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That isn’t terribly surprising, said Rosanne Pane, mutual fund strategist at S&P, because active managers tend to have difficulty beating indexes when market leadership changes. And in the third quarter, many stocks that had paced the market for much of this decade began to fall behind. Small-company stocks were finally beaten by shares of big, blue-chip companies; sectors like energy also started to lose ground. Still, such transitional periods aren’t the only good times for indexing. S&P research shows that while active management fared poorly in the third quarter, it has actually been lagging behind the indexes for a considerable period. Over the five years through the end of the third quarter — a span that included both bull and bear markets — only 29.1% of large-cap funds managed to beat the S&P500. What’s more, only 16.4% of mid-cap funds beat the S&P400 index of mid-cap stocks, and 19.5% of small-cap funds outpaced the S&P600 index of small-company shares. “The long term does seem to favor the indexes,” Ms. Pane said. So does the near term. That’s because corporate earnings are finally expected to decelerate meaningfully over the next several quarters, said Richard Bernstein, chief investment strategist at Merrill Lynch. And in a period of slowing profit growth, stock market leadership typically narrows. You would think that active fund managers would thrive during such periods — because, in theory, they could select the winning stocks from the market’s losers. But choosing the winners actually becomes that much harder, Mr. Bernstein said. “In the past few years, when we saw unprecedented breadth in the stock market, it was a stock picker’s paradise,” he said. “Even if you were a poor stock picker, your chances of outperforming the broad market were quite high.” But as it becomes more difficult to find stocks generating sizable gains, “we’ll begin to uncover who truly has the stock-picking ability out there,” he said. For John Bogle, founder of the Vanguard, which started the first retail stock index fund 30 years ago, the recent success of indexing is self-evident. Fads come and go, buts costs and taxes are forever. And indexing minimizes the transaction costs and capital gains taxes associated with active investing. And this strategy is even more valuable in a period of modest returns. If equities gain only 6% or 7% annually in the coming years, the higher investment management fees, transaction costs and taxes associated with actively managed portfolios will take a disproportionate bite out of a fund’s gross returns.
It's a familiar story. The financial bear is seen as a fierce, wily creature, the bull as a simple oaf. Hedge funds are revered for their sophistication because they can play the market from both sides, while most old-fashioned mutual funds remain stuck in a `long-only' rut. These sorts of perceptions have been around forever, and they are unlikely to change. As the information explosion continues, the tendency to equate skepticism, even cynicism, with savvy will only increase. The only thing is, the images fail to square with certain realities. One of these caught my eye the other day as I looked at the latest mutual fund performance tables published by Morningstar. Among 68 categories of stock, bond and hybrid `balanced' funds, 67 sported positive returns across the board for the past year, the past three years and the past five years through the end of last week. Moderate allocation funds, the sort of ultra-diversified vehicle preferred by bulls of limited sophistication, had returned 13% for the past year, 9% a year for the past three years and 6.4% per annum for the past five. The lone loser? Bear funds, which seek to profit from falling markets. They were down 12% in the past year, 9.6% annually in the past three years, and 11% a year in the past five. It's not as though the period we are examining has been heavily skewed against the bears, the way the 1980s and 1990s were. These are the 2000s, a decade that began with a great tech wreck in the stock market and the terrorist massacres of Sept. 11, 2001. It is fair to ask: If bear funds can't make money in a time as messy and muddled as the '00s, when can they? Even in an age like the present, it turns out, the bulls travel with the prevailing winds.
Stephen Biggar, director of American equity research at Standard & Poor’s, questions the reliability of those estimates. In the weeks before an earnings announcement, Mr. Biggar said, companies often talk down their prospects so that analysts reduce estimates, making the actual numbers sound better. He prefers to compare reported earnings with estimates made before the expectation-management exercise begins. Using estimates in place on Sept. 18, he concludes that companies are not doing as well as many people think. Of 68 S&P500 companies that have reported third-quarter results, 41 failed to meet the September estimates for operating earnings, he said. The median shortfall was 4.3%. But 74% of companies in the S&P500 that have reported so far exceeded the latest estimates and only 8% undershot them, according to Thomson Financial. “There probably was some softening in the final month of the quarter, and companies had to do some fancy footwork to bring estimates down a bit,” Mr. Biggar said. Some companies also appear to be rewriting corporate history, he added, restating earnings from previous quarters, which can make growth seem more robust. “There is a penchant by companies to make this year’s number look good but to make last year’s number look bad,” he said. General Electric recently reported an increase in third-quarter operating profit, to 49 cents a share from 43 cents, but last year the company said it had earned 44 cents a share in the quarter, Mr. Biggar said. That one-penny restatement, the result of G.E. subtracting $85 million in profits from discontinued operations last year, he said, lifts apparent growth to 14% from 11%. A G.E. spokesman said that there was nothing misleading or unusual in its quarterly statement. Companies are required to report net earnings and earnings from continuing operations, and G.E. focuses on continuing operations because that measure provides “a better perspective on our true performance.” Mr. Biggar said investors need to scrutinize earnings reports carefully. “A lot of these companies that say they’re 11, 13, 14% growers are not,” he said. “It’s difficult to have confidence in the numbers they’re reporting.”
"In the grand scheme of economics, this is not rocket science. It's just something that needed to be done," Mr. Dolmas said in a recent interview. A senior economist and policy adviser at the bank, he introduced a new treatment of the personal consumption expenditures index, the broad inflation index the Fed prefers over the more familiar consumer price index. We'll leave the details of how his measure is figured in a black box somewhere filled with the nasty little creatures that statisticians deal with, like kurtosis and skewness. Suffice to say the "trimmed mean" rate is created by eliminating the extreme changes in price measures in any month. Instead, it concentrates on the more central changes. Only time will tell if Mr. Dolmas' measure will gain favor among policymakers. It is, however, in regular use by the Dallas Fed. Mr. Dolmas is modest about his accomplishment. "A good deal of the credit goes to earlier efforts at the Cleveland Fed and elsewhere," he said. Since most of this is pretty arcane stuff, I asked whether he would start by explaining why the Fed preferred the PCE index over the CPI. The PCE "is a much broader basket of consumption goods," he said. "The CPI is a typical urban consumer index based on a basket of goods and services. The PCE goes with everything that gets consumed. "More important, it doesn't have fixed weights. The weights [of any consumption category] vary with actual consumption. ... Basically, the PCE is a much more dynamic index. If the price of gasoline goes up, people cut back. Or if we have employee pricing for cars and people buy more cars, the weight of cars in the index rises." Whereas the CPI reflects a limited, fixed basket of goods and services, he pointed out, the PCE measures all consumption. It avoids the inaccuracy introduced when people move their purchases from traditional department stores to discount stores. Why do we hear about "core inflation" when everyone consumes food and energy? I asked. "We care about core inflation because that's what policymakers may be able to control – they can try to control the trend in consumer prices. But more important, core is better for forecasting future inflation. If you ask whether you want to look at the overall rate or the core rate, it turns out that you're better off looking at the core." Since food and energy prices are highly volatile – and always have been – they can be misleading. So the core rate is likely to be predictive? I asked. "Yes. Getting a good picture of the trend is good for looking at what the rate may be in 12, 18 or 24 months. It's better than looking at the more volatile broad rate. So it's more useful for forecasting. Unfortunately, that doesn't address the complaints people have about the specifics." Mr. Dolmas pointed out that most of us respond to our personal experience of inflation but that central bankers are looking for a measure that indicates our broad, general well-being. Basically, they are looking for how inflation affects the average dollar. His measure, the "trimmed mean PCE," works to include more meaningful indications of general inflation. In late June, for instance, Mr. Dolmas found that the number of PCE index components that were rising at rates over 3% had risen from 33% to 57% since December 2005. He also found that index components rising faster than 2% had risen from 47% to 68% over the same period – both indications of a broadening higher inflation. This month he found that the trailing six-month annualized rate for the trimmed-mean PCE was (1) larger than the PCE excluding food and energy, and (2) rising. Although both had started at a 2.4% trailing rate in March, the PCE excluding food and energy had risen to only 2.6% by August, and the trimmed-mean PCE had risen to a 3% rate over the same period. What does this all mean for you and me? For the moment, it means that inflation is higher than the Fed would like it to be. The Fed is likely to act accordingly. That means interest rates are more likely to remain stable or increase than to decrease.
