April 2007

April 27, 2007 10:00 a.m. Supporting the Stock Market

What is pushing stocks higher? Analysts have been expecting a substantial correction for some time. It was only two month ago that pessimism was reigning, and many believed a substantial correction was underway. Yet, the Dow is hitting record highs, and the S&P 500 is not far behind. What forces are pushing stock prices higher?

• Momentum is a factor. A force in motion tends to stay in motion. As headlines report higher stock prices, investors put more money into stocks. Professional money managers chase the market, especially as we near month-end.
• The economy is stronger than many expected. We have been saying for some time that the economy is doing well, and those who are expecting a recession will be disappointed. Reported earnings so far this season have caught many by surprise, coming in higher than expected. A number of investors who had shorted stocks or the market are reversing their positions, and that short covering is part of some of the recent gains.
• Interest rates remain low. The market declines of the past few years occurred when the 10-year treasury yield hit 5%. The yield is below that level now, and seems likely to stay there for a while. Low yields make stocks attractive. Return-hungry investors avoid bonds and seek the potentially higher returns of bonds. Low rates and the availability of credit also make it easy and profitable for investors to acquire companies and for companies to buy their own stock or other companies.
• The global economy is booming. Multinational U.S. companies have higher-than-expected sales overseas and also are benefiting from the dollar’s decline against many currencies.

How can this surge end? Factors outside the markets and economy always are possibilities. A more likely trigger is elevated inflation. Another possibility is a reduction in credit. The problems in the subprime mortgage market and regulatory initiatives could lead to that. Another warning sign is that there is a lot of money chasing buyout deals; experienced dealmakers say that all the competition is reducing the number of profitable deals available. Buyouts have kept a floor under the stock market, and reduced purchases by buyout firms could bring down stock prices.

We have a number of portfolio positions benefiting from the recent run in stocks. But we also are hedging our bets by holding Hussman Strategic Growth. This balanced portfolio allows us to participate in the rally but retain a margin of safety in case the market reverses couse.

April 20, 2007 10:05 a.m. Good News for Medical Care Orphans

Most people do not consider medical care until late in their retirement planning. Medicare and most employer retirement plans do not kick in until age 65. Most people still retire before age 65. That leaves a gap in medical expense coverage for many early retirees, making them what we call medical care orphans. AARP announced a potential solution. The group is expanding its sponsored medical-care products to include those under age 65 who have no coverage. AARP-sponsored plans currently are offered by UnitedHealth Group. These plans will be expanded to include a Medicare Advantage plan. AARP also signed a deal with Aetna to offer medical coverage to those under 65. The new plans will be available at the beginning of 2008.

April 20, 2007 02:05 p.m. Third Avenue on REITs

The shareholder letters from most mutual fund companies are formal and boring. There are a few, however, that are worth reading. They are informative, educational, and sometimes entertaining. One group of quarterly letters worth reading are from the Third Avenue Funds.

In the first quarter commentary, Michael Winer of the Third Avenue Real Estate Value Fund made some interesting comments. Winer points out that the fund was over 86% invested in U.S. real estate companies and 96% in either U.S. or Canada; in January 2007 only 58.9% of the fund was in the U.S. and 73% in either U.S or Canada. Roughly equal amounts were invested in Canada, the United Kingdom, and Hong Kong. (Most of the Hong Kong investments essentially are investments in China.)

Winer’s explanation is that it began easing into U.K. stocks because it found several quality companies selling at discounts. In addition, the fund concluded that most (but not all) U.S. and Canadian REITs were too expensive, trading at premiums to their net asset values. Returns for the last three years seem to support the decision. An index of international real estate securities gained 108.7% the last three years while a U.S. REIT index gained only 108.7%.

The U.K. investments were followed by the Hong Kong investments, because the fund wanted exposure to “dynamic real estate markets” in Mainland China, Hong Kong, and Singapore.

NOTE TO MEMBERS: The journal on the members web site has additional features today on changes at Fidelity Funds and on what is happening to some homeowners in the Washington, D.C. area. It is a tough market even in this prosperous region.

April 17, 2007 04:00 p.m. Market Update

It has been a tumultuous few days here in Virginia. The Nor’easter that produced flooding farther up the coast brought us winds of up to 60 mph. Before that could subside, we received news of the shootings at Virginia Tech.

The markets also have not been quiet in one way, but have been in another.

