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Fear of a False Factor is Favourable – II (Long Answer)

This is a continuation of the 4 Fs: Fear of a False Factor is Favourable but with an expansion of the main points.

What is really going on?

The reason that today feels as scary as 2008 is that the memory of 2008 is still fresh. But this is nothing like 2008. In 2008, credit dried up and nobody could get cash. Today, many companies and investors are sitting on huge cash holdings. In 2008, we had real problems – a credit crisis, a real estate crash, an oil bubble, and a recession. In 2011, all we have is primarily political issues.

U.S. “debt crisis”

The U.S. can easily pay its bills if it wants to. It has huge powers to raise taxes. Simply adding a GST of 5-7% would already put the U.S. into annual surpluses. Their income taxes are the lowest since the 1950s (only 14.9% of GDP).1 Of US households, 51% pay no federal income tax. 1 Their gasoline taxes are extremely low. There is no national sales tax, their mortgage interest is tax deductible and it is the largest consumer economy in the world.

The US is a massively under-taxed country.

The news makes it sound like everyone has lost confidence in the US. However, there is clear evidence that they can pay their debts:

  1. The credit rating agencies, who analyze finances to death, still rate the US AAA or AA+. If they were unable to pay their debts, the rating would be far lower.
  2. US treasury bills are still the safest investment in the world. This is why huge investors globally have been piling into them lately. It’s very ironic and revealing that fears that the US cannot pay its debts on its bonds resulted in huge amounts of money being invested in US bonds.

The U.S. budget looks quite bad because it shows lower tax revenues during their recession combined with large tax cuts. Obama also spent a lot of money on a “stimulus package” the last couple of years. Like most government spending, it was 80% wasted. Projections of U.S. debt just project the existing inflated budget deficit and assume that nothing will be done.

The statistic used to try to claim the debt is too high is that the total debt to GDP ratio is over 90%.1 This is a strange comparison that accountants and lenders rarely use. It compares debt to income. It is like saying your mortgage is more than 90% of your salary. So what? The relevant figure is your debt payments to your income. This figure is not quoted because there is no story. U.S. debt payments are lower now than 3 years ago, because interest rates are so low. Interest on public debt in 2010 was $414 billion, down from $430 billion in 2007. 1 How can there be a “debt crisis” when interest payments on the debt have declined?

The US can easily pay its debts and the solutions are not complex. Solutions will certainly involve some tax increases. It is not clear yet what it will take to give them the political will necessary, but their politicians will eventually be forced to work together and create a solution.

Political Circus

The real issue is political. Politicians have made it an issue as they posture leading up to the 2012 election.

Obama and the Democrats spent (or wasted) tons of money to try to stimulate the economy and create jobs in 2009-10. The vote in November 2010 that gave the Republicans the majority in the Senate deadlocked the government and meant Obama needs the support of Republicans to pass any legislation. The Republicans, including their more radical Tea Party movement, are using the debt and deficit to push for spending cuts and make Obama look bad for having spent so much on the “stimulus”.

The “crisis” is not that the U.S. cannot pay its bills, but that the politicians are rigidly stuck in their positions and will not compromise. The government is dysfunctional.

There was never any real doubt that a deal would eventually be reached on the debt ceiling, since no politician wants to explain to seniors in their district why they did not get their pension cheque. Back in May, it was obvious to us that there would be a “miraculous”, last minute deal.

You can understand all the news about the US debt if you think of it as political posturing.

U.S. Credit Rating Downgrade

Even the downgrade of the U.S. credit rating from AAA to AA+ is political. Only 1 of 3 credit agencies downgraded them and the reason given was a lack of political willingness to compromise, not the actual ability to pay. The S&P said they had lost confidence in the ability of the US government to make decisions. The S&P debt rating agency even made a $2 trillion math error, but that did not matter, because the downgrade decision was based on the state of U.S. politics.

Canada went through this 20 years ago. We were running large deficits and had our credit rating cut. There were predictions of a debt spiral. Then we implemented the GST (replacing the dreadful manufacturers’ tax), made some spending cuts and were back in a surplus. It took a few years to regain our AAA credit rating. The US can do this as well.

This downgrade is not really relevant to investing anyway. The huge investors around the world are piling into US treasury bills (even though the interest rate is almost zero) because they know it is still the safest investment on the planet.

Debt in Europe

The problem in Europe is also primarily political. The Eurozone has provided one currency, but there are still 17 countries with their governments trying to hold onto their identity and power to make budget/fiscal decisions. These 17 governments are the problem. They need to give up more power, move toward a more complete political union and not allow themselves to spend more money than the taxes they bring in.

As usual, governments need a crisis before they act, which is why we have had a series of crises in Europe. We will likely continue to have a series of small crises in Europe until the governments are forced to act, but we believe that all will be resolved. The European Union will definitely support all its member countries through each crisis. Why?

There is a deep 60-year commitment to the European Union. American news questions whether the Euro will survive, but as usual, Americans are out of touch with the rest of the world. The extreme nationalism that resulted in the 2 world wars made it clear to Europeans that they need to work together.

Europe dominated the world in the 1800s, but US economy is almost as large as all of Europe combined now for one main reason – they have 50 countries vs. 1 for the US. Wealth is created by the free movement of workers, money and products. Until the European Union was created, all the country borders were a massive drag on growth. Even now, Europeans hesitate to leave their country and the Eurozone is only 17 of 50 countries in Europe.

Europe is slowly moving to financial and political unification, and the Eurozone continues to add countries. These “financial” crises are speeding up this process.

We expect more crises in Europe, but we expect all to be resolved.

Double-dip Recession

As usual, the media exaggerates a story. Our fund managers are all forecasting economies to only slow down a little. The US economy will grow a bit slower for the next few years – probably 2-2.5%, not the 3-4% we have been used to.

There is often talk of double-dip recessions, but they almost never actually happen. There is only one case of 2 back-to-back recessions in history (early 1980s). Another recession is usually predicted after a recession, but double-dip recessions are actually very rare.

This is again only partly relevant to investing. Despite what you hear, the stock market is not really correlated to the economy – either short term or long term. The stock market usually rises during recessions, just as it does during economic growth.

Companies are in great shape

The real news that is not getting proper coverage is that companies are in great shape:

  1. Profits at record highs: The consensus forecast for earnings in the S&P500 is $100.07 for 2011 and $113.43 for 2012 – both are all-time record highs.3
  2. Markets are cheap: The forward P/E ratio for the S&P 500 is 11.52 4, which is 28% below the historical average of 16%. This is the lowest since 1985. Low P/Es are usually associated with high interest rates. If you exclude periods of high interest rates, then this is the lowest since 1954.
  3. Balance sheets are strong: Company balance sheets are financially more solid than they have been in decades and many have mountains of cash. There is no “debt crisis” for companies either.

Summary

The US can easily pay its debts and will eventually find the political will. Europe will likely continue to have crises, but the Eurozone will stand behind all its members and the crises will all be resolved. We are not having a double-dip recession and our financial system is not falling apart.

The stock markets fear many things now, but we believe NONE of them will happen.

This is why stock markets are the cheapest they have been for decades. Unlike the end of 2008, company profits are at record highs. Company balance sheets are financially more solid than they have been in decades and many have mountains of cash.

For long term investors, this is what great buying opportunities look like – overly pessimistic markets combined with very strong company fundamentals. “Be fearful when others are greedy and greedy when others are fearful.” 2

The current price of stocks is based on what most investors think will happen. There is a buying opportunity when the market is too fearful of things we are confident will not happen.

The long term growth of the stock market will continue to reward those that have faith and patience.

Remember the 4 Fs: Fear of a False Factor is Favourable.

1 Wikipedia
2 Warren Buffett
3 Reuters
4 Wall Street Journal

“Disclaimer: Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Opinions expressed are the personal opinion of Ed Rempel.”

About the Author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.  If you would like to contact Ed, you can leave a comment in this post, or visit his website EdRempel.com.  You can read his other articles here.

If you would like to read more articles like this, you can sign up for my free newsletter service below (we will not spam you).

About the author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.

Ed has written numerous articles to educate the public and his clients on his unique insights into strategies that actually work, instead of the “conventional wisdom” common in the financial industry.

Ed has trained more than 200 financial advisors and is considered the Smith Manoeuvre expert in the Toronto area. He has received accolades from Frasier Smith in his book “The Smith Manoeuvre” for customizing this strategy for hundreds of clients. His extensive experience in tax and finance has placed him in high demand. Ed’s team collaborates on each of their clients to help them create financial security and freedom.

{ 111 comments… add one }
  • Glenn Cooke August 29, 2011, 10:03 am

    Ed’s articles are always an interesting and stimulating read. Researched source material, explanation of fundamentals, someone who’s analyzing instead of passing on company pablum. Darn few in the industry like that.

  • Steve August 29, 2011, 10:20 am

    A little heavy on the generalized bashing of Americans, Europeans and Governments.

    The Great Depression also was a double dip. 1929-1933 and 1937-1938.

  • Curtis August 29, 2011, 12:31 pm

    I discovered your blog a few months ago, and have enjoyed reading your very informative posts, however I strongly disagree with your assessment of the economy, and just had to comment.

    The US will have a debt and currency crisis soon. I’d say 75% in the next 2 years 100% in 5. The ability to pay isnt the problem, you’re correct in that assumption. The problem will be the ability to borrow. Basically every country that runs a large trade surplus with the US has been buying large amounts of US treasury bills – essentially vendor financing the US trade imbalances. The problem is that the US debt is out stripping the trade imbalance, thus nations like China, Saudi Arabia, etc don’t have the cash flow to buy all the new T-bills. The difference will get bought by the Fed, (either directly or from the primary dealer network that will borrow freshly printed cash at 0% and buy T-bills)

    This will eventually lead to consumer price inflation (severe inflation to hyper inflation)… (I stipulate consumer prices – as the real inflation – the massive expansion of the US dollar supply has already occurred) at some point in the near future people will loose faith in the value of the dollar, and all US dollar assets will be sent to slaughter.

    I agree that there is a fear factor restraining the value of US dollar assets; however this fear is not false or unreasonable.

  • SST August 29, 2011, 12:49 pm

    Interesting how a person who’s living is made from selling the market writes an article on how great and safe the market is.

    For each and every point Ed makes, I can find a “professional” opinion out there which states the opposite. You know what they say about opinions…
    (It may be a while before I have the time to expound…)

    Obviously Ed has done some homework and is an intelligent person, my advice: be your own intelligent person and do your own homework on the matter.

    Choose your side, I’m sure the next 20 years is going to be a fun ride!

  • Tom August 29, 2011, 1:00 pm

    I don’t think we can fully discount a second recession just yet. PMI activity in Asia is still showing contraction, and political/climate shocks, although not causing recessions, can be a catalyst to existing slowdown in economic growth. Caution is the word of the day for now – I wouldn’t be jumping in and loading up on equities at this point, though at the same time I wouldn’t necessarily liquidate all my holdings either. August data will be very interesting to watch as it trickles in in September..

    Tom

  • Ivan August 29, 2011, 2:00 pm

    “The U.S. can easily pay its bills if it wants to. It has huge powers to raise taxes. Simply adding a GST of 5-7% would already put the U.S. into annual surpluses.”

    USA 2010 tax revenue ~ $2.16 trillion
    http://en.wikipedia.org/wiki/United_States_federal_budget

    2011 United States federal budget deficit $1.65 trillion
    http://en.wikipedia.org/wiki/2011_United_States_federal_budget

    taxes will have to go up 76% to break even. Also consider that when taxes are raised GDP contracts (businesses and people have less money left to spend). You don’t grow economy by raising taxes.

  • Jungle August 29, 2011, 3:14 pm

    Great article Ed! Well researched and brought together. Also, is it possible “The Fed” could just print money and use that to pay debt?

  • Al August 29, 2011, 3:45 pm

    @ Jungle

    re: printing money – look up QE, QEII, QE3 (Quantative Easing). Looks like a duck, quacks like a duck…

    “to make lies sound truthful and murder respectable, and to give an appearance of solidity to pure wind.” to quote Orwell

  • SST August 29, 2011, 5:24 pm

    A very quick note to those who wish to follow Ed’s market punditry: Ed is claiming that certain events will NOT happen by arguing for events which have NOT happened (ie. 1+1?0 because 1+1?0).

    “People fear the US defaulting on its debts (not happening) simply because it could raise taxes (not happening).”

    There is plenty more to dissect from Ed’s two articles.

    As always, DYOD.

  • Melanie S. August 29, 2011, 7:04 pm

    Who is “we”? Was this written for a company newsletter first, or is Ed the reigning monarch?

  • Mario August 29, 2011, 8:50 pm

    My favorite lie from this article

    “The stock market usually rises during recessions, just as it does during economic growth.”

    Yep, just like it rose during the depression of 1929, every single recession since then, including the market making new highs during the recessions of 2001, 2008.

    This article is probably the most useless thing you will read this month. I have bookmarked it so that I can post it again in a few months, once we finally realize that we are in recession again, and the market has fallen dramatically.

  • Ed Rempel August 29, 2011, 9:57 pm

    Hi Glenn,

    Thanks for the support.

    Ed

  • Ed Rempel August 29, 2011, 10:39 pm

    Hi Tom,

    We think this a great buying opportunity. Not like early 2009 (“Irrational Pessimism”), but still a very good time.

    Even in the unlikely event that we slip a bit into another recession, that is barely relevant to the stock market. Everyone is used to thinking they are correlated or that there is a cause-and-effect, but there isn’t – short term or long term.

    For example, corporate profits are at all time highs and continuing to grow strongly. They rose 37% in 2010. How can that happen when the economy is slowing?

    The truth is, No economic growth is necessary for strong stock market growth. When the economy or speeding up or slowing down, the stock markets very often do the opposite. Stock markets usually rise during recessions. Unemployment is bad for the economy, but good for corporate profits.