The study has been circulating since September as a National Bureau of Economic Research working paper. It is titled “Why Do U.S. Firms Hold So Much More Cash Than They Used To?,” and its authors are Thomas W. Bates and Kathleen M. Kahle, finance professors at the University of Arizona, and René M. Stulz, a professor of banking and monetary economics at Ohio State. A version is at nber.org/papers/w12534. The professors found that the average cash-to-assets ratio for corporations more than doubled from 1980 to 2004, to 24 percent from 10.5 percent. Yet until their study, few people tried to analyze the investment implications of this trend because its causes appeared isolated — and therefore seemed to carry little long-term significance. For example, it may have appeared that the increase resulted from nothing more than cash hoarding at just a few large companies like Microsoft and Exxon Mobil, each of which has more than $30 billion in cash and short-term securities. But the professors found that the growth of cash was not confined to some big corporations. In fact, the steepest climbs in cash from 1980 to 2004 occurred among companies with the smallest market capitalizations. And the gains were registered not only in the last few years of the study; they were fairly evenly spaced throughout the period. Could it be that corporate cash accumulated because of the surging number of companies that had IPOs in the 1980’s and 1990’s? After all, newly listed companies typically hold large amounts of cash just after their IPO’s, and they often raise even more money in secondary offerings. But the professors found that this could not explain the long-term trend, because the cash increases were most pronounced at companies that had not recently gone public. The professors also rejected another possible explanation: that the cash hoards resulted from a growing share of corporate income from foreign operations. During much of the period studied, multinational corporations based in the United States would have incurred hefty tax bills had they repatriated the cash held by their foreign divisions. But the researchers found that cash holdings grew just as quickly among companies with no foreign income. So what is the main cause of the climb in corporate cash? Upon analyzing a dozen factors that economic theory suggests could play a role, the professors found that the biggest was an increase in risk — as evidenced by factors like unpredictable cash flow. Corporations have become less able to count on steady cash flow from year to year, according to the professors, and despite the growth of a complex derivatives market, companies can’t adequately hedge this risk without holding more cash. This helps to explain why so few companies are paying out their bigger cash hoards as dividends. Because companies are loath to cut or eliminate a dividend once they start paying it, they won’t establish or increase a dividend unless they are highly confident that they can stick with it through thick and thin. But that confidence is precisely what is missing at a growing number of companies. The professors’ analysis casts an entirely new light on valuation measures that rely on cash levels — gauges like cash-to-assets or cash-to-sales ratios. An investor who relies on such measures often assumes that companies with more cash are less risky, because they have more of a buffer against rainy days. But this assumption may well be wrong, Professor Stulz asserted in an interview, if the companies holding more cash have more rainy days than companies holding less cash. To properly compare two companies on the basis of cash holdings, Professor Stulz says, you should first compare their risk, as measured by factors like the volatility of their cash flows. Only if a company is holding more cash than is justified by its risk can we conclude that it is genuinely more conservative. Professor Stulz says he is not aware of any investment firms that now conduct the econometric calculations needed to make these assessments. And he concedes that those calculations would be complex. But without them, contrasts of companies’ cash levels amount to little more than comparisons of apples and oranges.
"Although issuers must disclose information intended to help consumers compare card costs, disclosures by the largest issuers have various weaknesses that reduced consumers' ability to use and understand them," the GAO report states. The disclosures by credit card companies use tiny print in the least legible typeface known to man. The disclosures often are poorly organized, with important information scattered throughout various sections. And the language in the disclosures is often difficult to comprehend. Although about half of adults in the United States read at or below the eighth-grade level, most of the credit card materials were written at a 10th-to-12th-grade level, the GAO found. Because of the poor quality of disclosure statements, many cardholders are not adequately informed. For example, they may not know they are charged up to three different interest rates for different transactions on the same card. They may not know their card's issuer has the right to raise the interest rate based solely on their paying late to other creditors. So what can the average person learn from the GAO report? Some important things popped out at me. There are big differences in the credit policies among companies. For example, in the GAO's analysis, 22 of 28 popular cards from large issuers assessed over-limit fees. But they varied as to when the fee was assessed. About two-thirds (14 of 22) assessed fees if the cardholder's balance exceeded the credit limit anytime within a billing cycle; eight of 22 would assess the fee only if a cardholder's balance exceeded the limit at the end of the cycle. If you have a habit of going over your limit (which you need to stop), you might want to find a card with an end-of-the-month policy, which might give you time to pay down the balance before you are hit with a fee. And fees matter. Penalty fees such as for making a late payment averaged almost $34 in 2005, up from an average of about $13 in 1995. Exceeding a credit limit could cost you an average of about $31 in 2005, up from about $13 in 1995. Somewhere deep in the disclosure you might find that your card issuer has separate credit limits for cash advances and for transfers from other cards or creditors. Four of the six largest issuers typically allow a cardholder's interest rate to be reduced from a higher penalty rate imposed for a late payment or for exceeding the credit limit, if he or she abides by the terms of the card agreement for a period of six or 12 consecutive months. However, at least one issuer indicated it would still apply that higher penalty rate on existing balances even after six months of good credit behavior. This issuer applied the lower non-penalty rate only on new purchases or other new balances. "This practice may significantly increase costs to cardholders even after they've met the terms of their card agreement for at least six months," the report points out. You might want to stay away from issuers that use the double-cycle billing method. With this type of billing, the interest you are charged is based on your average daily balance over a two-month period. As cardholders, we do have something working in our favor. The credit card industry is so competitive right now that if you play your cards right, you can find a company with policies that minimize the fees and penalties you are assessed and then take your business to those companies.
