Bob Brooks - Prudent Money Blog

I thought that I would write a quick post today on the stock market.  We really faced the perfect storm of bad news today. 

First, there was the reality that Congress might not bail out the automakers today.  That has very large implications for the economy.  However, a bail-out would only delay the inevitable.  Throwing money into a bad business model is not a good idea.

Second, there was the reality that we could be facing a deflationary recession.  It has been my feeling all along that we are already in a deflationary recession.  Well, today the Consumer Price Index was reported and the news had deflation written all over it.  The Consumer Price Index measures whether prices of goods and services are rising or falling.  Today the biggest drop in 61 years was reported. 

Third, the Federal Reserve Board released their minutes from their last meeting.  In a very unusual move, they were negative and cut growth rates on the economy into 2011.  They also uttered the “d” word (deflation) in their report.

Fourth, the credit markets worsened today.  The credit markets are in worse shape than they were before the bail-out.    

Fifth, the crisis of confidence continues.  It appears that mutual funds and hedge funds are being forced to sell stocks.  Investors are lining up at the window stating that enough is enough.  This is the reason why the last hour of the market is so negative.  That trend continued today where it got extremely ugly in the final hour of trading.

Any good news?

Yes, there is some good news.  I wrote in this blog the roadmap that I thought the market would take in the short term.  Well, we are at the spot that I felt was an inevitable landing spot for the market.  We are now just above the bear market low of 2002.  The stock selling should stop there and then we have the potential to see a good stock market rally.  However, if that level doesn’t hold, it might get ugly.

I don’t think that it will be THE bottom of the bear.  However, it could be A bottom.  For anyone who wants to reduce risk in their portfolio, a good stock market rally affords the opportunity to do so.

The amazing statistic is that the S&P 500 is 48% from the very top back in October 2007.  It is unbelievable that the stock market could be cut in half in just 13 months.

I am going to keep this week’s outlook.  The bottom line is that I think we are near a bottom in the decline.  I didn’t say THE bottom.  I said A bottom.  This would allow for the market to actually recover some of the loss and give investors the ability to lighten up on their stock positions as the market recovers.

This could actually be a significant rebound.  The market is declining in what is referred to as a parabolic move.  The hallmark of a parabolic move is the strength of the move when the market changes directions.  In other words, the stock market could go up very strongly.  However, I do want to stress that I don’t believe this is the end of the bear market. 

For that to occur, I think that the S&P 500 would have to decline down to around 776 and HOLD.  It can go as low as 768.  However, it is very important that the market does not close below 776.  I talked about this pattern in an earlier blog.  If it does hold, we could get that opportunity to see the market recover strongly.

The bad news is what happens if this does not hold.  Unfortunately, the probabilities for another crash-like scenario rise.  The 776 level is about 8.7% below Monday’s close.  However, the next level down in the S&P 500 is roughly another 23% loss.  If that were to occur, I would think that a monster rally would occur.

I must stress that this is a critical point that we find the markets right now. 

The General Motors story is my greatest concern. Ultimately, I think that the auto industry will get bailed out.  However, it might not be in time.  Republicans are digging in their heels and it looks like they are going to be very defiant.  Congress has this week to get this bail-out done.  I have a bad feeling it is not going to happen.  Yes, Republicans are that mad right now.  They didn’t want the bail-out in the first place.  Now, they surely don’t want this one.

They do have a point.  The auto industry is a broken business model.  Bailing out GM would only be the start of things.  It will be a continuous process of throwing our money after bad money. 

ASK Bob Q and A

Currently my 401(k) portfolio has the following distribution. This was done after reading your advice on the coming recession/crisis in July and I have limited my losses to ~12% for the year.  After reading your advice this morning, how can I still make my financial goal for the retirement? 

I am 56 and have half of what I need to retire currently. Since I have 9 years, I need to grow it at 8% annual return to double what I have now. If I stay where I am currently, the best I can do is about 4%, which is 1.4X rather than 2X what I need. I am discounting what I will invest every year in this calculation. That will be kids college fund -They will be in college at this time.

