Market To Politicians: Thanks, But No Thanks...
Remember last week when the Dow fell 777 because politicians didn't pass the Banker Bailout Bill (BBB)? Well earlier today the Dow was down over 800. Worse, this was 1,300 from the market peak last Friday, around the time the bill passed.
My government spent almost one trillion dollars and all I got was this crummy market! For those looking for a bright side, consider many emerging market funds are down 50% from the peaks; heck Russia fell around 20% in a day and is now down 65% from highs. And Russia didn't even have a housing bubble! They did have a commodity bubble but we'll save that tale for another day.
This makes one wonder, what would have happened if no rescue package was passed? The non-U.S. government bond market - the area the bailout is targeting - is not fairing much better.
The trouble is panic has set in. Not just with investors, but consumers. For the first year or so of the unwinding of the Great Real Estate bubble, experts were sure it was somehow going to be contained - that trillions of instant wealth could just disappear with nobody noticing (except the banks then lent money against the phantom gains). Well if you've been to a car dealership lately, people have started to notice.
While we don't think the Dow under 10,000 is such a bad place to be compared to government bonds, CDs, or real estate, if this downward spiral continues HGTV's "My House Is Worth What?" will be renamed "My House Is Worth What!"
Bailout Delayed, Free Market Returns With Vengeance
Congress Killed the bailout. Everybody is mad at somebody. The bailout is too big. Too small. Doesn't spread the wealth. Will hurt taxpayers. Will lead to more bad behavior. This list goes on. In this upside down world, Republicans want big government solutions to market problems while Democrats want to redistribute wealth to bankers. Everybody has a bone to pick on the bailout yet nobody can explain exactly how $700 billion stops the market madness.
What did the stock market think about the delay in the $700 billion fix? Dow down -777. Yesterday, even lucky numbers meant bad luck.
With big banks dropping like flies (A.T.B.T.F. almost to big to fail...) and every kind of debt with more default risk than U.S. government bonds going through bouts of panic selling (even munis! ) its time to reflect back and remember one thing: this is all the result of the Great Real Estate Bubble.
While there is certainly much blame to go around, the biggest villain was a simple widespread belief that homes were a perpetual upward motion machine.
Like everybody, we have our own ideas on how to 'save' humanity from our greatest bubble yet (bonus feature - it doesn't require creating another bigger bubble somewhere else). But who cares what we think about the bubble anymore... All you need to know is there are only three parties that can take the fall as trillions in phantom real estate wealth evaporates:
1) Home Owners
2) Lenders (this includes investors in mortgage debt, not just jet-set bank execs)
Government polices and bailouts can shift the burden between the big three, but all will take a hit. Without magically re-inflating the housing bubble, there is no way all groups can come out unscathed. The best way to start crafting a bailout package is determine how you want to spread the multi-trillion dollar burden.
And remember when you go around finger pointing, those that live in glass houses shouldn't have taken out a pick-a-payment home equity loan to renovate their kitchen with stainless steel appliances and a granite counter top because someone on HGTV said repeatedly it adds value beyond the cost of the renovation...
Muni Money Market Yields Skyrocket
Money market funds have quickly taken center stage in the real-estate-bubble-created credit crisis. Last week we saw 'safe' money market funds slip under a buck a share. A true run-on-the-bank-style panic was averted by (yet) another government scheme to calm the jittery (who are mostly institutional investors incidentally). Around $150 billion flew the money market fund coop early last week before Uncle Sam said 'keep buying increasingly questionable commercial paper, we'll pick up the losses!" Outflows dropped to just a few billion a day.
Now we're seeing tax free municipal money market fund yields skyrocket - which could be a good thing for investors. Hopefully. Tax free money market funds own debt issued by state and local governments - not corporations like the now defunct Lehman Brothers. Traditionally this is a very low risk investment, but then traditionally banks aren't failing every few days as a twenty trillion dollar real estate bubble deflates.
