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He quotes Flavia Cymbalista, a specialist in market uncertainty: "[these traders] listen to the stories the companies are telling and to the stories that the market is hearing and make their bets according the their judgement of how good the story is as such and how it's likely to unfold." This may be right because many investors fall for the most unlikely stories over and over again. Today this story might be the fable of ever increasing commodity prices, a few years ago, it was the myth of the new paradigm wrought by technology where profitability didn't matter. Besides that, a liberal arts education can help investors understand the curious verbiage that that companies regularly spout. Here are five examples: 1. When the Chairman says, "I am pleased to announce...", he usually isn't and would no doubt prefer to be somewhere else far, far away from the wrath of shareholders. 2. If a set of results start with the words "turnover has increased...", you can bet that so have losses. 3. "The environment remains challenging" means "we're flying by the seat of our pants". 4. "Progress is being made" means "we're still making a loss - fingers crossed it won't get any worse". 5. "We achieved our principal target" means "Some companies aim to make money. We don't." There is so much corporate drivel about and it seems unfair to single out one company. But I will. The Chairman of Whitbread (LSE:WTB) said in the company's most recent preliminary results: "My first year as Chairman has seen the company continue to evolve. Our announcements today are good evidence of the progress we are making towards becoming a leaner, sharper and more focused group. We are intent on continuing to deliver shareholder value through utilising our assets ever more effectively whilst achieving profitable growth in our chosen markets." A humanities graduate would immediately see that this verbiage has little value. It obfuscates rather than clarifies. It uses many words where a few would have done. It generalises where what is needed is specifics. Having to deal with this sort of stuff makes you wonder whether having a degree in English literature shouldn't be a prerequisite for investors.
Big cash stakes generally are a sign that a company is healthy. They're certainly refreshing, after the late-1990s technology-spending and acquisition binge was followed by the post-2000 bear market. But big cash stakes can be a troubling omen, too. When big cash balances persist for several quarters, it can be a sign that corporate managers don't see growth opportunities. That's not the hallmark of a healthy economy. "If I'm investing in a company, I'd rather it had a little too much cash on the balance sheet than a ton of debt," says Patrick Dorsey, head of stock analysis at Morningstar. "But you do wonder if the pendulum has swung too far toward caution." Where did all this money come from? It is the result of record corporate profits during the economy's heady past few years. Companies in the S&P500 have seen their profits rise at a double-digit rate from a year earlier for a record 17 quarters in a row. The key question now: When and how will companies spend the bounty? Broadly speaking, companies can do five things with their cash: keep it in the bank, pay down debt, invest in new projects, buy a competitor, or return cash to shareholders (via dividends, share repurchases or both). Many big companies have cut debt in recent years and spent billions on share repurchases in recent quarters. Time Warner has plans to buyback $20 billion into its stock. Microsoft plans to repurchase up to $36 billion of stock in the next five years. Dividends have been rising, but on average companies aren't paying out a higher percentage of their earnings in dividends, according to S&P. Companies are also being careful about investing in new projects or acquisitions. Many recent acquisitions were driven by deep-pocketed private equity funds, not corporate buyers. At the same time, spending on new projects has risen, but not by leaps and bounds. The corporate cash glut raises six issues for investors to consider. Economy Might Be Winded A heap of cash says good things about the economy's health in the recent past, but maybe not about its future. Chief executives' caution today could starve research and prevent mergers that would stoke profit growth years down the road. That means the cash glut may not be a good sign for investors or the broader economy. For technology businesses in particular, a big cash hoard is one sign that the industry is maturing and that executives don't see tremendous opportunities for growth. Poor Acquisitions May Loom Of course, poorly conceived projects and acquisitions wouldn't be good for investors either. Some investors currently fear that corporate managers will plow billions into acquisitions to boost growth in a hurry - a strategy that has produced checkered results. Stock Analysis Gets Murkier Analysts often judge a company's value by estimating how much profit it can generate from its business over several years. But if the company has a lot of cash, that math gets tougher. Analysts must assume how the company will use cash and what return it will earn on new projects. The exercise feels a lot like guesswork. "A lot of cash makes analysis complex because you just don't know where the money will go," says Milton Ezrati, chief economist at Lord Abbett Funds. Interest Income Clouds Profit Big cash stakes also can make it tougher to figure out how much a company is currently earning from its core business. How? A growing percentage of the company's cash flow is coming from interest income earned on money in the bank. Interest income for companies in the S&P 500 index is expected to jump more than 60% this year from last, according to S&P. Buybacks Cloud Profit Growth Cash also can mask a company's growth after it's put to work. If a company reduces its share count by 10% through a stock buyback, say, that can overstate the company's profit growth. Because there are 10% fewer shares, the company can report 10% EPS growth even if earnings don't actually rise at all. Investors who don't look deeper will be mislead. Buybacks Aren't All Alike Shareholders usually cheer buy backs. But they should check the fine print. The value of a buyback comes down to the price paid. If a firm buys back shares when they're undervalued, it has made a savvy investment on shareholders' behalf. But if it buys at a high price, that's a poor investment. Intel sank more than $4 billion annually into share repurchases in 1999, 2000, and 2001. Today, the stock is below where it was at the start of each of those years, showing that even managers who know a firm well can overestimate its value. Also, if buybacks aren't reducing a firm's share count because of ample stock-option issuance, buybacks are merely a hidden compensation expense. "The difference between good and bad management teams is magnified when there is a lot of cash," says John Linehan, manager of T. Rowe Price Value Fund. "Good teams will use that cash to add value. Bad teams will do the opposite."
The legislation not only affirms that advice is permissible within 401(k) accounts, but it also spells out the conditions under which it can be offered. Advice can be provided so long as the company giving it doesn’t receive higher fees for certain recommended investments — or if the advice is based on unbiased computer models certified by a third party. Yet as advice becomes more ubiquitous, there is a growing sense that investment guidance really isn’t helping most workers. That’s because a vast majority of 401(k) investors who are offered advice - regarding how to allocate their portfolios between stocks and bonds, and which funds to choose among their investment options - don’t take it. A recent survey of 401(k) plans by Deloitte Consulting found that only 17% of participants who were offered advice by their plans had asked for it. Of that group, only 39% acted on the recommendations they received. In other words, less than 7% of 401(k) investors who had access to advice used it to manage their accounts. “You can tell people all day long what to do, but if they don’t do it or don’t do it when we tell them to do it, it doesn’t really matter,” said Mike Scarborough, president of the Scarborough Group, an investment adviser that works with 401(k) participants. Even advice providers concede that their counsel won’t help everyone. Only around 20% of 401(k) participants are likely to make use of standard tools, like online questionnaires that help determine appropriate asset allocation or select specific funds, said Patrick Reinkemeyer, president of Morningstar, which offers advisory services to 401(k) plans. That leaves about 80% of the 401(k) population to worry about. And this group is made up mostly of employees who want to delegate these decisions, Reinkemeyer said. For these people, more hand-holding is clearly needed. One solution is so-called managed accounts, for which advice providers offer much more than recommendations: in fact, they go ahead and allocate your portfolio, select investment funds and rebalance and adjust the portfolio without having to be prompted. “It’s clear that the movement beyond advice — to have money managed for people who are intimidated by the process or who don’t want to make investment decisions at all — is well under way,” said David Wray, president of the Profit Sharing/401(k) Council. In many circumstances, the same companies that offer traditional online advice, like Financial Engines and Morningstar Associates, have begun offering managed account services to 401(k) plans. Already, 18% of 401(k) plans offer them, according to the Deloitte survey, and an additional 17% said they were considering it. Whether more plans jump on the bandwagon will depend largely on regulations that the Department of Labor will have to draft as a result of the Pension Protection Act. The legislation includes a section on the use of “default” investments for workers who have not selected options on their own. It instructs the Department of Labor to “provide guidance on the appropriateness of designating default investments that include a mix of asset classes consistent with capital preservation or long-term capital appreciation, or a blend of both.” Debra Davis, a benefits lawyer at Reish Luftman Reicher & Cohen in Los Angeles, said the specific language “sounds like they’re describing managed accounts.” Many 401(k) experts said that if the Labor Department affirmed the use of managed accounts as default investments, the move could be seen as a tacit endorsement of managed accounts as a 401(k) investment option in general. The pending Labor Department regulations could also embrace the use of old-fashioned balanced funds as well as life-cycle funds as defaults. Life-cycle mutual funds are designed as single-fund solutions for investors: the funds invest in a diversified mix of stocks and bonds that are tailored to specific age groups, gradually reducing portfolio risk as retirement age nears. A life-cycle fund is often the simplest and, in many cases, the cheapest way for investors to hand over decision-making to a professional, said Ted Benna, an employee benefits specialist regarded by many as the father of the 401(k). Before investors jump to managed accounts, he said, they should consider whether life-cycle funds will suit their needs. Mr. Benna noted that most life-cycle funds offered by the Vanguard Group charge only around 0.20% of assets annually. Through Morningstar, managed 401(k)’s could cost 0.5% to 1% of assets annually, depending on your plan, and that’s on top of the fees charged by the funds. But most life-cycle funds have higher costs than Vanguard’s, and Mr. Benna concedes that for some investors, life-cycle funds may not be personalized enough. For example, a life-cycle fund will not take into account company stock that you may hold in your 401(k). Moreover, it won’t factor in the risks presented by your outside accounts, including money held in your IRA or in a spouse’s 401(k). In most cases, managed accounts will be able to use this information to customize your portfolio. Christopher Jones, chief investment officer at Financial Engines, said, “If I had to bet, five years from now, most of the money in large 401(k) plans will be professionally managed, whether that means invested in life-cycle funds or in managed accounts.” That would mean that most investors would be on autopilot. And that’s not necessarily bad, given that inertia tends to be the most popular strategy exercised in these retirement accounts.
