Monday, August 18, 2014

CITI: The Economy Has Entered Its Scary 'Phase 3' Where Bubbles Form Prior To A Crash

Phase 1: This begins at the end of a recession, when interest rates have fallen, money is cheap, but stocks are still battered. 
Phase 2: A bull market sets in during phase 2, when stocks start to rise as easy credit lubricates the economy. 
Phase 3: This is the tricky part. Stocks are still flying high, but credits spreads are widening as investors become increasingly unwilling to finance further risk. Corporate CEOs have now experienced a lengthy period of gains and become risk-happy. (And we'd note that central banks are already talking about tightening credit by raising interest rates.) Bubbles can form in Phase 3, Buckland says, as the high-flying stock market ignores the early warning signs of the deteriorating credit market. Hello, tech startup IPOs! 
Phase 4: Stocks react to the lack of available credit by collapsing, and we see the kinds of things you get in a recession: "This is the classic bear market, when equity and credit prices fall together. It is usually associated with collapsing profits and worsening balance sheets," Buckland says.
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John P. Hussman, Ph.D.

Our perspective is straightforward: on the basis of measures that have been reliably correlated with actual subsequent market returns in market cycles across a century of data, we estimate that the S&P 500 Index will be no higher a decade from now than it is today. On the basis of nominal total returns (including dividends), we estimate zero or negative returns for the S&P 500 on every horizon shorter than about 8 years. SeeOckham's Razor and the Market Cycle for a review of the total return arithmetic behind these estimates, and Yes, This is An Equity Bubble for additional background on our present concerns. 
At the same time, we don’t have strong views about immediate market prospects. Still, even a run-of-the-mill completion to the present market cycle would wipe out more than half of the market’s gains since the 2009 low, so whatever gains the market experiences in the interim are likely to be transitory, and few investors will retain them by exiting anywhere near the top. Frankly, we doubt that the present cycle will be completed with the S&P 500 even above 1000 (a level that we would associate with historically normal subsequent total returns of roughly 10% annually). We readily accept that 3-4 more years of zero interest rate policy would justify market valuations 12-16% above what would otherwise be “fair value” (see Optimism vs. Arithmetic to see why) but we also recognize that the vast majority of bear markets have overshot to the downside. In short, an informed view of market history easily admits the likelihood that the S&P 500 will lose half of its value over the completion of the present cycle.

DYI Comments:  DYI has stated many times in the past that at these market levels a 45% to 60% decline is very much in play.  The price to dividend ratio is now 117% above average; please note that in the classic macro definition a bargain would be 25% (or more) BELOW the average.  That's a long way to go before stocks bottom out on a secular basis.

  8-1-2014
STOCKS

100 - [100 x ( Curr. PD - Avg. PD / 2 ) ]
________________________
(Avg. PD x 2 - Avg. PD/2)


Avg. Price to Dividends PD  23
Current Price to Dividends   53

% Allocation  -17%
-17% x 60 (max. allocation) = 10% short

AGGRESSIVE PORTFOLIO - ACTIVE ALLOCATION


Active Allocation Bands 0% to 60%
68% - Cash -Short Term Bond Index - VBIRX
13% -Gold- Precious Metals & Mining - VGPMX
 9% -Lt. Bonds- Long Term Bond Index - VBLTX
10% -Stocks- Federated Prudent Bear Fund - BEARX
  0%-REIT's- REIT Index Fund - VGSLX
[See Disclaimer]

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30 Years Ago Warren Buffett Gave Away The Secret To Good Investing And Correctly Predicted No One Would Listen

Isn't he just giving away the secret? 
"I can only tell you that the secret has been out for 50 years," Buffett writes, "...yet I have seen no trend toward value investing in the 35 years I've practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult. The academic world, if anything, has actually backed away from the teaching of value investing over the last 30 years. It's likely to stay that way. Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper." 
Indeed, all of the research continues to show that the vast majority of professional and retail investors are underperforming.
DYI Comments: Straight from the book Intelligent Investor chapter on Margin of Safety required reading for serious value players.

Ben Graham Corner

Margin of Safety!


Central Concept of Investment for the purchase of Common Stocks.
"The danger to investors lies in concentrating their purchases in the upper levels of the market..."

