Monday, August 13, 2007

The latest reason to disregard the AP's "economic" news

"U.S. Homeowner Woes Felt Around World" laments the headline. With phrases like "The latest crisis in financial markets," "fears that Americans are failing to keep up with their mortgage payments" and "a glut of foreclosed homes," you'd think it was the end of the world. After all, we have sources like the prescient "Gabriella Savarini, a 69-year-old shopkeeper in Rome"! Never mind that she's telling us the obvious ("problems on the stock exchange have consequences for the economy of America and of the world"), the fact that the Associated Press quotes her means we must regard her opinion as gospel, right?

Let's go through some of the ludicrous doomsaying in the article:
"The sharp falls in global stock markets obviously affect consumer wealth, which again could dampen spending," said Howard Archer, chief British and European economist at Global Insight.
How can a top economist at any reputable company be so confused about saving and spending? If this is an example of their usual "insight," then Archer and his employer had better stick to providing raw data, instead of analyzing it (let alone making predictions!). The "sharp falls" will have minimal effect on the portfolios of those who meant to save their stock investments. On the other hand, the drops will, as we'll see below, (properly) penalize those who think they can time the market with short-term investments.
The most immediate effect for the half of all American households who own mutual funds and other individual investors worldwide is a decline in the value of their investments, which may or may not be short-lived.
This will require a trifle lengthy debunking, as I'll have to get into numbers. Thankfully, people like Paul Krugman and the AP's "economic writers" (particularly the perma-bear hacks Martin Crutsinger and Jeanine Aversa) are a great indicator of the economy. When they're predicting gloom while there's a Republican in the White House, things are actually going great.

Stock markets across the world have been dipping lately, but as far as the American exchanges, let's look at the facts. As I noted back on April 5th,
Year-to-date, the DJIA has gained only 0.8%. But if you had bought a Dow Jones Industrial Average index fund on February 28th, the day after it closed at 12216.2402, then your purchase as of April 5th's close would have already gained 2.8% (the DJIA closed at 12560.8301). If you had bought on March 6th, the day after the market "tumbled" to 12050.4102, then your purchase as of April 5th's close would have gained 4.2%.
As I explained in that post, I refer to "the day after" because when you buy a index fund, the Net Asset Value is calculated from the underlying securities' prices from the day before. So on February 28th, you're buying at prices determined at the close of February 27 (the day of the first big dip).

The Dow Jones Industrial Average was at 12216.2402 on the close of February 27th, and at 13239.54 on the close of this last Friday, August 10th. So if you had bought into a simple DJIA index fund on February 28th, then excluding fees and taxes, you'd now be up almost 8.4%. If you had bought into the index fund on March 6th, the day after the DJIA closed at 12050.4102, you'd now be up almost 9.9%. (For simplification purposes, when I talk about funds' gains, I'm not counting dividends you may receive.)

Let's look at the S&P 500: 1399.04 at the close of February 27th, 1374.12 at the close of March 5th, 1453.64 at the close of August 10th. So the gain since February 27th is still 3.9%, and the gain since March 5th is 5.8%. For the NASDAQ, the numbers are 2407.8601 at the close of February 27th, 2340.6799 at the close of March 5th, and 2544.8899 at the close of August 10th. The gain since February 27th is 5.7%, and the gain since March 5th is 8.7%.

So what's the lesson, that the DJIA is better? Not necessarily. The first secret to successful investing is to diversify: index funds in each of the three (plus others like the Russell 2000) are a desirable, and even then, they are only a portion of a successful portfolio. Buy into some tech funds, but don't ignore other vehicles like emerging market funds, health care mutual funds, and energy SPDRs.