    The difference is larger. Stock markets are based eventually on the bottom line – profits. The economy is measured by the top line – total sales.

    Bottom line – don’t look at the economy to help you predict the stock market. They are like profits on apples vs. sales of oranges. Can profits on apples go up when sales on oranges go down? Of course.

    Corporate profits keep rising and stocks are very cheap. Eventually this will drive stock prices, regardless of what happens with the economy.

    Ed

  • Ed Rempel August 29, 2011, 11:29 pm

    Hi Jungle,

    Thanks. The Fed could print money, but that is highly unlikely. Controlling inflation is one of the main purposes of the Fed.

    The quantitative easing they did was mainly about preventing deflation. Another round, QE3, will likely only happen if the Fed expects deflation.

    Remember, there is no reason the US needs to pay off their debt. They just eventually need to stop increasing it more than, say, inflation.

    Ed

  • Ed Rempel August 30, 2011, 12:45 am

    Hi Ivan,

    Why does everyone seem to believe the US can’t pay its debt??? The rating agencies analyze this in depth and still all give the US very high ratings. If the US could not pay its debt, there is no way they would get a high rating.

    I am not an expert on US debt, but it is clear that the real experts are confident in the US. This includes rating agencies, huge bond investors (bond investors tend to be highly analytic) who still buy US bonds when there is fear, the Fed, and our fund managers.

    Here are a few thoughts though.

    The US deficit will come down quite a bit normally as the economy recovers. A normal recovery will mean personal incomes will be higher and inflation will be lower, so taxes will go up naturally. The existing figures include some of Obama’s stimulus spending (which has stopped) and higher unemployment expenses.

    The Republicans and Democrats agreed on some large spending cuts. No specifics yet, but that intend on large cuts. That will also bring down the deficit.

    If we just look at taxes, US consumer spending is over $10 trillion and imports are over $2 trillion. A GST of 5-7% could bring in $.6-.8 trillion, which would probably balance the budget (especially, considering a normal recovery and that it is considered acceptable if the debt rises by inflation).

    Adding a GST would probably cut spending less than you may think. Consumer spending is surprisingly consistent. Most consumer expenses are relatively fixed. Even if you make less money, you will probably make the same mortgage/rent payment, the same utilities, the same medical expenses, you won’t drive much less, your groceries won’t change much, etc.

    Even though consumer spending is about 70% of the US GDP and business spending is far less, in recessions the drop in business spending is usually a bigger effect.

    That is just one tax. I listed a bunch of other taxes that could be raised.

    Here is another option. The US could sell some assets. A reasonable evaluation of debt should include an evaluation of assets. A recent article by Jason Schwartz from Seeking Alpha explained that the US government has 55,000 buildings that are vacant or heavily underused. If they sold them off, that would pay off 1/3 of the debt. They also have military bases on thousands of acres of ocean-front property.

    They could also sell their gold (I would at these super-high prices.) which would pay off about 1/3 of the debt.

    Then they could start with selling vacant land. The US government owns perhaps 1/3 of all the land in the US, so they could sell some. Much is forest or areas of nature they would not want to sell, but they could easily sell quite a bit if they wanted to.

    In short, the US could probably pay off its entire debt (or make the next 50 years’ interest payments) just by selling assets.

    Bottom line, printing money is possible but very unlikely. There are a bunch of better options for preventing the US debt from growing.

    Our opinion is that the chance of either a US debt default in the next 20 years is zero. We also think the chance of massive inflation from printing money in the next 20 years is also zero. The deficit will eventually be addressed with other options.

    Ed

  • Ed Rempel August 30, 2011, 12:51 am

    Hi Melanie,

    Very funny. :)

    I am part of a team.

    Ed

  • Curtis August 30, 2011, 1:52 am

    These “real” experts on bond ratings, also kept mortgage backed securities at AAA, right up to the day they defaulted. Why do these agencies have any credibility?

    The problem with all these large numbers, is that you can often lose a sense of scale after a while. The US Gov’t gold reserves are about 8000 tones. If they sold all that gold at $1800 an ounce – I come out with a number under $500 Billion, about 1/3 of the current deficit – not debt.

    There are lots of assets the us gov’t owns that should be sold. 100% agree with you, however it wont raise the amounts of cash you think. If they sold all those 55 000 office buildings for an average of 10 million each – that nets about 550 Billion. Again about 1/3 of the deficit – not the debt. There is also the BLM which owns millions of acres in the American west. (The western states are actually mostly owned by the federal government, look it up at Wikipedia, its amazing how much land they’ve got) They could sell the white house silverware and still not cover 1/3 the debt… Also remember that the 14 Trillion dollar debt is only the publicly held debt – the lock boxes for social security, medicare and other gov’t pension programs arent included in that number… I think the total comes much closer to 17 Trillion.

    As (IF) the economy improves the US deficit will not decline Obama-care is on its way, the spending it mandates, plus the growth in the traditional ponzi schemes will keep the deficits growing. Not to mention the political inability to make any spending cut stick (look up the doctor fix if you’re unaware of it) means that the deficits will just keep coming.

    In your last paragraph, you stated that there is zero chance that the US will not default. I agree with that, they dont have to default when they can just print the money. Every bond will get paid 100 cents on the dollar – unfortunately those dollars probably wont buy very much. This will happen quite soon, maybe in less than a year – but absolutely in less than 5.

  • Sampson August 30, 2011, 11:58 am

    “For example, corporate profits are at all time highs and continuing to grow strongly. They rose 37% in 2010. How can that happen when the economy is slowing?”

    Look at the top line. Most companies did a fantastic job cutting costs and also those that had cash, stock piling inventory during 09/10.

    Profits may remain high, but the evidence is in the balance sheets, very low/little to no real growth in the businesses.

    I’m not exactly sure why this post has drawn all the bears out though. It might not be the most optimistic time now, but I don’t think it’s all doom and gloom from here.

  • DividendMan August 30, 2011, 3:10 pm

    There is an error in your article where you state the republicans control the US Sentate, in fact, the Democrats have retained their majority in the Senate, the US House of Representatives now has a Republican majority (which is worse if you’re a democrat than losing the senate!).

  • Al August 30, 2011, 4:51 pm

    @ Ed Rempel,

    I disagree with your point that there is zero risk of massive inflation

    Inflation is a less painful solution to US debt problems than raising taxes, cutting spending, or selling assets (even though these are better long-term solutions). Yes the US government CAN do these things, but I really doubt that they are WILLING to. Most politicians do what is necessary to get themselves re-elected (or what is necessary to land a plum job afterwards) which isn’t always what is best in the long-term. Both the Democrats and the Republicans will be aware the the introduction of the GST was one of the main factor that cost Canada’s conservatives the election in the 1990s in Canada; just as Thacher’s tories lost their election largely based on the attepted introduction of the poll tax, in the US of course George HW Bush’s read-my-lips about face.

    The “solution” of QE should create credit (we’re not seeing it yet because the transmission mechanism is bust – the banks, worried about their own capital ratios are not lending the proceeds out). Credit is money and more credit is inflationary. If the economy recovers, I would expect to see the banks lend more money and inflation to pick up.

    Furthermore, for the US, since it has the world’s reserve currency, inflation is even less painful because in our postwar system a lot of the extra circulating currency winds up sitting in China, Japan, Russia, the Middle East and other surplus / export economies. The big risk is that if these creditor countries get nervous, or decide to buy proportionally less dollars/treasuries the US will no longer be able to export it’s currency to the same extent. I would expect more whining from the central banks of these countries about US budgetary profligacy and expect to see further moves to establish the yuan, rupee etc. as larger players in international transactions. That would lead to more dollars circulating domestically and dramatically higher inflation.

    The US will not default, but inflation is likely on the way, maybe not massive (in the sense of hyper inflation), but I would expect significantly higher than historical levels of inflation over a long period. I think equities make a lot of sense in this environment.

    I also disagree outright with your ratings agency based defence of the US’s financial situation. As you are well aware, rating agencies suffer from a total conflict of interest and tend to be behind the curve – remember they rated Iceland’s banks Aaa back in Feb 2007 (only eighteen months before default).

    Anyways those are my two cents [will be a nickel next time I write…]

    Otherwise thanks very much – I very much appreciate your articles.

  • Ed Rempel August 30, 2011, 10:38 pm

    Hi Mario,

    What date did you bookmark to followup? We think that another recession now is very unlikely. Also, the markets falling dramatically as a result of another recession would be even much less likely. We think that stocks have fully discounted fear of a recession – and then some.

    I’ll bookmark the same date for a followup here. It will be interesting to see what happens.

    Ed

  • Jungle August 30, 2011, 10:58 pm

    Ed, the Bears posting on there are scared and now there is a possibility qe3 is coming sept 21. Markets have been green the last couple of days..although not sure if the whole qe thing is really beneficial or just artificial?

  • Ed Rempel August 30, 2011, 11:00 pm

    Hi Sampson,

    I think the main reason company profits have leaped so much is because they were artificially low after 2008. Profits are at record highs because they have kept their costs low, while sales have mostly recovered.

    I think this is one point that most people miss. Unemployment remaining high is very favourable for company profits and the economy. Companies can relatively easily hire new people, they are much less worried about losing their best people, and most importantly there is little pressure to raise wages.

    For some reason, people tend to focus on the negative effect that high unemployment has on the economy, but the best time in a normal business cycle for companies is during the latter part of a recession and early in the recovery. Sales start to recover, but high unemployment helps them keep costs low. Having 1-2% of the population unemployed has a small effect on consumer spending and demand, but the effect of helping keep the wage/salary costs low is a major factor for higher profits.

    This is my point – the economy and the stock market are apples and oranges.

    Ed

  • Rolland August 30, 2011, 11:02 pm

    @ Ed,

    I’m not sure if I can agree with you the following:

    1) US Credit Rating agencies gives US a AAA and AA+. Weren’t they the same rating agencies who held AAA on all the sub prime mortgages until it all went bust? You’ve made a good point that these agencies analyze these materials and data to death, but help me understand how a AAA can go sour within minutes! Also, rating agencies have a disclaimer…that all their analysis are purely based on their opinions…. hmm, interesting.

    2) US Treasuries. Funny how you mention more and more investors are piling into them. Isn’t this how bubbles are created? We may never know whether it’s a bubble or not until it pops…

    3) US paying down its debt. I agree that US can raise tax to pay down debt, however there a consequences to this. The US unemployment rate is hovering over 8.5%…raising taxes on American people will increase the rate of unemployment, and increase the risk of US moving back into recession again. Times like this when American people are already struggling with daily expenses, raising taxes will simply burden them even more…forget about the political issue between Democrats and Republicans…it can never happen…. if it does, then US has certainly learned its lesson…that it’s better off to “fix-it” now, rather than kicking the can down the road…

  • Ed Rempel August 30, 2011, 11:11 pm

    Hi Sampson,

    Good point about all the bears. I find is strange how many people think that if you buy a 30-year US government bond today, you are at risk of not being paid. They actually think the US will default on their bonds. We just don’t see any possibility of that.

    This pessimism has been all over the internet. I think it has been promoted by the “gold bugs” to promote further propping up what we think is a gold bubble. Both a US default and high inflation would help the gold speculators, but we think both are very unlikely.

    I agree with you – it is not all doom and gloom from here. In fact, there are lots of reasons to be very optimistic. Massively overdone pessimism is “fear of a false factor…”.

    Ed

  • Ed Rempel August 30, 2011, 11:28 pm

    Hi Al,

    I stand corrected – it is 1/3 of the deficit, not the debt, that can be paid with selling buildings or selling gold reserves. Thanks for your well-written response.

    We do not think high inflation is likely, though. The main reason is that maintaining “price stability” (low inflation) is one of the top goals of the Fed. QE1 and QE2 happened because of fear of deflation, but Fed stimulus will stop completely when they no longer fear deflation. They want to keep inflation between 1-3% and remain focused on this. That is why QE3 or other monetary easing measures by the Fed will likely stop dead as soon as there is no risk of deflation.

    If inflation does start to rise, you can expect the Fed to do everything possible to keep it down. If there are inflation pressures, we think the most likely result is higher interest rates to keep inflation down.

    You are right that politicians will have trouble agreeing on tax increases or spending cuts, but the Fed will not cooperate with them once we have even low inflation.

    Eventually, the politicians will be forced to deal with the deficit, since they will lose more votes by not dealing with it that by dealing with it. The politicians ARE the problem.

    This is similar to the politicians governing each country in Europe who ARE the problem. They will slowly be forced to give up power and move towards a unified Europe

    Ed

  • Ed Rempel August 31, 2011, 12:00 am

    Hi Jungle,

    I agree – the Bears are just scared. I’m reading an awesome book called the “Rational Optimist” by Matt Ridley. The chapter I am reading now is going through a very long list of all the reasons pessimists have forecast the end of the world in the last few hundred years – and how they have consistently been wrong.

    It is fear that creates this pessimism. The reason that pessimists have been wrong consistently for hundreds of years is that they just project current figures, without allowing for humans doing something about it, normal market balancing countering it or that new ideas/technologies will change things.

    A great example was the forecast in the early 1800s that the US will be covered by 50 feet of horse manure by 1950. Back then, people assumed that either transportation (by horse) would have to be reduced a lot or else pollution (horse manure) would take over. What happened? Transportation increased exponentially while pollution plummeted.

    The logic error by pessimists was not allowing for the fact the humans as a species have steadily (mostly) developed over thousands of years, with nearly everything improving exponentially – that human ingenuity tends to solve most problems.

    There are similar forecasts today about energy, transportation and the environment that also assume nobody does anything about it or that new technologies don’t address the issues.

