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The Blue Money Report
"The knowledge of an effect depends on and involves the knowledge of a cause."
~ Spinoza

Welcome to the Blue Money Report

Today's Commentary: 04.30.03

Note from the Editor: The following article appears courtesy of Tom Madell. Tom is a Ph.D. psychologist by training, and frequently writes about the important role of your own psychological reactions as well as market psychology in determining your investment results. Tom has written and published two books and numerous journal articles. All told, he has accumulated over 18 years experience as a highly successful mutual funds investor enabling him to retire early from the 9-to-5 working world to use his time helping others with their investing through his writings.

I hope you enjoy.

The "Free Ride Era" Is Over

It's too bad but the title of this article is true.

Back in the mid to late 1990s, almost any stock-related investment you picked, it seemed, would lead you to easy success. We all know that era is now gone.

But it's not just the stock market's free ride that's past history. Back at the end of 1999, you could get close to a 6% compound yield without taking any risk in a good money market fund. Today it's more like 1%. What this means is that if you've moved some money out of stocks into cash, your real return after inflation (and possibly taxes) is decidedly less than 0%.

Of course, most people hold on to the hope that in the years ahead, when many of them hope to retire, stocks will again return to their winning ways. After all, stocks have averaged returns of about 10% over the last 100 years or so, right? So it seems this would be well worth continuing the ride assuming we get the payoff in the end. But will we?

If you, like the majority, cling to this optimistic view, or just if you wish to see an interesting projection of future possibilities, I strongly urge you take a look at this free article from the New York Times. The gist of this article, based on research by experts at 3 top universities, states that due to cashing in of stocks by retiring baby boomers during the next 15 years, there will be more sellers than buyers of stocks, causing prices to continue to head down.

While obviously, population trends are not the only determinant of stock prices, we can find other reasons for caution in assuming that stocks will always eventually reward investors, an assumption that therefore relieves us from having to think (or worry) much about our investments. The main one is probably this: The world is far too unpredictable a place to simply have confidence in any one anticipated-in-advance outcome.

Remember all the people who until recently thought they had job security, pension guarantees, and who thought that only people in foreign countries, certainly not here on US soil, had to worry about major loss of life as a result of foreign hostilities? And when many people thought they could believe what widely quoted financial industry experts said about the prospects for stock investments (never mind that they had and still do have a financial and career interest in the very investments they were touting)? And perhaps to show the point even further: Surveys have shown that a large percentage of people no longer feel that they can even count on Social Security being there in its present form when it's time for them to collect.

Couple this unpredictability with the proven fact that most people are poor market "timers" and it becomes even more reasonable to conclude that many of them will never achieve the promised 10% annual returns: We all, even the pros, tend to make the majority of our purchases, exchanges, and cash outs at just the wrong times.

Research shows that the vast majority of mutual fund investors consistently achieve results far poorer than market averages. For example, from January 1984 through December 2000, the average yearly return for the S&P 500 Index was 16.3% a year while the same results for stock fund investors was a scant 5.3% a year! - for an interesting perspective on this which includes the role of psychology in investing, see this article.

All this leads me to conclude that investors are still far too blaise about their investments. Free rides are what kids get from their parents at amusement parks; for everyone else, we all need as much information and advice from well-read, independent-thinking individuals as we can get if we hope to assuredly get from point A to point B.

Tom Madell Ph.D. publishes Mutual Fund Trends & Research Newsletter, a popular, currently free source of mutual fund advice. The Newsletter has been in existence since May, 1999.

Today's Commentary: 04.28.03
A Seer Again
Tucked inside both the good and bad news that happened this past week, was a tidbit that genuinely caught me by surprise. Closer inspection however seems to uncover yet another well calculated move by the Bush administration.

Alan Greenspan was nominated again as Federal Reserve Chairman, a tenure that began back in 1987. He has been a stalwart of financial stability, magnifying the influence of the money supply and the effect of interest rates over that span. He has tweaked and turned the economy with more success than failures, although he is credited with the dismal performance of the economy of the last three years, his record will show a consistent shrewdness that at times remained apolitical, and other times looked paternal.

So why did he decide to accept the nomination and stay on? Was it the fact that his term as a Fed Chairman expired in 2004, a coincidence conveniently aligned with the election. Was it because his term as Fed governor expires in 2006? Or was it because he expected a change of the guard in 2004.

Mr. Greenspan has not been much of a fan of the current tax cut plan citing the problems with the idea as taking a short term problem and spreading it out over generations. He was unable to embrace the administrations' take on the stimulative growth the plan provided and was soundly censured for his opinion. If you will remember, there was even some big talk about having him removed mid-term.

A stable Reserve Board adds to the illusion that things are on the right track monetarily, even if the aftermath of bad policy will be laid in the laps of these bankers to fix.

The rate cuts, eleven in all, may be finally taking hold on the economy, although not everyone seems to agree. Credit ratings are improving and with that so are the bonds these companies issue. Consumer confidence is generally seen as on the upswing and if this continues, the economy will stage a noticeable recovery before Congress gives the President what he thinks we need. Will it be big enough fast enough? Not likely.

James A. Baker III made an excellent point recently that was only clouded by some basic differences in time and place. Mr. Baker was the Treasury Secretary under President Reagan and Secretary of State under the first President Bush. Admittedly a fan of these two men and their accomplishments, his arguments for the current administration's tax cut, taken to print in the Wall Street Journal last week, reflect a decidedly skewed point of view. One that, even by his own admission, comes from his advanced age.