To be sure, 20 years seems like a long time. But it isn't long enough to ensure returns that look like the 10%-a-year historical average. Suppose you dumped a wad of money into the S&P500 index at the start of 1960. According to Ibbotson Associates, you would have eked out 6.8% a year over the next 20 years, barely beating the 4.9% inflation rate. By contrast, if you had invested in the S&P 500 at the start of 1980 and held on for two decades, you would have reveled in a 17.9% average annual gain, trouncing the 4% inflation rate. At issue here is so-called sequence-of-return risk. The question: When we get whacked with the next period of rotten results, will you be busily shoveling money into the stock market -- or relaxing after years of diligent savings and wondering whether to retire? With any luck, you will be socking away money like crazy, so you're buying shares during a period of lackluster returns and low valuations. Eventually, stocks will perk up and your years of thrift will be richly rewarded. What if you aren't so lucky? You could get hit with low returns and maybe a devastating bear market during the crucial age-55-to-75 stretch, when your stock portfolio is at its biggest and you are looking to sell shares, not buy them. Faced with that sort of market downdraft, you could delay retirement by a year or two or crank up your savings rate. But if you have already quit the work force, things could be dicey. The problem: If you get battered by a vicious stock-market decline during retirement, your nest egg suffers a double whammy. Not only will your stocks plunge in price, but also you are dipping into your portfolio for income, thus further eroding its value. To limit the financial damage, you should move quickly, especially if you're recently retired. Consider taking on part-time work, so you don't have to draw so much income from your portfolio, while simultaneously trimming your expenditures. You can also protect yourself by leaving your stocks to recover and instead taking spending money from the bond side of your portfolio. You might even shift money into stocks to take advantage of the decline. "At the time when it's most painful to invest in an asset class, that's when you should be buying," argues Minneapolis financial planner Ross Levin. Your best bet, however, is to bear-proof your portfolio before the bear market strikes. To that end, think about stashing maybe 25% of your nest egg in a lifetime-income annuity. That will give you a generous stream of monthly income, no matter what's happening in the market. Also use a conservative portfolio withdrawal rate. These days, many investment advisers recommend a 4% or 4.5% withdrawal rate, equal to $4,000 or $4,500 for every $100,000 saved. This is the amount you would take out of your portfolio in the first year of retirement. Thereafter, the idea is to step up the sum you withdraw each year along with inflation. Keep in mind that the dividends and interest you receive count toward your total annual withdrawal. Mr. Levin uses a 5% withdrawal rate, which he concedes is a little aggressive. But, as he notes, "most people won't maintain that withdrawal rate in a bad market, because they have an emotional reaction and spend less." He also advocates calculating how much income you will need from your portfolio over the next three years, and then setting that sum aside as a cash reserve. "We do three years of spending money in a combination of money-market funds, short-term Treasury notes and certificates of deposit," Mr. Levin says. "During a bad market, we'll spend down that cash." Even if you are prudent, a bear market could take a big chunk out of your nest egg, leaving you with the prospect of years of penny-pinching. That, no doubt, is an alarming notion. But fortunately, the danger period is relatively short. In retirement, the first five years is what really matters. If you can get through those first five years with reasonable returns, you will likely be in good shape for the rest of your retirement, thanks to the cushion of gains built up in those early years. All this raises an obvious question: Where do we stand right now? It would be surprising if we got another brutal bear market so soon after the 2000-2002 collapse. Bear markets like that just don't roll around that often. In addition, valuations today are less alarming than they were in early 2000. That suggests today's newly minted retirees should survive their crucial first five years without a truly catastrophic market decline. On the other hand, neither stocks nor bonds are cheap. The implication: Long-run performance is likely to be lackluster, so retirees shouldn't be too aggressive in drawing down their portfolios. "We're in a period of modest inflation and modest returns," figures Mr. Levin. "Outside of some big surprise event, I think it's unlikely we'll see a large market correction. But I also don't anticipate huge market returns."
The penalty for ignoring that tectonic shift was huge. On average, blue-chip value mutual funds have generated about twice the investment returns of their growth-stock counterparts over the last five years. People who have been light on value stocks in their 401(k) portfolio or other investments have paid a price. They may be much further behind in their savings plan than they had expected. Now, the buzz on Wall Street is that growth stocks - specifically, the biggest of the big names in that sector - are returning to favor and could be poised for a multiyear stretch of strong performance. It could be bunk. The same buzz was out there a year ago, but the stocks couldn't muster much of a run. Still, growth and value have repeatedly traded places on the market leader board. After nearly seven years with value on top, "by virtue of time, of course, the odds get better for growth," said Daniel Wiener, editor of the Independent Adviser for Vanguard Investors newsletter. But even if the market is turning, picking winners among individual stocks and mutual funds may be no simple task. What looked like a growth stock seven years ago may look like a value stock today - which raises the possibility that traditional value fund managers may again be in the right place at the right time. "Growth" and "value" are to investing what "conservative" and "liberal" are to politics: generic terms that suggest polar opposite points of view, when in reality the differences between them often are shades of gray. Growth and value always are in the eye of the beholder. A common refrain on Wall Street these days is that many big-name growth stocks of the 1990s have become value issues. After badly lagging behind the broader market over the last six years, the stocks are reasonably priced compared to earnings and ready to rebound, some assert. Cases in point are Microsoft and Intel. Both are holdings of the Third Avenue Value fund, managed by Martin Whitman, one of the pillars of the value-investing discipline. It would have been impossible to imagine Whitman touching most technology stocks in the bubble days of the late 1990s. But this year, Whitman said, he was able to buy Microsoft and Intel each for less than 15 times annual earnings per share. (He arrived at that price-to-earnings ratio by first subtracting the per-share value of the cash on the companies' balance sheets from the stock prices.) By comparison, the average blue-chip stock in the S&P500 index is priced at about 16 times estimated 2006 operating earnings, without adjusting for cash holdings. "When Marty Whitman is buying Microsoft, you know something has changed in the world," said Russ Kinnel, director of mutual fund research at Morningstar. Yet Microsoft, Intel and other major tech stocks also still qualify as bona-fide growth stocks to many fund managers of that persuasion. Growth Fund of America, managed by the American Funds group, had Internet search leader Google as its largest holding as of Sept. 30, according to the company's website. The fund also had tech titans Oracle, Cisco and Microsoft among its 10 biggest holdings. Paul Herbert, an analyst at Morningstar, notes that Growth Fund of America has always had "an eye for value," despite its growth moniker. So it isn't surprising that, like Whitman, the fund's managers would find some tech stocks too cheap to ignore, he said. But in a recent report, Herbert said he was concerned that Growth Fund of America "doesn't appear to be very well positioned for the rebound in the type of beaten-down large-cap growth names that appear to be the cheapest right now." When many on Wall Street think of classic growth stocks, the names that pop up tend to be those of old-line consumer-oriented companies such as Wal-Mart, McDonald's, Pfizer and Time Warner. All have been miserable stocks to own since 1999. Is it their time to shine again? Money has been flowing into many of those issues since mid-July, when the overall market turned decisively higher. Pfizer shares have soared 23.1% since July 17, more than double the 10.6% gain of the S&P 500 index. In the same period, McDonald's is up 21.3%, Time Warner 21% and Wal-Mart 12.6%. By contrast, old-school value stocks such as machinery giant Caterpillar and Citigroup have lagged. Caterpillar is nearly unchanged since mid-July; Citigroup is up 8.6%. Why should the classic growth stocks come back into favor? Sheer momentum is one factor: Once money starts pouring into a market sector, the trend feeds on itself. Hedge funds and other opportunistic investors can't stand not to be on the train. Fundamentally, there's an argument that investors again are appreciating the global reach and financial stability of established growth companies without having to pay the stratospheric price-to-earnings ratios that the stocks commanded in the late 1990s. Even so, it's reasonable to wonder whether the stocks are cheap enough, given that, as mature companies, their growth prospects naturally aren't what they used to be. The good news is that the confusion over whether to affix a growth or value label to some of the stocks means they have fans on both sides of the aisle. Shares of drug company Pfizer meet the criteria of growth portfolios such as the T. Rowe Price Blue Chip Growth fund. They also meet the strict value criteria of Jim Cullen, co-manager of the Pioneer Cullen Value stock fund. Cullen's fund limits its holdings to stocks whose price-to-earnings ratios are in the bottom 20% of the market universe. "The Achilles' heel of investing is overpaying," said Cullen, reciting the mantra of the value school. Many growth investors learned that the hard way seven years ago. They think they're a long way from overpaying now, but they'll only know that in time.
