BUFFETT - The RISK$ of Pension Accounting

Will U.S. Corporate PENSION Fund Accounting practices one day evolve into a Legitimate economic concern/headwind for the country ? Considering the Market's DECADE long bout of NON-performance (the Dow Jones Index is up a paltry 3.1% since its level of 8,452 on 10/19/1998...the S+P 500 is now down a stunning 17% over the same 10 year period as the S+P 500 was at 1,100 on 10/22/1998 vs. 910 today, 10/22/08), coupled with the FACT that we are entering 'prime retirement age' territory for the country's Largest Population segment (BABY BOOMERS - those Americans born in between 1946 and 1964), I decided to look into this issue a little bit more carefully.

While on the lookout for pension accounting related insights + risks I rediscovered Warren Buffett's 2007 Annual Shareholders Letter. For my reference, I'm including below the hugely informative bit he penned on pages 19-20 related to the potentially RECKLESS market-return related assumptions currently governing Corporate America's Pension Fund Accounting model (click the below link for full access to Buffett's 2007 Letter):

http://www.berkshirehathaway.com/letters/2007ltr.pdf

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Fanciful Figures – How Public Companies Juice Earnings
By Warren Buffett


" Decades of option-accounting nonsense have now been put to rest, but other accounting choices remain – important among these the investment-return assumption a company uses in calculating pension expense. It will come as no surprise that many companies continue to choose an assumption that allows them to report less-than-solid “earnings.” For the 363 companies in the S&P that have pension plans, this assumption in 2006 averaged 8%. Let’s look at the chances of that being achieved.

The average holdings of bonds and cash for all pension funds is about 28%, and on these assets returns can be expected to be no more than 5%. Higher yields, of course, are obtainable but they carry with them a risk of commensurate (or greater) loss. This means that the remaining 72% of assets – which are mostly in equities, either held directly or through vehicles such as hedge funds or private-equity investments – must earn 9.2% in order for the fund overall to achieve the postulated 8%. And that return must be delivered after all fees, which are now far higher than they have ever been.

How realistic is this expectation? Let’s revisit some data I mentioned two years ago: During the 20th Century, the Dow advanced from 66 to 11,497. This gain, though it appears huge, shrinks to 5.3% when compounded annually. An investor who owned the Dow throughout the century would also have received generous dividends for much of the period, but only about 2% or so in the final years. It was a wonderful century.

Think now about this century. For investors to merely match that 5.3% market-value gain, the Dow – recently below 13,000 – would need to close at about 2,000,000 on December 31, 2099. We are now eight years into this century, and we have racked up less than 2,000 of the 1,988,000 Dow points the market needed to travel in this hundred years to equal the 5.3% of the last. It’s amusing that commentators regularly hyperventilate at the prospect of the Dow crossing an even number of thousands, such as 14,000 or 15,000. If they keep reacting that way, a 5.3% annual gain for the century will mean they experience at least 1,986 seizures during the next 92 years. While anything is possible, does anyone really believe this is the most likely outcome? Dividends continue to run about 2%. Even if stocks were to average the 5.3% annual appreciation of the 1900s, the equity portion of plan assets – allowing for expenses of .5% – would produce no more than 7% or so. And .5% may well understate costs, given the presence of layers of consultants and highpriced managers (“helpers”).

Naturally, everyone expects to be above average. And those helpers – bless their hearts – will certainly encourage their clients in this belief. But, as a class, the helper-aided group must be below average. The reason is simple: 1) Investors, overall, will necessarily earn an average return, minus costs they incur; 2) Passive and index investors, through their very inactivity, will earn that average minus costs that are very low; 3) With that group earning average returns, so must the remaining group – the active investors. But this group will incur high transaction, management, and advisory costs. Therefore, the active investors will have their returns diminished by a far greater percentage than will their inactive brethren. That means that the passive group – the “know-nothings” – must win. I should mention that people who expect to earn 10% annually from equities during this century – envisioning that 2% of that will come from dividends and 8% from price appreciation – are implicitly forecasting a level of about 24,000,000 on the Dow by 2100. If your adviser talks to you about double-digit returns from equities, explain this math to him – not that it will faze him. Many helpers are apparently direct descendants of the queen in Alice in Wonderland, who said: “Why, sometimes I’ve believed as many as six impossible things before breakfast.” Beware the glib helper who fills your head with fantasies while he fills his pockets with fees.