The current Mr. Bush has grabbed a page from Mr. Reagan's handbook on tax cuts. The belief that a deficit weighted tax cut could somehow spur growth based on what it did twenty some odd years ago is further proof of his fondness for living in the past. Mr. Baker pointed out the harsh economic conditions inherited by Reagan in the early eighties. This was a time when inflation (13.5%) and unemployment (7.1%) were added together to produce what was called a "misery index". Those were trying times indeed. But looking back doesn't shed any real light on the present.

We have been involved with positive growth, albeit slower than we would like, for quite some time now. Numbers posted last week of 1.6% are actually better than the Bush administration would like you to believe. Consensus estimates of growth of GDP were 2.4% with the belief that any recovery in the economy will need to see 3% sustained growth. Current inflation is at 2.5%. The growing unemployment rate with 455,000 new claims last week still keeps our current unemployment rate at a less than the devastating pace than two decades hence. It also effected a tighter radius of workers, almost to the exclusion of white collared employes. Even if you add in the much misaligned number of underemployed, you still don't come close to the misery index of 20.6%.

Mr. Reagan's answer was a tax cut. Mr. Bush's answer to a modest economy, certainly not one remotely comparable to Mr. Reagan's, is a long term crush of government debt that is being sold ambitiously around the country as stimulus. What's the difference between stimulus, which the economy needs, and the growth that Mr. Reagan sought to achieve and Mr. Bush as well? Depends on who you listen to.

"Growth" is a Republican buzz word, while "stimulus" is the Democratic word of choice. They vary only on one key point: who gets the money.

The Republican version lands the majority of the deficit expanding tax cut in the comfortable laps of the upper and upper-middle class, a group that has proven time and again as the least likely to spend the extra cash. They are supposed to, according to those who believe this type of plan, create jobs through reinvestment of the money saved by not paying taxes.

The Democratic version sees the money going to the less fortunate and also lower tax bracket tax payer. The theory here is that these folks, with cash in hand, will immediately spend it, thus stimulating the economy.

There is little chance of either growth or stimulus happening either way. A recent National Public Radio poll conducted with the Kaiser Family Foundation asked, before the war in Iraq began, what would you do if you had $300 in a tax cut. A surprising 41% said they would save or invest it, 40% said they would pay down debt, and a slim 19% would do their part and get out and spend the money. An informal CNBC poll found 41% of Americans in one mid sized town barely aware of the ongoing debate.

Either way, the effect of the tax cut will have little near term effect on the economy. Any long term effect will be difficult to blame on or give credit to, the expansion of the deficit to record levels. But what do you do in an imperfect fiscal world where any available tax dollar is spent as soon as it is collected? Tax consumption.

In every step of the life of a product, there are a series of transactions that begin with raw materials and end in the purchasers shopping bag. Suppose the taxation of that product was spread fractionally among each and every step of that process. The rate could be set and all that was left would be a system that would be neutral to who had the most money and who had the least. Taxes would be collected efficiently and without the burden on payrolls, freeing the portion that is paid to Social Security, to go directly to that fund without political interception. Granted this would be tantamount to complete overhaul of the tax system and such a maneuver, especially difficult since we didn't think of it first, is not likely to happen. Value Added Tax is a European notion that deserves a look. And as much as I hate to say it, adaptation of this idea would ensure a second term for the current President.

Without it, the only growth will occur in the supply of red ink.

The Week Ahead in Equities
As we head into the fifth month of the year, it is a mixed bag of news and numbers from the major indices. The Dow year to date is barely in the negative (0.4%) but seems to have found a comfortable trading range. A holding pattern here seems likely no matter what transpires and I tend to agree with the growing consensus of early 2004 before any significant move begins. Companies are not anxious to do much about anything. It is wonderful that the focus on fundamentals has a renewed vigor but that rearview reacting is hardly worth betting on. Good earnings and the belief that the big caps are soundly whipped has seen the S & P 500 index keep moving forward. Even with a 1.38% weekly drop in value, the year to date number of 2.16% looks good. Breaking the 890 barrier is even more encouraging. The index finished the week at 899 after topping 911 early on. The mid and small caps will languish, and possibly become a real bargain, as long as investors believe that large companies will lead the way.

The Week Ahead in Bonds
Even with the economic numbers showing less feeble signs of late, the worst may still be on the horizon. Although, "worst" might too harsh of a word, it still looks as if the economy has a few hurdles in it's path. If the U.S. Treasuries are any indication, first time jobless claims, and the respectable yet anemic 1.6% GDP, coupled with the possibility the May FOMC meeting will exercise their right to lower rates yet again, the state of the economy will keep bond prices inflated and in the process lower yields. This is not likely to change and may even see yields on 10 year Treasuries as low as 3.7% before there is any real improvement.

Eating away at those meager yields is inflation. It is beginning to move modestly but with enough conviction to be noticed. Crowding out other bonds meanwhile is next month's quarterly debt sales by the Treasury Department. This sale will set records and keep this market without a sense of real direction.

The rise in bond prices coupled with the stagnation of stocks within a predictable range seems to be pointing toward another rate cut in the fall instead. I would be willing to wager that the Fed is still sorting through the numbers and will be unwilling to lop off another 25 basis points without some clear indication that what they were doing would have an immediate impact.