The recently ended third quarter, which many people regarded as a stellar period for stocks, is a case in point. The S&P500 index posted gains of 5.7% in the quarter, but long-term Treasury bonds generated total returns of 6.7%, Mr. Bernstein noted. And long-term high-quality corporate debt gained 7.1%. “In this environment, you want to be broadly diversified,” he said. What’s more, the same forces that would cause the Fed to cut rates next year are likely to be a boon for bonds. “Inflation is always the main focus of bond investors,” said Mario DeRose, fixed-income strategist at Edward Jones. “And typically, when the Fed begins to cut rates, they do so because they are no longer worried about inflation.” In fact, inflation fears often subside well before the Fed begins to trim rates. Historically, the bond market has rallied soon after the Fed has stopped raising rates — in anticipation of future rate cuts. Since 1980, there have been five periods in which the Fed has paused after a series of rate increases, just before starting a series of rate cuts. During these periods, the Lehman Brothers aggregate bond index returned 8.9%, on average, according to Mr. Stovall. During the same periods, on average, the S&P500 rose by only 2.3%. Clearly, the bond market tends to rally as investors pour money into fixed-income securities in an attempt to time the market. Adding to the allure of bonds during these transitional periods is the uncertainty surrounding the financial markets, Mr. Stovall said. And during uncertain times, investors often prefer to be paid to wait in bonds than to take chances on stocks. To be sure, some people would argue that bonds are unlikely to outperform stocks this time around because long-term bond yields remain at historically low levels. The 30-year Treasury bond isn’t even yielding 5%. But even if long-term interest rates are low, they can still go lower. After the Fed decided to hold interest rates steady at its August meeting, yields on 10-year Treasury notes fell to 4.63% by the end of the third quarter, from around 5%. (They have since rebounded slightly, to around 4.8%.) “The greater risk going forward this year is that rates will go lower, not higher,” Mr. DeRose said. This risk stems from the distinct possibility that the economy will slow much faster than the equity markets anticipate. That could happen if the housing market cools much faster than expected. Another clue to the likelihood of falling interest rates is the shape of the yield curve. Anthony Chan, chief economist at JPMorgan Private Client Services, recently studied inverted yield curves, which are often a precursor to a recession or a milder economic slowdown. He discovered that inverted curves generally don’t correct themselves because long-term bond yields rise. Instead, both short- and long-term rates tend to be lower six months after yield curves invert. The only difference is, short-term rates tend to fall faster than long-term yields. Since 1978, yields on 10-year Treasuries were down 0.66 percentage point, on average, six months after yield curves inverted. Yields on two-year notes, meanwhile, were down by 1.21 percentage points. So don’t be surprised if long-term rates fall further. Mr. Chan says it will be hard to know which of these two asset classes — stocks or bonds — will outperform in the coming months without knowing when the Fed will start to trim rates. “If the Fed ends up easing sooner rather than later — or sooner than it should — that’s likely to benefit the equity markets,” he said. That’s because inflation-fearing bond investors won’t be in a bullish mood if the Fed starts to cut rates before it eliminates all inflation threats. On the other hand, he said, “if the Fed waits longer than expected before it cuts rates, then the bond market will probably outperform,” Mr. Chan said. That’s because bond investors will be convinced enough that inflation has been stamped out. “In this scenario,” he said, “the bond market will have nothing to fear.” And that has to be a bullish sign for bonds.
Lately, funds based on covered-call strategies have re-emerged like cicadas. Now they are generally called “buy write” funds and sold as closed-end rather than open-end mutual funds; 21 of them have popped up in the last two years, according to Lipper. Bill Sickles, a senior research analyst at Lipper, says investment firms hope the funds’ combination of equity exposure and current income may entice aging baby boomers. “There’s a big marketing push on,” he said. A covered-call fund sells options to generate cash and thus guarantees itself a modest return from them, but, in doing so, it also limits its possibility of big gains. (The option buyers, for their part, get the right to “call away” the fund’s shares if they hit or exceed agreed-upon prices.) Fund shareholders must still bear the risk of losing money from large stock-market losses. When the market treads water, “people look for added returns,” Mr. Sickles said. “Covered-call funds can give you a little additional return in a sideways market.” Wall Street has introduced a variety of tweaks to the basic covered-call approach. Merrill Lynch, Eaton Vance and BlackRock have introduced new funds. At Eaton Vance, the Tax-Managed Buy-Write Income fund aims to beat the total return of the S&P500, while its Tax-Managed Buy-Write Opportunities fund splits its money, aiming to beat the S&P with one pool and the Nasdaq 100 with the other. The BlackRock World Investment Trust, roams the world and can invest as much as 25% of its money in debt. A 2004 study by Ibbotson Associates found that, for 16 years starting in the late 1980’s, a covered-call portfolio would have slightly beaten the S&P500, while its returns would have zigzagged less. Ibbotson’s report gave the strategy a boost, as did the creation in 2002 of a covered-call index by the Chicago Board Options Exchange. The index, called the BuyWrite Benchmark Index, tracks the performance of a passive investment in the S&P500 paired with a monthly sale of an S&P500 index call option. The “buy write” name is shorthand for the approach: an investor buys stocks and then writes call options on them. The covered-call strategy has plenty of detractors. Even one fan points out that the sorts of returns documented by Ibbotson could disappear as more investors piled on. Robert Whaley, a professor at the Owen Graduate School of Management at Vanderbilt, helped the Chicago Board create its index. In a 2002 study, he showed that from 1988 to 2001, the strategy would have had about the same return as the S&P500 but only two-thirds the risk. Ibbotson built on his work by stretching the time frame. While doing his research, Professor Whaley discovered that index options sold for more than financial theory says they should. Heavy demand by institutional investors for options pushes up their value, and that premium plumps the return of the covered-call strategy. But as new funds crowd into the market, they may gobble up the premium, Professor Whaley said. “What you have is all these funds jumping in and systematically selling calls, and maybe that will bring the prices back into alignment,” he explained. “That could destroy the strategy, though that hasn’t happened yet.” Alan Marcus, a finance professor at Boston College, remains skeptical of the covered-call approach. He faults what he calls “the peculiar and not particularly attractive risk profile.” Covered call funds are still exposed to big drops in stock prices. “This isn’t the way that most people would choose to hedge — that is, keeping all the risk of a downturn while getting rid of all the opportunity of a major market upside,” he said. And any complex strategy imposes additional costs that eat into an investor’s return. The covered-call funds tracked by Lipper have an average expense ratio of 1.3%, whereas the ratio at big index funds typically is much lower: 0.18% at Vanguard’s 500 Index stock fund, for example, and 0.2% at its Total Bond Market Index fund. Another potential difficulty of the current covered-call funds is that they typically operate with a closed-end structure - sometimes, the shares trade at a discount, and other times at a premium. Many fund managers like the closed-end setup because it frees them from wrestling with daily inflows and outflows of money caused by the customer purchases and withdrawals common in open-end funds. That lets them focus on picking investments.
