The Myth of Diversity from Mutual Funds

It had never happened before. All asset classes dropped in the fall of 2008. It wasn't supposed to happen like that. 80 years of history says that when bonds go up in value, equities decrease and vice-versa.

I had avoided the storm--barely--by moving out of equities quite a bit before the calamity of August 2008 hit.

So after an absence of attention to markets coinciding with the birth of my son in April, I am looking to get more of a return and increase my risk.

I come across the Edward Jones Advisory Solutions (TM) program from my trusted and likeable Edward Jones agent. I do like him, and I trust him. However, I am having a hard time seeing the value.

Lets talk about being diversified. You can have diversity across an asset: ie. owning shares in lots of different types of companies. This protects you when one company goes bad. And then you can have diversity amongst asset classes: ie. owning equities and bonds--because historically, they move in opposite directions.

What happens when they all move in the same direction? Well that was the question no one asked until the Fall of the fall of 2008. Now that the stock markets have gain 50%, have bonds sold off like they should have according to the last 80 years of history? Nope they are even higher. Some of them at their 52 week highs. So asset classes are moving together again but no one cares because they are moving in the right direction: up.

There are two reasons to own stocks: 1) because you think you will be paid a dividend on the stock, and 2) you think someone else will come along and pay more than you did for the stock.

For bonds it is much the same: 1) the interest paid on the bond, and 2) Someone else will pay more for that interest than you did.

But lets get back to the myth of diversity.

In the Advisory Solutions (TM) program, there are dozens and dozens of different funds to choose from for both equities and bonds, and then a couple of 'niche' market real estate and commodity funds plus a couple of money market funds.

The program is marketed as one that provides diversity. And maybe in another time, it would have.

But it doesn't now.

It looks like it is diversified: the color coded brochure helps my eyes to understand which funds have which size caps, and which ones focus on value as opposed to the completely different growth. Then there are US, international, and emerging market funds.

Wow feeling pretty good about diversity--as there are all the big names in each of the colored sections--and we haven't even gotten to the bonds yet. Then there are bonds: government, corporate, domestic, tax exempt, etc. And then a couple of commodity ETFs (I count ETF's as the poor-mans mutual fund). Now to own these, you have to pay fees the companies that run these funds (fees are smaller for the ETFs) and of course there is the fee to Edward Jones.

So then I start looking at how some of these funds have performed.

Google finance is the great equalizer, and I click on charts for the various equity funds in the various colors. I click on 'max' for time view.

And here is where the illusion of diversity disappears.

Every equity fund's chart has the exact same shape. Prices may be very different. But they all went up up up through 2007 then crashed fall of 2008 to March of 2009, and then rebounded 50% higher to today.

I am pretty sure in a year or so if I were to make toys in the shape of all these different mutal funds and then ask my 2 year old which one of these is not like the others, he would tell me they are all the same.

Now 80 years of history tell my Edward Jones guy that Mid caps are the first ones to rebound, followed by Small Caps, and the Large Caps--or something like that.

But a two year old would be able to tell me that they all look the same.

So why should I pay several points for someone when they all move together?

Well at least there are bonds. Except that all the bond funds are mostly at their 52 week highs. Plus debt markets are a bit unpredictable as the US government is incurring massive debt to stimulate the economy. And debt is what got us into the trouble in the first place.

The bottom line here for me on equites is that meeting either of the two conditions is suspect: Dividends aren't being paid enough to justify the risk of equities. And if I am skeptical of buying at these prices, how can I expect someone else to come along and pay more for something I already think is overvalued?

Then again, this kind of thinking went a long way in driving real esate and equity markets higher in the past, so we could see a lot more upside.

The consumer makes up 2/3rds of the economy. 1 in 10 consumers are out of work. Their houses are worth less. The banks won't lend to them. The credit card companies have decreased their lines of credit.

How exactly is the consumer going to spend enough to increase earnings?

It is kind of annoying.

"Professionals" tell you never to try to 'time' the market. Except that now is always the best 'time' to buy into the market. Buy and hold.

The old adage that 'this time its different' is usually said at the tops of frothy markets. From Tulips to NASDAQ, this time there won't be a crash. Buy real estate now, because you may never get in at these prices.

I have a suspicion that this time it truly is different.

And the professional investing class has not adjusted to the undpredictable future where the old rules of investing don't work.