    There is a great quote by Thomas Macaulay: “On what principle is it that when we see nothing but improvement behind us, we are to expect nothing but deterioration before us?”

    This does not mean that no problems are serious, but I tend to be very skeptical about any beliefs that the world is coming to an end – including the issues today in the US and Europe.

    You are exactly right that it is fear that creates this pessimism. There are Bears and “Chicken Littles” in every environment and they are virtually always wrong.

    Ed

  • My University Money August 31, 2011, 12:03 am

    All I know is that my boy Warren Buffett just majorly bought into Bank of America, and he is quoted as saying that the USA government should have a AAAA rating. Anyone on here want to claim they know more about balance sheets, forecasting financial futures, or finance in general, than the Oracle of Omaha?

    As usual, if you just follow the simple contrarian investing philosophy of investing when everyone is screaming, and being cautious when others think they should all be hedge fund managers, you will be fine. How is this not a good time to be in stocks? If it’s not the basement, it definitely isn’t a market peak that’s for sure! Look at P/E of many great companies on the S & P right now. Their stock valuations barely cover much of their assets, never mind their future growth opportunities! As a young investor I count my lucky stars that I am just hitting my income earning years…

    Wait a second… Why am I urging people to invest again…I meant to say, “The sky is falling, this is obviously much worse than the great recession and no one will ever recover, follow the new market guru Glenn Beck and throw your money into gold!”

  • Curtis August 31, 2011, 2:14 am

    Com’on, Ed I never suggested that the world would end. The US will loose its place in the financial world, but the rest of the world will go on, and after a few months a new normal will shake out. Sure, it’ll be a tough time to be an American – but the tough times will pass. Perhaps the next president will be competent. (But not holding my breath)

    I understand the value to being contrary to the masses, but sometimes the masses are right… you know the old saying “If you keep your head, while all those around you are loosing there’s – you havent heard the news” I feel that there are many great companies living in the US markets – and would consider buying some of them – however I feel that buying a broader market index like the S&P 500 for a long term holding – would be catching a falling knife (or maybe a piano). I think you could do well buying specific companies, kept on a tight collar trade. The last 10 years have proven that buy & hold forever – is an investment strategy that will only get you killed.

    As for Warren Buffet – he’s an oligarch. The deal he made to invest in BAC isnt available to you or me. Warren elbowed his way in, ahead of the common share holder, and will be getting a very good yield on his investment. Very much like the Goldman Sacs deal he made a few years ago. I used to like him but since the crisis of 2008, I really havent liked anything he’s had to say. Just an oligarch out for himself… nothing special.

  • Jungle August 31, 2011, 9:11 pm

    The best value right now is stocks. It certainly is not bonds, gold, or Canadian real estate..

  • SST September 1, 2011, 10:36 am

    About the only thing that is obvious and certain about these issues is the polarization which people have; there is no middle ground. Once swayed, it’s pretty hard to chance a person’s mind on the matter.
    That said, here are MY opinions on Ed’s articles:

    Ed has admitted to being a market optimist, however, on these issues he (and his group) may be more pollyanna than optimist. As I’ve posted before, he states that one should not be fearful at the events which are perceived to be happening simply because they will not happen, and argues that by stating just the opposite will happen. For example, the US defaulting on it’s debt will not happen because it can easily raise taxes. The thing, Ed, the US is NOT paying off it’s debt — it’s acquiring MORE — and at the same time NOT raising taxes.
    Perhaps people should focus on what IS happening rather than what couldashouldawoulda.

    There are MANY errors in Ed’s two articles — eg. “bull markets happen 75% of the time”. You know what they say, don’t believe everything you read. Research Ed’s research, he is definitely not the be-all end-all of the financial world. It would take up a lot of space if I were to post all opposing facts on these issues. DYOD!

    And now for a few personal irks (mostly from part I):

    “The markets are only down roughly 10% year-to-date.”
    My precious metals holdings are up over 30% year-to-date.
    Of course we all know PM’s are the bastion of safety, and that’s a lot of flight to safety (ie. flee from paper) the WORLD has priced into gold and silver.

    “There are the permanent gold bugs (“The US dollar will lose its value. The only safe investment is gold or silver.”)”
    Um…the US dollar has lost value every single year since 1913, and the trend is not showing signs of reversal any time soon. Perhaps you mean the US will not loose the remaining value ($0.05) of it’s purchasing power.

    As mentioned above, my metal holdings are up over 30% year-to-date.
    I starting buying silver in 1998 and gold in 2005. I currently have a 640% return on silver (16%/yr) and 260% on gold (24%/yr).

    Let’s see how the major indices would have treated my same 1998 dollar: TSX 72% (thanks commodities!), DOW 33%, S&P 10%.
    Or perhaps my 2005 dollar: TSX 41% (thanks commodities!), DOW 11%, S&P 3%.
    Wow. And that’s not even factoring in double-digit inflation!
    Guess my “gold bug” mentality hasn’t paid off at all!
    How have your market portfolios done over the 5-10+ years, Ed?

    It’s an absolute insult to any intelligent investor to say buying gold and silver is for the “crazy”. The reason metals are so heavily shunned by the entrenched financial industry (and government), is that they collect neither commission nor tax — the profit goes directly into YOUR pocket, not theirs.

    Gold and silver have been used in a financial context for over 5,000 years, to refute they have a place in the current economy is being nothing short of willing blindness. Even more so considering the FACT that every single fiat currency throughout history has been reduced to zero value…the same can’t be said about gold and silver. They have a place, they serve a purpose.

    What you seem to overshoot, Ed, is just that — THERE IS A TIME AND PLACE FOR EVERYTHING. The pumped-up fraudulent 80’s and 90’s were a great place to get rich off the stock markets. The pumped-up fraudulent markets-in-broad of the 00’s are a great place to go broke, or at least not get rich. The last decade has been fabulous for metals and commodities. In the face of all the vapid political upheaval and the deep-seated corruption within the financial stalwarts, why wouldn’t the next decade bring even more of the same?

    The ONE thing I do agree with Ed on is investing in COMPANIES, not the market or economy as a whole. However, you have to know WHICH companies will make it in the economy of the future (which has not been good for a decade now).

    To further that, my own strategy this year has been to seek out and invest in proven companies — NOT STOCKS. I have moved approximately 1/3 of my investment assets into unlisted companies. Being tied to a paper market which is controlled by fear and greed, is not a good thing these days.

    Thanks.

  • Ed Rempel September 2, 2011, 12:08 am

    Hi My University,

    Very funny. :) You have the right outlook. For your sake, let’s hope that the markets take a while longer before they recover.

    Ed

  • Ed Rempel September 2, 2011, 12:45 am

    Hi Curtis,

    Yes, I am an optimist, but a rational optimist. I have faith in humans to be able to solve problems and that explosive growth of new knowledge & technology will mean the future will not be simply a straight line continuation of what we see today.

    I have studied the stock market in depth and seen that it’s long term return is far more consistent than people realize. With the stock market it is true that “it is darkest just before the sun starts to rise”.

    To put some perspective on my “Rational Optimist” view, this blog post by Matt Ridley is a classic: http://www.rationaloptimist.com/blog/time-its-different .

    It lists some of the huge fears that dominated headlines in the past – and NONE of them happened. For some reason, the pessimists have been consistently wrong in the past.

    Ed

  • Brian Poncelet, CFP September 2, 2011, 12:58 am

    Hi Ed,

    The other factors not talked about here is rising taxes (property taxes,HST,etc.)

    Health Care costs “Health care costs make up 42 per cent of the Ontario government’s total program spending” http://www.fin.gov.on.ca/en/economy/ltr/2010/ch3.html

    Aging population. (less workers, more health care costs)

    These are new (except rising taxes) factors not considered when looking at a rear view mirror…back in history.

    Can markets go lower? Is there many headwinds? Since consumer debt is high and must be paid down over time, the market may be stuck in this range for years.

  • Ed Rempel September 2, 2011, 1:03 am

    Hi Curtis,

    Regarding Warren Buffett, I personally have the highest respect for him. I think he is a genuine guy doing what he sincerely believes. His simple, honest way of speaking and his insights are what make his annual meetings in Omaha classics.

    His awesome returns are mostly a result of the in-depth analysis he has always done on companies. He found “cigar butts” – companies selling for less than cash, or some other ridiculously low value, and bought in heavily to make great returns.

    I agree that his style has had to change recently because he manages so much money now. He can’t really buy “cigar butts” any more. He now gets offers that nobody else gets because companies benefit hugely by being able to say Warren Buffett bought their stock.

    However, I do not think he is just out for himself. The money itself is irrelevant to him. He just makes money for the shareholders in his company.

    His investment in Bank of America was mainly fixed dividend preferred shares, but he is still investing to participate in the growth of the company. His investment includes a lot of long term options to buy, and I believe that is the real reason he made this purchase.

    I think his integrity is at least as much the reason for his fame as his investing success.

    Ed

  • Ed Rempel September 2, 2011, 2:24 am

    Hi SST,

    Congratulations on your profits from investing in gold and silver. Some of our fund managers have owned some gold and silver (mainly gold or silver companies), but I believe these are temporary holdings just riding the momentum.

    Most are not touching gold or silver. The say they are trading purely on speculation, not on fundamentals. I have heard the story everywhere about currencies losing purchasing power because of inflation and that gold is the “safe haven” when there is fear related to the US dollar.

    Here are a couple of things to consider:

    1. The long term growth of gold is negligible compared to stocks. See the graph here: http://www.esrresearch.com/stockmarketinthelongrun.html . After inflation, from 1800-2002, gold only went up from $1 to $1.19 over 202 years. Meanwhile, stocks grew steadily (note the line) to $463,000. That is 2.3 million times the growth of gold over 202 years. The last few years have only slightly narrowed this massive gap. Gold is not a long term hold. The investment value is in riding up temporary bull markets (and then getting out before everyone else does).

    2. There are no actual fundamental uses for gold, other than speculating on currencies. It is a substance that is dug out of the ground and put into vaults. We could close every gold mine in the world for 100 years and there would be no shortage of gold. Gold might well continue to rise, but there is no fundamental demand that would prevent if from falling to $200 and staying there for 100 years.

    3. Gold is touted as a currency, instead of “fiat currencies” (real currencies), but it will never be an actual currency. Real currencies are backed by the ability of countries to collect tax. Gold is only backed by the belief of people that it has value. There were solid reasons that the gold standard was abandoned. John Maynard Keynes is quote in 1924 saying: “In truth, the gold standard is already a barbarous relic.” Our economies have growth exponentially, which is not really possible with the gold standard. I don’t think there will ever be a time when you can take a gold coin to your local grocery store to buy food.

    4. The growth of gold in the last few years mirrors quite closely purchases of new gold ETFs. I believe that most of it is speculative, short term money that would get out quickly if it started to fall. The last big rise in gold prices in 1980 ended with a 60% crash that took 30 years to recover.

    5. Gold is a store of wealth, while stocks are a return on wealth. Gold does not pay dividends or have earnings. Earnings of companies are the reasons the stock market rises consistently over the long run. Even gold companies are a difficult business. Because of the immense amount of rock that needs to be dug up to get a bit of gold, gold companies almost always underperform the broad stock market.

    My personal opinion is that gold is in a bubble. There is no way of knowing how high it will go, since it is trading on speculation, not on fundamentals. I also believe that the fears that support gold are “false fears”. The economy and stock market go through cycles and will both be strong again sometime soon. Once things stop looking scary, gold may start to fall and at some point speculators may start to dump it.

    Eventually, fundamentals always kick in. Since there is no actual demand for the use of gold and it trades on speculation, there is no way to know where the price is going. It could go to $10,000/oz. or to $200/oz.

    In the investment industry, any gold or precious metals investment (gold bars, companies or ETFs) is considered a high risk, speculative investment. Note the risk notices that should accompany any gold investment. It is not a safe investment – it is a very high risk, speculative investment.

    Gold is not like the stock market which rises long term based on the solid fundamentals of rising earnings of companies over the long term. I think that over the next 200 years, the stock market will again have returns 2.3 million times that of gold.

    Ed

  • Curtis September 2, 2011, 2:36 am

    I used to have a lot of respect for Warren Buffet. I really did. However over the last 5 years or so, Ive had some reconsideration of my opinion. Some of it is here:

    http://finance.yahoo.com/news/Why-You-Cant-Invest-Like-usnews-1319897523.html?x=0

    And other reasons are here:

    http://www.businessinsider.com/buffett-has-hidden-agenda-when-it-comes-to-higher-taxes-james-altucher-2011-8

    Keep in mind, the second guy is James Altucher, who once wrote a book in admiration of Buffet. It takes a lifetime to build a reputation, but only moments to destroy is very true. And I think we’re starting to see his start to unravel.

    I dont think companies get that much out of Buffet owning the stock. If you had bought Goldman at the same time Buffet did, you would be heavily down right now… and thats the point – with out these special finance deals – he’s at best an average investor. I think his investment in BAC could well blow up, Chris Whalen – possibly the best bank analyst in the world – has recently called for the bank to be taken over by the FDIC:

    http://blogs.reuters.com/christopher-whalen/2011/08/17/housing-debt-ceilings-zombie-banks/

    The solvency crisis of 2008 wasnt solved, the FED just used liquidity to paper it over, When there is another shock to the system, these same banks will be back for another bailout.

    I really dont want to get side tracked into a squabble over Warren Buffet, I really cant imagine owning any US bank, when any of the Canadian banks are so much better capitalized, and much better positioned to consume parts of the US banks as they are allowed to fail.

    I agree with SST, and I too own some real money, I have been dollar cost averaging into physical silver bullion (meaning I take delivery of the metal) for the past few years. I started at under $20, and have continued to buy some almost every payday. Iam quite happy with how this investment has been running for the past few years, and fully intend to continue with it.