If we take a simple average of the quarterly percent changes posted by the index from 1996 through 2005, the fourth quarter towers over the other three. By my quick calculation, the fourth quarter averaged a 7.8% gain, compared with a 3.7% advance in Q2, a 1% rise in Q1, and a 3.9% loss in Q3. As long as you stayed in the market, and didn't jump in and out at just the wrong times, the fourth quarter alone was often enough to make your year. With compounding, the S&P 500 climbed through those October-December periods at an average annual rate of 35%. Why this skewed pattern? All sorts of elaborate explanations offer themselves. Maybe it results from mutual funds reinvesting money raised by weeding out their losers as they prepare their portfolios for yearend. Maybe it's the handiwork of calendar-conscious traders trying to stay ahead of the famous January effect, a long-studied tendency for stocks to rise at the start of a new year. Or maybe it has something to do with the holding of U.S. elections in early November. In some recent presidential and congressional election years, great angst has surrounded the counting of the ballots. Once the outcome is known and it becomes clear that the republic is still functioning, relief rallies often occur. Gridlock is good? As it happens, there is an election coming again this year. It's a midterm election, with no presidential race -- but nevertheless a source of much uncertainty over whether the Republicans will keep their majority in Congress, or whether the Democrats might gain control of the Senate, the House or both. Should power wind up divided, expect to hear echoes of that popular 1990s watchword on Wall Street, `Gridlock is good!' This maxim holds that a standoff in Washington helps minimize the chances of any troublesome legislative surprises. So the timing is ripe for a new study that challenges the validity of this theory. Where stocks are concerned, it's `a myth,' say researchers Robert Johnson, Scott Beyer and Gerald Jensen, writing in the Financial Analysts Journal. `Political harmony, when the same party controls Congress and the White House, is more favorable to equities as returns are both higher and less volatile during these periods.' Gridlock does appear to help bond returns, they acknowledge: `This finding supports the view that gridlock leads to a slowdown in legislative action, which in turn dampens government spending, inflation and deficits.' For any would-be rider on stocks' fourth quarter gravy train, another question must be addressed. Just as the January effect has shown signs of shifting to December or even November, is it possible the fourth quarter rally is migrating back to the third? In 2005, the S&P 500 posted a better gain in Q3, 3.1%, than its fourth-quarter advance of 1.6%. This year, the index rose 5.2% in Q3, not including dividends, for its best July-September showing since 1997. As soon as any pattern like the Fourth Quarter Cornucopia comes to be recognized in the markets, investors start negating it by acting on it ahead of time. It really doesn't matter whether the perceived repetition results from real calendar forces, or mere random accident. Patient, long-term investors have the luxury of viewing all this with a certain bemused detachment. The buy-and-holder doesn't care so much when the stock market rises, as long as it finds a way to keep doing that at one time or another. So if the fourth-quarter bonanza is fading, well then, long live the third-quarter effect.
While there's a good chance Q2 profits, at 12% of GDP, will be revised down based on upward revisions to personal income, it's still premature to conclude that the era of big margins is over. And stock prices seem to be reflecting that optimism. So why is the bond market so glum? Long-term rates have been consistently below the federal funds rate for three months, a harbinger of bad economic times. They can't both be right, can they? Let's look at the underlying dynamics of each market. Now that housing is past its prime, corporate profits remain the brightest spot of the expansion, rising 18.5% in Q2 from a year earlier, a touch above the average for the last four years. Since the fourth quarter of 2001, the official trough of the recession, corporate profits have doubled while nominal GDP is up 29%. `Corporate profits are an important signal of the future direction of the economy, although they are also an indicator with relatively long leads,' says Gail Fosler, chief economist at the Conference Board. With a couple of exceptions, `most recessions have been preceded by a well-defined turn in corporate profitability of three to seven quarters,' she says. On the performance of corporate profits alone, then, there is no sign of recession on the horizon. However, it appears that `non-financial corporate profits have peaked, and they're normally a leading indicator' of overall profits, Fosler says. Profits for non-financial corporations fell 3.6% in the second quarter from the first. It was the first decline - excluding the Hurricane Katrina-related drop in the third quarter of 2005 - since Q1-03. If the inverted yield curve is right, and the economy is looking at a period of sub-par performance (Fosler's forecast), shouldn't stock prices reflect expectations of slower revenue and profit growth? Not necessarily, according to Bob Barbera, chief economist at ITG/Hoenig, who sees nothing inconsistent about stocks and bonds doing well. `To date, it's been a prototypical mid-cycle slowdown model,' he says. `The economy slows, the Fed is done tightening, bonds rally and stocks take their information from bonds as to how to value earnings.' Because future earnings are typically discounted to present value using a risk-free rate, such as the 10-year Treasury note, `falling interest rates allow stock prices to go up even in the face of an obvious slowdown for earnings,' Barbera says. Barbera points to previous periods when stocks struggled (1984 and 1994) in the face of strong profits because of the rise in long-term rates. `Once Fed tightening is over - and the Fed usually has to take a couple of those moves back - the stock market focuses on lower discount rates rather than slower earnings,' he says. Economic growth `is slow enough to keep the Fed on hold, bring core inflation down and deliver respectable earnings,' says Steven Einhorn, vice chairman of Omega Advisors, a New York hedge fund. `It's the sweet spot for equities.' But if the inverted yield curve persists for several more months - it would reinforce the idea of recession next year. If the yield curve inversion persists and deepens, the odds of a shipwreck will only increase. Fellow travelers for now, the rising stock market and inverted yield curve cannot coexist forever.