But, naysayers may argue, what about those who buy at the top of a bull market? After all, the DJIA closed at 14000.4102 on July 19th, the same day that the S&P 500 closed at 1553.08 and the NASDAQ closed at 2720.04. The losses since then, respectively, have been 5.4%, 6.4% and 6.4%. Well, the second secret is that no matter how well or poorly the markets are doing, think long-term. Wait a few years and see how the averages do, considering U.S. stock markets have a consistent historical upward trend. Individual investors should never expect to get consistent short-term gains, but they can have every confidence in the long-term gains of properly diversified holdings.
The distress in the markets makes it harder and more expensive for businesses and consumers to get loans and cash, Archer said. If companies cannot get loans, they cannot expand and may have to cut expenses, typically through layoffs.
This is a common logical fallacy: make a questionable statement, and make it seem valid by immediately making a generalized statement that is only generally true. In this case, the current "distress" in the markets does not necessarily make it harder for "businesses and consumers to get loans and cash," whether any particular entity or on average. Such a blanket statement is simply not true, for the very reason that if you are competitive, then by definition, you'll get a loan at competitive rates. So it's more accurate to say, "The current dip in the markets, which some economists and financial analysts explain is a natural correction from recent highs, could further tighten the easy credit of the last several years. If so, it will be harder for less competitive businesses and consumers to ride the coattails of the successful when seeking to borrow."
America faced a crisis similar to the current mortgage fiasco when hundreds of savings and loan companies went belly-up in the 1980s. Back then, the fallout did not spread dramatically to foreign shores because the U.S. government stepped in to bail out the banks and repay depositors.
So is the reporter shilling for Hillary Clinton or John Edwards, that he implies the federal government will need to bail out all these defaulting mortgages? Is he even serious in making the comparison to the S&L scandal? The two situations are completely different. The S&L crisis was borne of government, first because the federal government insured S&L loans (creating the moral hazard of encouraging S&Ls to make bad loans, knowing they couldn't lose if the loans weren't repaid), and second because of certain government officials' participation in the fraud that exacerbated the collapse. What's happening today with mortgages is typically that stupid people get in over their heads by borrowing money they latter cannot afford to repay, allowing smart investors to buy foreclosed properties. Finally, the doomsaying about "foreign shores" didn't apply then or now: foreigners weren't heavily invested in S&Ls compared to other things, and the same applies today. Foreigners love our stocks more than investing in S&Ls or buying mortgage-backed securities, and they especially love U.S. Treasury securities and our real estate.
A steep sell-off in global markets on Thursday and Friday was triggered by distress signals from France's biggest bank, BNP Paribas, which had to freeze billions of dollars in assets in three mutual funds because of the falling value of securities linked to high-risk mortgages taken out by U.S. borrowers.
Incorrect. They were hedge funds that dealt with asset-backed securities, which are different from a mutual fund. Hedge funds are all about investing in very high-risk securities, and with the fact that they require heavy initial investments (US $100K is not uncommon), would-be investors know what they're getting into.

In any case, BNP Paribas only temporarily suspended redemption of three funds, whose aggregate value is about $2 billion (compare that to the, what, $10 trillion today in mutual funds?). Now, the mainstream news would you have think the worst, that BNP was having troubles like American Home Mortgage (which recently collapsed into bankruptcy because it cannot repay loans). But the reality is that BNP didn't have any loan troubles, but that with the latest market volatility, it simply had trouble valuing the funds' underlying securities. Doesn't it make sense that if you don't know how much something is worth, you can't trade it?
Global interdependency isn't a recent phenomenon: The Wall Street stock market crash of 1929 and the Great Depression affected the entire world, and helped create the conditions for the rise of fascism in Europe.
Stock markets were only one portion of the Depression, and in fact, the events of October 1929 was merely a symptom, not a cause. (Click here for my blog entries involving it, they're all worth a read.) Simply, the Depression was triggered by the Federal Reserve suddenly cutting the money supply by a third in the late 1920s, then exacerbated by the Hawley-Smoot Tariff (protectionism that hurt all nations that tried to retaliate against each other), and further by tax hikes that strangled any attempts to invest in business growth (as compared to "public works" that wasted money hiring people to dig holes and fill them back up, or build bridges nobody needed at that cost).
But with faster communications and real-time trading, market jitters in New York race around the world almost instantly today.
And this is undesirable? Information should spread as quickly as possible, because markets work most efficiently that way.
More Americans are failing to keep up with their home mortgage payments, and there are concerns that this could ripple around the globe because much of the debt from mortgages has been packaged into securities sold to pension funds, banks and other investors who were hungry for high returns on investments.
This would be a problem if most or at least significantly more Americans were having trouble, but that's not true.
The same mortgage securities in the U.S. that are crumbling in value are a part of bigger holdings that banks from Japan to Germany bought into because of low U.S. interest rates and a good returns.
They're part of overall portfolios, but not a major component at all. Remember that word "diversified"?
Meanwhile, the ability of banks to convert assets to cash quickly was in doubt because some were unable to track how much money they poured into now worthless securities backed by sub-prime U.S. mortgages, or loans made to high credit-risk individuals.
The attempt is to lump all sub-prime mortgages together, and make it seem like they're all in trouble. They're not. But, the liberal media always needs to create some sort of economic Armageddon, at least when a Republican is in the White House.

The rest of the article is historically accurate, but with the same Chicken Little tone. UBS lost $125 million, and Bear Stearns closed two funds that had been worth $20 billion. Yet the companies are still solvent, aren't they? We shouldn't be surprised that they are. Financial giants and their high-risk investors are prepared for such losses: hedge funds' inherently high risks keep them from being no more than a small portion of, you guessed it, a properly diversified portfolio.

Toward the end, it's explained how central banks are intervening, as they've occasionally done in the past, increasing the supply of loanable funds by injecting money into financial markets. Actually, this is the last thing we want: if credit is too easy to come by, why do we want it to continue?

Sleep well tonight: unless you put your 401K into a single individual stock, and barring the Democrats screwing up our economy, things will be fine.



Blogger Bret said...

I'm I wrong for wishing for an earthquake so I can buy land in CA?

Wednesday, August 15, 2007 4:23:00 PM  
Blogger Bret said...

Ugh, that's supposed to read:

"AM I wrong for wishing for an earthquake so I can buy land in CA?"

Furthermore, I have no confidence that the recent housing downturn is going to bring housing prices anywhere close to where I can afford them. That's good for the economy (I guess), but not good for me, personally.

Wednesday, August 15, 2007 4:24:00 PM  

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