  • Ivan September 2, 2011, 12:50 pm

    So, according to today’s NFP report US added a total of zero new jobs, average hourly earnings down, underemployment up. Recovery at full speed! Labour force participation up, but still at 30 year low. Everybody is hinting for QE3 in some form or another. They will print more money and then print again, Fed has no choice, causing even more inflation (hey, no wonder gold and silver is up again).

    Good luck with your paper equities which are loosing value against gold for the last 10 years or so (check Dow/gold ratio).

  • SST September 2, 2011, 1:42 pm

    @Ivan: as I posted, people/investors are polarized on where things are headed and it is useless to try and convince anyone of something they don’t already think. Everyone is completely entitled to their ideas, opinions, and choices — that is the real beauty of a free market, as Mr. Market has the final word on who’s investment decisions are ultimately correct and profitable.

  • SST September 2, 2011, 3:30 pm

    As for Mr. Buffett, he is certainly a complete capitalist, demonstrated by his purchase of Bank of America paper.

    During the ’08 crash I had the opportunity to buy Citibank (C) at ~$2 per share (a successful trader associate heavily recommended it) — I didn’t. If all I wanted out of life was to make as much money as I possibly could, I would move to Wall St. and start scamming and scalping everything in sight.

    The reason I refused the now +1,300% return was based upon principles and values. In no way did I want to contribute any form of support towards a company or industry which was, and still is, rife with intentional criminal activity which caused so much damage, all in the name of greed.

    I’ll be the first to admit I am well over $1,000,000 “not richer” today for not having bought the stock three years ago. And you can surely label me a naive pollyannist (?) for bringing such things as ‘values’ into the financial area, where only money matters — but I can most definitely live with myself.

    Can’t say the same for Mr. Buffett. I guess his corporate conscious outstrips his personal conscious when it comes to buying business that engage in financial fraud. And apparently his shareholders don’t care how they get rich either.

    Let the good times roll!

  • TJ September 2, 2011, 6:44 pm

    @ SST

    “During the ‘08 crash I had the opportunity to buy Citibank (C) at ~$2 per share…..The reason I refused the now +1,300% return was based upon principles and values.”

    Are you aware that Citi is only trading at ~$2.85/sh adjsuted for their 1:10 reverse split?

    Not sure where you get the +1,300%

  • TJ September 2, 2011, 6:50 pm

    correction – that should be 10:1 reverse split.

  • SST September 2, 2011, 7:26 pm

    LOL!
    I rest my case:

    New York (CNNMoney) — Government goes after financial firms over mortgage losses

    http://money.cnn.com/2011/09/02/news/companies/government_mortgage/index.htm?hpt=hp_t1

    “The lawsuits were filed against many of the nation’s largest Wall Street and financial firms, including BANK OF AMERICA, CITIGROUP, Goldman Sachs and JPMorgan Chase.”

    But hey, why let a bit of crime get in the way of making a buck!
    Enjoy your ill-gotten gains, Mr. Buffett.

  • Brian Poncelet September 2, 2011, 7:37 pm

    Ed,

    A couple of points missed here. One is the housing market. Most Americans like Canadians have most of their net worth in real estate. Until a bottom is reached (housing) the economy will be weak.

    The most recent comments I have seen are from Robert Shiller, an economics professor at Yale University and co-creator of the S&P/Case-Shiller home-price index, he claims (interview on Bloomberg) a further fall in housing prices is likely.

    Health Care Costs. Lots of information on how and why this is growing faster than the economy. Who pays for it?

    In Canada we have similar problems (real estate to follow soon).

    Recent statistics show Canadians now hold the highest household debt-to-income ratio among the developed countries of the OECD, surpassing even the peak American households hit before the U.S. housing market collapsed.

    Cheers,

    Brian

  • SST September 2, 2011, 8:31 pm

    @TJ: nope, did not know about the reverse split — I stopped following bank stocks after my no-buy decision. Thanks for the info and the correction.
    Makes me feel better now that I’m only out a tenth of a fortune instead of a whole fortune! Ha!

  • Curtis September 3, 2011, 2:37 am

    Hey Ed let me bud into your argument with SST a little. In relation to your post 36 let me rebut some of your points.

    1) Currencies used to be backed and exchangeable with gold. Only during times of war did countries really run debts and debase their currencies. So there should be no change in the price of gold for long periods of time – this is a sign of a strong monetary system. Only since 1972 when Nixon closed the gold window did the US dollar become a fiat currency.

    2) Gold is money. Has been for thousands of years, and will continue to be for thousands more. Our latest little experiment with fiat money will end the way all the other fiat systems of the past have ended. In fraud, then failure, then revolution.

    3) Gold is money. Fiat currencies only have value because both parties of a transaction have faith in the value of those currencies. When that faith gets shaken the value drops…. John M Keynes, really shouldn’t be taken seriously in a economics context. If you want to study his work in a poli-sci class, that would be more appropriate. ((Keeping in mind that he was a fascist, supporter of Mussolini and that Adolf guy)) If you really want to understand how the economy works you need to read Hayek, and Von Mises and learn about the Austrian Business Cycle Theory.

    http://en.wikipedia.org/wiki/Austrian_business_cycle_theory

    — As a side note, its all these Keynesians who didnt see the housing bubble or the sub-prime bubble as being a problem in 2006 or 2007, where as the Austrians saw it coming, people like Peter Schiff, Ron Paul, Marc Faber, and Jim Rogers had been warning of the housing bubble for years – and largely ignored by the media. To me this is a real value of a scientific theory, if your theory can predict the events in the real world, then it has merit. Keynesian ism is a political theory of fascism, that pretends to be economics, as long as people like Mark Zandi have sway over public policy there will be no economic recovery.

    4. Partially true. The rise in gold also tracks the rise in the money supply. As more and more Dollars and Euros have been created, the price of gold has gone up. Gold isnt the bubble, paper credit is the bubble. The last rise in gold prices in the late 1970’s became a bubble – this bubble deflated very rapidly once Paul Volker took over the FED and pushed up interest rates.

    5. I agree Gold is a store of wealth, that makes it money – it has actually fared better as a store of wealth than the real dollars have. We’ve all seen the charts of purchasing power of dollars declining over the decades – its this decline that purchases of precious metals is designed to protect the purchaser against. In short, we own metals not to get rich, but to prevent poverty.

    Now I wouldn’t suggest that everyone be totally invested in metals, but its an asset class that everyone should own. Just like people shouldn’t be totally invested in just bonds or stocks.

  • M. Morinizi September 3, 2011, 12:55 pm

    It seems predicting lottery numbers is as complicated as predicting what the market will do. Stock market = gambling.

  • SST September 4, 2011, 12:14 pm

    @Ed: I had a lovely list of rebuttals typed out for you, unfortunately my http://www.internet decided to play hide-and-go-seek on me — it won, and I lost all. I’ll post a reply to your first comment in #36, and if you or other readers wish me to post on the rest, I will.

    As I’ve posted before, there is a time and place for everything (even super duper gold-bug Mike Maloney says gold et al will not always be the place to be!); this is something every investor should fully realize and understand.

    Without further ado:

    1. “The long term growth of gold is negligible compared to stocks. See the graph here: http://www.esrresearch.com/stockmarketinthelongrun.html . ”

    Without going into what a complete and utter sham this article is, I’ll simply post some math:

    Dow 1972: 904
    Dow Now: 11,240 = 1,143%
    S&P 1972: 100
    S&P Now: 1,174 = 1,074%
    Gold 1972: $45
    Gold Now: $1,885 = 4,088% — WINNING!

    Dow 1976: 980
    Dow Now: 11,240 = 1,047%
    S&P 1976: 100
    S&P Now: 1,174 = 1,074%
    Gold 1976: $132
    Gold Now: $1,185 = 1,328% — WINNING!
    (all figures nominal; if you need further explanation of dates, I will provide)

    The figures are even more astounding once you ply the grabby hands of commissions, fees, and taxes to the paper products which do not apply to the metal products.

    If you can refute MATH, Ed, please show me my errors.
    (it is early AM with little sleep, after all…)

    I have much more to say (probably a small warehouse worth), but I’ll leave it up to the readers if they want me to fill up a bunch of space.

    Enjoy your long weekend!

  • Ed Rempel September 4, 2011, 3:27 pm

    Hi SST,

    You used the stock market figures excluding dividends. The total stock market growth is the index growth plus the dividends that are paid out.

    The actual growth of the S&P500 is:

    Beginning of 1972 to end of 2010: 4,803%
    Beginning of 1976 to end of 2010: 5,669%

    Note this is the best ever run for gold and yet it still lagged the stock market. That is because it does not make earnings, like the businesses that make up the stock market.

    Ed

  • SST September 4, 2011, 5:33 pm

    @Ed: well…you asked for it….

    (Disclaimer! I don’t want to get belligerent on here, because this is actually a very decent (on all counts) website for a wide range of financial ideas, however, the one thing that makes me incessant is the posting of factually wrong information under the guise that it is correct — especially from industry “professionals”.)

    Growth of the S&P: the bogus stats that are used are just that — bogus. What the generalized calculations consider is that a person buys the WHOLE S&P portfolio — NOT an ETF or index fund, but every single stock listed within the index. Every dollar of dividend is pumped back into the portfolio to purchase more stock, and so it goes.

    (This is also fairy tale calculation because with $100 or so I can go buy gold and start my investment; with that same $100 what I can NOT do is go buy fractions of 500 companies.)

    What the calculations EXCLUDE is, well, a whole lot.

    1) How many times has the S&P changed composition since its inception in 1923? A person would therefore have to buy and sell and buy whatever stock was being de-listed/enlisted. This means paying commission. The index has also grown from 90 companies to 500. This means a person would either hold only those original 90 stocks or throw gobs more money into the market. This gives false readings.

    2) All dividends would be taxable. As well, once a person sells the de-listed stock, taxation of any capital gains would be triggered and applicable.

    3) Compare the S&P dividend yield with the inflation rates of the corresponding year. What you will find is that inflation wipes out the “growth” provided by dividends.

    Can you provide the S&P gains with no buy-ins, commissions, fees, taxes, and inflation applied?

    The reason the linked article is a complete sham is the FACT (yes, let’s not forget about those!) that the price of gold was controlled by the government up until 1971. Notice what the price of gold does from 1972 onward?

    For an article to boast that over 200 years a free-market beats a price-fixed market is absolutely laughable, and to pass it off as some kind of marketing scheme (but then so is the “math” of statistics). Not to mention the article states nothing about WHICH stocks or market was being bought in 1801 — the DJIA didn’t exist; the S&P didn’t exist; perhaps the London exchange? Philly? Thin air???

    “Note this is the best ever run for gold and yet it still lagged the stock market.”

    Are you serious? Please, Ed, no more false statements.
    Here is a link on “the best ever run” for you to take note of:

    http://www.measuringworth.com/growth/growth_resultf.php?begin%5B%5D=2001&end%5B%5D=2009&beginP%5B%5D=&endP%5B%5D=&US%5B%5D=SAP&gold%5B%5D=NEWYORK

    [ a note on their calculation methods — READ!: http://www.measuringworth.com/datasets/sap/ ]

    Unfortunately their data set only includes up to 2009, when gold was $858, or 120% less that it is currently, and the S&P was ~850, or 38% less that its current value (using their ‘January average’ method for both entities). This leads to an even greater gap between gold and the market.

    Since gold’s low ($255 in 2001), the FACTS are as follow (CAGR):
    S&P 2001-Current: -1.23%
    DJIA 2001-Current: +0.5%
    Gold 2001-Current: +22.15%
    Silver 2001-Current: +25.78%

    I will restate my thesis: there is a time and place for everything.
    The easy credit/free money era of the 80’s and 90’s was a great time to get rich from…well, easy credit and free money. The last decade was a movement either into a bubble of a different sort, or into safety (because you knew the chickens were coming home to roost!).

    We can volley facts and math all day, Ed, but what matters at the end of the day is who made the most money with their dollar. Facts show it sure as hell wasn’t the dividend power of the S&P. Nope, it was that barbaric relic that stored a lot of wealth and created a lot more wealth — with no “earnings” anywhere in sight!

    You may be a very competent and thorough accountant, Ed, but as far as investment advice goes… I hope this next decade in stocks is kinder to you.

    (hope all the links work!)

  • Al September 4, 2011, 11:57 pm

    @ SST

    Let me wade into this briefly in defense of Ed because while I don’t agree with everything he says, he is generally well researched and has his own opinions and thinks for himself – that is much better than your average adviser out there. My point is that I totally agree with you that Gold is a store of value and I really don’t trust the government to protect the purchasing power of my dollar.

    However if the government continues to enforce property rights and since stock ownership represents fractional ownership of companies I believe owning a slice of a profit making company beats storage of wealth over any long period. Gold is only useful to buy things (whether for consumption of investment i.e. company ownership) (and it’s for optimists – if you really believe in a total collapse of government then guns and tins of beans are better investments) – otherwise I prefer ownership of hard assets and companies.

    I’ll take the S&P500 today over Gold today, I’ll take the S&P in 1976 over Gold in 1976 as well. Granted I would rather own individual stocks than the index, but these are the parameters of the debate.

    Finally your points 2 and 3 in point 50 are equally applicable to holding Gold. And I am not sure I understand your point 1, certainly with $100,000 I could buy ownership in the various constituent companies, and certainly with $100 I could by a pretty good proxy for the S&P via an ETF.

    Finally to the Buffet fans out there, me too I used to be a big fan but not so thrilled with him these days with his off-market deals. And to Ed, besides Buffet’s stock picking prowess, Buffet arguably gets his biggest kicker from from leverage (his control of insurance premium cash flows/float).

    That’s all I’ll say.

    Kind regards all

  • SST September 5, 2011, 5:14 am

    @Al: I too believe in owning companies. As I posted earlier, this year I have moved ~1/3 of my investment capital into direct ownership of private companies — NOT public stock.

