Whether you are old enough to appreciate Pete Seeger or the Byrds, you are no doubt exposed to their classic, Turn!Turn!Turn! Taken from Ecclesiastes 3:

“To everything there is a season, and a time to every purpose under heaven: ….a time to plant, and a time to pluck up that which is planted;”

We still have a lot of “financial experts” explaining that the time to own a basket of stocks is now, in the future, and always. If they could only embrace the simple message of Ecclesiastes 3, they would begin to understand the folly of their advice

Doomsday marketers are everywhere now and they are succeeding in their marketing efforts. One famous doomsday fellow predicts the Dow will fall to 1000! That would mean that stocks would fall by over 90%. If earnings were flat, that would mean that the return on your investment (earnings versus investment) would be over 50% per year when the market is at 1000.

We don’t know about you, but we would gladly put all of money into stocks well before our return would be need to be 50% per year. Alternatively, we might consider that earnings would have to fall 90% from current levels. As current earnings are rebounding from rather low levels, it is hard to imagine that scenario either. Anything can happen, but this is about as likely as being struck by lightning.

But the doomsday crowd is succeeding in frightening people and we are getting calls about how to invest in the likely fall of the market. We don’t say that a market crash is impossible or that a decline will not take place. We do say that profiting from a market decline is the most difficult strategy to employ and that the skill and timing required to do so successfully is daunting.

First, stocks have an upward bias. This is just common sense. A big company makes money every day, so it is literally “worth” more each day. The counter balance to this is that the market has over valued the stock (i.e. investors are paying too high a price in order to own part of the company) and so it will fall even though its worth is increasing daily. So, our common sense means it is relatively harder to make money on stocks falling as opposed to their increasing in value.

Second, let’s go back to the notion that we are market realists. One of our favorite market realists is Jeremy Grantham. He has long produced his 7-year market forecast with astonishing accuracy. He basically normalizes earnings and uses them to figure out likely returns over 7 years given current valuations. His latest forecast shows positive real returns (above the rate of inflation) for all stock classes over the next 7 years.

Many are below normal, but all are positive. These seven years will likely include some big plus and some big minus periods. But, if at the end of the day returns for the period are positive as he predicts, you are once again swimming upstream by trying to invest in a market fall.

We believe we are in a difficult environment and that you need to take more risk when stocks are cheap and rising and less risk when stocks are expensive and falling. To try to make money based on the doomsday scenario,…….., just doesn’t make much sense to us. It is betting on a long shot.

Senator Harkin is someone who has at times impressed us by seeming to stand up for the common man. Yes, at age 69 he now stands firmly against the people and for the insurance companies. He wants to make sure that one of the most abused products on the market is not regulated with rules to protect consumers. Iowa has a lot of insurance company employees and, we assume, contributes handsomely to the coffers of the Senator.

At almost 70 years of age, it is time for anyone to “do the right thing”. In this case, the right thing is simple and apparent to anyone. Yet, for a change, we are close to Senator Harkin and our elected officials acting in a manner that is to our direct detriment. Thanks a bunch!!

The source for this chart is Bloomberg. The story with it was the traditional sell side story, basically that the market is soaring but that it is not too late to join in. Appealing and compelling! Get on that train today!

The other chart we received was also from Bloomberg, covering the S&P 500 index going back to January of 2007 instead of February of 2009. 

So, the part from February of 2009 looked identical but the left side had a very large fall included. The point of that chart was to show that, from January of 2007 through  the late 2009 you still needed more rise in the market just to break even. Not compelling! Not appealing!!

Which chart is more important to an investor-the one showing that they need to hurry and join in the meteoric rise or the one that shows that they still have significant market losses and no compounding of your money? You be the judge.

We did not see the market rising as quickly and steeply as it did in 2009 and now we certainly did not expect this rapid a drop. What can we learn from this? First, the market volatility of 2008 is not totally behind us. We still remain in a turbulent market, range bound in the long term but able to climb steeply and then fall sharply. It is a market best suited for hard work and diligent processes rather than passive investing.

The other problem from yesterday was the fact that we seemed to have computers running amuck. Much of the speed of the descent stemmed from computer trading programs, flash trading, etc. The passive investor believes the “market is efficient” and correctly prices stocks at all times. Yesterday afternoon, in that case, all American businesses lost more than five per cent of their total value in less than ten minutes and then regained most of that value over the next hour and a half. I don’t think even the staunchest advocates of efficient markets would like to defend that proposition. So, we had computers and people losing their grasp on reality and nearly causing a calamity worse than the oil spill in the Gulf. It seems to us that we need to replace some of the speed of computers with some more level headed market makers. Flash trades and High Frequency Trades take place on Wall Street in milliseconds. We don’t know about you, but we like to consider our decisions a little longer than a millisecond before we make them. If we don’t want to risk more meltdowns (or melt ups), we need to get some rational people back in front of the market, instead of just the computers that people have programmed to respond quicker that we can poor mortals can think.

Let take two investors, each of whom has $100,000 to invest. Investor A (the tortoise) gets 20% of market up and 20% of market downs. Investor B (the hare) gets 100% of market ups and 100% of market downs. Now, let’s add some volatile market returns (certainly not beyond the realm of possibility). The market goes up 50% and falls 40% in year 2.

Investor B has a lot more fun at cocktail parties than Investor A. Our hare (B) gets to brag about the huge returns in year one, while the tortoise (A) tries his best not to discuss his portfolio. Arithmetically, our hare ends up with a 5% annual average return (up 50% and down 40%). Our poor tortoise averages only 1% per year (up 10% and down 8%).