Some companies have pension plans in Europe as well as in the U.S. and, in their accounting, almost all assume that the U.S. plans will earn more than the non-U.S. plans. This discrepancy is puzzling: Why should these companies not put their U.S. managers in charge of the non-U.S. pension assets and let them work their magic on these assets as well? I’ve never seen this puzzle explained. But the auditors and actuaries who are charged with vetting the return assumptions seem to have no problem with it.

What is no puzzle, however, is why CEOs opt for a high investment assumption: It lets them report higher earnings. And if they are wrong, as I believe they are, the chickens won’t come home to roost until long after they retire. After decades of pushing the envelope – or worse – in its attempt to report the highest number possible for current earnings, Corporate America should ease up. It should listen to my partner, Charlie: “If you’ve hit three balls out of bounds to the left, aim a little to the right on the next swing.”

Whatever pension-cost surprises are in store for shareholders down the road, these jolts will be surpassed many times over by those experienced by taxpayers. Public pension promises are huge and, in many cases, funding is woefully inadequate. Because the fuse on this time bomb is long, politicians flinch from inflicting tax pain, given that problems will only become apparent long after these officials have departed. Promises involving very early retirement – sometimes to those in their low 40s – and generous cost-of-living adjustments are easy for these officials to make. In a world where people are living longer and inflation is certain, those promises will be anything but easy to keep."

Data Courtesy: BerkshireHathaway.com

Big 3 EMPLOYMENT - Ford, GM and Chrysler

Given the country's ongoing recession, I decided to look into how much of a RISK to overall EMPLOYMENT numbers (payrolls) it'd be if any or all of the U.S.'s 'Big 3' Auto Manufacturers were to go under/declare BANKRUPTCY. While I have trouble envisioning a scenario in which ALL 3 U.S. major automobile manufacturing companies are 'allowed' to FAIL (I believe the government will step in at some point and most likely arrange/force a merger of at least 2 of the 3 companies to prevent a massive loss of JOBS), I do believe there's a solid chance of seeing AT LEAST one company go under before the current recession runs its course.

Regardless of WHO goes under, given the amount of JOBS each of these companies are directly responsible for (and don't forget about each of their major auto parts supplier relationships...job losses will unfortunately be felt 'indirectly' on that end as well if any of the Big 3 fail), when one of these entities eventually collapses, the ramifications to the U.S. (and of course Michigan as all 3 of these companies are headquartered in Michigan) economy will most certainly be negative (I think I just set THE record for most commas in a run-on sentence).

* According to Hoovers and year end 2007 data :

1.) General Motors (GM)
2007 Employees: 266,000
2007 Sales: $181 Billion
2007 Profit (Loss): negative $39 Billion

2.) Ford Motor (F)
2007 Employees: 246,000
2007 Sales: $173 Billion
2007 Profit (Loss): negative $3 Billion

3.) Chrysler (private company)
2007 Employees: 72,000
2007 Sales: $49 Billion
2007 Profit (Loss): N/A




Data Courtesy: Hoovers

IBM 3Q08 Sales Growth By Industry + Geo

Per IBM's 3Q08 Earnings Report Presentation + the slides below, approx 30% of the company's Total WW Sales come from customers operating in the Financial Services industry ($7 Billion out of $25 Billion).


*IBM's 3Q08 Sales Growth by Industry:


* IBM's 3Q08 Financial Services Industry Exposure:


* It's interesting to note that IBM actually grew its Financial Services revenue during the quarter by 2% (after adjusting for constant currency) DESPITE the ongoing recession...Anecdotally thinking, not sure how they pulled it off but I wonder how realistic of an expectation it is for one to expect IBM to continue growing its financial customer revenue moving forward when considering the current macro-economic environment + recent collapses of former financial bellweathers including Bear Sterns, Lehman Brothers, AIG, Merrill Lynch, Fannie Mae, Freddie Mac, Countrywide Financial, Washington Mutual, Wachovia, etc.

