," says Levkovich. "When people get worried, they will want the safety of U.S. equities." For a time, they will. But don't expect 2006 to kick off another 20-year blue chip bull market. One of the byproducts of globalization has been more efficient capital markets, with swifter and larger money flows. That poses a challenge for the millions of investors out there still fixated on big U.S. indexes. Stubbornly sticking with what used to work is a sure way to fail. "The 1990s spoiled us," says Jeffrey Mortimer, chief investment officer for equities at Charles Schwab Investment Management. "All you had to do was show up." Mortimer, who keeps his finger on the retail pulse by checking in on Schwab branches, says he's "shocked" by how hard old habits die. "They're looking east for the sunset," he says. "The reality," says Edward Yardeni of Oak Associates, "is that we live in a much more competitive world than ever before." Big U.S. stocks will have to duke it out with red chips, small caps, gold ETFs, and all the new issues that'll hit the scene in the years to come. What's the good news? Increasingly complex financial markets mean more opportunities for investors - and, if they're played right, fewer risks. Bank on this: The blue chips will see another bull market, and perhaps soon. But with so many choices at investors' fingertips, the easy money may have already been made. Diversification is back. And that's not a bad thing.
In the quarter ended Friday, investors continued to bid up the things that have done very well over the last few years, such as U.S. small-company stocks and commodities like silver and copper. Shares in emerging markets including Brazil, India and Russia also continued to soar, even as some Wall Street pros warned that those rallies, in particular, were overdone. Among the worst bets were the government bonds of the U.S., Japan and Germany — securities that are considered low-risk investments. As the Federal Reserve, the European Central Bank and the Bank of Japan all tightened credit in the first quarter (in Japan's case, officials took a very tentative first step in that direction), the prices of U.S., Japanese and German bonds slumped, driving their yields up sharply. Shares of the Vanguard Long-Term Treasury bond mutual fund sank 5.1% in the quarter. By contrast, the share price of the Fidelity New Markets Income fund, which owns bonds of emerging-market countries, rose 1.6% in the period. A long list of veteran investors have decried what they've viewed as inordinate risk-taking in financial markets in recent years. That risk-taking, they say, is evident in the narrowing of the "spread" between U.S. government bond yields and yields on securities normally seen as much less secure than government issues. Case in point: Four years ago, the average annualized yield on an index of 100 corporate junk bonds tracked by KDP Investment Advisors was about 10.5%, while the yield on the 10-year U.S. Treasury note was 5.4%. The spread therefore was more than 5 percentage points. Now, that spread is a mere 2.7 points, with the junk bond index yield at about 7.6% and the 10-year Treasury at 4.85% as of Friday. The argument against junk bonds, emerging market bonds, small-company stocks and other classically risky assets is that current prices can't be justified given what could go wrong. These historically have been volatile sectors, prone to sudden and deep sell-offs. Bill Gross, who manages the world's biggest bond mutual fund at Pacific Investment Management is among the market pros who don't have the stomach for the level of risk other investors have been happy to take on in certain bond and stock sectors. They say they want prices of those assets to fall before they'll consider buying. "The crash of risk assets and their return to normalcy may be hard to time, but … these periods never end well," Gross wrote in his latest monthly client letter. "If an investor is being paid too little to await his eventual demise, then it seems he should rethink the proposition," he added. Too little reward for the risk, though, seems to have applied as much to the developed world's government bond markets over the last year as to more speculative markets. For example, why were some investors willing to buy 10-year Treasury notes with a yield of 4.33% as recently as mid-January? At the time, the Fed's benchmark short-term rate already was 4.25% and almost certainly was going higher (which it has, to 4.75% last week). Those bond buyers probably would argue that they expected the economy to slow substantially soon, leading to falling interest rates and making a locked-in 4.33% rate look smart. Likewise, some investors accepted a yield of just 1.2% on Japanese 10-year government bonds in June, apparently figuring there was little chance of a sustained recovery in that nation's long-suffering economy. But that recovery now seems quite real, enough so that the Bank of Japan said March 9 that its 5-year-old policy of holding short-term rates near zero was coming to a close. The 10-year Japanese government bond yield ended the quarter at 1.78%, its highest level since August 2004. In the bond market, "have we been faked out? You bet," said Andrew Brenner, head of global fixed-income investing for Hapoalim Securities in New York. To look at it another way, aggressive betting on an economic slowdown has been a form of greed on the part of bearish investors for the last year, and they've been consistently wrong. Now consider the investors who have been happy buyers of junk bonds, emerging market stocks and bonds, small-company stocks, commodities and other classically risky assets. Those are the kinds of investments you want to own when the economy is expanding. Consciously or subconsciously, buyers of those assets have bet on global growth, and they've been right. They've also been backed up by the world's three major central banks, in the sense that the banks' message in the first quarter was that the global economy was healthy enough to warrant — and to handle — higher interest rates. Could classically risky assets be due for a pullback? Of course. They've had a great run. The Russell 2,000 index of U.S. small-company stocks zoomed 13.6% in Q1, compared with a 3.7% gain for the S&P500. The Brazilian stock market rocketed 13.4% in the quarter after rallying 28% last year. Even if the rallies in riskier assets are overdone at the moment, we don't know whether we're near the end of the line for these bull markets or just somewhere in the middle. The economic fundamentals look powerful, especially overseas. One irony is that, by holding government bond yields so low in recent years, risk-averse investors have made other assets look all the more enticing. That could go on. If the demand for U.S. bonds from big investors such as China's central bank remains reasonably strong, bond yields may not rise dramatically from current levels. That could underpin global economic growth and boost the appeal of taking greater risk in search of greater return. Boiled down, there are three potential scenarios for the world economy and central banks over the next year. One is that the economy remains robust and the banks continue to tighten credit. The second is that the economy slows modestly and the banks stop raising interest rates. The third is that the economy slumps and the banks cut rates. Of the three scenarios, the first two could be far better for more speculative investments than for government bonds. Only the third scenario would seem to be a sure winner for government bonds and a sure loser for higher-risk assets.