Nonfinancial companies saw their debt rise 6.3% in the 12 months that ended in Q1-06 to $5.5 trillion. That is the fastest yearly growth for debt in five years. In 2005, debt increased at an average 12-month pace of 5.1%, while in 2004 debt growth was 2.7%, according to John Lonski, an economist at Moody's. Debt is expected to have increased about 7% in Q2. The rosy debt scenario is predicated on an economy that doesn't weaken significantly, and on interest rates not climbing much higher, both of which would make the increased debts more of a burden. It all comes at a time when individuals and the U.S. government are dealing with their own heavy borrowing, making it more important for U.S. companies to successfully handle their added debt. "I don't think we are at the point of excess yet, we've had five years of discipline for corporate balance sheets," says Richard Berner, an economist at Morgan Stanley. The increasing embrace of debt "is bad news for bondholders but good news for shareholders." Analysts and investors are compiling lists of companies with relatively clean balance sheets and steady cash flows that could find themselves attractive as leveraged-buyout candidates, which depend on adding debt to a target's balance sheet. Among the companies that analysts say are candidates include BJ's Wholesale Club Inc., Liz Claiborne Inc. and several home-builder and technology stocks. Rising debt is only a problem if companies can't handle it, or it is being spent on projects that don't pay off. For now, there are few signs of those problems. U.S. corporate revenues rose 8.6% in Q1 and profits jumped 25%, according to Moody's, far outpacing the growth in debt. Meanwhile, the debt of U.S. nonfinancial companies stands at 42% of U.S. GDP, close to the lows of the past five years, while corporate holdings of liquid financial assets have more than doubled in the past decade. That is part of the reason companies are defaulting on their debt at a historically low pace, though it is rising this year. And the cost of debt is usually lower than the cost of equity, in part because of the tax benefits that debt carries. But net borrowing as a percentage of pretax profits for U.S. nonfinancial companies rose to 36% in Q1, up from 32% in the past two years and the highest level since Q2-02, according to Moody's. If the economy slows, profits drop and record profit margins slip, as many expect, the debt will be more of a burden for many companies, potentially causing problems. "The unsustainability of recent growth suggests that once profitability eventually slows, credit worth may soften by enough to prompt a scaling back of business spending," says Mr. Lonski. For now, though, Wall Street is focused on who might be the next target of a lucrative leveraged-buyout offer. That is in part because private-equity funds have raised more than $199 billion since the start of 2005, but have spent only $56 billion of that sum, according to Thomson Financial. Analysts at Goldman Sachs say warehouse-club retail chain BJ's and New York apparel company Liz Claiborne could be attractive to leveraged-buyout specialists in part because they have seen their shares tumble and trade at attractive levels relative to their EBITDA. Meanwhile, strategists at Morgan Stanley point to an unlikely sector for potential leveraged buyouts in the months ahead: home builders. Although tech stocks haven't been the target of many leveraged buyouts, some say more deals could take place in that sector, where growth is slowing but shares are reasonably priced and cash flows remain strong and relatively predictable.
The reason for this anomaly, he said, may be found in financial markets, specifically in the billions of dollars that investors, mainly pension funds and other typically conservative institutions, have poured into commodities in recent years. Commodities futures that track indexes like the Goldman Sachs Commodity Index or Dow Jones AIG Commodity Index have become fashionable for many investors. Their reasoning is that this asset class, though volatile, affords portfolio protection because it has often performed well when stocks and bonds have been weak. Close to $100 billion will be invested by pension funds and other institutions in futures contracts tied to the commodities indexes this year, up from less than $20 billion three years ago, according to Goldman Sachs. Pension funds, whose charters often prohibit short-selling, have been exerting upward pressure on futures prices, several analysts said. “They want to be long. They want to stay long and ‘don’t bother me with it.’ ” said William H. Brown III, president of WHB Energy Research. “It definitely adds a positive bias to the market.” This persistent upward pull on futures prices creates an arbitrage opportunity that drags the price of spot oil higher as well, according to Mr. Dell. With futures prices higher than the spot price, why not buy oil, store it and then sell it forward in the futures market at a profit? Mr. Dell and others argue that this is precisely what’s happening. “It’s a typical commodities play currently being employed in oil markets,” said Sal Gilbertie, a trader at Fimat USA. Similarly, Phillip Verlander, an independent energy economist, said that on Aug. 4, it was possible to “buy heating oil in New York Harbor at $2 a gallon and store it and sell a future to deliver it in December for $2.24,” and that many traders were doing so. Mr. Dell said that current oil prices were a bubble comparable to the tech investment bubble of several years ago — and that the oil bubble was likely to burst before very long. Others on Wall Street agreed that the flood of institutional dollars had had some effect, but they disagreed about just how much. Edward Morse, chief energy economist at Lehman Brothers, said, “There is no doubt in my mind that there’s an impact from a new class of investors into commodity markets, especially pension funds and also speculative investors including hedge funds.” That impact can at times be as much as $10 a barrel, but “fundamentals play a much bigger role,” he added. In a similar vein, Mr. Stuart of UBS said: “Explosive growth in commodity-related financial investments has translated into sharply higher prices and higher trading volumes on long-term oil futures. In effect, financial buyers have become consumers of oil, contributing to the persistence of high prices.” But he said that tight supplies, China’s growing appetite for oil and other considerations were more important. “The arbitrage that’s available is only one of the factors supporting the price of oil,” he said. Mr. Stuart expects the average price of oil to hold around $69 a barrel next year; oil has been trading around $75 recently. On the other hand, Mr. Brown of WHB Energy Research supports Mr. Dell’s view of current price levels. He has studied the historical correlation of oil prices with inventory levels and, at current levels, oil should sell for just $27 a barrel, he said. The impact of passive, long-term investors “is in my view $33 a barrel,” he said, with other factors, like flagging production in the North Sea and in Nigeria accounting for much of the rest of the gap. Still, he says he does not expect prices to tumble unless there was “a major slowdown or even reversal of demand growth.” Dell said that prices could weaken once global storage capacity filled up, limiting the possibility of arbitrage profits. He said that this could happen within four to six months but emphasized that it would be hard to predict precisely when. In Cushing, Okla, a giant oil storage hub, the tanks are indeed filling up. “In today’s environment, all the major tankage owners are being very well utilized,” said Rick Sandahl, senior vice president for market development at Enbridge. He said that 80% to 90% of his company’s storage capacity of 12.5 million barrels was in use. Asked if his customers seemed to be hoarding oil to take advantage of a price arbitrage, Mr. Sandahl replied: “I would think it’s a factor in their decisions.” Investors who believe that oil prices are ready for a fall would want to avoid mutual funds or ETFs that are linked to commodities indexes. Mr. Dell said that stock investors should “underweight” oil, recommending only such “defensive” plays as Exxon Mobil, Chevron, Total and Apache, all of which have “considerable excess cash flow beyond their capital spending needs.” As such, he added, they could withstand a drop in oil prices “and still deliver their growth plans.” Another Prediction of Falling Gasoline Prices Scott Patterson, WSJ 8-03 Citigroup oil analyst Doug Leggate thinks consumers may get a break in the second half of 2006. A big factor behind the runup in gasoline prices has been the substitution of ethanol for the additive methyl tertiary butyl ether, or MTBE, for environmental reasons. A lack of enough storage tanks and shipping options has caused a surge in ethanol prices, which has spilled over into prices at the pump. Due to factors related to the volatility of gasoline in the high-temperature summer months, other additives need to be mixed in to meet government regulations, says Mr. Leggate. But those components are in tight supply with the nationwide transition to ethanol. "That's what we believe has created the spike in gasoline," the analyst said, in a strategists roundtable transcript, released by Citigroup on Thursday. That means the onset of colder months should bring a significant decline in gasoline prices as demand for such products wanes. Citigroup estimates that gasoline prices could decline by 40 to 50 cents in the winter months, which would come as a welcome surprise to consumers, and retailers, just as the holiday season begins.