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Other interesting 3Q08 Slides per IBM's presentation:

*IBM's 3Q08 Sales Growth by Geo:



*IBM's 3Q08 Liquidity Position:



ibm.com/investor/sharedv3/auditorium.phtml?/investor/3q08


Data Courtesy: IBM's 3Q08 Earnings Presentation
Full Disclosure: I own shares of IBM.

BUFFETT - American Stocks 4 The Long Term

When Mr. Buffett speaks, I listen. Warren Buffett, arguably the most $uccessful and DISCIPLINED Investor of ALL TIME, believes NOW is the time to be ACCUMULATING U.S. Stocks for the Long Term. According to Mr. Buffett's Op Ed piece in Friday's New York Times, he is not sure WHEN things will turn for the U.S. economy but he is certain that a turn will EVENTUALLY occur. As a result, he is taking advantage of the market's recent crash and purchasing American stocks for his personal non-Berkshire Hathaway account. For my future reference, I am including his entire New York Times Op Ed piece from 10/17/08 below:

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Buy American. I Am.

By WARREN E. BUFFETT

10/17/2008

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So … I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

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* Anecdotally thinking, I of course believe Buffet's PATRIOTIC advice ('invest in AMERICA') is sound but that advice should NOT be heeded without caveats. As an individual investor, it's critical to realize that Mr. Buffett is dealing with a lot more CASH (Buffett's Berkshire Hathaway held about $40 BILLION in Cash entering 2008) than the rest of us. Because of his MASSIVE cash position, Buffett is dealing from a relative position of strength and does not need 'Mr. Market' to turn or trend up anytime soon. Therefore, while his advice is indeed sound it should not be acted/relied upon without consideration of your own personal investing time frame. If you're investing time frame is less than 3-5 years then Buffet's advice above may not hold water because market volatility in the short term could very well continue. On the contrary though, if you're bullish about stocks as a long term asset class, and if you're investing time frame is 10 years or more then Mr. Buffet's article above should confirm your instincts that NOW is an opportune time to start/continue investing.

Data Courtesy: New York Times

SIN City Feels The Wrath Of ReceSsIoN

Besides New York, Nevada may be the state with the MOST to LOSE as a result of the ongoing U.S. housing bubble-induced Recession. Some interesting/scary points that caught my eye per the below informative Bloomberg article focused mostly on Sin City itself, Las Vegas:


* During 2000 to 2007, Nevada led the U.S. housing boom with an estimated amount of 275,000 new homes built...a 33% increase that was the highest of any state, according to the U.S. Census Bureau


* Las Vegas currently leads the country in falling Home Prices, Foreclosures and stalled Construction projects


* Las Vegas's housing market is the worst in the U.S...Home values in the area at the end of the second quarter had fallen to March 2004 levels, according to the S&P/Case-Shiller Home-Price Index. Las Vegas prices fell 30% in July from a year earlier, the biggest drop among 20 U.S. metropolitan areas...The median home price in August was $210,000, and 3 out of 4 home sales were bank-owned properties that were foreclosures, the Greater Las Vegas Association of Realtors said


* Over $10 Billion of Hotel and Casino projects with 10,000+ rooms have been delayed on Las Vegas Boulevard ('the Strip'), according to locally based real estate and economic consulting firm Applied Analysis LLC


* According to the Nevada Gaming Control Board in Carson City, gaming revenue for casinos on the Strip fell for the 8th straight month in August from a year earlier, the longest streak of declines since records began in 1983 . The 16% drop in May was a record. August revenue fell 7.4%..."The only comparable period was around 9/11, when we were down for 5 straight months,'' Frank Streshley, senior analyst at the board, said in an interview.


* At Las Vegas's McCarran International Airport, the total number of arriving and departing passengers in August dropped 10% from a year earlier, when a record 4.3 million passengers went through the airport... Southwest Airlines (LUV), which has more flights leaving Las Vegas than any other city, had a 7.3% drop in Las Vegas passengers in August, and starting in January the Dallas-based carrier will cut its daily Las Vegas departures to 227 from 240... "We are uniquely positioned to be penalized by the global slowdown, because we're hugely dependent on the consumer getting in a car or plane to get away from their lives,'' said Jeremy Aguero, co-owner of Applied Analysis.


