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DEEMER ON TECHNICAL ANALYSIS
Expert Insights on Timing the Market and Profiting in the Long Run
By WALTER DEEMER, SUSAN CRAGIN
The McGraw-Hill Companies, Inc.Copyright © 2012Walter Deemer
All rights reserved.
WHO IS THE "AVERAGE" INVESTOR AND WHAT'S WITH THE HANDBASKET?
The "Average" Investor
Average stock market investors today may have wealth, but most are not wealthy. Most have a 401(k) account and maybe some savings to invest, and they are worried about retirement. And why not? They know that they may need much more money in retirement than they have needed to survive thus far.
Their safety nets—Social Security and Medicare—are in danger of being reduced as our government grapples with an ever-widening deficit. And another government deficitshrinker, monetary inflation, may halve the value of all dollars over the next 15 years.
Artificially low interest rates have kept the rates of no-risk investments such as Treasury bills and bank certificates of deposit (CDs) at unattractive levels.
Health costs are astronomical, are rising, and are a black box where a seemingly simple trip to the hospital for a couple of days, with a combined total of under an hour's supervision by a doctor, can add up to hundreds of thousands of dollars. Even with health insurance, out-of-pocket costs can be steep.
Basic living costs will only rise. Taxes, energy, and food prices are on their way up.
Most Americans own a home as their major asset, but the future value of that asset is in doubt. Home prices are still falling in many parts of the country. And, as our states grapple with declining revenues, local entities, especially schools, will attempt to make up some money through increased property taxes. This will raise monthly costs and may make the value of the average family home decline further. (This is so because most home purchasers calculate the total monthly payment to determine affordability, and that payment includes an increasingly high percentage of taxes.)
Food is expected to become more expensive. Global warming, a decrease in the underground water supply, a burgeoning world population, and increased living standards all will drive up the price of food.
Energy costs will be affected by instability in the Middle Eastern and African oil-producing countries and new worries about atomic energy stemming from the recent disaster in Japan.
The formula that the government uses to tackle these problems, the "core" consumer price index (CPI), is flawed because it doesn't take into account the cost of energy or the cost of food. And those prices may rise the fastest.
So I Get A Part-Time Job?
It won't be easy.
Our real unemployment and underemployment rates together are near 25 percent.
Our government's unemployment figures are narrowly defined and do not include those who have given up looking or have taken part-time employment. They do not include those who have been laid off from a well-paid job and have had to make real sacrifices to feed their families by moving, retraining, and/or taking a much lower salary. They do not include young people who are unable to find a first "real" job and are working part time or in minimum-wage retail and are living in their parents' basements.
Even if government numbers painted an accurate picture of the current economy, even if they reflected the real unemployment and underemployment rate and the real rate of essential consumer-good price increases, what can the government do? Our government is so far in debt that it has run out of powder.
Our economy needs to create well-paid jobs on an unprecedented scale. But where?
Private-sector job creation used to be in vital and necessary areas such as construction, factory work, and agriculture. But the construction industry is a mess, we don't manufacture consumer disposables in the United States any more, we don't manufacture most consumer durables, and farms now hire machines, not people. In suburban America, those jobs have been replaced by nonvital jobs that depend on disposable income and consumer choice (whether this be poor choice or not, I leave to the reader's discretion). Employment among the middle class has been concentrated around financial services and real estate development and sales. Among the working class, retail and food-service seem to employ most. But all this depends on optional local consumption, demand for which can vanish overnight.
A raft of jobs that once guaranteed a modestly paid but very permanent place in the local society—the civil service, the police and fire departments, school teaching, and nursing—are now few and competitive. Military service, formerly a fallback, is now a first career option for many working- class young people.
In fact, the benefits that these modest jobs have—good health insurance and a secure retirement—were derided a few years ago as the type of compensation only conservative, unimaginative workers desired. How ironic that those same workers now seem greedy because our health care and its attendant costs have pushed the value of those benefits to heights unimagined when most of them started working.
But even these jobs may not last. Look for angry taxpayers to demand long-term efficiencies and fewer municipal services. Look for angry voters to demand an end to government mandates that require local spending, especially in the schools and social services. Look for nervous elected officials to renegotiate union contracts.
You get the picture. There seems to be little salary income on the horizon. At least in the short term, underemployment will become the norm. And there is no quick fix out there.
Investors need to save more than they ever have, they need to start sooner, and they need to make wise investment choices. Unfortunately, most of them make the wrong choices.
What Are These Wrong Choices?