    We’ve all seen it before, and very recently: GM.
    How do you think all those ‘old’ shareholders felt about loosing every penny only to see a $20 billion IPO pop up a year and a half later, complete with employee bonuses?

    If you truly do prefer “hard assets and companies”, stocks may be the easiest route, but definitely not the safest or most profitable. I have ownership in two companies, my profit is tied to their profit. My profit is NOT influenced by the fear of the mass public or the greed of Wall St. In other words, these companies are not affect by the “false factors” which affect public stock markets.

    I’ll say it again, there is a time and place for everything. I’m not a hyper-gold bug by any means, I put my money where it will grow best — period. I don’t discriminate (heck, I even bought Apple four years ago!). But when I see all the garbage floating (pouring?) out of the financial district, I am extremely wary as to how long the stock markets can hold their house of cards together.

    As per #50, points 2 (taxation) and 3 (inflation):

    Taxation does not strictly apply to buying and/or selling gold.
    That’s a lovely loophole-of-sorts provided by the Canadian government. I could sell my entire holdings and not declare a red cent of capital gain. Should I declare it? Probably, yes. Would I? Time will tell.

    Yes, inflation is applicable to gold as well. Thus all we are left with is the “growth”, which still beats the S&P.

    My “point 1” is to flush out such nonsense and debunk fly-by articles such as the one provided. If you wish further explanation, shoot me your email and I will.

    It’s safe to say that this has strayed very far off the course of Ed’s original topic, probably mostly my fault. Good luck to all those going heavy into the stock market. May we all profit, no matter which path we take.

  • Ed Rempel September 5, 2011, 8:21 pm

    Hi Morinizi,

    The reason you don’t see the difference between gambling and the stock market is that you are looking at the wrong time frame. Both are unpredictable short term. However, the longer you gamble, the worse you do, while the longer you invest in the stock market the better you do.

    With gambling, the odds are always against you. However, the stock market consistently goes up because it is based on companies that grow their profits over time.

    The worst-ever 25-year period in the S&P500 was 5%/year, which is more than tripling your money. I’m sure that lots and lots of people that gambled for 25 years did not triple their money. :)

    The patient investor will eventually be rewarded.

    Ed

  • Curtis September 6, 2011, 9:13 pm

    Wow, Iam glad I didnt buy Swiss Francs in the past few weeks.

    I agree with Ed, that with proper selection, and diversification the stock market isnt a gamble… ((Not to dismiss the idea – that there are risks involved with investing – but taking a risk isnt always a gamble))

  • SST September 7, 2011, 4:52 am

    Ed — what is the time frame (years) for the “worst-ever”? Great Depression?
    And where do you get your data/numbers?

  • Ed Rempel September 7, 2011, 4:55 pm

    Hi Curtis,

    Right on. There is a big difference between a gamble and a calculated risk.

    Life is full of risks. You can’t avoid all risks. But you should understand why you take the risks you do

    Ed

  • Ed Rempel September 7, 2011, 5:08 pm

    Hi SST,

    I have the figures for the annual returns of the S&P500 since 1871.

    The worst-case scenario for a 25-year period was back in the 1800s – 1872-96. It was 4.93%/year.

    The 2nd worst ended at the start of the Great Depression – 5.15%/year from 1907-1931.

    If you start at the end of the bubble in the Roaring 20s and go through the Great Depression and WWII (from 1929-53), the returns were 5.84%/year. This is not bad considering inflation was negative much of the time.

    The best ever 25-year period was 1975-99 with explosive growth of 17.37%/year.

    This is part of the confidence we have in the stock market and why we think it is appropriate for most or all of long term investments, such as retirement planning. Even the worst-case scenarios are not that bad.

    Ed

  • SST September 7, 2011, 8:39 pm

    Interesting data.

    Could you please demonstrate how an average investor, earning an average wage, could have invested in the “S&P 500” during these periods — 1872, 1907, 1929, and 1975.

  • Ed Rempel September 10, 2011, 6:36 pm

    Hi SST,

    Fortunately, we don’t have to. The stats show the consistency of the long term growth of the stock market. There are multiple ways to participate today.

    Ed

  • Brian Poncelet,CFP September 11, 2011, 1:15 pm

    Ed,

    “Past performance is no indication of future returns”

    We don’t know where is market will go. We do know there will be taxes and inflation in the future. To get a break even return we need to get at least 4 to 5%.

    We do know the debts levels for Countries (like US, Greece, UK, Japan, etc.)around the world is without precedent.

    Markets can fall anytime so as one gets older there is less time to recover.

  • Ed Rempel September 11, 2011, 5:18 pm

    Hi Brian,

    Yes I do know where the markets will go. Long term, they will go up.

    The reason people have issues with the stock market is their time frame is too short. Who knows where is will be next year, but there has never been a 15-year period when it did not go up or a 25-year period without strong growth.

    The disclaimer is actually: “Past performance is no GUARANTEE of future returns.”

    Of course it is possible to not go up long term, but that has never happened for good reasons – especially when you start with periods of time when the markets are so extremely cheap.

    The reason is that company profits keep rising. If they keep rising, the stock market will eventually have to go up, regardless of what happens in the economy or the government.

    You are right that someone in the highest tax bracket would need to make 4-5%/year just to break even after taxes and inflation. The stock market has made this return 100% of the time over 25-year periods. Besides, how can you reliably make that type of return with any other investment?

    The debt levels are NOT unprecedented, though. In fact, these debt levels are relatively common. Most countries, including the US, had higher debt to GDP back in the 1940s after WWII: http://www.usgovernmentspending.com/federal_debt_chart.html . It only took a few years go pay it down.

    The UK actually had higher debt than today for almost all of the last 300 years: http://www.ukpublicspending.co.uk/uk_national_debt_chart.html . In fact, the stat that news media would have us believe is too high is debt to GDP of 100, but the UK had higher debt than that from 1750-1870 during their major global expansion and from 1920-60.

    What’s more, is that US government debt PAYMENTS are lower today than 3 years ago and lower than in the 1970s and 1980s when interest rates were high.

    Another interesting stat for Ken Fisher (“The Only 3 Questions You Need to Ask”) is that in general, countries with higher government debt have stronger stock market growth.

    I agree with you that market declines are a bigger problem as you get older. However, the markets do recover more quickly than most people realize. The longest time it has taken the S&P500 to recover after a losing year is only 7 years.

    Most people would think it is longer, but the market has always recovered in 7 years or less. 89% of the time, it recovered in 4 years or less, and 100% of the time it recovered in 7 or less.

    That was after 1929, when there were 3 more years of losses from 1930-32, but then the markets roared back for the next 4 years and were back above the Jan../1929 point by the end of 1936.

    My points are:

    1. If you look long term and ignore news, you can be confident in the stock market.
    2. The best times to invest are when there is lots of negative news and stocks are very cheap. We have not had P/Es as low as today (under 12) combined with low interest rates since the early 1950s.

    Ed

  • Brian Poncelet,CFP September 11, 2011, 10:45 pm

    Ed,

    Long term the markets go up?

    Lets look at the Nikki 225 ( blue chip companies like Sony, Toyota, Honda) $10,000 in June 1996 would be $4,181 in June of 2011 (assuming no fees).

    The US Debt story is correct if you take a lot of debt off the books and don’t count it as debt.

    Although not included in the debt figures reported by the government, the U.S. government has moved to more explicitly support the soundness of obligations of Freddie Mac and Fannie Mae, starting in July 2008 via the Housing and Economic Recovery Act of 2008

    The two GSEs have outstanding more than US$ 5 trillion in mortgage backed securities (MBS) and debt; the debt portion alone is $1.6 trillion.[6] The conservatorship action has been described as “one of the most sweeping government interventions in private financial markets in decades,”[7] and one that “could turn into the biggest and costliest government bailout ever of private companies”.

    http://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Mac

    Unfunded obligations excluded

    The U.S. government is obligated under current law to mandatory payments for programs such as Medicare, Medicaid and Social Security.

    These deficits require funding from other tax sources or borrowing.

  • SST September 12, 2011, 3:48 am

    I still have much to say in regards to this article and subsequent comments, but am waiting for a response from Frugal Trader about writing an article instead of just a comment. If he declines my offer then I will post away!

  • InsureCan September 12, 2011, 11:35 am

    Yes, long term the markets will go up.

    It’s not just science fiction or vague hope. The model of the market is a random walk with upward drift. Short term nobody knows which way it’s going. Long term, it drifts upwards. It’s been doing it consistently forever, it fits the model. Everyone’s required to put in disclaimers about past performance because the industry flogs investments that rather than following the stock market (like index funds),they flog investments that have a model of monkeys flinging poop at a wall. These are frequently called ‘mutual funds’. And those investments go all over the place. Add in consumers (and advisors) who think low risk investments are GIC’s and bonds, and you’ve got an environment where people don’t grasp that the markets go up over the long term.

    If you don’t believe statistics, you don’t have to believe that the market will go up over the long term. .

  • InsureCan September 12, 2011, 11:49 am

    Here’s a primer link for people who haven’t read this stuff yet:
    http://arnoldkling.com/econ/saving/portfol.html

    There’s arguments against it, and there’s been more theory around this, but the basic premise stands yet today.

  • Brian Poncelet,CFP September 12, 2011, 1:40 pm

    Long term the market goes up.

    So does inflation and taxes.

    I guess the NASDAQ or the Nikkei 225 should come back to its highs over time.

    The concern here is DEBT. Until that is dealt with (which could take many years) the market may not give the returns it had in the past.

  • Troppus September 12, 2011, 2:29 pm

    Wow! Just found this blog and post and enjoyed reading the comments and perspectives of not just Ed but everyone contributing. Will start to follow your blog more and look forward to more posts. Any thoughts on what’s predicted for 2012 and onwards when the baby boomers start pulling out their 401Ks?

  • InsureCan September 12, 2011, 4:45 pm

    Really?

    Yes, they should. If they’re down *right now* that’s called volatility. it goes up, it goes down.

    I guess it shouldn’t come as a surprise that people don’t realize the crashes aren’t any different than the long runs of 10% that advisors seem so proud of. Over the long term, equities and indexes should return 6-8%. That’s as solid statistically as putting your money in GIC’s and bonds which are only going to get you 3% over time.

    What sounds less risky, getting 3% over the long term, and barely beating inflation and taxes? Or getting a statisically solid 6-8% over the long term? Getting that 6-8% is no higher risk than investing in GIC’s – as long as you do it over the long term to eliminate the volatility.

    The biggest sales job today is the advisor/fund industry, almost none of whom work on anything based on what they know to be true – indexes over the long term are low risk and outperform 97% of every other equity based product. Instead, they continue to sell stuff that sounds emotionally right and ‘makes sense’, but has been repeatedly shown to be wrong.

  • Ed Rempel September 13, 2011, 12:56 am

    Hi Brian,

    The only reason the NASDAQ is down for the last decade and the NIKKEI is down for the last 2 decades is that they had super-bubbles just before that. The NASDAQ was up 920% in only 5 years from March/95-March/2000, while the NIKKEI was up over 900% in the 1980s (I don’t have the exact return).

    If you include the boom and bust, the NASDAQ has a 10.4%/year return for the last 20 years.

    Your comment about DEBT sounds entirely logical, but is not supported by the facts. This is important, since it is so common for people to see some economic factor and assume it will be negative on the stock market.

    The facts are that the OPPOSITE is true.

    Consider the following:

    1. The one time in history when the US debt-to-GDP ratio was higher than today was right after WWII in 1945. In the following year, they paid down their debt in half (from 120% to 60% of GDP). That was an “Age of Deleveraging”, similar to what everyone falsely fears today. How did the stock market do in that decade from 1945-54? 17.1%/year – one of the strongest decades in history!

    2. The lowest debt the US has had since WWII was from mid-1960s until debt shot up in the 1982 recession. That period from 1965-82 was a 17-year period with growth of only 6.7%/year – one of the lowest returns! This is the same period many people wrongly think the DOW was flat.

    The facts are that the stock market has performed far higher during and after periods of high debts than when the debt was low.

    How could this be? Three possible reasons:

    1. High spending spurs growth and low spending reduces growth.
    2. Periods of high debt tended to have undervalued stock markets.
    3. Economic statistics are mostly irrelevant to business profits and stock market returns.

    Ed

  • Ed Rempel September 13, 2011, 1:22 am

    Hi Insure,

    I agree with you. However, your 97% stat is not correct.

    The percent of mutual funds that beat the index varies widely from year to year.

    Here are the recent stats on the percent of domestic equity mutual funds that beat the index (to end of July/11):

    TSX 1-year return: 485 of 937 mutual funds = 52%.
    TSX 10-year return: 61 of 228 mutual funds = 27%

    This is the TSX which is not really a proper index. It is a pond, not an ocean, and not at all diversified. It is essentially a resource/financial sector fund.

    Let’s take a look at a proper index.

    The percent of global equity mutual funds that that beat the MSCI World index:

    MSCI World 1-year returns: 189 of 534 = 35%
    MSCI World 10-year returns: 34 of 96 = 35%

    That assumes AVERAGE mutual funds. I agree – I wouldn’t buy an average mutual fund.

    Just like any other field, there are skilled people that perform far better than average people (or indexes). We believe we can identify them. Our investment process is focused entirely on identifying All Star Fund Managers (instead of wasting time on the economy or trying to predict the markets).

    We think of investing similar to hiring a CEO for a company you own. It is like a job interview/hiring process trying to sort through many complex factors to try to identify true stock-picking skill.

    I’m not going to try to defend all financial advisors or average mutual funds, but I know from experience that there are top fund managers that have true stock-picking skill that beat the indexes by wide margins over long periods of time.