* The Unemployment Rate for Las Vegas rose to 7.1% in August, a 2.1 percentage point increase from a year earlier.


bloomberg.com/apps/news?pid=20601109&sid


Data Courtesy: Bloomberg

CHART - Median Family Income + CHANGE

Check out the below interesting New York Times CHARTS reflecting the Historical response of U.S. Median Family Income during times of Economic CHANGE (Click the below for a LARGER image) :


I don't mean to sound overly negative but I'm a realist and believe in evaluating ALL 'informed/substantiated' evidence, whether it supports my current view or not. Unnecessary 'Holier than Thou' disclaimer out of the way, there's nothing TOO earth-shattering about the above charts as they shape up just about how you'd probably expect them to. But sometimes it takes a trigger to enable a LargeR, more significant Real World Realization. Hopefully these charts do the trick because To those of you ABLE to keep your JOBS during the current DOWNturn, one should not be naive enough to believe his/her real Rate of Salary Growth will go UNchallenged / UNinterrupted / UNpillaged (if that's not a word then it SHOULD be).


Data Courtesy: NY Times

CHART - Top 3 U.S. Market Slumps

Double-Click the below Wall Street Journal CHART to see a larger view of the data comparing the 2008 Stock Market Crash to the equally (if not more) painful market crashes of the 1930s and 1970s :


Per the below linked WSJ article:
* A common definition of a market 'Crash' is a 20% decline in a single day or span of several days. For some perspective, the Dow's crash in 1987 was a 22.6% correction in one day. The 1929 crash was punctuated by back-to-back declines of 12.8% and 11.7%.

* U.S. stocks, as measured by the Dow Jones Wilshire 5000 index, have shed about $2.5 Trillion of market value over the last seven trading sessions (including a loss of $872 Billion in market value on Thursday alone)...According to the WSJ, about $8.4 Trillion of total market value has been wiped out since the 5000 company index hit its all time high one year ago Thursday (10/11/2007).

* The Dow Jones Industrial Average index is Down 39% since hitting a record of 14,164.53 one year ago...The Dow's recent 7 day decline of 21% is the largest seven-session percentage drop since the 1987 crash. During the 1987 crash, the Dow Jones lost 43% over seven days.

* At Thursday's close, the Price To Earnings Ratio (P/E Ratio) of the S+P 500 was down to 10.7, the Lowest since the Early 1980's (hopefully those 2007/08 earnings won't turn out to be 'peak year' earnings)...the market's historical P/E Ratio is 15


http://online.wsj.com/article/SB122359593027021243.html


Data Courtesy: The Wall Street Journal

PIN The Blame On The SEC ?

OK, I admit it - the Blame Game is often petty, annoying and almost always Unbecoming. But that's only when insignificant people assign it to inconsequential events. The current Credit Crisis can be a lot of things but its definitely not inconsequential. Former FDIC Chairmen can certainly be a lot of things but they're also most definitely not insignificant. Quite to the contrary + due to their banking system 'powers', they're in fact perhaps the most influential and important officials in the WORLD. With that said, former U.S. FDIC Chairman William Isaac believes that the SEC deserves the most blame for the banking system's recent meltdown. He also has very strong feelings on the SEC's 2006 decision that required banks to value their assets using the ' Mark To Market ' accounting method vs. the previous practice of ' Fair Value ' accounting. Check out the below link which contains the CNBC video interview...some quoted excerpts below:


http://www.cnbc.com/id/27100454

"...The SEC has destroyed $500 billion of bank capital by its senseless marking to market of these assets for which there is no marking to market, and that has destroyed $5 trillion of bank lending...That’s a major issue in the credit crunch we’re in right now. The banks just don’t have the capital to start lending right now, because of these horrendous markdowns that the SEC’s approach required...Once they declare that there’s a 'systemic risk', the FDIC at that point can say that we’re going to protect all general creditors when a bank fails. If they do that, then I think the banks will start lending to each other again...It’s just a lack of confidence, because we don’t know which banks are going to go next. And banks we never thought would go, have gone, and we don’t know how the government’s going to handle them..."