Question No. 1: Am I thinking about selling this stock based on thoughtful analysis of the business, or just general market panic? Bad moods, unfounded fears, and "general market sentiment" shouldn't shake you loose from a company that is still fundamentally the same as when the market's mood was peachier. Question No. 2: Do I have a plan for where the proceeds of the sale will go next? I've found that almost every time I have no plan to put freed-up cash to work, I'm making an imprudent choice to sell. It makes sense that you should sell only when you've concluded that there is somewhere else your money would be better invested, or spent. The money should move to something better. Question No. 3: Have the original reasons or assumptions I made about the stock when I bought it changed significantly? This entails asking hard questions about the business fundamentals and the market or markets a company is pursuing. Actually, investors should regularly check the fundamental drivers for a company's growth and look for warning signs that point to potential trouble. There may have been changes in management. Perhaps the company has shown lackluster operational performance, regardless of the potential that is often cited in press releases. Any of these or other changes could tip the risk-vs.-reward ratio of a stock out of your favor. Let us end with a final note: Expect imperfection. Realistically, investors should expect to be imperfect at selling investments. Even the best investors lament at least a few huge opportunities cut short by an ill-timed sell. In the end, though, the goal should be to ensure solid reasons to cash out of a stock, not just anxiety or emotion.
In the U.S., the disconnect became apparent during the recent round of Q2 earnings reports from companies in the S&P500: While the U.S. economy has lost momentum, corporate results have been better than expected. Real GDP grew at a seasonally adjusted annual rate of 2.5% in the April-to-June quarter, down sharply from annualized growth of 5.6% in Q1. But the ratio of S&P 500 companies whose earnings were better than Wall Street expected to those whose earnings fell short of forecasts has been around 3.6-to-1, according to Brewin Dolphin Securities, based in London. Merrill Lynch points out that some of the best-performing U.S. companies are commodity and mining companies. These industries are doing big business in China and other booming nations. And those U.S. companies that compete abroad against companies with lower operating costs are more efficient. "Years ago, people would have made a connection between developments in [national] economic activity and what it meant for the [that country's] stock market," says Darren Winder, a strategist at UBS in London. "Now people realize it has more to do with developments in global economics." Elsewhere, the phenomenon is even more pronounced. In Germany, for instance, the blue-chip DAX index has nearly tripled since the beginning of 2003, while Germany's economy has posted very lackluster growth over the same period. The reason cited by analysts: The DAX is stuffed with German manufacturers such as BMW and Siemens that also happen to be some of the biggest exporters in the world, making them less susceptible to domestic economic trends. In contrast, bond markets, or portions of them, are often still a decent gauge on the direction of local economies. For example, in the U.S., whenever long-term interest rates fall below short-term rates, economic growth almost always decelerates and recession follows; the lower long-term rates typically reflect that bondholders anticipate that Federal Reserve policy makers will push up rates too far in warding off inflation and will choke off growth. The untying of stock indexes to local economies is picking up pace as global trade grows. Five years ago, 38% of sales at nonfinancial firms in Britain's blue-chip FTSE 100 came from the home market. By last year, that had fallen to 32%, with the remainder coming from overseas, according to UBS. "When you buy the FTSE 100, you are not buying the U.K., you are buying global companies that happen to list in the U.K.," says Peter Toogood, chief investment officer at Forsyth Partners, a fund-management firm just outside London. International mining companies increasingly seek to list their stocks in London, citing the city's established banking base and an abundance of money-management firms and big investors in the industry. Kazakh miner Kazakhmys, for instance, is listed in London, yet almost none of the company's revenue comes from the U.K. This globalization of stock markets means investors need to take a world view and be aware of the state of the economies where their portfolio companies are doing business, not simply where their stocks trade. At the same time, as stock markets in developing nations start to track the same global trends, these markets' performances are converging, making it harder for investors to diversify. "As we move to a world where all markets are increasingly affected by the same factors - the global as opposed to the local economy - it becomes harder to diversify an equity portfolio through regional equity selection alone," says Gerard Lane, an analyst at Morley Fund Management in London. "You are effectively increasingly exposed to the same global risks whether you are investing in the U.K. or the U.S., even if to a different extent." Some indexes are closer proxies for their local economies than others, particularly in emerging markets. Russia's main benchmark, the RTS Index, and its economy tend to trend together, but that's in large part because they both follow the price of oil, a key component of the country's economic output and among the biggest presences in its stock market. Also, indexes that include a lot of smaller companies more closely follow local conditions, because many of these companies are too young or too small to have expanded abroad. And, even within major indexes, there are sectors that can still shine a light on domestic economic trends. Richard Iley, senior economist for North America at BNP Paribas in New York, often looks at the S&P's house-builder's index as a gauge of the U.S. economy. So far this year, the builders have underperformed the S&P 500 by 34%, a trend that Mr. Iley says points to the possibility of a recession. The Intersection of Economics & Investing
In practice, the Fed has achieved only one true soft landing — in 1994-95, when, under the leadership of Alan Greenspan, it was able to slow the economy enough to cool spending and ease inflation pressure but not so much as to cause a big jump in unemployment. But even Mr. Greenspan, whose ability to fine-tune policy made him famous, presided over two formal recessions, in 1991 and in 2001. This time, many analysts say that the Fed and its new chairman, Ben Bernanke, face considerably tougher challenges. Crude oil, at more than $70 a barrel. Productivity growth, which was accelerating in 1995, is slowing. The dollar, which was climbing against other major currencies in 1995, is now declining. Analysts and other experts say that if Mr. Bernanke is serious about his goals for controlling inflation, at least two million more workers may have to lose their jobs over the next two years. “The economic slowdown has to be much more substantial than anybody in the Federal Reserve or on Wall Street is expecting,” said Robert Gordon, a professor of economics at Northwestern University, who has analyzed the trade-off between inflation and unemployment for the last several decades. Mr. Bernanke and other Fed officials say they want to keep core inflation below 2% a year. But core inflation is already 2.9% and almost certain to climb as the cost of oil pushes up other prices. Mr. Gordon said the last few decades had shown a grim but consistent trade-off: to reduce inflation by one percentage point, the unemployment rate has to rise by about two percentage points for a full year. To reduce inflation to the upper limits of what Mr. Bernanke and other Fed officials consider acceptable, more than three million jobs would be lost, a bigger drop than in the recession of 2001. And that is Mr. Gordon’s relatively upbeat hypothesis, which assumes no other shocks to the economy — no additional increases in energy prices, no collapse in the dollar’s value, no collapse in housing. “I think the Fed is facing an absolutely classic case of stagflation,” Mr. Gordon said, “a situation in which they cannot win.” He is not alone. Many other economists contend that inflation is more entrenched and will be more painful to reverse than the Fed thinks. Others predict that inflation will indeed subside, but only because the economy will weaken much more than the Fed is expecting. The chief forecaster at Decision Economics, Allen Sinai, said unemployment would have to rise to at least 5.5%, from 4.8% today, putting a million more people out of work, before inflation begins to decline. The chairman of Roubini Global Economics Monitor, Nouriel Roubini, predicted that the economy would fall into a recession early in 2007 as a result of high energy prices, higher interest rates and a housing collapse. “Either the Fed does not believe its own inflation forecast, or the slowdown is going to be greater than what they have been saying. They can’t have it both ways” Mr. Roubini said. The very idea of a 'soft landing' is only about a decade old. It was conceived by Mr. Greenspan as a way to attack inflation before it started, by shrewdly using the levers of monetary policy to slow the economy just enough to keep it from overheating. Mr. Greenspan’s greatest success was in the mid-1990’s, when the economy had been expanding for nearly four years. Though inflation was declining and was lower than it is today, the Fed doubled short-term interest rates, to 6% from 3%, in just over a year. At the time, the result seemed neither soft nor smooth. Several financial institutions, caught by surprise, found themselves in big trouble. The economy slowed for a while, and unemployment edged up. But by 1996, the economy was rapidly growing again and the nation enjoyed several years of booming stock markets, falling unemployment and relatively low inflation. The success, along with Mr. Greenspan’s growing aura as a wizard of monetary nimbleness, prompted the Fed to step in and help soften the blows of the Asian financial crisis of 1997-98, the stock market collapse of 2000, the recession of 2001 and the surge of unemployment that followed. He failed in preventing the 2001 recession, but the Fed cut interest rates so deeply that this started a boom in housing prices and home refinancing that kept consumers spending even as incomes stagnated and unemployment moved higher. Laurence Meyer, a former Fed governor and now a chief forecaster at Macroeconomic Advisers, said Mr. Bernanke needed to do more than simply duplicate Mr. Greenspan’s one soft landing. Mr. Greenspan was merely trying to keep inflation from going up. Mr. Bernanke is trying to reduce it substantially. Uncertainties