With the help of favorable labor costs and robust consumer spending, the profits of S&P500 companies more than doubled from 2001 to 2005, according to Zacks Investment Research. S.& P. 500 profits now stand at 8.6% of GDP, a high-water mark in Commerce Department data reaching back to 1947. And analysts predict that the median S&P500 company will enjoy 12.8% profit growth this year and 12.9% in 2007, according to Zacks. Not so fast, warns Thomas Doerflinger, equity strategist at UBS. Noting that analysts were projecting lush technology profits just as the bubble was about to burst in 2000, Mr. Doerflinger wonders if they might be repeating their mistakes. Weakness in housing and a slowdown in consumer spending will eat into profit growth next year, he said. “We are looking for a significant slowdown” in profit growth, to about 4% in 2007, he said. William Priest, chief executive of Epoch Investment Partners, which manages over $3 billion in mostly institutional assets, says he believes that some factors that have swelled corporate earnings in the last few years are beginning to turn. Access to cheap labor overseas, along with productivity gains in the United States that have exceeded wage gains, created the best of all worlds for big companies, Mr. Priest said. “You essentially doubled the labor pool without really changing the capital pool,” he said. “The developed world has benefited tremendously. Unit labor costs have declined dramatically.” But, he warned, “this is all changing as we speak.” Wage gains have begun to outstrip productivity gains, and much of the advantage of cheap offshore labor has already been exploited, he said. Mr. Priest also expects to see increasing evidence of retrenchment by consumers. “In the last few years, there’s been an acceleration of consumption relative to income,” he said. “It’s essentially come from the home A.T.M. machine.” But the combination of higher interest rates and declining property values in many areas will make it harder for consumers to draw on the value of their homes. Over all, Mr. Priest expects profit growth to slow to 3% to 5% next year. Even more pessimistic is Douglas Cliggott, chief investment officer at the hedge fund Race Point Asset Management. Mr. Cliggott expects profits to shrink next year by 10% to 15%. “We’re downshifting from a very favorable environment,” said Mr. Cliggott, who bases his forecasts on a macroeconomic model. Over the years, he said, there has been an “almost perfect correlation” between corporate profits and changes in four factors: household savings, the government deficit, the trade balance and business investment (which includes capital expenditures and residential construction). Increases in investment spending and government budget deficits are positive for corporate earnings, as are an improving trade balance and a decline in household savings (which generally accompanies a climb in consumer spending). Since 2001, he noted, overall corporate profits have doubled, to more than $1 trillion. Contributors to that gain include a cumulative $440 billion increase in investment, a $375 billion expansion of budget deficits and a $140 billion decline in household savings. The only negative during the period was a $405 billion widening of the trade deficit. But Mr. Cliggott says he sees several positive factors turning into negatives over the next year or so. Consumer spending and investment in residential construction will both drop, he said, and he expects the budget deficit to narrow. Capital spending should climb and the trade deficit should shrink, he contended but these two positives for profits will not be enough to offset the other factors. Because he expects rising exports to be a bright spot for the domestic economy, he favors investing in strong export industries like farm equipment and aerospace. Consumer-staple and pharmaceutical stocks, traditional defensive plays in a weakening economic environment, should also fare well, he said. Mr. Priest agreed that “our exporters will do better than importers.” He also favors farm equipment companies, along with industrial and oil service equipment businesses. He would avoid real estate, bank and mortgage companies and retailers. Predictions of a worsening housing slump that eventually crimps consumer spending are at the heart of bearish profit forecasts. But some of the more bullish market watchers do not believe that housing woes will set off a full-blown, profit-smashing recession. “People still have a large reservoir of housing net worth they can draw on” said Brian Gendreau, investment strategist at ING Investment Management. “Industries boom and bust simultaneously,” and “housing could bust and other industries continue to flourish” said Steven Wieting, lead economist for domestic equities at Citigroup. Slowing profit growth would not necessarily mean falling stock prices, said Mr. Doerflinger of UBS. Price-to-earnings multiples have declined in recent years, he said, as profits have grown faster than stock prices. If profit growth slows, investors may be willing to pay higher multiples, allowing stocks to rise even as profit growth stalls. Mr. Cliggott, by contrast, says he believes a market that has been strengthened by rising earnings will fall with weakened earnings. “Robust corporate profits have supported equity markets in the face of rising interest rates and steeply rising energy costs,” he said. But with an anticipated 10 to 15 percent profit drop next year, he added, “we’re expecting the market to go down.” At Zacks, which compiles the analysts’ forecasts that now call for double-digit earnings gains through next year, the research director, Dirk Van Dijk, wonders whether the rosy numbers will come to bloom. “There is some doubt in my mind as to the ’07 numbers,” he allowed. “There are a lot of yellow flags out there in the macro picture.” One concern is a sharp decline in the ratio of positive to negative revisions in analysts’ earnings forecasts. In late August, the ratio stood at 1.35. Since then, it has fallen to 0.80, with downgrades now exceeding upgrades for the first time all year. Mr. Van Dijk called the increasingly pessimistic ratio “the canary in the coal mine. I don’t want to overplay the decline in the revisions ratio, but it is a trend that bears very close scrutiny going forward,” he said. “If we see this trend continue, it’s time to be afraid — and very afraid.”
It may have to do with how long this bull market is taking to bring stock prices back to their previous highs. It’s been more than six years since equity prices peaked. Although the S&P500-stock index has rallied for four consecutive years, that benchmark is still 13% below its highest close in the previous bull market. The Nasdaq is still down 55% from its record high. The Dow is near its all-time high close. But one reason that the Dow may have recovered faster is that it had a shorter path to travel. From peak to trough, the Dow fell 38% in the most recent bear market. The S&P fell 49% and the Nasdaq 78%. Historically, the S&P has needed 3.3 years, on average, to return to new highs after suffering through a bear market, according to an analysis by InvesTech Research. This time it may take significantly longer. For starters, the bear market that preceded this bull was no ordinary sell-off. “It was the bursting of the largest bubble in U.S. capital markets history,” said Robert Arnott, chairman of Research Affiliates. Investors must realize that “great bear markets have a lasting effect,” said Jeremy Grantham, chairman of Grantham, Mayo, Van Otterloo, the asset management firm. This hangover continues to influence the market today, he said. What’s more, not all bull markets are created equal. Many, in fact, have simply not been strong enough to return stocks to their previous highs. Since September 1900, there have been 33 bull markets, according to Ned Davis Research. Of those 33, only 15 were able to establish new all-time highs. In other words, more than half of all bull markets fail to return stock prices to their prior peaks. Much of this depends on what kind of bull market you’re dealing with. First, there are cyclical bulls and bears, which run their course in the span of a few years. Then, there are longer-term, secular bull and bear markets; those can last for decades. Many market strategists say that the current bull market is a cyclical rally stuck within a secular bear. One telltale sign is that the S&P has yet to revisit its record high. Consider, too, the modest range of the recent four-year rally. “While this has been one of the longest bull markets we’ve seen historically,” Mr. Arnott said, “it’s also been among the weakest.” From the market trough in Oct. 9, 2002, the S&P500 has climbed 72%. By comparison, the average bull market has returned almost twice as much from trough to peak, based on data back to 1932, according to InvesTech. The solid but unspectacular returns are a classic symptom of a cyclical bull within a secular bear market, said Jeffrey Hirsch, editor in chief of the Stock Trader’s Almanac. Mr. Hirsch recently studied past cyclical bulls trapped in secular bears. In those instances, the Dow rose by only around 35%, on average, going back to 1929. By comparison, cyclical rallies within secular bull markets have typically pushed stocks higher by 110%. For the record, the Dow is up by about 60% in the current bull market. The last cyclical bull market to occur within a secular bear started in October 1974, according to S&P. It’s hard to miss the similarities between today’s market and that one. Sam Stovall, chief investment strategist at S&P, noted that the bull that started in 1974 produced gains of 38% in the first 12 months, 21% in the next 12 months, a loss of 8% in the third year and 7% gains in the fourth and fifth. In the current bull run, the S&P500 gained 34% in the first year, 8% in the second and 7% in the third. And it is up by about 12% so far in the fourth. Mr. Stovall added that the two periods have other things in common, like “high oil prices, concerns over inflation, fallout from an expensive and unpopular war and a not-so-popular Republican president in his second term.” If this is a secular bear market, how long until it goes back into hibernation? That’s hard to say. Given the enormity of the late-90’s bubble and the duration of past secular bear markets, Mr. Arnott said, it could be that, taking inflation into account, “15 years from now, stock prices won’t be materially higher than they are today.” If he’s right, investors will have to rely less on capital appreciation and more on personal savings to help them reach their investment goals. “They’re going to have to save more aggressively to get ahead,” he said. Investors must also reset their overall expectations. Just because we’re in a bull market right now, the stock market won’t necessarily produce the 20-percent-plus annual gains to which investors grew accustomed in the late 1990’s. “Forget it,” Mr. Arnott said. “Wake up — this is a different market.”