Data Courtesy: CNBC

Heebner - Largest Margin Call Since 1929

During an interview today with CNBC's Larry Kudlow, Ken Heebner, a widely respected hedge fund manager for Capital Growth Management, offered the following interesting 'Hedge Fund INSIDER' perspective behind the Dow's recent 7 day, 2,300 point CRASH :


" I think one of the things that's happening here is that the Fed and Treasury are doing all the right things and the market is (still) dropping at an accelerating rate. What is NOT being recognized is that there is a major MARGIN CALL on the HEDGE FUNDS. They were Levered a year ago at 4.5 to 1 on average for equity funds. It's (the leverage ratio) been coming down and now there's pressure to reduce the leverage considerably because the prime brokers are all owned by banks regulated by the Federal Reserve..and their pulling back their loans. There's PANIC Selling. This is the biggest MARGIN CALL since 1929. And what's sad about this is that the market collapses as the Fed and Treasury do all the right things and it creates the impression that there's something wrong and all these great moves that the Fed and Treasury are making aren't going to solve the problem. "

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Anecdotally thinking...of course current market fundamentals are TERRIBLE (please refer to my 10/08/08 ' The Holy Economic Trinity - C, J and H ' post for more background on this), but are they terrible enough to warrant a massive index loss of 18% over the past 5 days ?? Perhaps so but Mr. Heebner's explanation should at least provide some semblance of comfort to individual stock owners (I guess I believe in silver linings). If this horrid action is truly being driven by an event of UNPRECEDENTED proportions ('The Largest Hedge Fund Margin Call since 1929') as Heebner suggests, then the likelihood of seeing this type of watershed event repeating should become MUCH Less probable (...OF COURSE only After this Once in an Lifetime period of Hedge Fund DE-Leveraging is finally over...could take weeks/months to play out !).



Data Courtesy: CNBC + Ken Heebner

Understanding CREDIT And The TED Spread

The DIFFERENCE ('spread') between what commercial banks and the U.S. Treasury pay to borrow money for 3 months widened TODAY to 423 basis points (4.23%), the most since Bloomberg began tracking the data in 1984. For some perspective, the 3 month spread averaged 41 basis points (0.41%) in the 17 years leading to July 2007 (the approx beginning of the subprime-related 'credit crisis').


The U.S. TED spread represents the difference in Interest Rates banks charge on loans to other banks vs. the interest rates offered by U.S. government short-term debt ('T-bills')..more specifically, it is the actual numerical difference in interest rates between the 3 month Treasury bill and the 3 month LIBOR. The spread is regarded as a valueable Credit market Indicator because it reflects perceptions of how RISKY it is for banks to lend their money to other commerical banks. When the TED spread increases, that is a sign that lenders believe the risk of default on inter-bank loans (also known as counterparty risk) is increasing. When the risk of bank defaults is considered to be decreasing, the TED spread decreases. According to Wiki, a rising TED spread often foretells a downturn in the U.S. stock market, as it indicates that liquidity is being withdrawn.

* By comparison, on Oct. 20, 1987, when stocks collapsed globally on what became known as Black Monday, the spread was at 300 basis points (3.0%).

* By comparison, the TED spread peaked at 160 basis points (1.6%) in 1998 during the collapse of hedge fund Long Term Capital Management.

bloomberg.com/apps/news?pid=20601109&sid=a6.wGKIe.RGg

Data Courtesy: Bloomberg + Wikipedia

CHART - U.S. Debt % Of GDP

Welcome to the TRUMAN Show ? ?




Data Courtesy: Zfacts + Whitehouse.gov

The UNDERWATER Mortgage Rate

According to today's Wall Street Journal, about 1 out of every 6 U.S. homeowners now owe MORE money on his/her Mortgage THAN the current Market Value of his/her home.

There are about 75.5 million homeowners in the United States (approx 25% of the country's population)...12 million or 16% of these homeowners are now 'underwater' on their mortgages. About 33% of total homeowners (24 million homeowners) own their homes outright or without debt.

In 2006, the underwater mortgage rate was 4%.

In 2007, the underwater mortgage rate was 6%.