    Ed

  • Brian Poncelet September 13, 2011, 6:28 am

    Ed,

    The major point missed with respect to Glen’s points to index funds is taxes. You can’t switch from one index fund to an other and not pay capital gains. If you are not making money of course you don’t have that problem.

    The index story only makes sense in an RRSP or TFSA.
    Most people don’t understand what taxes like T5s and T3s do to your real returns and don’t understand lost opportunity costs.

  • Brian Poncelet September 13, 2011, 6:42 am

    Ed,

    The Debt situation in the US is serious… the fact that

    Although not included in the debt figures reported by the government, the U.S. government has moved to more explicitly support the soundness of obligations of Freddie Mac and Fannie Mae, starting in July 2008 via the Housing and Economic Recovery Act of 2008

    The two GSEs have outstanding more than US$ 5 trillion in mortgage backed securities.

    How do you square that circle?

    Plus,

    Unfunded obligations excluded

    The U.S. government is obligated under current law to mandatory payments for programs such as Medicare, Medicaid and Social Security.

    These deficits require funding from other tax sources or borrowing.

    I get back to you on why the Nikkei 225 (index of companies like Toyota, Sony, and others) has lost over 2% (yes negative) for over twenty years.

    The ten year return is over -27%!

  • InsureCan September 13, 2011, 11:41 am

    The fact that index funds beat 97% of mutual funds is proven over the long term. It is not true in a one year period.

    However, selecting a fund that beats the index in the short term has been shown to be statistically random. You can’t beat it in the long term, and in the short term it’s a crap shoot. Because funds that beat the index in the short term don’t beat it in the long term.

    So you have to change funds, try and find another fund that beats the index in the short term. And now you’re back to being in the category of the 97% that don’t beat the index over the long term.

    You folks surely know this. It’s not a matter of opinion, it’s been shown statistically. There is nothing that the investment industry can do surrounding equities that has been shown to outperform index funds.

    The real problem with index funds is that they pay effectively no commissions.

    The issue of taxes is a redirection. Wherever mutual funds are found, you can generally get an index fund as well. If you’re investing in something to reduce taxes, you can almost certainly do so in an index fund as easily as a mutual fund.

    Of course taxes make a difference. But keeping an eye out for taxes works better with an index fund than a standard mutual fund.

    I find it absolutely bizarre that advisors defend this stuff publicly, when the entire industry knows the facts as well as I do – index funds outperform 97% of mutual funds over the long term, and selecting that last 3% has been shown to be statistically random.

    It’s why one company rep I know described index funds as ‘the industry’s dirty little secret’.

  • InsureCan September 13, 2011, 11:44 am

    and one further point. Ed said:

    Just like any other field, there are skilled people that perform far better than average people (or indexes).

    And again, you know better. Attempting to select fund managers that outperform the index has once again been shown…yes, NOT to be able to outperform index funds over the long term. Your statement has been demonstrated to be false.

  • Anti-Index Funds Investor September 13, 2011, 3:22 pm

    I don’t understand why so many people on this blog have such a hard time believing that there are mutual fund managers/ hedge fund managers that can beat indexes after commissions consistently in the long term.

    There is simply no disputing the fact that the track records of specific managers show consistent 20+ year returns that are superior to the index by significant margins. I fully understand the theory that if you take a large sample size of investors that statistics would expect a small % at the end of a bell curve that would have superior returns from what appears to be random luck.

    Yet this method can’t explain the superior results of Graham/Dodd disciples that follow his value investing style approach to security analysis. Warren Buffett is the most famous of these disciples and has written specifically about the random theory of superior investors in his talk “The Superinvestors of Graham and Doddsville”.

    http://www.tilsonfunds.com/superinvestors.html

    The summary of this article shows a number of specific people that have been directly counselled or influenced by this investment approach consistently beat the index by wide margins after fees for the majority of their careers. The concept that all these individuals working independently in the same investment era including bullish/bear markets could provide these returns is statistically impossible.

    So many people here believe heavily in dividend investing as a solid approach because they can analyze data and determine which blue chip company has consistently paid regular dividend regardless of the stock price over time. This is applying rational analysis to determine how to create passive income regardless of the growth potential of the stock. Is it really that hard to believe that someone can consistently analyze a company to determine it is underpriced and then have superior long term GROWTH potential when given a long enough time horizon for its fundamentals to play out and catch up to its true value?

    We all know that the uber-wealthy or institutional investors are largely in active management – they invest in hedge funds or if they have made their money in the markets personally, they invest it themselves. Are these people idiots that have looked past all the data that the average mutual fund is inferior to the index?

    I think maybe the ultra rich have the money to access vast resources to try to analyze who they can trust with their fortune to grow it faster than the market alone. I understand we don’t have these resources but given the amount of time most bloggers read financial books/debate topics I’m surprised that nobody is interested in trying to figure out how selecting superior investments might be possible for the average person. I don’t think anybody can learn a value investing approach and start analyzing stocks themselves, but why can’t we look for funds that apply this approach, analyze their managers long term record and feel justified in believing they can beat the index? Is this so naive?

    Who knows…..this may be impossible but I believe heavily that value investing is a tried/tested fundamental way to approach security analysis and has a rational/calculable way to prove its path to superior results. At the end of the day, my portfolio of active managed value stocks may underperform the index after fees, but I think it is ridiculous to say the whole concept of superior returns is a statistical anomaly and therefore index investing is the obvious superior choice.

    When the wealthy start investing in index funds I might change my mind……

  • InsureCan September 14, 2011, 9:17 am

    I don’t believe it because it’s not a ‘belief’. Academics have studied the results. The 97% number I keep quoting is what came from analysing the number.

    If you don’t want to ‘believe’ in statistics, then go ahead and invest in whatever tickles your fancy and makes you feel good.

  • SST September 14, 2011, 11:51 am

    @InsureCan: your “stat” is not a statistic, it is, as you stated earlier, a fact.

    Statistics, generally, is a hocus-pocus math which can be used and manipulated for whatever purpose is at hand.

    One personal example, a highly intelligent friend of mine had to take a stats course to compete her university degree. It was painfully obvious to her what a sham it was and she wanted to voice her disgust, so her thesis was to show that one ethnic group is more intelligent than another ethnic group. Much to the horror of her prof, but fully supported through the “math” of statistics.

    Not only that, my stats prof, when questioned about the validity of stats (because intelligent people figure it out pretty quick!), unabashedly answered ‘Yes’ to its manipulative, deceptive nature.

    Apologies for the tangent.

  • InsureCan September 14, 2011, 5:18 pm

    Oh, so the whole branch of math and science centered around statistics is baloney? Alriiighty then.

  • SST September 14, 2011, 7:24 pm

    Statistics is not a science.

    From the magical Wiki:
    “Statistics is the study of the collection, organization, analysis, and interpretation of data.”

    What I said, and thanks for putting words in my mouth, is that statistics is a wholly manipulative math.

  • Anti-index funds investor September 14, 2011, 7:29 pm

    To InsureCan

    The science of computing statistics isn’t baloney, but it can be skewed by multiple factors including inappropriate sampling, inappropriate inclusion/exclusion criteria, inappropriate sample size etc.
    Therefore a statistic can be quoted in an individual study, but unless it can undergo rigorous study to evaluate for potential sources of bias or skewing of data and then be replicated in recurrent analysis, then the statistic may very well be non factual

  • Ed Rempel September 15, 2011, 12:50 am

    Hi Insure,

    Sorry to interject into your little debate, but your 97% figure is neither a stat or a fact. It is clearly not a proper figure if you compare mutual funds objectively to an index.

    You cannot quote one figure like that and pretend it applies to all mutual funds vs. indexes.

    There are all kinds of categories of mutual funds and the % that beat the index varies quite a bit. The 97% must be the single highest one available.

    If you look at properly diversified indexes, such as the global stock market, the that stats are far different – more like 35% of mutual funds beating the index, as provided by Morningstar (see post 70).

    Canada is a small pond with hardly any choices (just 60 stock to pick from), so the indexes do better. The US is the most efficient market, so the indexes do relatively well. In less efficient areas with more selection and more growth, such as small cap or emerging markets, the mutual funds do far better.

    The percent of funds that beat the market also varies a lot from time to time. Indexes are generally more risky than mutual funds, because most fund managers are targeting lower risk based on investor demand. So indexes tend to make more in strong growth markets, but also fall more in big down markets.

    What is your source for that figure? The only place I was able to find a 97% stat was one specific study in one time period of “Canadian Equity” – which is less than 1/3 of the Canadian large cap mutual funds. It excludes Canadian dividend funds (which are almost identical to Canadian equity) and Canadian-focused funds (the main category for Canadian mutual funds).

    “Canadian equity” is not representative of proper indexes. There are just 60 stocks. Fund managers have a universe of 60 stocks and are supposed to pick 30 or 40. In “Canadian equity”, most investors have all the same stuff. Most are just “closet indexers”.

    Have you ever thought of doing a bit of research? Just go online and compare returns of mutual funds to the index. That is what I did in post 70.

    Whether you look at the last 1 year or the last 10 years, you normally find that somewhere between 20-40% of mutual funds beat the index:

    Canadian domestic equity (all categories):
    TSX 1-year return: 485 of 937 mutual funds = 52%.
    TSX 10-year return: 61 of 228 mutual funds = 27%

    Global equity
    MSCI World 1-year returns: 189 of 534 = 35%
    MSCI World 10-year returns: 34 of 96 = 35%

    This is not a proper study, but as you can see 97% is very far from a realistic, objective comparison.

    Ed

  • Ed Rempel September 15, 2011, 1:06 am

    Hi again Insure,

    The “efficient market hypothesis” is generally accepted as false now. The underlying assumption is that investors are rational – which is obviously not true. As we have all seen recently, the vast majority of investors are irrational the vast majority of the time.

    Economics has the same fault. It assumes people are rational, which is part of why economists have trouble predicting real world economies.

    Back in the 80s and 90s, most academics believed it to be true, but today hardly any academics believe it any more.

    If you want to read the story of the rise and fall of the efficient market theory, I would highly recommend reading “The Myth of the Rational Market” by Justin Fox.

    There was also a very detailed study called “Active Share” by 2 Yale professors that was far more in-depth than any other index-related study. It is the only study I have seen that filtered out “closet indexers”. They are fund managers that don’t even try to beat the index. Morningstar now tracks these with a stat called “ISC”.

    The Yale study showed that once you filter out the closet indexers and take the fund managers that invest very differently from the index – called “stock pickers” – then more than half beat the index. This superior performance was persistent as well over different time periods.

    The Yale study and the Morningstar stats help us identify the All Star Fund Managers by easily filtering out the closet indexers.

    Ed

  • InsureCan September 15, 2011, 10:09 am

    Ed said: What is your source for that figure?
    Before running off at the mouth, I read easily a dozen books and did a lot of research, just a few short years ago. I’m not inclined to pour through the books to find the source.

    Unlike most mutual fund managers, who apparently haven’t even heard of modern portfolio theory. I’m no expert, but at least I’ve done a bit of reading on it. Enough to know that I don’t mix up some stocks and cash, throw in some European or Asian stocks, and call myself diversified or low risk.

    @anti-index said: The science of computing statistics isn’t baloney, but it can be skewed by multiple factors including inappropriate sampling, inappropriate inclusion/exclusion criteria, inappropriate sample size etc.

    Give me a break. The number is false because I didn’t do a rigorous breakdown of the study?

    Someone pipe up and show me, over a 30 year time span where 10% of the mutual funds have beaten the index. Until then, I call baloney on your stats.

  • InsureCan September 15, 2011, 10:15 am

    I further note that I keep clarifying that index funds beat other funds over the long term, and Ed keeps returning with examples over the short term. Not very ingenious.

  • Al September 15, 2011, 11:18 am

    I couldn’t resist another quote here:

    “There are three kind of lies: lies, damned lies, and statistics.”

    Mate, you can create statistics to prove anything – 90% of people know that.

  • SST September 15, 2011, 9:32 pm

    This topic has definitely hit a vibrant chord with more than a few readers!

    I did have ideas of posting a tome or two of research and data, but then I thought, wouldn’t make a difference, people think and believe what they want, no matter how much fact you pile on their plate.

    I do have to say, however, I really am dismayed at some/most of what Ed has presented about the nature and performance of the markets (of various types); there is a lot of incorrect material in these two articles.

    It’s true, we all make mistakes, personally and professionally, and the finance industry is no different. It is, however, infinitely easier to create “mistakes” or “alternate truths” in a profession of numbers.

    In the end, it was this this exchange (#57-59) between Ed and myself which did me in:

    SST:
    “Could you please demonstrate how an average investor, earning an average wage, could have invested in the “S&P 500? during these periods — 1872, 1907, 1929, and 1975.”

    Ed:
    “Hi SST, Fortunately, we don’t have to. The stats show the consistency of the long term growth of the stock market. There are multiple ways to participate today. Ed”

    Excuse me?!?!

    “Fortunately we DON’T HAVE TO”?!?!
    Or is that you CAN’T?
    I really hope you don’t respond to any of your clients’ requests for information with the same line. Extremely amateurish. I’m sure you have a thriving business, Ed, hopefully it’s just the freebie internet articles that get the shabby treatment.

    Just to let you know, Ed (and everyone else), if you want a TRUE S&P 500 return rate for the average investor, use the Vanguard 500 Index Fund starting in 1978.

    Any data prior to this is NOT relevant to ‘real people’ investors and is used as a marketing tool by the financial industry. Want more info? I’ll e-mail it to you.

    Enjoy the remaining days of summer!

  • Ed Rempel September 15, 2011, 11:51 pm

    Hi Insure,

    The core of our discussion here is whether it is possible to chose mutual funds that would reasonably be expected to beat the index.