Investors with a moderate appetite for risk often opt for a 60% stock/40% bond mix. But, truth be told, this classic "balanced" portfolio hasn't lived up to its low-risk reputation - until recently. Consider some data from Ibbotson Associates. In the late 1950s, there was a negative correlation between stocks and bonds, meaning that when one rose, the other often fell. But the correlation turned positive in the 1960s, as stocks and bonds increasingly moved in lockstep. And the relationship only got stronger from there. By the 1990s, there seemed scant reason for stock-market investors to own bonds, because bonds appeared to offer so little diversification. To understand how we got to that point, think about the economic environment. Inflation surged during the 1960s and 1970s, driving interest rates higher. That long rise in rates hurt bond prices, which move in the opposite direction from yields. At the same time, the new higher bond yields were a drag on stocks, which now seemed less appealing. All this went into reverse in the 1980s and 1990s. Falling interest rates drove up bond prices, while also spurring interest in stocks, as investors sought alternatives to low-yielding bonds. "I really feel that that mountain, where we got a big rise in interest rates and then a big decline in interest rates, is a nonrecurring event," says New York economic consultant Peter Bernstein. "The whole fixed-income environment is likely to be more like the distant past, before the late 1950s. If interest rates are going to move in a smaller range and without these long trends, then bonds should again be a good diversifier for stocks." That's certainly been true so far this decade. In fact, the correlation between stocks and bonds has been negative, just as it was in the late 1950s. Will this low correlation continue? I suspect so. A combination of government vigilance and global competition should keep consumer prices largely in check. That means we probably won't see stocks and bonds buffeted by big interest-rate swings. Instead, the normal business cycle will loom much larger. When the economy is growing briskly, stocks will gain as investors anticipate higher earnings, but bonds will struggle as folks worry that an overheating economy will drive inflation higher. Conversely, when recession threatens, stocks will suffer as investors fear slower earnings growth, but bonds should thrive as inflationary pressures recede. Sound like good news for the good old balanced portfolio? There is a downside. While bonds may be a better diversifier for stocks in the years ahead, we won't see the huge bond-market gains enjoyed in the 1980s and 1990s, because interest rates are now so much lower. That shouldn't, however, stop you from buying bonds. You don't use bonds to maximize return, you use bonds to diversify a portfolio. Bonds play two crucial roles. Not only do they lower a stock portfolio's volatility, but also they can be easily sold at any time to generate spending money. Still, all this raises a key question: Given that we won't have the tailwind of falling interest rates, how should you construct the bond side of your balanced portfolio? Investment advisor Nelson Lam suggests dividing a bond portfolio so that a third is in U.S. bonds, a third in foreign bonds and a third in inflation-linked securities. "If we ever get wholesale overseas selling of our bond market, the one bond they won't be selling is munis, because the only people who own munis are U.S. taxable investors," Mr. Lam notes. "International bonds are the most important element in the bond strategy, because they offer the greatest diversification for a U.S. balanced portfolio," Mr. Lam says. "While emerging-market debt has been on quite a run, its diversification and risk characteristics are fantastic. Over a 10-year horizon, emerging-market debt is a must." Monthly Employment Stats
Health care employment continued to grow, with a gain of 24,000 in September. Within the industry, ambulatory health care services (which includes doctors’ offices and home health care) and hospitals added jobs. Since December, health care employment has increased by 231,000. Financial activities gained 16,000 jobs in September, as employment continued to trend up in credit intermediation and insurance. The monthly gain was about in line with the industry’s average monthly gain during the past year. Real estate employment was flat over the month and has shown no net change since April. Within professional and business services, accounting and bookkeeping services added 10,000 jobs in September, and employment in the management of companies and enterprises grew by 6,000. Temporary help services employment was little changed over the month and has been relatively flat in 06. Professional and business services employment has risen by 416,000 over the past 12 months. Elsewhere in the service-providing sector, employment in food services and drinking places edged up in September (+15,000). Over the month, employment continued to trend up in the durable goods component of wholesale trade. Within the retail trade industry, sporting goods, hobby, book, and music stores lost 8,000 jobs, as did general merchandise stores. Since its most recent peak in August 2005, retail trade employment has declined by 116,000. In the goods-producing sector, employment in mining was flat in September. Reflecting the continued slowdown in the housing market, employment in construction was little changed over the month. Job losses in residential specialty trade contracting nearly offset gains in nonresidential specialty trade contracting and in heavy construction. Job gains in construction have averaged 6,000 per month since February of this year compared to increases of 27,000 per month during the 12-month period ending in February. Manufacturing lost 19,000 jobs in September. Within durable goods, factory job losses occurred in several industries that are related to home building—wood products, nonmetallic mineral products, and furniture. Employment continued to trend downward in a number of nondurable goods manufacturing industries, including textile mills, plastics, and paper products. The average workweek for production or nonsupervisory workers on private nonfarm payrolls was unchanged at 33.8 hours in September, seasonally adjusted. The manufacturing workweek decreased by 0.2 hour to 41.1 hours, and factory overtime was down by 0.1 hour to 4.3 hours. Average hourly earnings of production or nonsupervisory workers on private nonfarm payrolls rose by 4 cents, or 0.2%, in September to $16.84, seasonally adjusted. Average weekly earnings increased by 0.2% in September to $569.19. Over the year, both average hourly and weekly earnings increased by 4.0%.