* According to the First American Index, U.S. home prices peaked in mid-2006, after rising 86% since January 2000. Since peaking, the index has fallen 13%.


http://www.msnbc.msn.com/id/27089919/


Data Courtesy: The Wall Street Journal

The HOLY Economic Trinity - C, J and H

If you've been monitoring the performance of your heavily stock-weighted 401K and/or IRA plan at all this year then it should be of no surprise to you that the Stock Market is currently mired in a cruel and unusual DownTREND. Below are some 'Random Thoughts of BLOGiance' (RTOB) on why this occurred and, more importantly, what Variables/Indicators (Credit...Jobs...Housing) we need to see Flash 'GREEN' before we can be confident of seeing a fundamental REVERSAL of the DownTREND:

* WHAT?
Today's stock market is tied to Housing. Make no mistake about it, the United States' Stock Market Bull Run of 2003-2007 was fueled by an ARTIFICIALLY inflated domestic housing market (a Housing BUBBLE). FYI + If you're not a regular reader of this blog then please click on keyword 'recession' in the 'ETB Archive Keyword REF' on the right to find some posts related to the topic.


* What caused the housing market to be ARTIFICIALLY inflated?
The 'demand' side of the housing price equation (Economics 101 - prices are determined by both supply and demand). Demand for housing was artificially pumped up during the bubble primarily because of the UNPRECEDENTED, Loose lending standards of banks. Exotic loan types including Subprime, Interest Only, Option ARMs, Alt A mortgages, etc. were created by institutional lenders at an UNPRECEDENTED rate and deemed affordable even though their terms were incredibly MISUNDERSTOOD. Many banks approved mortgages for customers without accepting down payments and also without even VERIFYING the INCOMES of homebuyers. Would you ever give $100,000+ to someone whose income you cannot verify?? Would you ever give $100,000+ to someone whose JOB you cannot verify?? STUPIDITY at its finest and most greediest degree.


* Why were banks irresponsibly creating risky mortgage products?
In a hands-OFF Regulatory Environment (thank you good for nothing SEC...thank you ignorant Federal Reserve...thank you incompetent WHITE HOUSE), banks were allowed the room to give into GREED via engaging in absolutely reckless risk (mis)management. From 2003 to 2007, financial institutions were making ridiculous amounts of money from this less than honest practice. Not only were banks making money off of selling the suspect mortgage to a homebuyer, they were also passionately involved in a now nefarious process of 'repackaging' these same mortgages into complex assets/derivatives commonly referred to as 'mortgage-backed assets' (FYI - It is these types of shoddy assets that the U.S. Treasury is now scrambling around to purchase from the country's biggest banks with the recently approved $700 Billion TARP deal). During the boom, 'mortgage backed assets' were produced in UNPRECEDENTED numbers for both residential and commercial loans and became a phenomenal investment for banks and brokers as long as housing prices kept going UP. While the risk is now readily apparent, before the collapse in U.S. real estate prices, these once incorrectly perceived low risk assets were a favorite of banks, hedge funds and institutions of all types as they were yielding as much as 8-12% a year. Banks and brokers alike (including Countrywide Financial, Bear Sterns, Lehman Brothers, Wachovia, Bank of America, Citigroup, etc.) were loading up on these now crippling assets because it provided them a 'sure-fire' way to prop up/inflate their company earnings (profits). Hedge funds loaded up on these assets because their delicious double-digit yields provided them a 'sure-fire' way to outperform the annual returns of their stock market 'benchmarks' (i.e: indices like the S+P 500, Nasdaq, Dow Jones 30, etc.). Enough with the background..


* What needs to happen for the stock market to REVERSE?

TIME

CREDIT needs to stabilize.

TIME

JOBS need to stabilize.

TIME

HOUSING prices need to stabilize.

As mentioned above, the HOUSING boom from 2003-2007 was fueled by incredibly LAX (and sometimes fraudulent) lending standards resulting from the illegitimate, greedy, reckless decision-making of virtually unsupervised banks. During the boom, Joe 'six pack' could get a mortgage without having his income verified and without paying any money down. Those days are OVER. As a result of this subprime-induced mess, the easy credit days are gone. For emphasis' sake, please humor me and allow me to say this again (let it resonAte) - the easy credit days are GONE.