The stock indexes have been climbing since mid-March, and the pace picked up the last 10 days or so. Major market indexes are near their highs of Feb. 20. The caveat to these gains is that trading volume has been fairly light. It is nowhere near the levels reached in the market slide of Feb. 27. That shows mutual funds and other big money investors are not piling into stocks. That is understandable with the economy and earnings growth slowing, and interest rates rising. Positive signs are the indexes’ breaking through what had been resistance levels, and breakouts of market-leading stocks to new highs.

All in all, there are reasons to stay invested in stocks but also to maintain some caution about those investments.

MEMBERS’ NOTE: On the members’ web site, today’s journal includes additional features: an update on changes at Fidelty Funds and a view of what is happening to some homeowners’ in the Washington, D.C. area.

April 17, 2007 04:05 p.m. Retirement Dissonance

The annual Retirement Confidence Survey contains the usual puzzle. The study, conducted for the Employee Benefit Research Institute and other groups, asks questions of Americans each year for 17 years. The new information this year is that over the last two years 17% of workers had their retirement benefits reduced. Yet, only one-third of that group increased their savings or took other action in response. Another 40% said they did nothing.

As usual, the study found that many Americans had not saved much for retirement. Many also now are saying that they are unsure of the amount they will receive from employer retirement plans or they know that they will have less than they once thought. In addition, almost half said that they saved less than $25,000 excluding home equity and defined benefit pension plans. Yet, and here is where the dissonance is, a full 70% of workers each year say they are confident they will have enough money to live comfortably in retirement.

Do these workers know something that the experts do not? Or are they fooling themselves?

April 3, 2007 11:35 a.m. Advice from a Top CIO

Last week we reviewed the subprime mortgage analysis of Jeffrey E. Gundlach, Chief Investment Officer of the TCW Group. Gundlach doesn’t receive as much media attention as some of the other top investment analysts, but he is worth listening to.

Gundlach has an interesting take on the markets and good advice for investors. He expects growth to slow in 2007, and that will be challenging for investors in both stocks and bonds. With the Fed on hold and most economic data still looking good, many investors are tempted to put risk aside and seek profits now, believing they can sell before the market risks are realized. “Unfortunately,” says Gundlach, “waiting for tomorrow is a classic trap. The advent of a downside risk repricing usually occurs as a step function, rather than as a gradual decline. When that happens, few risk-takers can exit without losses.” We saw a taste of that on Feb. 27, when the stock indexes decline about 4% in one day.

Gundlach, like most seasoned investors, advises that investors use this period to reduce the risk in their portfolios and increase quality. Gundlach believes that the Fed is overstating today’s inflation risk. He states that the bond market and other markets are pointing to a peak in inflation. Signs of weakness in the economy, especially in the housing market, also are signs that inflation will decline. The combination of falling inflation and a weak economy point to lower returns for investors. That is where it is better to reduce the risk in a portfolio than to try to maximize short-term returns.

April 3, 2007 11:40 a.m. Inflation Precursor?

Investors and the Fed are searching for a reliable signal of the direction of inflation. One new signal, featured in The Wall Street Journal today, is the performance of apartment REITs.

The reasoning behind the signal has several steps. Rental rates are a significant portion of the Consumer CPI Index issued by the Department of Labor. If rents are rising, the CPI also rises. Falling rents can reduce CPI enough to indication deflation. Some analysts believe that the housing boom of 2000-2005 caused rents to stagnate or fall as more people purchased homes instead of renting. Lower rents led to a lower CPI. The housing bust coupled with reports or rising rents have raised fears that the CPI will keep rising.

But the REIT indicator says that the direction of rents is reflected in the prices of the shares of REITs. If apartment REITs are falling, lower rents are in the offing. Advocates of the theory say that REIT share prices reflect lower rent trends a few months before government statistics capture them.

I won’t leave you on the hook. Apartment REIT prices have been declining since late 2006, and the decline has been fairly steep.

The caution is that apartment REITs have been a meaningful market sector for only a few years, so there is not a lot of data to support the theory. In addition, the theory assumes that the investment markets are efficient and correct. Markets do make mistakes from time to time, so it is not always a safe assumption that something already is reflected in the markets or being forecast by the markets.

MEMBERS’ NOTE: The members version of Bob’s Journal on the Retirement Watch web site includes additional features. Today, read the “REIT Alert” and “The Battling Bond Gurus.”