Quick Facts, Stats & Opinions IRS Tax Stats Scott Burns, Dallas Morning News 10-15 In 1986, according to the Internal Revenue Service, the top 10% of all households had incomes of $48,656 or more, collected 35.1% of all income and paid 54.7% of all income taxes. They paid an average tax rate of 22.6%. By the recently released figures for 2004, the top 10% of all households enjoyed adjusted gross incomes of $99,112 or more. They collected 44.3% of all income. And they paid 68.2% of all taxes at an average rate of 18.6%. Lower tax rates on top-earner income had the beneficial result of reducing the portion of the tax burden the other 90% had to pick up. The bottom 90% of all households collected 55.7 percent of all income. But they paid only 31.8% of all taxes. Better still, they paid at an average rate of only 6.9%. You're pretty much excused as a taxpayer if your income is in the bottom 50%, about $30,124 or less in 2004, because your average tax rate will be only 2.94%. Buybacks Stealing Cash from Dividend Raises Stephen Taub, CFO.com 10-03 During the third quarter, 377 of the approximately 7,000 publicly owned companies that report dividend information to Standard and Poor's increased their dividend in 2006. This total represents a drop off from last year, when 3.6% of the 391 issues increased their dividend during Q3-05. What's more, September 2006 dividend increases declined 17.6%, to 89 from the 108 recorded in September of last year. The declines mark the first downturn in dividend increases since their rebirth in 2003, S&P noted in a press release. Why the downturn? It can be traced to the rapid rise in share buybacks, said S&P Senior Index Analyst Howard Silverblatt. Companies are increasingly rewarding shareholders with what it calls dividend extras, such as one-time dividend increases and special dividends. The number of dividend extras increased by 12.8% to 88 during Q3-06, up from the 78 recorded during the same period last year. In fact, overall dividend payments continue to rise, posting a 9% year-to-date gain over 2005, and a 21.3% gain over 2004, added S&P. John Authers writes in the Financial Times that the "rule of 20," used in the 1950s and 1960s to value the stock market -- subtract the inflation rate from 20, and that's the price-to-earnings ratio -- could be back in force. "Now inflation is in low single figures, multiples are in the teens, conditions look a little like those of the 1960s and the rule may again have its uses. Nerves about inflation on both sides of the Atlantic have been coupled this year with reductions in earnings multiples," he writes. (David Gaffen, WSJ 10-25) The past three months have been some of the best for the three major market indexes in quite a while, according to figures from Birinyi Assoc. Coming into today, the Dow, S&P and Nasdaq had gained, respectively, 11.02%, 11.49%, and 16.59% in the past three months. It's been a long time since all three indexes had a better three-month period at once, but the individual indexes have. (David Gaffen, WSJ 10-24) Financial engineering of year-over-year earnings continues via share buybacks. About a third -- 5 of the 15% E gains -- are due to the massive stock buybacks we have seen. According to Merrill Lynches David Rosenberg, this has reduced share count to the point of improving earnings by that third. Using a scanner built from commonly available components, researchers at the University of Massachusetts, Amherst, were able to retrieve sensitive data from credit cards that use RFID technology. Other tests have shown that often the data on RFID chips can be read several feet away, and the researchers in this test pointed out that even if closer proximity is necessary, someone could walk among people in a crowd and easily get within a few inches of credit cards in wallets and purses. Although the test was of a relatively small sample, the researchers also found that many of the cards transmit name and card number without encryption or with encryption that was easily cracked. (New York Times 10-23) Only 4% of American investors trade more than 10 times a year, according to Forrester Research. (J. Alex Tarquinio, NY Times 10-22) The Bank of America offer for free online stock trades has a few conditions: [1] keep $25,000 minimum deposit in traditional federally insured bank accounts like checking, savings, money markets and certificates of deposit; [2] limit of 30 free trades a month; [3] limited to orders that are entered on its Web site for stocks and exchange-traded funds. Bank of America’s online brokerage customers have free access to research from Standard & Poor’s, Argus Research, Briefing.com and Thomson Financial. Fidelity’s cheapest rate for an online stock trade is $8. You can qualify for it with as little as $25,000 in assets - but only if you trade at least 120 times a year. If you have $25,000 and trade at least 36 times a year, the cost is $10.95 a trade. Fidelity’s top rate for online stock trades is $19.95. If you have an account at TD Ameritrade, you pay a flat $9.99 for an online stock trade. (J. Alex Tarquinio, NY Times 10-22) As relatives of the 401(k) plan, 403(b)s are typically sold by brokers and insurance agents, carry above-average mutual-fund expenses and layers of other fees. Designed as supplemental retirement plans for teachers and other employees of nonprofit institutions, they are among the costliest retirement vehicles on the market. According to the Spectrem Group, a Chicago-based research firm, of the estimated $600 billion invested in 403(b)s through 2005, almost $500 billion was in variable or fixed annuities. (John Wasik, Bloomberg 10-08) The Dow Jones Industrial Average didn't manage to set a new record last week. But hang on. History suggests there's a good chance it will after the Nov. 7 election. Stocks tend to do very well following midterm elections, which occur two years into each presidential term. Indeed, since 1950, the average return for the Dow Jones Industrial Average from the November of a midterm-election year through the following October has been 18.6%. That's far better than the average annual gain of 8.4% from November 1950 through October 2003, a year after the last midterm election, in 2002. (Talley & Hadi, WSJ 10-01) Mark Zandi, the chief economist at Moody’s Economy.com, notes that about $2 trillion in A.R.M.’s are scheduled to reset at higher rates from the beginning of 2006 to the end of 2008. If the mortgages adjust upward by an average of 2.5 percentage points, the interest payments by holders of such mortgages would be $50 billion higher in 2009 than they are today. “That’s not much in the grand scheme of a $13 trillion economy, but it is a problem for those homeowners,” Mr. Zandi said. (Daniel Gross, NY Times 10-01) A new study by Robert Kosowski at Imperial College in London shows active managers regularly beat their indexes by as much as 3% -- in down markets. Their record of underperformance is caused entirely by what happens during a bull market, the study concludes. Kosowski has been analyzing this issue for years. In this study, however, he looked at bull and bear markets from 1962 to year-end 2005 and found active managers lagged in bull markets on average between half a percentage point and two percentage points. On the flip side, active managers are able to pick the best stocks in a given sector - stocks that do not fall as hard as the sector index in down markets, where active managers do better. (Thomas Kostigen, MarketWatch 10-03) `Since the start of 2005, the inventory of unsold new homes has climbed 29%, while the stock of unsold existing homes is up a staggering 82%,' says Joe Carson, director of global economic research at AllianceBernstein. `During the sharp, protracted housing downturn of the early 1990s, these inventories actually declined, helping to cushion prices.' Carson figures it will take another 15 percent decline in starts, which are already down 22 percent from the first-quarter average, to cut inventory to below the level of demand, thereby reducing the existing overhang. At the trough of the housing cycle in the first quarter of 1991, starts were down 40 percent from two years earlier. (Caroline Baum, Bloomberg 9-29) Hedge Fund / Private Equity News Briefs Affluent investors could live free of taxes on their hedge fund investments until they die, thanks to 'private placement' insurance. The Wall Street Journal reports that the insurance, a variation on a variable insurance policy, escapes taxation since payment comes only upon death. However, even in life, depending on the setup, policyholders can enjoy the fruits of their investment labor by borrowing or withdrawing from those same policies, also free, even from estate taxes after death. According to The WSJ, investors have used similar types of variable life insurance policies to invest in mutual funds, but the private-placement variety allows a broader range of investment options. The policies are especially attractive for HF investment, says the paper, since short-term gains can be slapped with a 35% federal tax, as opposed to a 15% levy on longer-term investments. These insurance policies also are shielded from creditors, too, but they still may not appeal to everyone because of one significant drawback: To satisfy Internal Revenue Service rules, investors are limited in control and choice of where they can place their money. 'The IRS has very strict rules about investor control and diversifications,' Gideon Rothschild, a New York City attorney, told The WSJ. 'Many high-net-worth people are control freaks and they don't really want to give up control. For many people it just isn?t the right thing.' (DailyII 10-24) With the number of hedge funds closing accelerating, there's talk again that the industry is in for a consolidation. In addition to the big spills of Amaranth Advisors and MotherRock, HF giant Vega Asset Management has seen its assets under management plummet 75% from its $12 billion peak just two years ago (though it reportedly plans to stay in business). More than 2,600 hedge funds have launched since January 2005, according to Hedge Fund Research, but 1,071 have closed during the same period. HFR says in 2005 alone, hedge funds of the total number of operating funds went out of business at a rate of 11.4%, more than double the year before, when 4.7% called it quits. ItÕs not bad news for everyone. The biggest and best hedge funds are just getting bigger and better, which has resulted in an estimated 300 hedge fund managers with more than $1 billion. (DailyII 10-04) Home Page Previous Factoid Top Sites
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