Recently, however, the opportunities to truly diversify seem to be getting smaller, according to Merrill Lynch strategist Rich Bernstein. Stocks are moving more in sync than they did a few years ago. Mr. Bernstein looked at 10 different sectors tracked by Standard & Poor's -- like, say, financials, consumer cyclicals, energy -- and compared their returns with the overall S&P 500-stock index. He found that in nine of 10 sectors, returns over the past five years showed a correlation of at least 75% with the overall index. By contrast, in 2000, only two sectors moved in such close step with the index. Mr. Bernstein found that the Russell 2000 index of small stocks, the Morgan Stanley Capital International EAFE index of developed-market stocks overseas and commodity prices all are more positively correlated with the S&P 500 index now than they were in 2000. Even hedge-fund returns are highly correlated with the S&P 500. That is especially odd. Hedge-fund managers like to argue they can tack against the market to earn higher returns than the crowd. Anthony Richards, managing principal at money manager Stairway Partners, thinks many hedge-fund managers, flush with cash, have been spreading money into asset classes across the board. This is making those assets move together and, in turn, making hedge-fund returns move in sync. The danger is that if one asset runs into serious trouble -- or if the cash hoard dries up -- trouble could quickly spread to other areas. "Everybody would end up plowing out of the same things at the same time," Mr. Richards says. Then, correlation would translate into another C-word: contagion. "A Texas Hedge” is futures market jargon for very risky position taking or having what looks like a hedge (protection) position which turns out instead to increase the risk exposure. The term originates from the Texas rancher who was “hedging” his cattle stock by going long cattle futures. The story goes that when he was told that he was actually not hedging his exposure at all, but had doubled his exposure, he proudly answered, “them are Texas hedges”. How Fund Categories Fared WSJ 4-04-2006
Monthly Employment Stats
Employment in professional and business services increased by 52,000 over the month. The gain was spread among most of the sector’s component industries, including architectural and engineering services, computer systems design, management and consulting services, and services to buildings and dwellings. Over the year, employment in professional and business services was up by 469,000. Leisure and hospitality employment rose by 42,000 in March. Within the industry, employment in food services and drinking places continued to grow, with a gain of 33,000 over the month. In March, retail trade employment increased by 29,000, with most of the growth occurring in general merchandise stores (26,000). Employment in wholesale trade continued its upward trend and has risen by 232,000 since its most recent low in August 2003. Health care added 24,000 jobs in March; over the year, employment in the industry has risen by 293,000. Over the month, job growth occurred in hospitals (8,000) and in ambulatory health care services (16,000), which includes doctors’ offices and home health care. Employment in financial activities rose over the month. Credit intermediation and insurance carriers each added 7,000 jobs, following similar-sized increases in February. In the goods-producing sector, mining employment continued to expand in March, rising by 6,000. Most of the gain occurred in support activities for mining, particularly those related to oil and gas. Since its most recent low in April 2003, mining employment has increased by 97,000. Manufacturing employment was little changed in March; it has decreased by 56,000 over the year. Over the month, employment declines in textile mills and in plastics and rubber products offset a gain in computer and electronic products. Construction employment was essentially unchanged in March, but the industry has added 311,000 jobs over the year. The average workweek for production or nonsupervisory workers on private nonfarm payrolls was unchanged at 33.8 hours in March, seasonally adjusted. The manufacturing workweek and factory overtime also were unchanged at 41.0 and 4.5 hours, respectively. Average hourly earnings of production or nonsupervisory workers on private nonfarm payrolls increased by 3 cents in March to $16.49, seasonally adjusted. This followed gains of 5 cents and 6 cents in January and February, respectively. Average weekly earnings increased by 0.2% over the month to $557.36. Over the year, average hourly earnings increased by 3.4% and average weekly earnings increased by 3.7%. WSJ 4-07: The report shows a tighter labor market and implies solid gains in income from employment which will support consumer spending," said Nigel Gault, U.S. economist at Global Insight. "But at the same time, a tighter labor market raises nerves about wage inflation." "With unemployment rates at their recent levels, some possibility exists that labor costs will begin to rise faster than productivity, which in turn could put pressure on inflation," said Boston Fed President Cathy Minehan, on March 20.