That is a great question.  The key is not to lose big chunks of money.  You have accomplished that so far.  You want to be in position to really get invested when this bear market finishes up.  Unfortunatey, I think that we have a ways to go before that happens.  However, when it does you are going to be in a position of making up for 50% plus losses.  You can make up for lost time due to the strength of the rally that should be coming out of this bear market.  That is how you play it.  Keep watching my writings - when I start to see something positive I will start writing about it.

A Recent Ask Bob

Bob,

It has been a while since I got in touch with you. I wanted to let you know that Discover card sued me on 08-29-08.  I got a lawyer and explained my situation to him and sent him a copy of the settlement letter  and bank statement showing that I had sent Discover Card the money they had settled for.  He found couple mistakes that the court had made, the court changed the date of the jury couple times, and on 10-29-08 the case was dismissed.

If you find yourself in a legal situation over a credit card debt, I always get an attorney.  Credit card companies and debt collectors are way more interested in those lawsuits that go unrepresented.  Unfortunately, that is most of them.  As this case illustrates, there are typically many mistakes in these cases.

It seems that those companies that have helped contribute to the destruction of the US financial system just don’t seem to get the seriousness of their actions.  After all, the Government certainly isn’t going to let a business fail.  So, there really aren’t any consequences for irresponsibility.  Well, executives at these bailed-out companies feel as if they are as entitled today to the good life as they were before the crisis. 

Entitled to Christmas Parties

Lloyd’s of London had recently received 6 plus billion dollars from a Government bail-out.  They also announced the big Christmas party that will be thrown this year to the tune of 3.7 million dollars.  The company representative said that the employees deserved (read: are entitled to) a reward after such a tough year. 

Entitled to a Partridge Hunting Trip

AIG, the poster child for financial irresponsibility, held a big $440,000 retreat on tax payer money.  Then a few of their top execs went partridge hunting.  The trip cost a mere $87,000.

A reporter asked one of the execs about how they were holding up during the financial crisis.  The executive said, “The recession will go on until about 2011, but the shooting was great today and we are all relaxing fine.”  Well, that is good.  I would hate for AIG, who is one of the big reasons why investors have lost all of that investment money, to be stressed about business.

Entitled to Golf

Fannie Mae, just 22 days after receiving a bail-out from the Federal Government, took 14 executives on a golf outing.  That cost the taxpayers $6,279.26.

Entitled to Bonuses

There is a huge debate in Congress about whether or not these companies should pay millions in bonuses to executives.  Are you kidding me?  There should be no debate about it.

I guess we shouldn’t be surprised.  These companies have proven time and time again that they aren’t responsible when given other people’s money.  They especially aren’t responsibile when given taxpayer money that has no strings attached to it.  Yes, Congress basically handed over the money with little or no restrictions.

If you spent it, you owe it!  It is amazing to me how out of control this credit crisis has become.  There was actually a proposal on the table in front of bank regulators proposing that up to 40% of credit card debt be forgiven for consumers who fit a certain criteria.  Finally, someone has enough a sense to say “no”. 

This was proposed by the Consumer Federation and the Financial Services Roundtable.  I am a little amazed that the Consumer Federation of America would be a part of something so ridiculous.  If you charged that big screen TV, you should pay for that big screen TV.  

There is a real simple solution to the debt crisis.  You shut down the practices of these credit card companies and make them treat consumers the right way.  You take away their ability to change the terms and conditions of a credit contract.  You put a limit on how high they can raise interest rates.  You limit their ability to charge fees. 

It is all too simple of a solution.  Unfortunately, Congress and the President do not have the fortitude to do the right thing.  The latest round of credit card regulation in Congress was hardly even considered.  It was a set of mild regulations on the credit card industry.  Of course, the President said he would not sign such a piece of legislation into law. 

The real solution to all of this mess is very simple.  Limit the ability for politicians to serve more than two terms.  Take measures to limit their ability to take campaign contributions from big business.  Finally, take their rock star lifestyle away and allow them to do what they were supposed to do in the first place - be a public servant.  The only reason that any politician would not regulate the credit industry is 100% about politics.   It is supposed to be about protecting the people.  Instead, it is one big conflict of interest.