and disagreement among experts about the economy’s direction are now unusually high. A big uncertainty is whether the nation is near full employment, meaning that additional demand for workers will tend to push up wages. Because wages account for more than three-quarters of total production costs, Fed officials view them as inflationary if they rise significantly faster than productivity. Specialists like Mr. Gordon at Northwestern and Mr. Meyer maintain that the labor market is already very tight and predict that wages will soon start to push up inflation. But others disagree, arguing that wages over the last five years have lagged behind increases in productivity and have barely kept up with inflation. The bigger risk, according to that school of thought, is to make the situation worse by driving up unemployment. “We have no clue about labor market tightness right now,” said J. Bradford De Long, a professor of economics at the University of California, Berkeley, who argues that workers still have little bargaining power. Depending on one’s perspective, Mr. De Long said, the Fed’s attempt at a soft landing is either a display of cool-headed technocracy or murky witchcraft. Right now, he said, “this is on the witchcraft side.” Two More Predictions Mark Gongloff, WSJ 8-18 Ed Yardeni when asked about a 'soft landing': "I'm not sure it's a landing at all. The economy is growing along its trend line, at roughly 3% to 3.5%. And since much of that growth is coming from productivity, it's not inflationary. That really means this is the best-of-all-words scenario, allowing the Fed not only to pause, but maybe to leave rates unchanged for a while. I think a federal funds rate of 5.25% [its current level] or 5.5% is neutral, and at neutral you can have sustainable trend growth with low inflation. It looks as though the Fed is getting its forecast: It wanted to see some slowing with inflation moderating, and the latest data are showing that." Ed Yardeni, chief investment strategist at Oak Associates and former chief investment strategist at Prudential Equity Group and Deutsche Bank and as chief economist for C.J. Lawrence, Prudential Securities and E.F. Hutton. John Mauldin beleives we are already headed toward a reccession. Mauldin is president of Millennium Wave Advisors, a Texas investment advisory firm, and Millennium Wave Securities, a broker-dealer. He is the author of a weekly e-letter, "Thoughts From the Frontline," with more than 1.5 million readers. Why should be expect a recession? Mauldin says "The Conference Board's index of leading economic indicators [has fallen at a 1.4% annualized pace in the past six months]. Every time it has turned down in a six-month stretch in the past, we have had a serious slowdown or recession. Another very good leading indicator is the ratio of concurrent to lagging indicators. That has been going down, and that trend has always been followed by a serious slowdown or recession." WSJ: How does the current period compare to the last soft landing in 1994? Mauldin: I don't think it's a fair analogy. The consumer wasn't nearly as tapped-out then. Corporate profits weren't as strong, so there was plenty of room to improve. It was a much rougher period of time, and P/E ratios were much lower. And remember, back then we had inflation and interest rates coming down. We're not watching inflation coming down now. WSJ: What about this week's weaker inflation numbers? Mauldin: What people didn't notice in the PPI is that finished consumer goods were up 5.1%. Core intermediate goods were up 0.7%, and intermediate goods were up 8.9% year over year. If the economy is slowing down, then inflation should begin turning over as well. But the Fed will have to attack it. WSJ: You recently wrote a note entitled "The Return of Stagflation." A lot of people scoff at the idea, saying we are nowhere near the ugly stagflation of the 1970s. Mauldin: We have a slowing economy and rising inflation -- by any other name that's stagflation. And given all the excesses of the 1990s and the excesses of the housing market, a little stagflation -- maybe including a mild recession -- may be about the best outcome we could ask for. I think, ten or 15 years from now, historians will say the Fed did a pretty good job. WSJ: But a recession is no picnic. Mauldin: Well, if we do have a recession, I don't think it will be severe. Eighty percent of our economy is service-oriented, not subject to the ups and downs of manufacturing. Meanwhile, a lot of our manufacturing is export-driven, and a weaker dollar is just going to help that. So I'm not looking for a repeat of 1980 or 1982, barring some silly Fed mistake. I think we're going to have another 1990/91, 2000/01 kind of slowdown. If there's a recession, it will be a mild recession, and then another weak recovery. New Car-Sales Indicator Suggests a Recession Floyd Norris, NY Times 8-18 If things are miserable for America’s new-car dealers, can a recession be averted? History says it cannot and suggests a downturn may have already begun. The rule — unveiled here for the first time — is that if the year over year change in new car sales [adjusted for inflation] is down 2% or more, a recession is either under way or set to begin within a few months. The figure fell to a negative 2.4 percent when June sales figures were released last week. The available data go back to 1968, a period in which the American economy has recorded six recessions. The “dealer doldrums indicator,” as we will call it, called five of them, missing the 1981-82 recession only because it was not persuaded that the 1980 downturn had ever ended. It has never warned of a recession that did not occur. The risk of using 12-month figures is that by the time bad news is clear from new-car sales, it can be overwhelmingly obvious from other economic indicators. But such long periods avoid the possibility of false readings because of the volatility of new-car sales. The indicator sounded two months before the 1980 recession began, but otherwise went off after downturns had started but before they had ended. In some cases, a recession was indicated before it was officially recognized by the National Bureau of Economic Research.
Economists, on average, forecast GDP growth at a 2.8% annual rate for Q3, the first time their forecast for that quarter has been under 3% since the economic forecasting survey first asked about the period in November 2005. While their forecast is slightly above the 2.5% real GDP growth recorded in Q2, it is well below the 5.6% growth in Q1 and average annual growth rate of 3.2% from 2003 to 2005. The economists forecast growth slowing to a 2.6% rate in Q4, and staying at that rate for the first half of 2007. "The economy has definitely slowed below trend," said Ethan Harris at Lehman Brothers. "Second quarter GDP is soft, employment numbers are coming in soft and the housing market is finally softening." Amid the rising forecasts for energy prices, the economists revised forecasts for inflation upward. The average expectation is for a 3.3% year-to-year increase in the CPI in November, compared with an earlier average forecast of 3.1%. While economists retained the view that inflation will slow in 2007, their forecast for CPI in May 2007 was also lifted, to 2.8% from a previous estimate of a 2.5% rise. The CPI rose 4.3% this June, the latest month for which data are available, amid rising shelter costs. Among other findings in the survey: [1] Twenty-nine of 56 economists expect the Fed to raise rates again this year beyond the current 5.25% target. However, 54% -- 27 of 50 who answered the question -- said they believe that rates should either stay where they are or be trimmed before the end of the year. [2] More than 80% of the economists say the European Central Bank should raise rates again this year beyond the current 3% target, with just less than half suggesting 3.5%. Almost 90% expect the ECB actually will boost its rate further, with most seeing the rate at 3.5% at the end of the year. Doubt the Conventional Wisdom That Be The next three articles are included in this financial update because they are a reminder to doubt conventional wisdom. And why should conventional wisdom have been doubted in the first article? Because the theory was a bet against big money. Ad agencies, the media, and even the advertisers themselves [who would have an interest in the success of the most cost effective media to deliver their message] had an interest in the commercial's success.
VCRs did not kill the commercail. Seven out of 10 owners use VCRs to play recorded tapes (such as rented movies) rather than to record television programs to watch later, according to the Consumer Electronics Association. The joke of the "blinking 12:00" -- a sign that viewers never learned how to program their VCRs -- turned out to be true. But with DVRs, viewers can, at the touch of a few buttons, record all of their favorite shows for an entire season, all of which are stored neatly on a hard drive inside the recorder. Given the opportunity to easily record shows, people wind up watching more of the most popular television programs. Overall television viewing in households that own DVRs increases after their purchase, according to a number of surveys. That means those viewers are exposed to more advertising. From Sunday to Friday, 84% of all prime-time television viewing in DVR households is live, according to Nielsen Media Research. According to the same data, 61% of all prime-time programming recorded by DVRs is watched on the same days it airs. And in more good news for the networks, even though there are only six major broadcast networks compared with hundreds of cable channels, 77% of the shows recorded by DVRs air on a network such as ABC or Fox, rather than a cable channel such as ESPN or TNT, Nielsen reported. A March survey by Millward Brown marketing researchers found that 42% of non-DVR owners recalled specific brands in commercials they had seen, such as Ford or Taco Bell. For DVR owners, the number was 43%. In May, General Electric began showing commercials touting the environmental benefits of some of its heavy industrial products, such as jet engines and diesel locomotives. One 30-second spot featured an elephant dancing in a jungle to "Singin' in the Rain," as other animals look on. Viewers with DVRs were shown how to pause the commercial at certain moments. When they did, up popped whimsical, fictional biographical information about the animals. Gamers call such hidden content "Easter eggs." GE calls the project "One-Second Theater," and it is designed to nudge DVR owners to spend more, rather than less, time with commercials. It worked, according to GE's research. Viewers spent a little more than two minutes watching and reading the 30-second spots, said GE's Jonathan Klein, marketing communications leader. So instead of DVR users never seeing the GE spot, as advertisers and networks have feared, "viewers ended up spending over two minutes with the GE brand in front of them," Klein said.