Besides just affecting the ability of Joe to get a mortgage, the now 'polluted' CREDIT markets (polluted because they're clogged with 'bad' assets including the aforementioned mortgage-backed assets) have become FROZEN and are adversely impacting the ability of even LARGE businesses to borrow from banks. Forget the consumer (because that's what banks now appear to be doing re consumer loans for autos, mortgages, tuitions, etc.), banks are also FRIGHTENED to lend these days to other banks and businesses due to the very real fear of 'counter-party risk'. We are still in a perilous time and today's 'Here Today, Gone Tomorrow' business environment (witness the rapid dissolution of former business GIANTS including AIG, Merrill Lynch, Bear Sterns, Lehman Brothers, Wachovia, Fannie Mae, Freddie Mac, etc.), are 'forcing' banks to keep their money to themselves. The White House and Federal Reserve need to do all that they can to diminish counter-party risk and restore confidence back to the financial system and more specifically, the practice of lending.


Once the credit markets are repaired and business activity has at least the CHANCE to resume, we should hopefully see some stability in the jobs market. Why are jobs and job losses CRUCIAL for our stock market ? It's quite simple really...as previously stated in this post, the stock market is currently tied to the performance of the housing market. Unless you're rich, if you want to buy a home then besides needing good credit you also need to have a stable JOB in order to afford the monthly mortgage payments. If the economy keeps losing jobs each month (according to the U.S. Labor Department, the economy has lost over 760,000 jobs thus far in 2008...including a loss of 135,000 in September alone), then the pool of potential homebuyers will continue to shrink. If the homebuyer pool shrinks then so does DEMAND for housing. If Demand for housing continues to fall then so will housing prices. If housing prices continue to fall then so will the STOCK MARKET.

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Lastly, I know I'm omitting some significant details re the ongoing recession (I, much like many others, could write a full blown-out THESIS on this subject including a bunch of great colorful statistics PROVING how dire the situation really is)...but the main purpose of this post is to simplify the explanation and catch people up to speed on the FACT that there are REAL factors driving down the stock market. Most stocks are down dramatically from their highs at the beginning of 2008 but that fact alone IS NOT A REASON TO BUY. The mentality of an opportunistic long term investor during this time should be to allow the downtrend to run its course while waiting patiently with some cash (at least 20-50% CASH makes sense) on the sidelines until the fragile situation with Credit, Jobs and Housing stabilizes.


Without a backdrop of all 3 occurring, stocks will NOT be able to act rationally and more importantly, the market will NOT be able to Reverse its DownTREND.


Be patient as these issues could take months and even YEARS (yes, YEARS) to resolve, depending basically on both 1.) LUCK and 2.) the Effectiveness of our country's Leadership (The President, The Federal Reserve, The dopes at the SEC, Congress, etc). The stock market will ultimately become investible again but the $60 TRILLION question is, how LONG will that take ? ?


While NO ONE including yours truly can tell you with confidence HOW LONG it'll take for the stock market to bottom, the purpose of this post is to inform you about WHAT INDICATORS you need to look out for (CREDIT...JOBS...HOUSING) so that you can identify when the fundamental bottom has occurred + invest accordingly/opportunistically.

CRAMER - Less Than 5 Yr Horizon, Get OUT

Per the below MSNBC article and video, CNBC market commentator Jim Cramer is advising ALL investors to CASH OUT of the STOCK MARKET if their investment time horizons are Shorter than 5 Years :





Cramer excerpts per the above video interview:
* “I thought about this all weekend...I do not want to say these things on TV...Whatever money you may need for the next five years, please take it out of the stock market right now, this week. I do not believe that you should risk those assets in the stock market right now.”


* “I don’t care where stocks have been, I care where they’re going, and I don’t want people to get hurt in the market."


* “I’m worried about UNEMPLOYMENT, I’m worried about purchases that you may need. I can’t have you risk that in the stock market in the next 5 years.”


* "I believe we may have as much of a 20% decline in the stock market. If you can withstand that, most people can't, then you'll have to ride it out."



http://www.msnbc.msn.com/id/27045699/



Data Courtesy: MSNBC