The plan keeps changing.  First, the bail-out was designed to buy troubled assets off of the books of banks.  That achieves two objectives.  First, it is a step towards making the banking system healthy.  Second, it would enable banks to loan money again.  I never agreed with their reasoning for this first bail-out plan.

Now, Paulson says that the Treasury will not be buying those troubled assets after all.  Instead, they will continue to pump money into these banks and troubled companies and take ownership positions in these companies (read: socialism) .

As a result, the market is selling off today (again) because he just changed the initial intent of the bail-out package which the market originally liked. 

Then he refuses to help GM with a bail-out (which I agreed with).  Today he says that the bail-out package was not designed to help a company like GM.  Secretary Paulson, I have a simple question for you.

What was the bail-out package designed for?  If you don’t bail-out GM, hundreds of thousands of people potentially lose their jobs and then 8% of the corporate bond market is threatened because of bonds from the auto industry.

Since the announcement of your historic intervention, the stock market is lower, the economy is much worse, and the credit markets are in extremely bad shape. 

Paulson’s reasoning for wanting to change the bail-out package was to get the money out there into the banking system quicker and for companies to loan money.  The problem is that they cannot loan money because they are trying to survive.  They are trying to survive because they have all of these bad assets on their books that the Government was suppose to remove through this bail-out plan.  Finally, all of that bail-out money is not getting put to use.  It is going toward absorbing losses and keeping bad businesses a float.

It makes you question the original intent behind this massive Government intervention.  I have this nagging feeling in the back of my mind that socialism is what this Government ultimately wants.  These are smart individuals making some pretty chaotic decisions.  They should know better and their intellect is not matching their actions.

I reported on this idea a few weeks ago about a proposal that was presented in Congress to implement a guaranteed retirement account.   The proposal is for consumers to put back 5% of their income into this account, the government would guarantee a 3% return, and then the consumer would have the ability to receive a second social security type pension pay-out at retirement.

The plan also proposed that the tax deductions for all retirement plans would cease.  You could still invest into your 401(k) plan.  However, you would not get the tax benefit. 

It was proposed that the Government allow for investors to roll their 401(k) plans over into this guaranteed account for a future benefit.  There was also a proposal that investors would get back some of their loss this year if they opted for their 401(k) plan to be rolled over.

Now the media has very irresponsibly caused a stir by misreporting the story.  For instance, one media outlet reports “Democrats in the US House have been conducting hearings on proposals to confiscate workers personal retirement accounts. “

That couldn’t be further from the truth as to what happened.

The original intent of the meeting that was held on October 7^th was about the future of retirement for workers due to the current financial meltdown.  During that meeting, Teresa Ghilarducci, a professor of economic policy analysis at the New School for Social Research in New York, gave this outrageous proposal.  This meeting was about looking at all types of ideas and not a meeting solely focused on this socialistic plan.

Listen to these remarks made byTeresa Ghilarducci –

“Humans often lack the foresight, discipline, and investing skills required to sustain a savings plan. She cited the 2004 HSBC global survey on the Future of Retirement, in which she claimed that a third of Americans wanted the government to force them to save more for retirement.”

In other words, we are to incompetent to handle our own retirement savings and think for ourselves.  So, let us let the Government think for us.  (What the survey actually reported was that 33 percent of Americans wanted the government to enforce additional private savings, a vastly different meaning than mandatory government-run savings.)

“I’m just rearranging the tax breaks that are available now for 401(k)s and spreading — spreading the wealth.”  You have to love it - spreading the wealth.

That is pretty scary in my opinion and these are some very radical, socialistic ideas.  Even more concerning is that some of Congress actually like the idea. 

What are the chances of this type of plan passing?  Maybe better than you might think.  Highly unlikely that Congress is going to “confiscate” retirement plans.  However, 5% of everyone’s income that are not participating in a similar plan would go a long way to put money in the Government Coffers.  They can rob Peter to pay Paul and shore up some current liabilities.  Sounds like a great idea for politicians to explore. 

Keep something in mind – We survived FDR and the Great Depression and we will survive this as well.  America is still a great country.  We are just in need of a huge paradigm shift on how we view money.