1. "Offense sells tickets, but defense wins championships." As with most football clichés, there's no evidence for this one. The Indianapolis Colts led the league in points (430) and lost in the playoffs; but the Chicago Bears allowed the fewest (202), and they lost, too. The previous season, the Colts also led in scoring but then got lost in the playoffs; so did the Pittsburgh Steelers, who gave up the fewest points. NFL champions have almost always been great on both sides of the ball. As football historian T.J. Troupe puts it, the adage should be "Great defense beats great offense -- and vice versa." 2. "You need a strong running game." That's the one ex-coaches-turned-TV-color-men love the most. Do the numbers support it? Last year, the Atlanta Falcons led the NFL with 2,546 yards on the ground, 323 more than the Super Bowl champion Steelers. The Falcons finished 8-8. History says if you can play defense and pass well, you can win with average running. In other words, if the Arizona Cardinals don't improve their passing and overall defense, the acquisition of Edgerrin James won't get them any closer to the playoffs. 3. "A turnover is a turnover." But not all turnovers are created equal: Interceptions are usually much more important than fumbles. As Bud Goode, the father of football analysis, maintains, bad teams don't really fumble any more often than good teams, and, on the whole, the odds of recovering any fumble are about 50-50. (Teams that excel in either fewest fumbles lost or most fumbles recovered in one season generally revert to the norm the next.) Interceptions are always indicators of strength and weakness (good teams make them on defense and don't have them on offense). Plus, as Mr. Goode notes, "Interceptions have a far greater chance than fumbles of being returned for touchdowns." 4. "Great teams are built around the kicking game." Last year, the Buffalo Bills and Oakland Raiders tied for the NFL's best punting average, 45.7 yards a shot. Those two combined for nine wins and 23 losses. The Cardinals led the NFL in both field goals (40) and attempts (43) but finished 5-11. In most NFL games, punting and kicking make a difference only if the teams are otherwise evenly matched. As Aaron Schatz, lead author of Pro Football Prospectus 2006, explains, "The strongest teams aren't the ones with clutch kickers, but the ones who don't need them." 5. "The draft creates parity." The NFL's draft of the top college players is touted as creating parity in the league, since the worst teams get to pick first. It does nothing of the sort. Pro football analyst Steve Silverman sees it this way: "[New England's] Bill Belichick has been selecting pearls in the draft even though the Patriots finish at or near the top every season, because he's smart enough to know his team's needs. Good teams are realistic and win because they make smart picks; bad teams stay bad because they don't recognize what they need and who can fill that need." A two-time Super Bowl MVP, quarterback Tom Brady was the 199th overall pick in 2000; wideout David Givens, who is now with the Tennessee Titans and has had a touchdown reception in seven straight playoff games, went 253rd in 2002. 6. "You have to control the ball." A sacred belief of coaches is that controlling the ball, as reflected in time of possession, is a key to victory. But there's no strong correlation between ball control and winning. Yes, the 13-3 Denver Broncos led the league last season with 32:37, but 6-10 Dallas Cowboys were a close No. 2 at 32:58. The champion Steelers were ninth in TOP, 31:16, while the No. 10 Titans (31:13) were a dismal 4-12. 7. "Dome teams have the advantage." Because some indoor teams, such as the Colts, have high-powered offenses, the myth has developed that domers have a "fast track" to the playoffs. Some domers do profit from playing under a roof. But as Kerry Byrne of the cutting-edge analytical Web site Cold Hard Football Facts notes: "In the history of the NFL, dome teams are 15-45 on the road in postseason play. And the best dome teams don't even do all that well at home in the playoffs -- like the Colts, who were heavily favored at home against the Steelers in the AFC divisional playoff last year and got stuffed." 8. "The pass sets up the run." You hear this one a lot. It's true that a team with a good passer will get a lot of rushing yards, but only because the passer will get more first downs, which in turn creates more rushing opportunities. Having a good quarterback doesn't mean you'll run the ball better, just more often. Last season the Steelers led the league in yards per pass, 8.2, and were just an average running team at 4.0. 9. "Pass completion percentage is a key stat." No, not a key stat. In fact, not particularly important at all. No one, of course, wants to throw an incomplete pass. The point isn't how many passes you complete, but how far downfield the passes go. Put it this way: Would you rather complete three of three passes for nine yards or one of three passes for 10? Of the top five passers in the NFC last year in pass-completion percentage, only one, Seattle's Matt Hasselbeck, played for a winning team (the Seahawks went to the Super Bowl). The other four played for teams that finished a combined 24-40. 10. "This is the age of the running quarterback." We've been hearing this for the past few seasons, particularly when the Falcons, with their great running quarterback, Michael Vick, are on TV. But there is no proof that having a great runner at the quarterback spot guarantees a winning team. In 2005, the Falcons lead the league in both rushing yardage and yards per run and still finished just 8-8. They won't get any better until Mr. Vick improves his TD-passes-to-interceptions ratio (15-13 last year).
But can these rules ever help us make better investment decisions? We asked seven investment professionals to separate the most valuable stock market maxims from the meaningless, and potentially harmful, myths. Maxim: "Investing based on market outlook is an added risk that investors do not need." Daniel White, European equities fund manager at New Star Asset Management, said some investors had a knack for second-guessing macroeconomic movements, while others let emotions cloud their judgments. So rather than worry about market timing and trends, White said he preferred to focus on cash-generating, cheap companies resilient in an economic slowdown. It is an approach that pays off some, if not all, of the time. Myth: "Bad news on the U.S. economy is good news for the market." Patrick Moonen, chief asset allocator at ING Institutional, said that investors, notably hedge funds, hated to miss a beat in the market, but that their obsession with short-term macroeconomic news was blinding them to the bigger picture. "Weak employment figures from the U.S.," he said, "have been greeted with delight by the many equity traders who view bad news on the U.S. economy as a clear signal for the Federal Reserve to put rates on hold, or better still to cut rates - usually good news for equity markets." Stephen Russell, an investment director at the London-based Ruffer Investment Services, agreed with Moonen. "The market sets great store by a rule known as the 'Greenspan put,'" he said, named for the previous Federal Reserve chief Alan Greenspan, that basically holds that "if markets and economies turn sour, the Fed will cut rates to save the day." "Greenspan's legacy had given birth to the dangerous view that there is no downside risk in the stock market," Russell said. It has also spawned "many dubious maxims," like the belief that market dips are buying opportunities. Maxim: "The trend is your friend." Kai Stefani, the Frankfurt-based senior capital markets analyst at Allianz Global Investors, is wedded to the notion that markets are increasingly being driven by "mega" trends, like commodity shortages. He looks at economic developments and how they affect sectors and companies. "We believe commodities shortages fueled by growth in emerging markets will be the dominant trend for the next few years," Stefani said. "Provided the U.S. does not fall into recession - an unlikely scenario in our opinion - commodities stocks and domestic consumption plays in the emerging markets space should continue to reward investors." Myth: "Buy low, sell high." Dennis Phillips, a London-based portfolio manager at Ashburton Investment Management, has yet to find an investment maxim that he wholly agrees with. "Enduring Wall Street sayings such as 'Buy low, sell high' may sound sensible in theory, but they are notoriously difficult to execute in practice," he said. "The antithesis to 'Buy low and sell high' is, 'Buy and hold for the long term,'" he said. "This strategy, favored by Warren Buffett, can have merits in secular bull markets, but there are long periods when stocks essentially trade sideways - I suspect we may be in that period now." We do not try to buy at the absolute bottom or sell at the top but aim to exploit the profitable segment in between. Sell decisions are generated by technical analysis based on a stop-loss of profit discipline." Myth: "The worst time to buy is when a stock has broken an old high." On the contrary, this is often the very time to acquire shares, according to Phillips of Ashburton Investment Management, as some investor resistance has been overcome and the price might break out further. "We invested in U.S. office supply company Officemax when it established a new high back in May," he said. "Four months on, the stock appears to be poised to break out again." Phillips said Exxon Mobil might also be on the brink of a higher trading range. Maxim: "Buy what Asia needs but does not produce." Nikolaus Pöhlmann, portfolio manager at DWS Investments, said the prospect of holding the next Olympic Games in 2008 might have prompted China to tackle its pollution problems. Pöhlmann, who is based in Frankfurt, suggested that Western industrial conglomerates would be the biggest beneficiaries of lucrative government contracts in Chinese waste management. "There are few Chinese companies with the resources and pricing power to satisfy China's need for waste management solutions," Pöhlmann said. "Stocks that play into this theme include the international heavyweights ABB and Siemens. We also like Socotherm, a small Italian company that specializes in pipe insulation." Mutual Fund Update