The hare, unfortunately, has only $90,000 of his original $100,000 investment left after year 2. Perhaps his excitement was worth $10,000 but we are not that interested in excitement here at Capstone. The tortoise has $101,200 to show for his investment. He averaged less arithmetically, had less excitement, but saw the return of his principal along with a small return on his principal.

When the odds of favorable outcomes are heavily on your side, it may be better to be a hare. When the odds are more neutral or against you, think hard about being a tortoise. The tortoise can make a bit of money in a turbulent environment while the hare loses his.

Stock                                       Price in 2000                          Price 12/31/2009

Nokia                                      $54                                          $12.85

Enron                                      $73                                          AARGH!!

Nortel                                      $77                                          $.002 (Wow!)

Oracle                                      $74                                          $24.53

Broadcom                               $237                                        $31.47

Viacom                                    $69                                          $31.50

Univision                                 $113                                        *(36.25)

Charles Schwab                      $36                                          $18.82

Morgan Stanley Dean Witter  $89                                          **$29.60

Genentech                               $150                                        ***(95.00)

• *Purchased by Broadcasting Media Partners in April, 2007 for $36.25 per share
• **Does not include value of Discover spinoff (not enough to avoid losing $$)
• ***Purchased by Roche in March 2009 at $95 per share

So, our version of the old joke- How do you become a millionaire investor? Subscribe to Money Magazine, cling to the buy and hold philosophy through thick and thin, have a 10 year time horizon, and……start with at least $4 million dollars!!!

Maybe take those buy and hold recommendations with a grain of salt???

Today Senator Dodd dropped from his financial reform packet the demand of a fiduciary duty on those who give investment advice. Simply put, this means that you the client will continue to be taken advantage of by the vultures that put themselves first at all times and that this will remain legal!

There are a myriad of financial products that will continue to be sold due to their high commissions and the story selling that surrounds them. Whether they are appropriate for you will continue to be up to you to determine. Of course, whether these are good solutions for you or not will require you to study investments and financial planning for a few years as many of these products are complex and intentionally opaque. An equity indexed annuity is a prime example of the difficulties you will encounter in understanding and evaluating whether something is a good investment. Not only are these complicated (though the sales pitch is simple), but you are unlikely to know about similar or better products available with FDIC insurance that may be preferable. Why won’t you know about them? Because they pay far smaller commissions so they will not be presented by sales people who do not have to put your interests first.

The thought that you would pay someone for investment advice (whether that is by fee or commissions) who is not legally bound to at least try to put your interests first is absurd. That the financial services industry at this late date would campaign to avoid this level of responsibility is deplorable. Given all that we have gone through, you would hope that putting clients first would be acceptable to all moving forward.

What should you do? I think there are two questions that should be foremost in your mind when dealing with anyone in financial services (insurance, stock brokers, financial planners, etc.). First, ask them if they are acting as a fiduciary? If they do not respond in the affirmative, make sure you ask them how they are compensated for a transaction and how much they are compensated for the transaction. If they are not forthright in disclosing these answers (e.g. they say their compensation is built into the product and you don’t pay anything additional), then you need to run for the exits. If you get a reasonable answer, then you may choose to proceed with the transaction. Just remember-caveat emptor.

The “sales forces” of financial services are out there now beating the drums for this new decade. Surely after a poor decade we should return to the norm by having excellent returns on our investments, shouldn’t we? Unfortunately, this decade is not really setting up to be any easier for investors than the previous one.

Stocks are certainly not beginning the decade by being cheap by historic measures, so we should expect an average to below average return. Thus, the range bound or secular bear market is likely to continue for some time in equity markets. Unfortunately, commodities and bonds are no longer cheap like they were at the beginning of the past decade. So, returns will be still tough to come by moving forward.

We think the key moving forward will be to be tactical with your risk budget. By that, you or your advisor needs to keep an eye on what are the risks and what are the potential returns of investments. So, if the stock of a great company has fallen to a very low price, buying the stock may increase your risk but be justified by potentially large gains. On the other side, if a stock is very expensive by historic measures it may have rather limited potential appreciation and considerable potential loss. To sell that position and reduce your risk may be the prudent decision. 

So, while investors traditionally have to decide on how much risk to take and stuck with that decision, we believe the prudent course is to adjust your risk budget by the opportunity available to garner good returns. You might still average the same amount of portfolio risk through a market cycle, but get to that average in a way that benefits your bottom line.

We have long held that for us personally retirement was not a goal. Restylement, with its ability to give you more time to pursue the things that are most important to you, is what appeals to us. There is something that we don’t like about retirement- there is a connotation of withdrawing in the word that does not appeal to us. We know retirement will still be the goal for many, but others will increasingly choose restylement as their goal. The ability to do the things you are passionate about and spend less time doing the things that you don’t enjoy.

This past week we were on “vacation”, but it did not work out that well. We found there were pressing work issues that needed to be dealt with during our time away. So, it occurred to us to re-think vacation a bit also. It seems to us that “vacation” is a corollary to “retirement”. The root word “vacate” has to do with leaving, emptying, etc. Our goal when we go away is really not vacating, but recreation. We want to re-create, not merely empty. Our goal in getting away is to refresh, step back, enhance, get new ideas flowing, etc. So, we did not really have our “vacation” spoiled by having to do a bit of work while away. We were still able to enjoy all the benefits of the time away and have it serve us well in “re-charging” for the road ahead. So- no retirement and no vacation, but bring on restylement and recreation. They both sound good to us.