Well, lets see - since the Government initiated their enormous infusion of cash in the form of bail-out money, not much has happened.  The Stock Market is still in the hole.  The credit markets by some accounts are worse today than before all of this Government intervention.

Just recently, Hank Paulson said that they were going to take part of that 700 billion dollar bail-out package and help out other companies besides banks and insurance companies.  Old Hank played a great game - get the money first and then change the rules accordingly.  This bail-out package does not look anything close to the original intent.

The Government is also batting around the idea of using some of that bail-out money to help banks cover from losses when troubled mortgage loans are re-structured.  This is the latest invention of the Federal Government in their effort to stop foreclosures.  It appears that troubled borrowers in bad loans are about to get the ultimate gift from the federal government - part of their debt forgiven. 

Now AIG who the Federal Government loaned $ 85 Billion dollars on credit is begging the Government to re-structure the loan because the terms are tough on the company right now.  Didn’t AIG CEO Edward Liddy say something in the effect that they would probably pay that loan off early?  Maybe he was confused after going on a golf outing and resort weekend paid for by you and I.

That mere 86 Billion dollars borrowed by AIG morphed into 123 billion dollars.  Yes, they went back to the Government and the Government gave them some more of our money.  Now, they are about in agreement that the 123 billion will turn into 150 billion in a restructured deal. 

Does anyone think that this has the potential to end real bad?  The Federal Government shouldn’t be in the business of managing anything.

I realize that there are huge problems in this country.  I also realize that President Bush has made some critical mistakes in his running of this country.  After going through this mind numbing election cycle, I come away with a few thoughts,

1)  It was not a Republican problem  - it was a politician problem

In talking to those who support Obama, I find two consistent themes.  First, this is all of the Republicans fault.  Second, the Democratic party will be the answer to change.  Please know, this was a politician problem and the two years of a Democratically controlled Congress just made the problem worst.  Both parties are at fault.   

They are all politicians.   A politician is one whose objective is to get elected and stay elected first and foremost.  That means anything goes.  I really want to be proven that there are those who think differently. Unfortunately, President elect Obama has done nothing in his career that would prove that notion wrong.  I am however, hoping that he changes the world of politics.

2)  This is the opportunity of a lifetime

I do not profess to know the entire history of politics.  From what I do know, this future President has the greatest opportunity afforded any President in decades.  The question is really simple.  Will he take this opportunity to change America for America’s sake?  Will he take this opportunity to build a personal political power base?    This will be the million dollar question.

I hope that my concerns are not validated over the next 4 years.  I hope that he knocks the ball out of the park.  I truly hope that he does the right thing. Although I disagree with most of what he wants to do as well as his idealogy,  I will pray for him as our elected leader and fully support him.  I think that is our responsibility as Christians. 

I want change more than anyone.  This kind of change has nothing to do with Democrates or Republicans.  It has to do with someone being a real leader and not a politician.  A leader who puts the American people first and politics and personal power second.

I plan on writing a full report on my market outlook on Monday. Until then, I thought that I would share some thoughts.  I am amazed at the speed of the deteriation of the economy.  Typically, things gradually decline over a period of time.  The economy seems to of fallen off the cliff.

My biggest concern is that we are maybe only 1/3rd the way through the cycle.  It is also very bad timing at this point being that we are in between two Presidential Administrations.  Thus, you might see Congress get some type of stimulus passed by the end of the year.  The problem is that leaves us very vulnarable for a good two months.

Plus, will that type of package even work?  The administration has thrown billions of dollars at this problem with very little to show for it.  Until then, this is what the US dollar might look like:

I will follow up with a full report on Monday.  I still fill pretty strongly that the market declines down to the October 2002 bear market lows before we get any type of meaningful rally in the stock market.

Well, a very long and historic election process is over and we have a new President-elect.  We can choose to debate the issues and whether Obama is the right man for the job.  We can argue amongst ourselves.  We can take any event and turn it into a negative.

If you are a staunch supporter of Senator Obama, I congratulate you on your candidate winning.  I personally did not vote for Senator Obama.   While voting, I was actually trying to talk myself into voting Libertarian.  I didn’t really care for Senator McCain as President either. 