The new measure, created by Antti Petajisto and Martijn Cremers from the Yale School of Management, takes a simple approach. Called the "active share" of a portfolio, it matches the holdings reported by a fund in SEC filings against the components of an index, and then measures the percentage of overlap. For example, if GE and Exxon each account for 4% of an index, and a fund had a portfolio exactly mirroring the index except it had 8% in GE and nothing in Exxon, its active share would be 4%. The more a portfolio differs from an index, the higher the active share percentage. The study found that the average fund using the S&P 500 as a benchmark has an average active-share percentage of 66%. In other words, the average large-company stock fund had a portfolio that was 66% different than the benchmark and the rest essentially mirrored the index. The study, which examined data from 1980 through the end of 2003, found an increase in funds that could be described as closet indexing during the 1990s, a period of major growth in the mutual-fund industry. Closet index funds (generally, those with active share falling into the 20% to 60% range) contained about 30% of all assets in 2003, up from virtually no assets in the 1980s. One reason investors should care: Actively managed funds charge higher fees than index funds. You're paying a premium for the talents of a skilled stock picker - not just someone who is mirroring a stock index. But the study found that funds charged similar fees, regardless of their active-share reading. Funds with an active share of 70% or higher have expense ratios averaging roughly 1.57%. However, closet-index funds with an active share of 40% to 50% charged an average of 1.31%. Portfolios with an active share of 30% or 40% charged an average of 1.13%. Index funds in the study charged on average 0.55%, though many are substantially cheaper. According to the study, active-share percentages are a good predictor of performance. Funds registering the highest active share beat their benchmark index by an average of 1.39 percentage points per year, while those in the lowest active-share group produced returns that, on average, fell short of their benchmark by 1.41 percentage points. This makes sense, argues Mr. Petajisto, one of the study's authors. Once fees are subtracted, a fund hugging an index is going be hard-pressed to provide investors with returns that top the index. In addition, the study found that, in general, funds with higher active-share readings tend to repeat top performance. "It's consistent with the idea that the most active funds are likely to have more skilled managers," Mr. Petajisto says. Mr. Petajisto suggests investors compare a fund's active share against the fees they're paying. "If a closet indexer has 30% active share but only charges 0.30% [a fee not much more than most index funds], it may still be a reasonably good deal," he says. The classic example of a mutual fund accused of being a closet indexer is Fidelity Investment's giant Magellan. In the early 1980s, Magellan's active share under famed manager Peter Lynch ranged between 70% and 90% -- a time when the fund earned its reputation by being a strong-performing, invest-anywhere portfolio. However, the active share declined later in the decade, to the mid 50%, coinciding with massive growth in the fund. By the mid-1990s, when Robert Stansky took the helm, the fund's active share started plunging to extremely low readings in the 30% range, a time when Magellan was widely criticized for being a closet index fund. During this time Magellan's performance suffered and the fund consistently landed in the bottom half of its peer group. When Harry Lange took over the controls at Magellan late last year, the fund's active share rebounded from 41% in September 2005 to 66% in December. "When Lange replaced Stansky, the fund became significantly more active within only a few months," Mr. Petajisto notes. A commonly voiced concern of fund industry observers is whether, as was the case with Magellan, mutual funds are more likely to become closet indexers as they grow in size. The Yale study did find that for funds investing in large-company stocks, active-share readings tend to decline after assets top $1 billion. "That doesn't mean a fund necessary always has to become an extreme closet indexer," Mr. Petajisto says. For example, the $19 billion Legg Mason Value Trust, run by William Miller, had an active-share reading of 85% for 2005 and the $36 billion Fidelity Low Priced Stock Fund, which compares itself to the Russell 2000 index of small company stocks, has an active-share reading of 90%.
Both ETFs and ETNs are designed to provide low-cost exposure to commodities and other investments, usually by tracking an index, and since these funds trade like stocks investors can go long or short, providing a chance to hedge against a market downturn. There are, however, several key differences between ETFs and ETNs, and each structure has its pluses and minuses. The new ETNs tracking commodities indexes are aimed at investors eager for commodities exposure. The group has had a strong run over the past few years, but it is a notoriously volatile sector. Financial advisers caution that investors should have no more than about 5% to 10% of their assets in commodities. The iPath ETNs are 30-year senior debt securities listed on the NYSE and issued by Barclays that essentially promise to pay investors the return of a commodity index, minus annual fees of 0.75%. Rather than buying a share of a fund's assets, as with ETFs, the ETNs shift index-tracking risk to Barclays. Investors, however, are taking on credit risk that Barclays will be solvent when they want to sell their ETNs. Observers say ETNs could end up being more tax efficient than commodity ETFs, which continually "roll" futures, meaning they move into longer-dated contracts to maintain exposure rather than taking physical possession of the commodities. Any capital gains are passed along to investors and are taxed as 60% long-term gains and 40% short-term gains. Conversely, Barclays says ETNs should be taxed as prepaid contracts tracking an index. Therefore, investors should only pay taxes if they recognize a gain when they sell the ETN or when the note comes due, if they chose to hold it that long. But the tax advantage remains theoretical at this point. Barclays acknowledges the IRS has not made a definitive ruling on the tax treatment of ETNs, so there is uncertainty and as always investors should consult a tax adviser. "The IRS could say ETNs shouldn't be taxed as a contract, but rather like a bond," said Dan Culloton, analyst at investment researcher Morningstar. Mike Latham, managing director of North American exchange-traded products at Barclays, stressed it depends on what investors want when choosing between commodity ETNs and ETFs. "Some prefer to have income distributions and consider that an advantage, while others prefer to defer all gains and income until the day they sell," Mr. Latham said. Barclays's first two iPath commodity ETNs track indexes which tackle commodities in different ways. The production-weighted Goldman Sachs Commodity Index, or GSCI, contains 24 futures contracts but has about 75% of the index focused on energy, according to Goldman Sachs. It also has about 9% in industrial metals, 2% in precious metals, about 10% in agriculture and 4% in livestock. Meanwhile, the Dow Jones-AIG Commodity Index is composed of futures on 19 commodities but has a rule capping energy or any one commodity group at 33%, so it has less than half the energy exposure as the Goldman Sachs index. Barclays has also filed for another commodity ETN tracking the Goldman Sachs Crude Oil Total Return Index. Barclays PowerShares DB Commodity Index Tracking Fund ETF follows a Deutsche Bank index which has base weights of 35% crude oil, 20% heating oil, 12.5% aluminum, 10% gold and 11.25% each in corn and wheat. Like their ETN cousins, the pair of commodity ETFs both have management fees of 0.75% of assets. The ETFs, which are structured as commodity pools, invest in futures contracts and also hold short-term Treasuries as collateral which supply a yield used to offset fees. Unlike ETNs, they throw off income to holders from the bond yield which is taxable. And depending on the difference between commodity spot prices and longer-dated futures contracts, the ETFs can also produce gains from rolling over the contracts, which is also taxable. The Barclays's ETF attempts to reduce taxes and transaction fees by investing in longer-dated futures contracts called "CERFs" which have a roughly five-year expiration, rather than monthly, although the contracts are relatively new and some have raised liquidity concerns. The ETFs, however, eliminate credit risk because investors own a piece of the portfolio, although compared to ETNs there's less assurance the ETFs will track the indexes perfectly. Aside from the pair of commodity-basket funds, there are several other more targeted ETFs tracking individual commodities. There are a trio of precious-metals ETFs: StreetTracks Gold Trust, iShares Comex Gold Trust and iShares Silver Trust. Shares of these ETFs represent ownership in gold or silver held in a vault. Additionally, U.S. Oil Fund (USO) provides exposure to crude oil by investing in futures contracts, cash-settled options and other instruments.