Small investors used to hope for a reasonable, steady return from a diversified portfolio that included cash, stocks (which small investors usually held in mutual funds), and bonds. Diversification was the mantra. In the selection of stocks, the mantra has always been buy and hold. Pick a portfolio, either a mutual fund or individual stocks, and stick with it.
Investors who classify themselves as traders tend to trade a lot and tend to watch their stock baskets obsessively, tracking the economic news, the financial news, and the company's filings.
Both methods may bring gains. But investors are usually their own worst enemies.
Today's investors are being forced to reach too much for yield.
Stock market returns until recently have been higher than average, and people have come to depend on them. Many people now are looking for 7, 8, or 9 percent returns a year from their stock portfolios.
This is especially true of retired investors, who tend to think of the yield, the profit on their investments, as a fluctuating part of their retirement income. The mantra is, "I'm not going to spend down my principal." The yield becomes a necessary part of their living expenses.
During the great inflation of the 1980s, retirees were getting 15 percent on their money-market funds and thought that this was going to be something they were going to enjoy for a long, long time. But they gradually saw that return go back to more normal levels and now, unfortunately, to below-normal levels. The return on money-market funds is now negligible.
Stock market investors were deluded by the outsized returns in the stock market for years, until the unfortunate incidents of the past decade (2000–2010). So they have their retirements planned around earning 7 to 9 percent compounded, year after year.
Ray DeVoe, a financial markets historian whom I first met when he was at Spencer Trask, says that more money has been lost reaching for yield than at the point of a gun. He's right. Investors now have to take on an extraordinary amount of risk to get this "normal" 7 to 9 percent return. This is going to be a lot tougher in the future than it was in the past. Historically, a normal risk-free yield is inflation plus about three percentage points. Right now, risk-free and low-risk yields have shrunk to almost nothing.
Not just individuals but also professional money managers have been making the same mistake. Pension funds are in a hole; they are underwater because they are projecting 8 percent compounded returns. And no one on earth knows where they are going to get them.
Getting an increased yield always—always—involves taking on increased risk.
Some financial people will gladly tell their clients that investments yielding 7 to 9 percent can be riskless. But outsized risk-free returns are not in the cards any more, and they probably never have been. A real risk-free return is usually something like inflation plus about 3 percent.
There is no such thing as a free lunch. If something sounds too good to be true, it is. But many retired people haven't changed their concept of "too good to be true" to comport with today's reality.
Making money takes some risk. Believing that there is no risk sets an investor up for fraud.
The Federal Reserve's Manipulation of Interest Rates Has Taken Small Savers Out of Cash and Cash Equivalents
The average small investor has nowhere to put cash because interest rates have been kept too low. The banks are paying 0.5 percent on a savings account. Some financial services firms aren't able to keep cash for their customers. So an entire class of assets is moving away from deposits, savings bonds, even government debt because there is no yield. (Of course, this also affects the amount of money local banks have to lend, but that's another story.)
Right now, if you have an extra $5, you put it in the stock market. And this is artificially propping up the stock market.
Interest rates, when they start going back up, are going to have all sorts of bad consequences for everyone but small savers and local businesses. The biggest consequence, of course, is that payments on government debt will skyrocket. But if interest rates go up, as they must sooner or later, bond prices will go down. This may result in a dramatic seesaw effect in stock market prices as people move in droves to cash, which is perceived as safer. We are going into a period of fear and uncertainty in the stock market. Investors are nervous. If interest rates rise, many people may withdraw money from the market, saying, "Whoopie!" 3 percent from the bank sounds like a great deal, and it is insured by the Federal Deposit Insurance Corporation (FDIC)! A positive 3 percent return, when everything else is having a negative return, is pretty good.
So I Buy Gold and Put It under the Floorboards?
Formerly, in times of uncertain financial assets, investors would shift to hard assets, but that cycle has been broken.
There is a cycle, of indeterminate length, swinging back and forth between financial assets and real, physical assets. At times, investors favor financial assets—stocks and bonds. At other times, they favor physical assets: real estate and gold. Normally, if financial assets are unattractive, this means that physical assets are attractive. But not all physical assets are attractive now.
The classic middle-class physical asset is real estate. Well, the real estate market is a mess. It's still overpriced compared with median incomes in most of the country. And there's still a huge glut of foreclosed properties that we have to get out from under before real estate can go back up. And most middle-class people buy real estate with loans and depend on being able to meet a monthly payment. Well, interest rates are near zero now, and they are going to go up at some point or another, so monthly payments will go up. Also, local real estate taxes may have to rise substantially to cover shortfalls in municipal workers' health care and pensions, as well as the school system. As monthly payments rise, house prices will fall.