Stocks compared to bonds:
Earnings Yield Coverage Ratio - [EYC Ratio]

EYC Ratio = [ (1/PE10) x 100] x 1.075] / Bond Rate
1.75 plus: Safe for large lump sums & DCA
1.30 plus: Safe for DCA

1.29 or less: Mid-Point - Hold stocks and purchase bonds.

1.00 or less: Sell stocks - rebalance portfolio - Re-think stock/bond allocation.

Current EYC Ratio: 1.04
As of 08-1-14

PE10 as report by Multpl.com
DCA is Dollar Cost Averaging.

PE10  .........25.53
Bond Rate...4.03%


Over a ten-year period the typical excess of stock earnings power over bond interest may aggregate 4/3 of the price paid. This figure is sufficient to provide a very real margin of safety--which, under favorable conditions, will prevent or minimize a loss......If the purchases are made at the average level of the market over a span of years, the prices paid should carry with them assurance of an adequate margin of safety.  The danger to investors lies in concentrating their purchases in the upper levels of the market.....

Common Sense Investing:
The Papers of Benjamin Graham
Benjamin Graham

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The Worst Investment You Can Make: Buying a Home


Mathematically, it doesn't make sense

When you do the math on home ownership, it's plain that it is one of the worst investments you can make. Consider the purchase of a $350,000 house, which is slightly over the current average U.S. sales price. 
In most cases, you will be required to have a 20 percent down payment, or $70,000. This leaves you with a loan balance of $280,000, which at the current interest rate of 4.5 percent for a 30-year fixed mortgage will give you a monthly payment of $1,853.10. 
At the end of that mortgage, you will have paid $667,166 in principal and interest –- or $387,116 more than the original loan amount. During that same period, assuming a 1.5 percent rate, you will also have to pay another $126,000 in property taxes. (And there are plenty of places where the tax rate is higher.) 
But wait, there's more. Using a 1 percent maintenance rate -- for upkeep, maintenance, and repairs -- you can add another $3,500 per year in costs, bringing the total out-of-pocket costs over 30-years to $898,166. 
Since you have to live somewhere, let's assume you could find a similar rental home for 75 percent of your monthly mortgage payment, or roughly $1,400 per month. Then say that you invested that $70,000 down payment in the stock market, which has averaged a 9.4 percent return over the last 100 years. 
Then, each year, you add to your investment the difference between your rent payment and potential mortgage payment, as well as the money you save by not paying for property taxes, maintenance and other costs of home ownership. 
After 30 years, you would have nearly $3 million in your portfolio.
Don't believe me? Check out this super cool interactive calculator that the New York Times created. It allows you to input over 20 variables to try and justify owning vs. renting. See if you can make the math work out in favor of home ownership.
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How to Fund Your Retirement With Passive Income

An alternative to the established retirement planning model is to fund your retirement with passive income. Instead of focusing on saving a huge amount, you can focus on generating income outside your day job. It will take a lot of time and effort, but hopefully the passive income will be able to cover your monthly expenses at some point. 
Here are some sources of passive income: 
Rental properties. Many investors have been able to retire from their full-time jobs with rental income. It can be difficult to get started because you'll need a substantial amount of money for a down payment. One way to start in the rental property business is to rent out your old home when you move. You're familiar with the home and can probably manage it yourself. 
Dividend stocks. Many companies in the stock market will send their investors a regular dividend payment. For example, AT&T will pay $1.84 dividend for every share. The good thing about investing in dividend stocks is that you can start small. If you have $1,000 to invest, you can buy AT&T and receive a steady 5 percent dividend every year. Fifty dollars might not sound like much, but the dividend income will increase as you add more to your dividend portfolio.
DYI Comments:  Use can use our model portfolio (exclude the short position) to build passive income.  This overvalued stock, bond, REIT market will NOT be forever.  Better dividend and interest rates will prevail in the long run as markets regress back to the mean and overshoot.

The problem with 401k's or other retirement programs is that you do not build up spendable dollars between now and retirement.  Also in a taxable account there is no limit to how much you can save as your spendable dividends and interest increase.  Of course this method is reserved for the true hard core saver and you start at a young age.  Most folks simply find it difficult to save even when they have those extra, extra dollars.  Human nature just gets in the way.  But if you are young (20's or 30's) a hard core saver, forget buying the house, buy for passive income.  You will be surprised what you can accomplish in ten years!

DYI  
 

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