Belatedly, more mutual-fund companies are taking steps to do what they can to minimize investors' propensity to buy high, sell low. There is less promotion of hot funds and fewer launches of funds in highflying corners of the market. More companies are promoting funds that offer diversification among investment styles that may or may not be in favor. "So many one-hit wonders came and went," says John Leuthold, vice president of retail marketing at Janus Capital Group, a fund company wildly popular in the late 1990s that has seen investors flee for more than five straight years. Having learned that lesson, the focus is on trying to create "a long-term relationship" with investors. For investors trying to figure out which fund companies will look out for their best interests, there hasn't been much in the way of tools. Of course, there are published fund returns. But while those numbers capture the abilities of fund managers, they don't say anything about how shareholders fared, if, for example, the fund company made an aggressive marketing push to draw investors into a fund after a long hot streak. That could change later this year when research company Morningstar expects to add data that tries to capture investors' experience. Morningstar's process takes a fund's stated returns and adjusts for the timing of purchases and sales to provide an estimate of the returns earned by a typical investor over different periods. For example, the $1.3 billion MFS Capital Opportunities Fund posted an average 6%-a-year return for the 10 years ended May 31, using conventional methodology that measures the change in value of the fund's holdings. But many investors jumped into the fund in 2000, according to Financial Research Corp., pouring in $2.6 billion following a chart-topping 47% gain in 1999. Then, during the next two years, the fund was among the worst performers in its category. Many investors bailed out. As a result of these investors' bad timing, the typical shareholder of the fund actually lost money during the past decade - an estimated 3.2% a year, according to Morningstar. That is a difference of nine percentage points from the stated results. It is a similar story for Janus Overseas Fund. While it has a top-notch 12.8% average-annual return for the past decade under the conventional methodology, the typical investor in the $4.2 billion fund earned a more modest estimated average-annual return of 5%, according to Morningstar. "It gives you a sense of how much money [mutual] funds are really making for people," says Don Phillips, a managing director at Morningstar. Morningstar is fine-tuning the data and the process, which is based on monthly-fund flows. One single fund's "investor returns," as Morningstar calls the approach, provide a relatively narrow view. Combined with data on a company's other funds, they give an overview of how well shareholders at a company have fared. That is especially the case when the figures are adjusted to emphasize a fund company's largest funds. Consider low-keyed Dodge & Cox, which offers just four funds, two of which are closed to new investors. Assuming the investor put the money in at the beginning of the period, Morningstar calculates, the company's average asset-weighted return during the past 10 years is 12.54%. Adjusted for timing of fund purchases and sales, the typical investor earned an estimated 12.51% -- meaning investors captured nearly all the potential returns posted by the fund company's managers. In other words, Dodge & Cox long has had a buy-and-hold crowd of shareholders. Other big fund companies where investors have had high rates of capturing their funds' returns are Vanguard Group, Capital Research & Management's American Funds, Fidelity Investments and Franklin Templeton Investments, according to Morningstar. In contrast, the typical Janus investor earned an estimated 2.3% a year, while the average asset-weighted return (unadjusted for investors' timing) is 7.9% a year. Of the 100 largest fund families studied by Morningstar, investors at Janus took home the smallest percentage of potential asset-weighted returns during the past 10 years. Investors at MFS Funds and AIM Funds also were among the worst performers, earning less than 80% of the potential 10-year, asset-weighted average return, Morningstar says. The worst-performing mutual-fund companies tend to have one thing in common: During the 1990s, they were well-known for highflying "growth" funds, focused on shares of technology, Internet and other companies with seemingly great expansion prospects, and they attracted investors by the droves. Besides Janus, fund companies with a major exodus of investors during the past five years include AIM and MFS, Financial Research's data show. As these fund companies have lost clients, competitors that were stodgier during the bull market have been the beneficiaries. American Funds has been the leader in attracting net new money during the past five years. Through the first six months of this year, it hauled in $37.41 billion. Vanguard is in second place, at $20.74 billion. Also in the top five: Dodge & Cox. To some degree, performance chasing is driving the popularity of these companies, too: They have strong value-oriented funds, an investment style that has performed relatively well since the collapse of the technology-stock bubble in 2000. American Funds, Vanguard and Dodge & Cox also have this in common: They were trying to help investors avoid hurting themselves before such preventive measures became popular. Vanguard warned investors in the late 1990s against putting too much of their money in the company's flagship fund based on the S&P500 index. Vanguard suggested investors consider its index fund focused on the entire U.S. stock market. Later, Vanguard warned shareholders about the risks facing its top-performing Vanguard GNMA Fund, which invests in bonds backed by mortgages. American Funds often has provided cautionary materials for securities brokers to hand clients. In 1998, one brochure raised the question, "Are investor expectations too high?" The brochure suggested customers' portfolios include funds investing in non-U.S. stocks, small-company shares and bonds -- all out of favor at the time. After seeing Vanguard, American Funds and a handful of others dominate the battle for investors' dollars, other fund companies are taking steps aimed at influencing investor behavior. The challenge is getting that message through. Monthly Employment Stats
Employment in professional and business services continued to grow in July (+43,000). Within the industry, job gains occurred in computer systems design (+12,000), architectural and engineering services (+10,000), and management and technical consulting (+6,000). Temporary help services employment remained flat over the month and has shown little net change since January. Health care employment rose by 23,000 in July. Nursing and residential care facilities, along with hospitals, continued to add jobs. Over the past 12 months, health care employment has grown by 274,000. In leisure and hospitality, food services and drinking places employment grew by 29,000 in July. Over the year, food services has added 229,000 jobs. Elsewhere in the service-providing sector, employment in wholesale trade was flat in July; this industry added an average of 11,000 jobs per month from January through June. Employment in retail trade was unchanged in July. General merchandise stores lost 8,000 jobs over the month; employment in the industry has declined by 74,000 since August 2005. Financial activities had little employment growth for the third month in a row. In the goods-producing sector, mining employment grew by 8,000 in July. The industry has added 123,000 jobs since its most recent low in April 2003, largely reflecting gains in support activities for oil and gas. In July, construction employment was little changed for the fifth consecutive month. Manufacturing employment edged down in July (-15,000); the decrease largely offset a gain in June. In July, job losses in transportation equipment (-9,000), computer and electronic products (-8,000), and textile mills (-2,000) more than offset employment increases in machinery (+8,000) and chemicals (+4,000). Weekly Hours (Establishment Survey Data) The average workweek for production or nonsupervisory workers on private nonfarm payrolls remained unchanged at 33.9 hours in July, seasonally adjusted. The manufacturing workweek rose by 0.2 hour to 41.5 hours, while factory over- time was down by 0.1 hour to 4.5 hours. The index of aggregate weekly hours of production or nonsupervisory workers on private nonfarm payrolls increased by 0.1 percent in July to 105.2 (2002=100). The manufacturing index rose by 0.4 percent to 97.3. Hourly and Weekly Earnings (Establishment Survey Data) Average hourly earnings of production or nonsupervisory workers on private nonfarm payrolls rose by 7 cents, or 0.4 percent, in July to $16.76, season- ally adjusted. Average weekly earnings also increased by 0.4% in July to $568.16. Over the year, average hourly earnings increased by 3.8%, and average weekly earnings increased by 4.1%. Job Market Has Stopped Improving Danielle DiMartino, Dallas Morning News 8-10 Jobless claims continued to rise. The four-week average of continuing claims rose to 2.47 million. Continuing claims have increased 69,500 since May 20. "These data continue to suggest weak labor market conditions," Northern Trust economist Asha Bangalore wrote to clients. Weekly data show the labor market has stopped improving. As Steven Wood, chief economist at Insight Economics, put it, "The declining trend in initial claims that was in place during 2004 and 2005 has been arrested." The most forward-looking indicator in the monthly jobs data largely mirrors what we see in the weekly data: Temporary help services jobs fell slightly and were down for a fourth straight month in July; they've basically held steady since January. [From Rick MacDonald of Action Economics via BusinessWeek 8-03: The bellwether "temp" employment series has dropped in four of the first six months of 2006. This is the worst stretch since late 2002. Given that the temp series is viewed as a leading indicator for broader employment trends - in light of the ease of hiring/firing workers - this may be sending a message of less job growth in the second-half of 2006.] On a deeper level, indirect fallout from the housing downturn is beginning to spread to other areas of the job sector. Financial services jobs, for example, grew by only 6,000 in July, putting up subpar gains for a third straight month. As for jobs tied directly to housing, at this time last year we were marveling at that magical sector's ability to create 22,000 jobs a month in the four months to July. This year, payroll growth in construction has averaged 2,000 over the same period, and the bulk of the additions have come from the nonresidential side. The bottom line: The labor market recovery has peaked. Since April, payrolls have grown by an average of 112,000, compared with 169,000 in the four months through March. Wages Fall Behind Inflation Michael Mandel, BusinessWeek 8-7 According to the latest numbers from the BLS, average hourly earnings for production and nonsupervisory workers are up by 3.8% over the past year. That may sound decent, but it lags the 4.3% increase in CPI over the same period. Even managers and professionals are taking the hit - their real wages have fallen by 1.8% and 1.1%, respectively, over the past year. Historically, real wages rise along with productivity once labor markets are tight enough. There are two alternative explanations for this broad-based problem. The first one has to do with globalization. Competition with low-cost workers in China, India, Eastern Europe, and the rest of the developing world may finally be taking its toll on American workers. With a surplus of labor around the world, real wages will stagnate, while returns to capital will rise. The other explanation - wages usually track along with productivity. But what if the productivity gains of recent years have been overestimated? The latest revision of GDP seems to have cut productivity growth in 2004 and 2005 by almost half a percentage point. Further revisions of the statistics could push the number down even more.
