Fagan Associates Archive for August, 2009

The anxiety and despair that was Wall Street just five short months ago has begun to recede. Gradually, investors are returning to investing in the stock market, thus pushing the overall market higher.  We believe that there remains a large degree of skepticism about the direction of the market despite all of this seemingly renewed optimism.

We often talk about the stock market being an anticipatory vehicle and that historically advances come during the most trying of economic times.  In fact, back toward the end of March, when stocks were just coming off ten-year lows, we penned an article that appeared right here in The Record, entitled “Try The Irrational.”  Contained within the body of this article were a number of reasons why, despite the fact that the economy was mired in a severe economic recession, one should consider investing in the stock market.  We observed that “if the entire objective of investing is to buy low and sell high, why then when investors have the chance to actually buy low and sell high, very few do?”

Fast forwarding to today, we see some sparks in the economy, specifically in housing and some of the Leading Economic Indicators.  However, in our opinion, alone not enough to justify the more than fifty-percent advance in the S&P500 off its March 9, 2009 close.  Jobs are still being lost, consumer spending remains soft and businesses are still reluctant to loosen the purse strings. Despite these remnants from this long, deep recession, the stock market remains steadfastly focused on what it appears as a gradually improving economy, one where at some point in time in the not-too-distant future, some of the pent-up demand in both the consumer and business sector will begin to be filled with orders.

Where do you stand in relation to your objectives?  How are your assets allocated?  Is your current strategy of investing appropriate for your particular situation or have you been scarred by this bear market and, most likely to your own detriment, unwilling to wade back into individual stocks or equity mutual funds?  It is a fact that upon exiting a bear market the vast majority of individuals are underinvested in the stock market.  Perhaps we may have indeed lost a generation of American investors.

THE BOTTOM LINE – It is important to objectively assess your own portfolio and the amount of risk involved, given the length of time remaining in which to achieve those objectives.  Furthermore, it is important for each of us to try to determine their ability to withstand the emotional weight of a declining market.  This “tolerance to risk” was by far the most important factor in determining which investors were able to focus on the long-term benefits of investing and which sold at or near the bottom.  It is also important to learn from the past, but not live in it.  Look forward and keep in mind that stocks have gone nowhere over the past decade.  Ironically, this most likely bodes well for stocks over the next ten years.

It seems like over the past few weeks, the new call-ins to our office have come from investors

who have committed similar errors.  Although common, some of these errors have severely

restricted their gains over the past few months, despite the huge run-up that we have seen in the stock market.  To be fair, some of the mistakes these investors have related to us have been made by their advisors.  That said, please don’t misunderstand that statement.  Not every stock or mutual fund that we pick is a winner.  However, there are certain errors that are easy to see coming and simple to avoid.  Therefore, these are the ones that we will discuss.

“Mistake Number One, not knowing the costs of entering or exiting a mutual fund.”  Generally

speaking, there are two different ways mutual funds can be marketed, either through a sales force

or directly to the consumer.  Those that are marketed through the efforts of a sales force or

stockbrokers are referred to as loaded funds.  These funds either charge commissions to get in or to get out.  Class A shares are funds that usually charge a commission in the range of four to five percent of the initial deposit at the time of the deposit.  Other mutual funds marketed by brokers or advisors levy fees if the fund is sold within a certain timeframe, usually seven years.  These are known as Class B funds and carry an internal expense ratio that is usually one percent higher than would be otherwise.  The final method of compensating the sales person of a loaded mutual fund comes from purchases of Class C funds.  These funds typically levy a fee of one percent per year and is used to compensate the broker who sold the investment.  In our opinion, this is the most cost efficient way to purchase a loaded mutual fund through a broker.  However, the most cost efficient way is to invest in a pure no-load fund or one that levies no sales fee to get in or to get out.

Just a reminder, we believe the mistake the investor makes is not investing in a mutual fund

that carries a commission, but rather not being aware of how that commission may limit future

growth or investment flexibility should the investor wish to make a change that would include

another fund family.

Another mistake that investors make is what we refer to as “waiting to break even.”  This occurs

when, shortly after making an investment, the security declines in price due to a company or

mutual fund specific problem or perhaps due to general market weakness.  Many investors recognize that the investment they now have no longer is the one they thought they were getting into.  It no longer is one they wished they had made.  It no longer is one that they plan on holding to for a long time or one that they view as having a lot of potential.  However, they tell us that once they get “even” or are no longer losing money in this investment they will sell.  This is a

mistake.  An investor must always ask his or herself the following questions.  Would I make this

same investment now?  Does this investment have worthy potential or am I better off investing

elsewhere?  If the answer to those questions is no then you cut your losses immediately and

move on.  Remember to recognize a couple of fundamental principles of investing.  The first

being that you will always choose some losers.  You can not invest without picking some

bummers!  The key is to have more winners than losers.  Remember, a .300 hitter in baseball

gets into the Hall of Fame even though he gets out seventy percent of the time.  The second

fundamental principle of investing is to “sell your losers and let your winners run.”  Don’t wait

to get even.  You may be waiting a lifetime while the overall market passes you by.