Today truly 'safe' money market funds that own government debt yield less than 2% (and falling). This below-inflation yield is also taxable. Municipal money market funds traditionally yield a little less than taxable money market funds, but can yield a little more after taxes to those in high tax brackets. Today this relationship is out the window. Now the unemployed will even earn a better after-tax yield in muni funds. A lot better. So much better that something just can't be right.
On Vanguard.com today, yields ranged from 1.52% for the taxable Treasury Money Market fund, to over 5% for certain single-state muni funds that let residents avoid state and federal tax on income. For those in a high tax bracket in Pennsylvania, this is like an 8%+ taxable yield on 'safe' money. Similar yield spreads can be seen on Fidelity and other money market fund manager's web sites.
How did this happen? Looking at Investment Company Institute data, in recent days money has been leaving muni money market funds faster than from taxable funds - a grave concern considering there is only about 15% as much money in muni funds. This, plus general problems in the municipal bond market partially because of Lehman's failure, has led to skyrocketing yields.
Is it safe? As we noted last year, even good money market funds can fail and break the buck if there is panic selling and nobody is left to buy the portfolio holdings - regardless of the their soundness. The same is true for municipal funds. However - and this is a big however - the government is also insuring muni money market funds from losses (according to the ICI). The coverage only includes those who bought in before September 19th, so those grandfathered in now have a 5% tax free federally insured investment while those buying in today are probably taking a risk (but if the flows of funds turns positive that risk will be negligible). Investors can tell if flows turn positive - the yields will fall back to earth.
Enjoy it while it lasts!
Money Market Fund(s) Fails
The dominoes are falling fast on Wall Street. It's not just a bunch of hedge funds that lent money to semi-defunct Lehman Brothers - mom and pop mutual funds are owed billions. On Tuesday the first money market mutual fund in over a decade announced it has 'broke the buck'. This collateral damage from Lehman is likely why Uncle Sam is now writing blank checks to AIG.
You may want to refill your Ambien prescription before you read this New York Times article about the mess:
The announcement was made by the Primary Fund, which had almost $65 billion in assets at the end of May. It is part of the Reserve Fund, a group whose founder helped invent the money market fund more than 30 years ago.
The fund said that because the value of some investments had fallen, customers now have only 97 cents for each dollar they had invested.
This is only the second time in history that a money market fund has 'broken the buck' — that is, reported a share’s value was less than a dollar.
This year alone, big banks and fund management companies have pledged more than $10 billion to rescue affiliated money funds that were caught holding mortgage market securities that were deteriorating rapidly in value...
The Primary Fund reported that, until further notice, it would delay paying redemptions to customers for up to seven days, as permitted under mutual fund law. That delay will not apply to debit card transactions, automated clearinghouse transactions or checks written against the assets of the Primary Fund, provided that the transactions do not exceed $10,000 from single or affiliated investors...
Several industry analysts said on Tuesday, however, that the Reserve Fund’s action came after its Primary Fund was hit by heavy redemption demands that intensified the impact of the Lehman losses."
Of course, the fund company trade association assures us that money market funds are sound...
See also: Can Money Market Funds Fail?
Wall Street Worries
Well, these are interesting days on Wall Street to say the least. We aren't going to pretend we know exactly how things are going to shake out (though we've been commenting on the dangers of the real estate bubble for years), but SmartMoney has some basic, sound advice for frazzled fund investors that could help ease the pain during the next market meltdown.
If, indeed, you haven't been able to step out of the way of these events, here's some advice to follow before the next downturn comes along (and, by all accounts, the next one may be sooner rather than later). First, don't make any knee-jerk reactions. If you think you can stave off further loses with a couple of trades you're fooling yourself (and probably selling at the worst possible time). If you are living off your retirement account, you may want to reconsider how much you are pulling out of it for household expenses. At least one study has shown that you can severely cut into the life of a retirement account by tapping it at its lowest balance.