Exporting premium health care to the U.K: The Steadman-Hawkins Clinic

Its mid August and for sports fans like me that could mean a few things. Being American, it certainly means one thing: National Football League pre-season. The signings. The trades. The Comebacks. The Tragedies.

For fan's of the Queen's football, it also means the beginning of the English Premier League.

For those that played NCAA soccer, it also means being at preseason camp.

After thirty-five years of playing, I have had 4 knee surgeries. ( 2 scopes, then ACL reconstruction, then another scope.) I kind of consider myself an expert on the choices available and the history of knee surgies. It also happens that the real experts on knee surgery, the surgeons of the Steadman-Hawkins Clinic, are head quartered in Vail, not too far from me here in Thornton.

And they are winning business from Britain's National Health Service. Some of Europe's top players come to Vail after they have damaged their knee. Alan Shearer and Michael Owen are two examples of top EPL players of British nationality that have come to the clinic.

This is nothing more than another example of a private company competing successfully with the government. Another example is the rise of UPS and Fedex, even though the US government had a monopoly on the delivery of mail. They did it by offering premium service. And don't forget the bond market. The government competes with private business every day in the selling of debt.

The healthcare companies are not lying when they say that the government would take away some of their business--it would. Conversely, if we got rid of mailboxes and the US Postal Service, Fedex and UPS stock valuations would surge.

Steadman Hawkins exposes the lie that private industry can't compete with the government

The government could provide healthcare in a 'basic/standard package' offering. Sun Roof, 17 Inch Wheels, Premium Sound are extra. If three tests are good enough, the government provides three. If private industry can innovate another two, and you want to be on the 'bleeding edge' of medicine, you can buy, from a private insurer, the Upgrade Package. You are a competitive teenage athlete whose family can't afford private health insurance and you blow out your knee. You are covered. And you may miss the season. You are the parent of a competitive teenage athlete. You buy the the upgrade health insurance and get the fastest service.

You have birth announcements, you use a US Postal Stamp. You need a passport in your hands before the flight tomorrow? Probably going to go with Brown or have it Fedexed.

This is exactly what private industry is so good at: filling the market for the buyers: the wealthiest and healthiest. This is a good thing!!! What is not so easy for them to do is to take on customers that cost them a lot of money and don't bring in much. This is the concept in private business known as 'Fire Your Customers.' Your customers suck? Get rid of them and get better ones. The better ones make you money--and that is what you are in business to do. Private health care has a natural incentive to try to disclude customers that don't make them any profit.

Why should we expect anything else from them?

The government doesn't. In exchange for taking market share from the private insurers, the government can offer to take on those individuals that cause damage to the private insurer's balance sheet.

I wonder if there is a waiting period for the Steadman Hawkins clinic.

Chuck Norris Solves the Banking Crisis

Chuck Norris announced today a plan to solve the financial crisis.

To strengthen the balance sheets of the major financial insitutions that have been wrecked by bad loans, a new class of assets will be created out of derivatives of Chuck's body.

These will be called WCD's: Weapons of Chuck's Destruction.

Banks will be allocated shares of these WCD's based on their performance in Chuck's "Stress Test." In Time's Square, one by one the stock price of each bank wanting Chuck's assistance will be put on the big screen.

Chuck and the stock price will stare each other down for 1 hour beginning at high noon. If the price of the stock goes up, the bank will be allocated shares of the WCD's based on its percentage gain during the stress test. If the price goes down, the bank will be allowed to fail. Chuck will also kick the ass of every "C" level in the companies that fail.

In return for allowing derivatives of his body to shore up the financial system, Chuck requires from the US Federal Government one change to the currency:

All faces of the bills of US currency will be replaced by the image of the face of Chuck. All backs of bills will have Chuck's fists.

This is because Chuck wants to let the banks know the following: 1.) he will be watching them and 2.) what they can expect from Chuck if they ever fuck us again.

The Idiocy of Cramer, Luskin, and Hassert

You would think that anyone who gets paid (a lot) to spew financial advice would receive said pay based on performance: you make the right call, your contract with CNBC goes up, you make the wrong call it goes down.

You would be mistaken.

People like Jim Cramer are experts in equities and investing. But they get paid because people enjoy watching, listening to, or reading material written by them. They don't get paid to be right.