    We believe from experience that if is possible to identify the All Star Fund Managers that beat the index long term ahead of time.

    It is not easy, since most mutual funds do underperform, but in our case, our entire investment focus is on trying to identify them. We don’t waste time trying to forecast the market or the economy. We are just focused on figuring out who the All Stars are. After years of working at this, we believe we have a good idea of what to look for.

    Some of these fund managers beat their index by very wide margins. Our favourite global fund manager has beaten the MSCI World index by more than 10%/year in the last 10 years. Our favourite Canadian equity fund manager has beaten the TSX 60 by more than 5%/year in the last 10 years.
    ————–

    As for your question about the average fund long term, I was quoting mutual funds vs. index for 10-years, since that is a reasonable compromise between too short (to be meaningful) and too long (so that too many funds have disappeared).

    Here are the longest stats I have readily available on the percent of mutual funds that beat the index:

    Global Equity mutual funds vs. MSCI World index for 25-years:
    4/8 mutual funds = 50%
    Good result for mutual funds, but hardly any funds.

    Domestic equity mutual funds vs. TSX 60 for 20 years:
    15/73 mutual funds =21%
    Lower result for mutual funds, but there are not a lot of stocks to chose from.

    This is not a proper study for a few reasons. I think the 10-year figures with a lot more funds would be more useful.

    Ed

  • SST September 16, 2011, 12:52 am

    @Ed: “Some of these fund managers beat their index by very wide margins. Our favourite global fund manager has beaten the MSCI World index by more than 10%/year in the last 10 years. Our favourite Canadian equity fund manager has beaten the TSX 60 by more than 5%/year in the last 10 years.”

    2000 to 2010:
    (yes, ’00-’10 because ’11 isn’t finished yet!)

    S&P/TSX 60 Index = 3.9% per year
    MCSI World Index = -1% per year

    Your “All Star” Managers = 9-10% per year (pre-tax/fees)

    Gold = 17% per year
    Silver = 19% per year

    Hmmm….so much for your all-stars.

  • Ed Rempel September 16, 2011, 1:35 am

    Hi SST,

    The returns I quoted for the All Star Fund Managers are after all fees.

    Good for you if you made that return on gold and silver. We generally avoid these 100% speculative investments, unless our fund managers decide to invest a bit there.

    Ed

  • SST September 16, 2011, 2:43 am

    Okay, Ed, you can keep your ideology and I’ll keep my barbaric, high-risk decade-long ‘All-Star Manager’ beating returns.

    Profit, after all, is the only thing that matters in the end.

  • Al September 16, 2011, 12:22 pm

    SST – I still don’t agree with excluding dividends from the calculation, they are part of the return (I for one, am sure happy to recieve dividends when I get them). I do however take your point regarding the difficulty of replicating the index given trading costs for small investors (assuming I even want index returns).

    XIU is an ETF on the TSX, it returned +6.03% from Dec 31 99 to Dec 31 00 on a total return basis. Including dividends (not reinvested, just sitting as unused cash) it returned 5.5% over the same period (I think this is a fair measure of the return a small investor could expect to get if they wanted index-like returns).

    Incidentally, S&P/TSX60 had a total return 6.22% over that same period so this ETF replicated it quite well.

    Your point that Gold still beat it over the decade holds, but the returns should be total returns for both asset classes (otherwise it’s comparing apples and oranges).

    (I’m not sure exactly what time periods you are using but I get a gold return of +11.7% over the period Dec 31 1999 through Dec 31 2010 measured in C$. Starting at C$416/oz on Dec 31 1999 and ending Dec 31 2010 at C$1,412/oz assuming I can get spot gold, and pay no storage costs (for a small investor this I think is a fair assumption) but it does flatter the returns somewhat). I do wish I had kept my gold a little longer, but live and learn.

  • Al September 16, 2011, 12:35 pm

    XIU is an ETF on the TSX, it returned +6.03% from Dec 31 99 to Dec 31 10* on a total return basis.

    * my apologies a typo in the date above.

    I’ll leave it to Ed to comment on the managers total return over the same period should he care to.

  • SST September 16, 2011, 8:46 pm

    @Al: the TSX 60 and MCSI World returns are including “dividends” — yet another false index calculation unless you are invested in an index fund or own shares in all the index companies.

    For an average investor to have tried to match the S&P 500 prior to 1978 would have been a lost cause. First off, they couldn’t have afforded to. Secondly, the commission cost and tax implications of replacement buying/selling as well as re-investing dividends (ie. buying more stock) would have severely eaten into returns.

    “Your point that Gold still beat it over the decade holds, but the returns should be total returns for both asset classes (otherwise it’s comparing apples and oranges).”

    I’m not on board with that. If you invest in apples and I invest in oranges, and I make a better return… That’s the whole point — apples vs. oranges!

    At any rate, gold getting 17% per year (no fund, no fees, no managers, no taxes; the MOST I ever paid in premiums for gold was 3%, and at times 0%!) results in a larger total gain than stocks (divs. incl.) returning 10% per year.

    I used US$ in my calculations, it is the world reserve currency, after all.

  • Jungle September 16, 2011, 10:13 pm

    SST I don’t understand.. You said you don’t trust the stock market any more and hoard gold. If you love your gold-good for you!! We get it-gold has shot up and is in a bubble.

    There is a risk gold is going to drop big time! But you look short term, not long term. That’s why at this point, there is more value in stocks. You can not argue what is better: P/Es of 9-12 or $1800 OZ gold. And the price of gold could be priced by the greater fool’s theory. I have more faith on companies that make money then people paying higher prices for gold.

    This is a good blog and Ed is a smart guy. He gives a lot of free advice by posting on the forums-you make it sound like he’s completely wrong. You seem to have your own agenda against him? Did something happen to you in the past that makes you this way? Your argument comes down to gold being the end all investment?

    PS: I read an article that all the worlds gold came from meteor strikes and I was thinking about you: You might want to put on a foil hat for this one!

    http://www.thestar.com/opinion/editorials/article/1051864–pennies-from-heaven

  • Al September 17, 2011, 2:32 am

    SST – so what is the S&P/TSX60 total return including dividends (or XIU the tracker returns) over the same Dec 31 1999 to Dec 31 2010 when Gold returned ca. 17% per year. It should be in the same currency as Gold returns, the number in post 88 is not this number in USD unless I have the period wrong.

  • SST September 17, 2011, 12:48 pm

    Straight from the iShares website:
    http://ca.ishares.com/product_info/fund/performance/XIU.htm

    XIU
    Total Returns as of 31-Dec-2010: 7.96%
    (Returns are average annual total returns)

    IAU
    (iShares Gold Trust; inception 01/21/2005)
    http://us.ishares.com/product_info/fund/performance/IAU.htm?asofDt=2010-12-31

    Total Returns as of 31-Dec-2010: 21.75%
    (Returns are average annual total returns)
    (You can do the currency exchange on this, but it’s only going to help improve the C$ return by 20%.)

    Gold (C$)
    12/31/99: $430
    12/31/10: $1405 = 12.5%
    (Returns are average annual total returns)

    Let’s recap:
    Average annual total returns in C$:

    XIU (S&P) = 7.96%
    IAU (Gold) = 21.75% (inception, 2005)
    Gold = 12.5%

    Hope this clears the issue for you.
    Have a great weekend!

  • Ed Rempel September 17, 2011, 1:25 pm

    HI Al,

    The return of our favourite Canadian fund manager for a similar period was 12.5%/year after all fees. This is Aug. 31/00-Aug.31/11.

    The TSX60 Total Return (including dividends) was 2.7%/year during the same time.

    This 10%/year difference is higher than usual, because the TSX60 was massacred in the tech crash. At the peak, it was 48% Nortel. Our fund manager avoided the tech bubble and crash.

    If we take out the tech crash period and just go back to 2001 (Aug.31/01-Aug.31/11), then our fund manager made 13.0%/year after all fees while the TSX60 Total Return made 7.8%/year – a smaller difference of a bit over 5%/year.

    We track the fund manager’s performance across more than one mutual fund where he has been the lead manager during that time, always with a similar mandate.

    Ed

  • Ed Rempel September 17, 2011, 1:58 pm

    Hi Al & SST,

    Here are the actual returns in the last 6 years that you are trying to figure out. This is Aug.31/05-Aug.31/11 in $C total returns. Gold is 23.0%/year while the TSX60 is 5.8%/year.

    This is the specific time 6-year time period from the beginning of the current gold bubble until now. Up until that point, Gold had flat-lined for decades (since the 1st gold bubble popped) – you know like the heart rate graph when the patient dies…

    I have the index data from Jan.31/87. $1,000 in gold would have hardly moved the entire time and would have been down to $940 by Aug.31/05, while $1,000 in the TSX60 would have grown to $5,948.

    If you include both periods, $1,000 in Jan.31/87 would today be worth $3,261 in gold and $8,341 in the TSX60.

    Ed

  • Ed Rempel September 17, 2011, 2:30 pm

    Hi Al & SST,

    I think we have lost everyone else, since gold is not the topic here. It can be relevant to the topic however. Let’s go back to the Fear of False Factors.

    Gold is a speculative commodity that sometimes rises when there is fear – real or imagined. The sharp rise in gold in the last few years is closely related to the general negative outlook today.

    Here is what we believe is most likely going to happen. Eventually, everyone will realize that all the major fears out there are not going to happen. We will NOT get:

    – a currency collapse.
    – a banking collapse.
    – major countries unable to pay their debt.
    – hyper-inflation.
    – deflation.
    – a decade of no growth.

    The fear of all these false factors will eventually dissipate.

    Things are starting to normalize slowly. Even the relentless mistake after mistake by nearly every politician will eventually give way to stronger underlying fundamentals.

    The economy will eventually recover like always, but it will take a bit longer this time because there is still a glut of real estate in the US keeping unemployment higher there a bit longer.

    The stock market will have to eventually take off because the companies in it are in great shape. Very strong fundamentals, strongly growing profits, strong balance sheets and the cheapest it has been in 60 years (compared to bonds).

    When will this happen? Who knows. It should happen soon, but it could happen now or take a few years.

    Once the fear reduces, the gold speculation will decline and gold will start to go down. So far, there have been enough speculators to “buy on dips”, but at some point there will not be enough fear to sustain it and it will become clear that gold is no longer rising.

    Since it pays no dividends and has no earnings, once there is no reason to speculate on a higher price, there is little reason to hold gold.

    In short, we are predicting another gold crash – just like happened the only other time in history that gold rose sharply in price.

    However, there is no way to know when. In the mean time, gold could keep rising. Since there are no fundamentals, there is no limit to how high gold could rise.

    When it finally collapses, it will likely start slowly and then fall off a cliff – similar to 1980. Again, since there are no fundamentals, there is no limit to how low gold could go.

    We think the most likely scenario is that gold hits both $2,000 and $1,000 in the next decade. It is possible that it hits both $2,500 and $500.

    My point is that the speculation on gold is related to the fear of false factors today. Gold price will likely track the amount of fear.

    Ed

  • SST September 17, 2011, 9:54 pm

    MY point is that Mr. Market is ALWAYS correct.

    Believe in all the “false fear” you think SHOULD not be taking place, and I’ll put my money in what IS taking place.

    All I can say to readers of this thread, if you want to believe in the words of Ed (or myself, or anyone!), take them and do your research. Find out what lays behind the veneer.

    Ed, the fundamentals of gold are tied to the fundamentals of the financial markets and government. The price you currently see in gold reflects the damage and corruption in these two areas. The fundamentals of gold are tied intrinsically to human nature, shown time and time again over the last 5,000 years. If you find a way to separate human nature from the markets, let me know. Remember, the two strongest drivers of ANY market are FEAR and GREED — these are your basic fundamentals.

    The “first gold bubble” you refer to was not remotely similar to what is happening right now. The 1980 spike was due to a few fellows trying to corner the gold market with mega-leverage; it crashed because the government changed the rules to stop them. Exactly like what happened recently when there were eight (8) margin increases in a row in the silver futures market — from $50/oz to $35 in a matter of days.

    “The stock market will have to eventually take off…”
    Says who? Recall Japan c.1990 and the Nikkei. Twenty years later and it’s still down 77%. I’m sure they too have lots of great companies with solid fundamentals, doesn’t seem to do their stock market any good. Read up on what happened in Japan during the 1980’s — easy credit, risky loans, real-estate bubble, equity bubble, bank bail-outs, quantitative easing, 0% interest rates — sound familiar? The only thing different is that more and more debt and credit is being sought instead of paying down liabilities.

    ” We will NOT get:
    – a currency collapse.
    – a banking collapse.
    – major countries unable to pay their debt.
    – hyper-inflation.
    – deflation.
    – a decade of no growth.”

    1) currencies have been collapsing since their inception (eg. US$). It’s called loss of purchasing power.

    2) banks already HAVE collapsed! Perhaps not in Canada, but certainly in other countries around the world. Oh, right, except in the US where they were bailed out for causing massive global failure.

    3) Ed, please show me ONE country that is currently paying down their debt. NOT just interest, but principle — and not incurring even more debt. Just one…

    4) “hyper-inflation is describe as episodes when the monthly inflation rate is greater than 50 percent.” Not even close to that and I too doubt we will ever see it. However, the true inflation rate is well above the “official” rate of 2.7%.

    5) This is a mixed bag right now. There are currently many characteristics of deflation — high unemployment, economic slow-down, 0% interest rates, asset prices dropping (eg. houses, stocks), loan defaults, increase in money supply.

    6) 2000-2010 US Real GDP growth was 1.5% annually — down 56% from the previous decade. During the Great Depression GDP growth was 80% higher than through the ’00s. Japan’s GDP growth during its “Lost Decade” was 1.3%. Four years into the current financial crisis and the US GDP growth (2008-current) is a 0.8% annual average. Not a stunning demonstration of hope for the largest economy in the world. Six more years to go…

    You are correct in saying things will “normalize” — eventually. However, seeing the astounding depth and breadth of the financial problems which have yet to be even remotely solved within the span of four years…I won’t hold my breath for a rosy end any time soon.

    p.s. — hope you all enjoyed the Wall St. protests today!