If it were up to me, I would get rid of all of the politicians because they are the problem.  I don’t agree with Senator Obama’s stand on how we fix the problems this country is facing.  His politics really concern me.   My hope is that his heart is truly in the right place, but as with any politician, we will not know that for a long time. 

Obama has the unique opportunity to take his strengths and unite a country that is broken and divided.  As with any politician, it comes down to the intent behind their actions.  Unfortunately, most politicians are concerned about getting re-elected and their own personal ambitions, not about the goal of the American People.  The jury will be out until time has passed.  I hope that he proves all who doubt him to be wrong.   There is so much at stake right now and huge penalties for any bad decisions.    

Last night was an extremely important night for African Americans.  Although I am not a big fan of how Jesse Jackson goes about his fight for equality, the moment of the night was the expression on his face and the tears in his eyes.  It was a realization for him that all he has fought for throughout his life mattered.

Racism is a real problem in this country.  All Americans now have an opportunity to change that problem.  Individually and collectively we have a choice regarding how we react going forward.  It is time that racism no longer be an issue in this country.   

Most importantly, as Christians, we have the responsibility to support the individual who God has allowed to hold the highest office in the country.  We have the responsibility to pray for our leaders. 

Prayer is what President-elect Obama will need more than anything.  He faces one of the toughest tasks any President has faced in decades.  My hope is that he surrounds himself with very wise individuals who can guide him along the way. 

It is time to move on and go forward and be thankful that we don’t have to listen to anymore politics…at least for a while.          

Believe it or not it, the race for the White House is not on the radar of Wall Street.  Wall Street is looking at the Congressional races as a positive or negative going forward. 

It is already accepted that the Democrats are going to gain more control in the Congress.  Given an Obama Presidency and a Democratic controlled Congress, there is already the potential for a problem.  Regardless of which side of the aisle you sit, I don’t think that it is a good idea ever to have the administration and the control of the Congress all belonging to the same party.  

The real problem occurs if the Democrates when enough seats to “filibuster proof” Congress.  Although the Republicans are the minority, they also have the power of the filibuster.  This is the process of using all types of tactics to delay the passing of legislation to the point of killing it.  However, if the Democrates win enough seats, the Republicans will lose that power as well.  This amounts to the Democrates controlling 60 seats in the Senate.  Without the filibuster, the Republicans are useless as a checks and balances system.   

What worries Wall Street?  A bunch of out of control politicians without any checks and balances.  Now, there is something for all Americans to have concern.   

 As far as President goes, I think that an Obama Presidency would be a huge negative for Wall Street and is probably already reflected in the market to some degree.  Most all of the legislation that he wants to pass has proven to be disasterous.  It would be nice for politicians to brush up on history before trying to pass legislation.  In the unlikely event that McCain wins, Wall Street would probably throw one heck of a party. 

In various conversations, I have come across some interesting but not too surprising reactions to the stock market route.  I was talking with a few individuals yesterday and one commented, “Well I just have to be in it for the long-term.  That is all there is, right?”

Then there was the comment that I heard this morning at the gym.   “I have a perfect strategy for you.  Just don’t look at your statements.  I  haven’t taken a look in over a year.  I figure that “my guy” is handling everything and that I will take a look in a 6 months or so.  I just need less stress in my life.  Besides, I will start being more active when I get closer to needing it. “ 

My reply, “Unless your financial advisor has you all in cash or is shorting the market, you are probably taking a big hit.”  He replied with a little uneasiness on his face, “How big?”  I replied, “You probably don’t want to know.”

There are three basic assumptions that investors are making right now that are just plain dangersous. 

“My financial advisor is taking care of it.”

The majority of the financial services industry has been taking very big losses over the past 12 months.  Unless an advisor is an active money manager that utilizes short positions in their strategy, chances are they are losing a lot of money.   That is always a dangerous assumption to make.

“I am a long-term investor.  I will get involved when I need the money.”

Long-term is one of the worst phrases to come out of the business.  You can spend the “long-term” going up for a period of years and then going down over a period of years and then reversing it.  The long-term investor invested in an S&P 500 index fund has virtually made no money in the last 10 years.  It hasn’t paid to be a long-term investor.