Remember, a house is primarily the place where you live. And you live there because of a job, because of a tax structure, and because of schools and other amenities. Because of uncertainties about all these things, the price point may not have settled and may not settle for a while.
Over the long run, real estate is probably a good investment, but it's got a lot of short-term problems.
Other physical assets have their own problems. Some wealthier people are going into art, gold, and various commodities. But commodities are usually lousy investments unless you actually take hold of them and deliver them later. Buying copper, for example, is out of the question for most of us because you're paying storage charges and so on.
And so, the question becomes, Where do you go? Gold is doing well, but when you buy gold, are you buying gold—or are you really selling the currency short?
So I Take My Money to a Broker, Right?
When most people look at taking on a level of manageable risk, they usually think first of talking to an investment professional, a broker.
Nowadays, most financial professionals who call themselves brokers are nothing more than asset gatherers. Their responsibility virtually stops when your money walks in the door.
Here's what the average investor should already know about the average financial professional.
Most work for some combination of base salary and commission. Commission is based usually on a combination of two factors: the total amount of assets under the broker's control and transactions fees that are generated when clients purchase or exchange certain assets. Thus the broker is incented to increase the amount of money under his control, whether or not he has the time or skills to manage all of it. He also may encourage his clients to purchase assets that result in a greater commission income to himself, such as annuities. He also may encourage them to overtrade.
In a time in the market when stock prices are declining, the amount of money under management naturally shrinks, and with it, the broker's income. It becomes important for the broker to take new assets under management. At the same time, though, if stock prices are going down, the best place to be may be in cash. Investors can do that cheaper for themselves. So the broker is likely to say that he has a formula for doing better than the market.
That broker is lying. Always. (Well, almost always.)
So I Select Some Mutual Funds and Hold onto Them, Right?
Not necessarily. This may not be a good environment for professional money managers at mutual funds.
Professional money managers live under a multiedged sword. Number one, their accounts have to go up. Number two, the accounts have to go up more than the market. Number three, the accounts have to go up more than their competitors' accounts. I have seen grown money managers weep because the stock market had a very good day and their fund was up 1 percent, but their arch rival's fund was up 1.3 percent. And so it was a terrible day for them. They had lost 0.3 percent to their competitors, even though they were up 1 percent that day. So it's a horrible thing. This is why good money managers have to have iron stomachs—the stress levels are unbelievably high. And they can measure their performance day by day, hour by hour, minute by minute so that they can see how they are doing in this never-ending race every single minute, every single hour, of every single day.
This kind of atmosphere encourages money managers to take short-term risks and very short-term profits—and use very short-term charts. But over the long term, such risk necessarily must have a downside.
There is another problem. In a down market, not all managers can move to cash. Some funds are charged with being fully invested all the time. And if they are, and if they become concerned about the market, they will buy what they think are the safest, lowest-volatility stocks they can come up with. This may be the closest to a cash equivalent they can get. Many mutual fund companies will not let their investment managers go above 5 percent cash anymore. And many pension fund managers at big corporations don't let their money managers go above 5 percent cash either. They will say, "I want you to run a fully invested growth portfolio. We have another 20 percent in small-cap value stocks, and we have another 10 percent in emerging markets. And so forth. But we want to have 20 percent of assets in a high-quality growth portfolio. Therefore, you are to be fully invested at all times. If we want to have cash, we will raise it ourselves."
So the individual funds—and the individual money managers—may have very little flexibility. There are all sorts of rules.
In the old days, money managers could go 50 percent cash with no trouble. The only risk was job risk. Now it is practically impossible for them to do this. So many money managers do very different things with their personal accounts than they do with the money they manage. It's always instructive to find out what rules they live under.
If they want cash, they have to fake it.
But Won't I Need to Take Money Out of My Account?
Yes. And that may result in another source of pressure on the stock market.
When baby boomers reach the age of 701/2 years, they have to withdraw money from their IRAs and 401(k)s. This phenomenon is going to put downward price pressure on stocks for the next 20 years or more.
So Who Should Do Their Own Investing? Should I? Should Everyone?
You are the best judge of this. But, in general, more people should invest for themselves than are in fact doing so. And even those who don't wish to actively manage their own investments should follow them more closely than they do. There was a cartoon once showing a broker's office with the company motto affixed above the door:
"Working to Make Your Money Our Money."
This is an apt description of all too much of the brokerage business.
Excerpted from DEEMER ON TECHNICAL ANALYSIS by WALTER DEEMER. Copyright © 2012 by Walter Deemer. Excerpted by permission of The McGraw-Hill Companies, Inc..
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