To employ another baseball analogy, the final investment error that we will discuss will be

“swinging for the fences.”  Many investors try to hit the home run by investing a great portion

of their money into little known or speculative companies in the hopes that they are buying into

the next Apple Computer or to find out some time later that their winner is a loser and that their

investment has gone belly up.  As a result of years of experience, I have come to realize that

there is no information scoop or free lunch.  We, like all other investment advisors have to work hard at researching and then making the right investment.  Shrewd investors know that the obtainment of wealth is a process that demands time and patience.  Sure, a few investors will strike it rich.  However, to think that we will be as lucky is like saying that most of us have

a good chance to play in Major League Baseball.  It happens only rarely.  If you do wish to speculate, please do so with less than five percent of your portfolio and recognize that you may lose all of that money.

THE BOTTOM LINE.  Know the cost of investing.  Know how you are compensating your investment advisor.  Finally, recognize that becoming a competent investor requires time, patience and that you will make mistakes along the way.

Investors hear a lot of talk today about how the massive spending by the Federal as well as State Governments along with the potential for a pick-up in economic activity during the latter part of 2009 and into 2010 may be inflationary.  To this point we can agree.  However, until all of the excesses in the economy get soaked up, inflation remains at bay.

This past week at the conclusion of their regularly scheduled meeting to determine, amongst other items, the direction of interest rates, the Federal Reserve’s Open Market Committee issued a statement outlining their reasoning behind keeping interest rates at 0.25%.  They stated that “information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out.”

Furthermore, they noted that despite the fact that “household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.”

Contained within this statement is also the conclusion that despite the fact that “prices of energy and other commodities have risen of late.  However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.”

Their conclusion is our conclusion.  Digging a bit deeper than the policy statement, one can find that Capacity Utilization, the percent at which our nation’s mine, factories, and utilities operate at remains near historic lows.  This excess capacity must be soaked up before any inflationary pressures mount.

The Unemployment Rate stands at 9.4%, a multi-decade high.  Furthermore, assuming that all of those that needed jobs were actually looking for them, the Unemployment Rate would approach 16%.  Once again, before any inflation pressures mount regarding wages, the rate of unemployment would have to fall substantially.

Factory hours worked ticked up last month to 33.1 from 33.0 hours.  However, this figure represents an historic low.  It would be natural for employers to offer more hours to their current employees rather than hire new ones.  Once again, this should keep the unemployment rate relatively high and wage growth tame.

Finally, consumers continue to repair their balance sheets by deleveraging.  The Federal Reserve recently reported that consumer credit dropped by $10.3 billion this past month, an unprecedented fifth consecutive monthly decline.  We believe that this deleveraging is part of a secular trend that will continue into the foreseeable future thereby reducing the pricing power of retailers and therefore controlling inflation.

THE BOTTOM LINE – Don’t expect inflation and therefore interest rates to tick up anytime soon.  We would strongly recommend that your investment portfolio reflect this expectation by looking for alternatives to Certificates of Deposit and other Fixed Interest Accounts.  Otherwise, the level of investment income will be far below what you are accustomed to and perhaps what can maintain your standard of living.

The initial look by the Commerce Department at second quarter Gross Domestic Product (total output of goods and services produced in the United States) indicates that the trajectory of the economic downturn is beginning to level off.  This stabilization is the first step toward a sustainable economic recovery.

The Commerce Department reported that GDP fell at an annualized rate of 1.0% during the second quarter, far less than the 6.4% and 5.4% drops recorded during the first quarter of 2009 and the fourth quarter of 2008, respectively.  The consensus estimate had been for GDP to fall 1.5%.  On an encouraging note, inventories continue to decline indicating that when domestic demand recovers, businesses will need to rapidly replenish their inventories resulting in stronger economic growth.

Another sector of our economy, one that helped lead us into this recession, that supports at least a bottoming of the economic downturn can be found in the housing market.  A couple of weeks ago it was reported that housing starts rose 3.5% or by 20,000 to 582,000 during the months of June and building permits, a sign of future home building rose 8.5%.  It is also very important to keep in mind that several hundred thousand homes need to be built each year due to the growth of the population in the United States as well as to replace those homes that are intentionally demolished or unintentionally destroyed.

The final piece to the “economy is bottoming puzzle” belief can be found in the labor market, and more specifically, claims for unemployment benefits.  Continuing claims, made by individuals reapplying for unemployment benefits due to the expiration of their current claim, has fallen from a record high of approximately 6.9 million eight weeks ago to approximately 6.3 million this past week.  This, once again, indicates a slight improvement in the labor market.

The above begs the question, “so what does this mean for my investment/retirement portfolio?”  We have and continue to hold the belief that the move on the Dow Jones Industrial Average from its all-time closing high of 14,164 on October 9, 2007 to 10,000 on October 6, 2008 accurately reflected the severity of this recession.  However, the move from Dow 10,000 to its closing low on March 9, 2009 of 6,547 was mostly panic driven.  It then becomes evident that, as the panic subsides, a move back to Dow 10,000 over a period of time is likely.  However, the pace at which we move toward this number will slow as it is approached.  Furthermore, moving above Dow 10,000 will be predicated upon the success of the economy to right itself through the efforts by both public and private entities.

Please note that all data is for general information purposes only and not meant as specific recommendations.  The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein.  Securities contain risks and fluctuations in principal will occur.  Please research any investment thoroughly prior to committing money or consult with your financial advisor.  Please note that Fagan Associates, Inc or related persons buy or sell for itself securities that it also recommends to clients.  Consult with your financial advisor prior to making any changes to your portfolio.  To contact Fagan Associates, Please call 518-279-1044.