You should also check to see how your funds react to these big downturns. We like the idea of a diversified portfolio in these situations. In concept, at least, a diversified portfolio should smooth out any wild rides. If, say, your portfolio of large-cap stocks takes a sharper dive than the overall market you may want to re-evaluate it, especially if you realize you can't stomach these ups and downs.
Finally, every investor needs to sit down after days like these and do a gut check. Once the dust settles there will be some prime buying opportunities for those with cash and the nerve to put it to use... Indeed, last week we polled some fund managers about where they saw bargains in the financial-services industry. This morning one of our interviewees, Anton Schutz, who runs Burnham Financial Services (BURFX), reiterated on CNBC what he told us last week: 'There will be great opportunities.'"
Target Date Drawbacks
Alex Anderson at Forbes does a nice job highlighting what we see as the major drawbacks of target date mutual funds, the popular funds in which portfolio managers slowly move from more aggressive to less risky as the fund's target date (and presumably investors' retirement) approaches.
First, within the equity oriented target funds, the portfolio consists largely of mutual funds. Management fees piggyback on both the target-date fund and the underlying mutual funds. Unless the sponsoring fund company is committed to low fees (like Vanguard), the total fees associated with the newer version of target-date funds can be double those of other funds.
Second, many target-date fund sponsors upped their average equity exposures during the recent bull market--probably in an effort to juice up investment returns. This has been unfortunate of late, as the bear market has hurt the recent performance of those target-date funds with heavy stock allocations.
Finally, the newer target funds have a 'one size fits all' approach. There are many valid reasons why two investors with the exact same retirement date should have dramatically different asset allocations. Perhaps there are differences in health and life expectancy, in risk tolerances and in basic financial circumstances.
The major drawback of the bond-oriented target date funds is reinvestment risk. Should investors receive their lump sum payments at a time of inflated equity prices and/or low interest rates, they would have limited opportunity to reinvest the lump sum proceeds advantageously. A second drawback is the fact that the investment structure is completely bonds.
Historically, equities have provided higher returns than bonds over the long term, and some portfolios with a conservative mix of both bonds and equities can actually be less risky than those that are completely bonds."
While a quality target date fund is a good choice for smaller portfolios and set-it-and-forget it types, they just aren't a substitute for a low cost portfolio of funds specifically tailored to an investor's retirement goals.
The Seven Percent Dissolution
The Wall Street Journal reports that Vanguard's so-called managed payout funds, which promise a 7% of principle distribution per year to investors, are delivering mostly phantom income.
..just four months after Vanguard's funds launched, their performance reveals one very big problem with how such funds are structured: to meet their payout obligations, the funds are dipping into principal.
Seventy-seven percent of the payouts from Distribution Focus Fund this year will actually come from the fund's capital, and it's a similar story for Vanguard's other two managed payout funds. For Growth and Distribution Fund that figure is 71%, while 63% of distributions from Growth Focus Fund have been taken from capital.
'People are getting their money back as a distribution,' said Dan Wiener, editor of The Independent Adviser for Vanguard Investors. 'These aren't coming from dividends or interest from holdings, or even short-term capital gains. These funds just haven't been making money.'"
The problem of course is that during rough market conditions these funds simply don't perform well enough to keep making payments without eating into principle. Since these fund's monthly payouts are set based on expected long term returns of the fund,when underlying investment performance doesn't live up to the payout goals, you are dipping into principal to 'earn' your 7%. Investors who bought into these Vanguard funds thinking they would be getting a steady, predictable stream of income have so far achieved this goal, but at the expense of their actual investment declining in value along the way - much like taking out 7% a year from your own portfolio as it sinks with the market.
Next year we expect Vanguard to lower the distribution to be 7% of the new lower fund price (which means those who bought in at launch will no longer be receiving 7% on their original investment). The current artificial yield is actual around 7.8% to those buying today because the fund price has fallen but the payout is fixed for now.