  • Ed Rempel September 19, 2011, 1:17 am

    Hi SST,

    I get it. You think that multiple catastrophes will happen and life as we know it will end. We should all start stocking up on canned food.

    We can quote all kinds of stats, but I all I’m saying is that our fund managers are confident that none of these things will happen (list in post 99). They are in the thick of the action, plus some have great contacts among the decision-makers in government and business.

    We’ll see in the next few months or the next couple of years what happens. Let’s make a note to check back in a few months.

    Ed

  • Ed Rempel September 19, 2011, 1:21 am

    Hi SST,

    Actually, it’s like deja vu all over again – the causes of the current gold bubble are very similar to the causes of the 1st bubble in 1980.

    The Hunt brothers tried to corner the market on silver, not gold.

    Check Wikipedia. The main causes of the 1980 gold bubble were:

    1. Speculation of inflation.
    2. High oil prices.
    3. Russia invading Afghanistan.

    “History teaches that man does not learn from history.”

    Ed

  • Ed Rempel September 19, 2011, 1:50 am

    Hi again SST,

    Wow, you have really bought into the index/ETF marketing. “Mr. Market is ALWAYS correct”???

    This is worth mentioning, because few people seem to know about the death of the Efficient Market Hypothesis.

    This theory is that the market is efficient and takes into account all information, so the Mr. Market always prices all stocks and market investments at the correct price.

    IF you actually believe that, then you must also believe:

    – All stocks and commodities have the same future profit potential (adjusted for risk).
    – You should be indifferent to which investment you have, since all other stocks/indexes have the identical profit potential to your investments.
    – All people that beat the market did it purely on luck.
    – A monkey can invest as well as Warren Buffett.
    – Nortel was correctly valued at $124 and also correctly valued at $.69 2 years later.
    – Bubbles, manias, and overly pessimistic markets cannot ever happen. The tech bubble correctly valued all tech stocks.

    In your specific case, SST, if you believe that “Mr. Market is ALWAYS correct”, then you should have zero hesitation in switching your gold for RIM shares.

    While the EMH is still talked about a lot, it is widely agreed to be false in its full form. Anyone that believes the investments they own are better than investments they don’t obviously does not believe the EMH.

    There are degrees of the EMH, though:
    – “Strong EMH” is the full theory discussed above that is obviously false.
    – “Semi-strong EMH” is also generally believed to be false. It holds that people can beat the market with insider or first-hand knowledge, but fundamental research and technical analysis (charting) are useless.
    – “Weak EMH” version is probably true, though. It holds that a good stock-picker can beat the market with insider/first hand information or with good fundamental analysis, but technical analysis (charting) still does not work.

    The most thoroughly-researched book on this topic I have seen is “The Myth of the Rational Market” by Justin Fox. It is a “must read” if you want to understand this topic thoroughly.

    In the book he tells about a recent conference of university finance professors. They were asked to raise their hand if the taught the EMH. Nearly all raised their hand. Then they were asked if they believed the EMH – only one hand went up.

    I wrote 3 articles with more info on this topic: http://www.milliondollarjourney.com/is-the-market-efficient-part-i.htm .

    Ed

  • SST September 20, 2011, 9:00 pm

    @Ed: First thing — I stand corrected — it was indeed silver the Hunt’s were after. No idea WHY I got that incorrect! Momentarily stupefied?

    The 1980 gold bubble was a one-month 75% spike. The current rise in gold has taken 10+ years — NOT one month. Take a look at a 10-yr. chart, see any spike at all? It has risen only 20% in the last two-and-a-half months. Hmmm, AAPL is also up over 20% during the same time — does that mean APPL is in a bubble, too? Oh, right, they have “earnings”. GM had earnings too. (Disclosure: I am long AAPL)

    Yes, gold is well above its trendline and could see a pull back to $1,400 (-25%), but a bubble? Hardly. Was gold in a bubble in 2008 when it dropped almost 30%? Nope. Take a look at the string of easy money-fueled bubbles since the 80’s: S&L, internet stocks, housing, credit (finally!)…and now ??? With the chickens coming home to roost, there isn’t any room or fuel left for any further bubbles, including gold. Guess time will show us.

    “Wow, you have really bought into the index/ETF marketing.”
    I’ve never bought an index or ETF, and most likely never will.
    Or do you mean marketing more in terms of trying to sell the long-term S&P 500 returns supported with data going back to 1872 — even though there was absolutely ZERO possible manner in which an average investor could have mirrored the movements of the S&P “500” prior to 1978?

    “I get it. You think that multiple catastrophes will happen and life as we know it will end. We should all start stocking up on canned food. We can quote all kinds of stats, but I all I’m saying is that our fund managers are confident that none of these things will happen (list in post 99).”

    I didn’t say fill your basement with canned goods, did I?
    What I did do was point out the very current position of your list (#99) which you and your team think will not and is not taking place. You can believe all you want that those events are non-events, the facts very much show otherwise — show me they are NOT happening right now! I’ll believe in facts long before an embedded fund manager’s confident opinion.

    As for your list, I’ll trend heavily, again, toward the facts (#100), unless you would like to point out exactly which major country is paying down their debt principal and not incurring any new debt? Or explain where the growth will come from in the USA — the world’s largest economy currently running (4-yrs. in) a GDP less than during the Great Depression with 20% unemployment? Or why you think there won’t be yet ANOTHER American Lost Decade with the S&P 500 eking out a brilliant -1.5% pre-inflation per annum loss as it did during the ’00s?

    Even the US Energy Information Administration admits: “Concerns about fiscal sustainability and financial turbulence suggest that economic recovery in the [developed] countries will not be accompanied by the higher growth rates associated with past recoveries,” But, hey, what do they know.

    As per “Mr. Market is always correct”…what I did NOT say was “Mr. Market always prices all stocks and market investments at the correct price” (and please, stop putting words in my mouth). What I did NOT say was that the market is efficient and/or rational — how can it be with all the government meddling and corporate fraud? What I DID say was that the market is always correct.

    Further explanation: let’s say the S&P is at 1200 — that is the level at which all current influences — real, irrational, — have determined the S&P to be at that moment. It doesn’t matter if your thoughts or opinions or confidences say the S&P should be at 1500. Mr. Market tells us, ultimately, what is going on right NOW — and that price is correct. You can only buy/sell the market at its current level (or higher/lower, if you so choose), regardless of any opinion you may have. Besides, any investment with a forward P/E greater (or less) than 1 is experiencing “incorrect” pricing.

    A good analogy would be to think of the market as a car crash. What the market shows is the result of the crash — that’s it. It doesn’t care which car was speeding or which driver was drunk or who ran the red light or if the road was icy; it doesn’t show how much will be paid out in insurance or the influx of business to the auto-body shop or car dealership; it doesn’t show which brand of recalled car or at what intersection or the price of gasoline — all it shows is the crash, NOT the cause and/or effect.

    Bottom line to all this back-and-forth (and as I’ve repeated many times) — there is a time and place for everything. Sometimes it’s best to put your money into stocks, or bonds, or precious metals, or real estate, or commodities, or even canned goods (hey, world food prices have risen 40% in the past year!). I understand that the paper markets are your business, and that you have to sell them to your clients in order to make your money. It is, however, personally naive and professionally irresponsible to think that the stock market is the ONLY venue in which to invest and make money.

    We can argue theories and course-of-action all day, but I prefer to rest on my bottom line profit — that bastion which can NOT be argued. As always, time will tell which investments yield the largest returns.

    As for switching my gold to RIMM stock…not gonna happen.
    I have, however taken some precious metal profits and invested in private companies — NOT public stocks.

    It would be great if we re-visited this in 365 days to discuss how the events of the day played out and what effect they had upon various economies and markets.

    May the biggest profit margin win.

  • SST September 21, 2011, 8:36 pm

    As an addendum, and for any who cares, I scoured this snugly bit of market truth from a source of utmost integrity and respect*:

    $1 invested in commodities or stocks; 1970 – current (41 years)

    Commodities = $97.55; 11.82% per year
    Stocks = $40.90; 9.47% per year

    The ONLY time stocks outpaced commodities during the last 41 years was 1997-2000 — during the internet bubble! Oops!

    Don’t let anyone sell you on stocks, especially if it’s their job to do so, and even more if you haven’t done your OWN research! Wealth comes in many different forms…

    *(if anyone wishes further info and/or data, please let me know and I’ll forward/post it.)

  • SST September 22, 2011, 11:35 am

    Good thing we have nothing to fear from an Operation Twist factor!

    Oh…wait…

    Looks like this five-years-running recession will keep on keepin’ on.

  • Ed Rempel September 23, 2011, 12:19 am

    Hi SST,

    I’m back from 2 investment conferences.

    Where did you get the commodities return figure? Is that commodity stocks or hedge funds? The only ones I can find show a low return with commodities only tripling over recent 25 years (about 3%/year). For example, http://www.chartsrus.com/charts.php?image=http://www.sharelynx.com/chartsfixed/rCRBTOTRETURN.gif .

    This would make sense, since commodities are a physical substance. Most physical substances are have long term returns not far different than inflation. They may have high and low periods, but the long term is usually not far from inflation.

    Ed

  • SST September 23, 2011, 10:23 pm

    @Ed: “Where did you get the commodities return figure? Is that commodity stocks or hedge funds?”

    The info is taken from an Ibbotson report.

    Neither stocks nor hedge funds — purely commodity indices vs. equity indices.
    I thought it fair since the ‘historical S&P 500 return’ mantra is a favorite among industry professionals.

    “Most physical substances [commodities] are have long term returns not far different than inflation. They may have high and low periods, but the long term is usually not far from inflation.”

    You better check your calculator batteries there, Ed.
    In the exact same report, annual inflation comes in at ~4.5%, commodities returned almost 12% per year — 166% more per year than inflation! Not sure what your definition of “not far from” is, but that’s a pretty wide gap in my opinion.

    All that said, however, it does not lend proclivity for gains in commodities. Although, with the world population growing and sucking up food, land, and energy at an ever increasing pace…I doubt a downward trend is in the books.

    (Disclosure: long land, food, energy, silver — yup, even after today!)

  • SST September 24, 2011, 11:23 am

    @Ed: “Companies are in great shape — Markets are cheap: The forward P/E ratio for the S&P 500 is 11.52 4, which is 28% below the historical average of 16%. This is the lowest since 1985.”

    Now seems like an apropos time to address this statement.

    1) using a forward P/E gives distorted and wholly false numbers. How can you quote historical returns of one type and then turn around and quote future returns of another type? You have to use trailing for any kind of consistency or credibility.

    2) Trailing (12-month) P/E = 13.5.
    However, Schiller’s data computes a trailing 10-year P/E = 19.5.
    I’m not exactly sure of his methodology pertaining to replacements, but I’ll take his word that his data is solid.

    3) Funny you should mention 1985. For me to actually buy into the S&P, the P/E (Schiller style) would have to drop to 1980/83 average levels = 8.5. Why, you might ask? My reply:

    i) Depository Institutions Deregulation and Monetary Control Act (1980)
    ii) Garn–St. Germain Depository Institutions Act (1982)

    And you wonder why the S&P P/E hasn’t been this low since 1985?

    A return to a true pre-credit tsunami P/E of 8.5 still requires another 26% – 56% drop (your ‘forward’ through to Schiller trailing) in P/E. This would come with a 38% drop in the S&P, down to 700 (using 10-year trailing earnings, inflation adjusted).

    Others might say the market needs to, or will indeed, plummet 92% to 100, to wipe out all the last 30 years of false prosperity and match the nominal 1979-80 level. I would use inflation-adjusted earnings for 1970-79 — $37.82 * 8.5 (P/E) = 320 S&P, only a 70% crash.

    Of this, I’m not so sure, but it is quite plausible: the 1929-32 market declined ~90%. I will put money on the pain being far from finished.

  • SST October 11, 2011, 4:13 am

    @Ed re:#36 — “Note the risk notices that should accompany any gold investment. It is not a safe investment – it is a very high risk, speculative investment.”

    An interesting statement from someone who will have nothing to do with gold, yet the graphics on his financial website are nothing but images of gold (and silver)!

    Gold dollar signs, gold watch, heavy gold weight, golden egg, golden ‘globe’, gold spike…

    Ed, just curious as to why you use gold to portray the image/sell the idea of wealth and security if you believe gold to be just the opposite?

  • Ed Rempel January 8, 2012, 11:53 pm

    Hi SST,

    The P/E of the market is usually high when interest rates are low and low when interest rates are high.

    The reason for this is the “earnings yield”, which is the P/E upside down, or E/P. The earnings/price of the stock market gives you a rate of return based on existing profits.

    Today, the forward P/E is about 11.7%, which is an E/P of 8.5%. That is far higher than bonds at about 2%, which means that stocks are very cheap vs. bonds today.

    The reason that P/E was low in the 1980s is because interest rates were sky high. A P/E of about 10% in the 80s, would be an E/P also about 10%, which was actually lower than bond yields at the time.

    In short, a P/E of 11.7% means stocks are very cheap vs. bonds today, but did not mean that in the 1908s.

    Using the forward P/E for next year is entirely reasonable. We are trying to get use it as an idea of whether the stock market is going. In recent quarters, about 70% of companies have had positive earnings surprises above the analysts expectations (which is what the forward P/E is based on), so there is no reason to doubt the accuracy of the forward P/E.

    To show how cheap the stock market is today, the last time we had a P/E of 11.7% without having sky high interest rates was 1954.

    Ed

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