“There is no other way but to be a long-term investor.”

As I sat and discussed all of the strategies that were available to investors, one guy looked at me and said, “I wish that I would have known.”  Yes, there are better ways to invest in this type of market.  However, by avoiding the situation, you will never know.  Time is what you cannot afford to lose.  If you are interested in a better way, send me an e-mail (bob@prudentmoney.com).  You don’t have to become the definition of the long-term investor.  That has not worked very well.

I wanted to take some time to share views on a disturbing white paper sponsored by the Economic Policy Institute.  It is entitled Guaranteed Retirement Accounts - Towards Retirement Income Security.   

This is a paper that goes through the details of a proposal that has been presented to Congress.  It is about these Guaranteed Retirement Accounts.  

This institute promotes economic agendas that have socialistic qualities.  They think that the system is unfair and  support the notion of redistributing wealth so that everyone can participate.

Their main focus is on the poverty rate in America and they want to redistribute wealth to take care of the problem. 

The latest initiative to come from this institute is a guaranteed retirement account.  It is designed to provide an additional social security-like benefit to workers.  The program calls for the abolishment of the tax breaks that you would get for contributing into a 401(k) plan or IRA.  The program requires any worker who does not participate in a defined benefit plan at a company (company pension plan) to mandatorily contribute 5% of their income into this account.

They also give a $600 tax credit to each worker, which can be used to offset part of that contribution.   They guarantee a return of 3% for the account.  For an average 40 year worker, it is intended to replace 25% of your pre-retirement income.  A worker can still participate in a 401(k) plan.  However, they will not get a tax deduction.

The alarming part of this plan is that certain members of Congress actually think that it is a good idea.

I read over the white paper and found many flaws with the theory that they present.  Keep in mind that most of these types of plans are written based on theory and not reality. 

(1)               They are protecting you from the flawed 401(k) system and stock market investing

The 401(k) plan is doing more damage than good according to them.  Since people do not know how to invest money, these plans are not providing a good retirement for individuals.  Plus, the wealthy receive a bigger tax benefit than others due to the current tax structure.  Actually their argument is extremely weak for this point. 

So, they are going to provide some stability to your life by forcing you to give up 5% of your income so that they can give you a 3% guaranteed minimum return. 

Well, I ran some numbers based on the stock market.  If you are investing for 40 years and did nothing but buy and hold, you would earn much more than 3%. 

If you started investing at the top of the stock market in 1929 before it lost 86% and continued to invest for the next 40 years, your average return would have been 6.03%.

If you started in 1962 and invested until the stock market hit the bottom of the bear market in 2002, you would have averaged 7.76%.  It is absolutely ridiculous that they based this on a 3% annual average return.  That time period experienced some big bear markets. 

Then my favorite part of the paper regarding 401(k) plans – “though the latter strategy (investing in 401(k) plans) may make sense from an individual point of view, it is inefficient from a societal point of view…”  Do they mean socialistic point of view?

(2)               Manadatory Contributions

This is a 5% tax hike on lower and middle class.  Most are not saving because they don’t have the money to save and are barely making ends meet.  Now make them save 5% and see what happens to them financially as well as to the economy. 

(3)               They claim that the guaranteed retirement account and social security will replace approximately 70% of pre-retirement income for the average 40 year worker.

According to social security, the amount of pre-retirement income covered by social security varies.  You would have to be a very low income worker to get to the 70% coverage.  That is not the average worker. 

(4)               Encourages a dependency on the Government and discourages additional saving

This will encourage people to further depend upon the Government to take care of their needs.  Because of that, most people will not save additional money.  Also 401(k) plans will not be as attractive due to the removal of tax deductions.  People will pay more in taxes. 

This is just a cover up plan to get more money to cover the short-fall of social security.  This plan would be managed by social security.  Plus, it is socialistic in just about every way.  It is disturbing that this type of plan would be considered as any type of a solution.  Dependency on the Government is part of the reason we are in this mess.  Adding more dependency only makes it worse.

(5)               They state that the Social Security Administration has a proven track record of efficient management

Need I write any more?