Bottom line, the only true yields above 7% are in distressed or non investment grade debt. The real yield on Vanguard Managed Payout Growth Focus Fund Investor Shares (VPGFX) is around 2.5%. Anything else - even higher yield stocks and REITs - will require some sort of liquidation of assets to generate that yield - hopefully after a capital gain but lately that as not been the case.
We (of course) predicted this outcome ("It’s unlikely Vanguard can create a fund delivering big 7% payouts with principal preservation and stability.") before the fund was launched.
Buy High, Sell Low, Repeat Until Nausea Sets In
The Gods Must Be Crazy
If you're one of the small-potato investors Janus exploited to make their big-time clients a bundle in the the great fund timing scandal of 2004, we've got some good news. The Securities and Exchange Commission has given the go-ahead for the Denver-based behemoth to begin disbursement of $100 million of settlement money.
"The payment of nearly $18.23 million is the first disbursement of $100 million Denver-based Janus set aside to settle a market timing case.
The SEC directed the funds be transferred to Deutsche Bank to be distributed to 'injured investors.'
Investors in Janus have been waiting since 2004 to recoup some of their losses. The SEC estimates investors lost $20.9 million because of market timing arrangements with certain large investment companies.
The SEC said Janus benefited from market timing agreements because the investors agreed to make long-term investments in certain Janus mutual funds. But the prospectuses for the funds being timed stated, or strongly implied, that Janus did not permit frequent trading or market timing, according to the SEC."
Too bad they didn't just say in the prospectus "we favor certain clients to the possible detriment of other clients" and everything may have been honky-dory for Janus. Why Janus would risk a multi-billion dollar money machine over a few million dollars remains a mystery.
Investors in seven Janus funds during specific months of 2002 and 2003 are eligible for a piece of the pie. Read this FAQ for more info.
Socially Responsible Fund Family Fined For Buying Socially Irresponsible Stocks
Apparently the tree huggers at the Securities and Exchange Commission were a little annoyed when they noticed that holdings in certain Pax Word socially responsible funds didn't seem up to the touchy-feely earth-friendly marketing hoopla on Pax World's site, according to this Wall Street Journal article:
"Pax World Management Corp., one of the best-known 'socially responsible' investment firms, settled Securities and Exchange Commission charges that it violated its own rules against purchasing shares in companies involved in such businesses as defense, alcohol, tobacco and gambling.
The settlement -- in which Pax agreed to pay a $500,000 fine -- marks the first time the SEC has taken action against a purportedly socially responsible fund for failing to live up to its mission. The SEC said it uncovered the problems in a routine examination.
...The SEC alleged that, from 2001 through 2005, Pax World Growth Fund and Pax World High Yield Bond Fund failed to screen 41 stocks and bonds at all to see if they met socially responsible criteria.
Of those securities, 10 violated the funds' written restrictions. Regulators didn't reveal the securities' names, but Portsmouth, N.H.-based Pax said they included Anadarko Petroleum Corp., an oil and natural-gas exploration company; Darden Restaurants Inc., which operates a chain with its own micro-brewed beer; and Jacobs Engineering Group Inc., a defense contractor."
We've complained in the past about some socially responsible fund portfolios being anything but, and while there are certainly higher crimes and misdemeanors in the world of investing, we're glad to see the marketing fluff produced by socially responsible funds finally come under under some scrutiny. Call us old fashioned, but when Pax world says their investment philosophy include so-called sustainable investing, "the full integration of environmental, social and governance (ESG) factors into investment analysis and decision making", we don't expect to see the number one holding on 6/30/08 of the Pax World Value Fund (PAXVX) to be Whiting Petroleum Corp (WLL), a company involved in "exploration, development, exploitation, and production of oil and gas primarily in the Permian Basin, Rocky Mountains, Mid-Continent, Gulf Coast, and Michigan regions of the United States" that was busted by the EPA and had to pay a fine under the clean water act for spilling oil into an tributary of Whitetail Creek in North Dakota.