Just the Facts Car Buying 101 Jeff Opdyke, WSJ 4-16 To negotiate on price, you must be armed with information about the true value of the car you want with all the options you demand. A variety of Web sites now offer detailed consumer information comparing the dealer's invoice cost against the MSRP printed on the window sticker. Three to check out are www.nada.com, the National Automobile Dealers Association site; www.kbb.com, the Kelley Blue Book site; and www.edmunds.com, which helpfully provides not just an analysis of the MSRP and the invoice prices but shows what consumers are paying for your exact car in your geographic region. Pay attention to the destination and delivery charges, the necessary fees for getting a new car from the manufacturing plant to the dealer. Some dealers will inflate that number to get a little extra profit into the price. Also, be very wary of dealer add-ons such as dealer-applied rustproofing and other such nonsense. You're paying for something you don't need on a modern car. And if ever you see on a sticker price a charge for "ADM," immediately subtract that from the total. That stands for "additional dealer markup," pure profit the dealer is building into the price. Never, ever pay that. At the end of the day you should never pay more than 3% to 5%, at most, above the invoice cost. What you're doing is negotiating the dealer's profit over invoice, not negotiating your cost under MSRP. Quick Facts, Stats & Opinions Since 1950, the average 6 month return for the S&P 500 after the Fed takes a pause is -1.7%. (The Kirk Report 5-01) Right now, the market value of the zinc and copper within a single penny is valued at nearly 0.9 cents. And since it costs an additional 0.6 cents to manufacture a penny, according to the paper, the Mint is paying roughly 1.5 cents for every penny it makes. (CNNMoney 4-24) Economists surveyed by WSJ.com expect the 10-year yield to be at 5.04% in June, on par with its current level, and near 5.1% by the end of the year. (Christopher Conkey, WSJ 4-24) E-filing "actually reduces the chances of you hearing from us" because e-filed returns are far more accurate than paper returns, says Nancy Mathis, an IRS spokeswoman. The error rate is only about 1% on e-filed returns. By contrast, it's roughly 20% on paper returns, Ms. Mathis says. This surprisingly high error rate on paper returns consists of bloopers both by taxpayers and by IRS workers copying data into the IRS's computer systems. The IRS's e-filing system is designed to pick up such things as routine math errors and transposed Social Security numbers that typically would result in attracting an unwanted pen pal at the IRS. (Russell Pearlman, WSJ 4-16) Home sales have been slowing for several months, but real-estate agents in some of these formerly red-hot markets have been surprised at how suddenly market conditions have deteriorated in the past few months. The Florida Association of Realtors reported recently that sales of existing single-family homes were down about 20% in February when compared to the same month a year ago -- and they were off as much as 47% in Naples. In California, sales dropped 15% in February compared with last year, led by a 30% decline in Sacramento, according to the California Association of Realtors. February sales were off year over year by about 19% in Washington, D.C., and down about 25% in and around Phoenix. (Michael Corkery, WSJ 4-12) Last year, ABC, NBC, CBS and Fox each ran an average of about 15 minutes an hour in prime time of "nonprogram material time," defined as commercials, public-service announcements and network promotions, according to research complied by WPP Group's media-buying unit MindShare. (Suzanne Vranica, WSJ 04-05-06) Americans tend to be an optimistic bunch -- except when it comes to their own longevity. They don't realize how long they might live, how ill-prepared they are for a lengthy retirement and how easy it would be to outlive their savings. Today, a 65-year-old woman can expect to live until age 85, three years beyond the median life expectancy for a 65-year-old man. What percentage of 65-year-old men and women will live three years beyond their life expectancy? New York insurer MetLife puts the number at 39%. Make no mistake: For today's 65-year-olds, living until their late 80s is a distinct possibility. (Jonathan Clements, WSJ 04-05-06) For the quarter, the Dow gained 3.66%, the S&P 500 rose 3.73% and the Nasdaq is 6.1% higher. (Christopher Wang, Associated Press 4-01) According to Stock Trader's Almanac, April is 1) still the best month for the Dow (up an average of +1.8% since 1950), 2) prone to weakness mid-month after taxes are due because stocks tend to ramp up ahead of earnings season, 3) rarely a dangerous month except in "big bear markets" like in 2002, 4) positive seasonal trends have historically been seen for internet, healthcare, and tech stocks, and 5) something you're likely to hear quite a lot over the next few weeks - the best six months of the year end this month. (The Kirk Report 4-4-06) Home Page Previous Factoid Top Sites
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||