Quick Facts, Stats & Opinions Dividend-Paying Stocks Outperform Scott Patterson, WSJ 8-27 When stocks surged in 2003, the dividend-paying stocks within the Standard & Poor's 500-stock index were trounced by the nondividend components, including technology stocks that were rebounding from a bear-market beating. But since then, stocks with dividends have delivered somewhat higher returns for investors. Last year, the dividend stocks in the S&P 500 posted a total return, from price change and dividends, of 9.3% -- beating the 8.2% return of the nondividend stocks. This year, the spread has widened. The dividend stocks in the S&P 500 gained 5.1% through Thursday, compared with a 0.9% advance for stocks with no dividend. Concerns that more than two years of interest-rate increases by the Federal Reserve are slowing the economy have drawn investors to defensive, dividend-heavy sectors such as health care and utilities. But the current level of dividend payments is skimpy by historical standards. The dividend yield on the S&P 500 is 1.5%, far below an average of 3.9% since the late 1920s. Dividend yield is a measure of annual dividends per share divided by the current stock price. Looking at it differently, in the 1980s, about 50% of corporate earnings were paid out as dividends, compared with about 30% today, according to Josh Peters, the editor of Morningstar Dividend Investor newsletter. Emerging-Market Stats Karen Richardson, WSJ 8-04 New data show that mutual funds bailed out of emerging-market stocks in a strong selloff in June, as violence in the Middle East further chilled investors' appetite for risk. However, there are signs the selloff slowed last month. The June selloff extended a sharp downturn in emerging-market stocks that began in May, when investors began selling out of overseas stocks due to fears of higher global interest rates. As rates rise, investors typically lower their appetite for risk and look to cash, bonds or large-capitalization stocks for more modest, but steadier, growth. Equity mutual funds with total assets of about $670 billion were net sellers in June of more than $15 billion of emerging-market stocks, or 2.3% of total holdings, according to EmergingPortfolio.com, a research firm in Cambridge, Mass. This was the "strongest selloff ever" of emerging-market equities, according to an EmergingPortfolio.com news release. The firm, which began tracking fund data in 1995, said the level of selling in June was greater than during the market meltdowns of August 1998, April 2000 and May 2004. Dale Carnegie had a brutally mechanistic view of human nature. He believed that words and deeds are largely shaped by genes, upbringing and circumstance. “You deserve very little credit for being what you are,” he tells the reader in How to Win Friends and Influence People. “And remember, the people who come to you irritated, bigoted, unreasoning, deserve very little discredit for being what they are.” (Richard Morrison, The [London] Times 8-08) Standard & Poor's reported that share buybacks hit another record in the second quarter. Dividend payouts, however, were up just 11.1% in the second quarter from last year to $54.5 billion. And since the third quarter of 2004, when dividend and share-buyback payouts were running about even, spending on buybacks has surged more than 150%, while dividend spending has gained just 25%. Companies in the Standard & Poor's 500-stock index sank more than $116 billion into their own shares last quarter. That tops the record $104 billion spent on share repurchases in last year's fourth quarter and is up 43% from the same period last year. More than 40% of the companies in the index cut their share count last quarter. And the combined dividend and buyback yield of the S&P 500 -- dividend and buyback spending divided by the index price -- has risen for ten consecutive quarters to 5.34% from 2.84%. (Scott Patterson & Ian McDonald, WSJ 8-24) In July, sales at gasoline stations accounted for 10% of all retail sales, the highest figure in decades. (Floyd Norris, NY Times 8-18) Last week, AOL released a trove of anonymous Web-search data from 650,000 of its customers. I got hold of the data set -- 2.27 gigabytes' worth, loaded it into my shiny new SQL Server database software, and started my own research project into how people really use the Web. How good is the Web with queries? Users seem to think it needs improving, because in 47% of all searches, they didn't click on any of the results presented to them. For those searchers who did click on something, in 42% of the time, they clicked on the first link presented to them. (Lee Gomes, WSJ 8-16) John Hussman writes that the chief difference, at this juncture, between Alan Greenspan and Ben Bernanke is that Mr. Greenspan had the benefit of fiscal discipline. "During Greenspan's term, the fiscal discipline of both Republican and Democratic leadership brought the growth rate of the U.S. gross public debt down from 16% at an annual rate, to just 2% annually. It's relatively easy for the economy to thrive and for inflation to fall, provided the government isn't sopping up the economy's resources and issuing liabilities in return," he writes. "Dr. Greenspan will undoubtedly be glad that his exit was so fortunately timed. Dr. Bernanke, probably not so much. His main fault, most likely, will be in believing that the Fed can actually exert much power independent of fiscal policy." (David Gaffen, WSJ 8-14) Is the market crazy? Dan Wiener, editor of the Independent Advisor for Vanguard Investors, outlined the case in favor: "Let's see. The Fed decides to at least take a pause, and maybe even put an end to interest rate hikes, and the markets sell off. Terrorists plot to blow up a series of airplanes using liquids and gels, and the markets rally, while gold sells off. Anyone who says they know precisely what's going on here, and that this all makes perfect sense, is just not telling the truth." (Mark Hulbert, MarketWatch 8-11) The Mortgage Bankers Association said this month that loan applications to purchase homes in July were down 20% from the same month a year earlier. The National Association of Home Builders said this month that its housing-market index dipped in June to its lowest level since 1991. And the National Association of Realtors said Wednesday that existing-home sales would fall 6.5% this year. Richard Berner, the chief U.S. economist for Morgan Stanley, expects the housing slowdown alone to trim U.S. economic growth by as much as 1.5 percentage points. (Kevin Hall, McClatchy Newspapers 8-10) According to the Investment Company Institute, total ETF assets rose 38% to $335.1 billion in the past 12 months. In the same time, global ETFs nearly doubled to $82.8 billion. The funds reached their peak of $88.9 billion in April, before emerging markets slumped. International strategies now account for about 26 percent of all money invested in U.S. exchange-traded funds, a bigger portion than the one enjoyed by international-style mutual funds, which hold about 21 percent of long-term mutual fund assets. The average expense ratio for international-style ETFs is 0.53%, compared with 1.68% for international mutual funds, according to Morningstar. There are now 63 separate global equity ETFs on the market. (AP 8-7) Ned Davis Research recently studied how various sectors in the S&P500 index have performed in past periods of declining home sales. As one would expect, the sector most affected by declining home sales has been basic materials — since demand for commodities such as lumber, steel and copper tend to be affected by construction trends. From the end of February 1972 to June 2006, every 1% monthly decline in new-home sales coincided with a 1.7% fall among materials stocks in the S&P500. But the consumer discretionary sector has been nearly as vulnerable to housing declines. Since February 1972, a 1% drop in new-home sales has coincided with a 1.4% decline in the stock price of consumer discretionary companies. (Paul Lim, NY Times 8-6) Google has debuted a new service that warns users who click links to visit sites that have been identified by the Stop Badware coalition, itself a project of Google, Lenovo, and Sun Microsystems. The coalition was founded to help address the problems of spyware and other malicious software by helping users know which sites have distributed such software. Users of Google's search engine who try to access a site on Stop Badware's list are shown a warning that the site they want to visit has been flagged as potentially dangerous. (BBC via EduPage 8-07) Any dovish stance taken by the Fed may be too late, and the wishing and hoping from investors looking for a post-Fed rally is unfounded, according to analysts at Comstock Funds. They said in a weekly commentary that, in the 12 periods in the past 53 years involving a series of rate increases, 10 resulted in the S&P 500 bottoming after the final increase, with an average drop of 22% to the bottom. (David Gaffen, WSJ 8-4) The short-term sentiment indicators, according to Birinyi Associates, are almost uniformly bearish, which could be a contrarian indication that stocks will turn upward. Among those signals are the Investors Intelligence surveys, which still show a high level of bearishness vs. bullishness and the Chicago Board Options Exchange ratio of equity puts to equity calls, currently at 0.8. Puts are options to sell stock; calls are options to purchase stock. When the ratio is near one, it means as many people are making bets on stocks going down as going up, and implies a high level of bearishness. (David Gaffen, WSJ 8-2) According to a study by the New York Fed, the more reliable indicator of an economic slowdown is the difference in yields between the three-month and 10-year, not the two-year and 10-year. Currently the three-month bill yields 5.11% while the 10-year note is at 4.98%, for a difference of 0.13 percentage point. At this time, that translates to a 25% to 30% chance of a recession, according to the study. (David Gaffen, WSJ 8-2) According to Bloomberg News, Eric Singer, with research support from economists Michael Ferguson of the University of Cincinnati and Huge Douglas Witte of the University of Missouri-Columbia, have studied the correlation between the markets and when Congress is in session and found that since 1897, 90% of the Dow Jones Industrial Average’s gains occurred when Congress was doing something other than their elected duties, creating the so-called 'Congressional effect.' (Hedge Fund Daily 8-03) Hedge Fund / Private Equity News Briefs Hedge fund risk ratings, to be introduced by Standard & Poor’s by year’s end, with systems by other firms in development, are being called a good thing for the industry. Emma Mugridge, director of the Alternative Investment Association, told Global Pensions that the ratings are “a natural progression for the hedge fund industry, which has become increasingly mainstream.” The ratings also reflect an industry that is becoming more conservative in an effort to satisfy the main source of new funds – institutional investors. (Hedge Fund Daily 8-25) Last year, private equity funds returned 27%, according to Cambridge Associates, which tracks them, compared with the 5% for the Standard & Poor’s 500 Index. (Hedge Fund Daily 8-03) Activist hedge funds have had “surprising success” in their campaigns to win a place on the board of target companies, according a report by Morgan Joseph & Co. The study by the firm’ new Shareholder Activist Group found that in 94 campaigns waged by 29 hedge funds, HFs succeeded 35% of the time to gain representation – a finding that the company says “will force management to be more mindful of their potential vulnerability.” (Hedge Fund Daily 8-01) Home Page Previous Factoid Top Sites
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