Case in point is Mr. Henry Blodgett. Remember Mr. Blodgett? He was the one who was pumping dot com stocks during the millenial NASDAQ bubble on national TV while he was privately emailing confidents about how ridiculous it was to buy these same companies.

Now, after having multiple 'come-to-Jesus' moments, he is writing and speaking about all things investing.

Donald Luskin was wrong about the biggest market movement in our lifetimes. He said there was no recession right before Lehman Brothers went under:

“[A]nyone who says we’re in a recession, or heading into one—especially the worst one since the Great Depression—is making up his own private definition of recession.’” —Donald Luskin, The Washington Post, Sept. 14, 2008

Jim Cramer, in classic form, gave this costly advice to some poor sap:

“Peter writes: ‘Should I be worried about Bear Stearns in terms of liquidity and get my money out of there?’ No! No! No! Bear Stearns is fine! Do not take your money out. … Bear Stearns is not in trouble. I mean, if anything they’re more likely to be taken over. Don’t move your money from Bear! That’s just being silly! Don’t be silly!”

—Jim Cramer, responding to a viewer’s e-mail on CNBC’s Mad Money, March 11, 2008

Remember the reason given by conservatives as to why Obama started pulling ahead of McCain ? It was the markets! Tanking markets helped Obama get elected. Now, Luskin is saying that Obama is causing markets to tank.

Now Cramer and Luskin are both blaming the Dow's drop on Obama. I do believe as they do and even Krugman that he is moving too slow with regards to resolving the solvency of the banks issue. However, last I checked, he has been in office for about 45 days.

Time for Change: why Geitner needs a new plan

Obama was elected on the promise of change, and change he has provided. As far as campaign promises go, it has to be the easiest of promises to meet. Change is change; if he wants to change his mind about things he said in the past, he has the logic to do it.

So far he has not changed his message of change--except where it comes to managing the banking crisis.

His Secretary of the Treasury, Timothy Geithner, has been stubbornly committed to continuity. Surely, this initially made sense. Change for change's sake looks like the desperation of uncertainty. Markets hate uncertainty. So it has made sense for Mr. Geithner to appear to have a plan that was somewhat consistent with the last plan, even if it was a plan created by an unpopular adminstration.

However, the time has come to say what the markets already know: the big banks are insolvent. They need to be wiped out, possibly bond holders as well. Trying to prop them up has more to do with protecting bankers at this point than protecting lending. Geithner needs a plan to restore lending, not keep bankers--including holders of shares and bonds banks--whole. Bondholders and shareholders of Citi, Wells, etc. need to be wiped out.

Fresh capital then can be injected into banks that are healthy and that are lending, rather than to inject capital to protect people that made stupid decisions (bankers, and buyers of banking shares and debt).

Obama can claim change. He can claim that he has been on the job only 6 weeks, and needed the time to make a plan. Now that it is evident what is happening, it is time to own it, and deal with the fallout.

Once the banking crisis is put behind us, there will be less uncertainty in the market

Will increasing government spending work?

Of all the discussion regarding where the economy and markets are headed and what policies will affect their directions, none is more well known or understood to be as simple as the debate regarding federal government spending. For the left, federal government spending will help us. For the right, it will hurt us.

The case on the left for increasing federal government spending

John Maynard Keynes simple model is that during times of economic booms, the government should save money, and during times of recession, the government should spend it. This should make economic cycles less volatile. Proponents point to the "New Deal" programs of FDR that were done during the 1930's: massive public works projects that put 'shovels to the ground.' The idea here is that when the private sector is not spending money, the government can 'forcibly' spend money. This should make recessions less severe, and prevent depressions.

The case on the right against federal government spending

Government spending 'crowds out' private investment, according to anti-Keynesian folks who typically line up on the right. Government gets money immediately in two ways: by taxing private individuals and corporations, or by borrowing against future taxes on private individuals and corporations. The more government taxes or borrows against future taxes, the less money individuals have to invest and spend. So basically there is a "Robbing Peter to Pay Paul" problem. Interestingly, these anti-Keynesians also point to FDR's New Deal as evidence that Keynesianism does not work, as there was massive federal spending throughout the 30's, unemployment still was above 20%.

The evidence provided by historical charts

In the chart on the left, the three biggest increases of federal government spending as a percentage of GDP correlate to WWI (1917-1919), FDR's New Deal (1931-1935), and WWII (1941-1945).

What got us out of high unemployment was the spending associated with WWII. Another way to look at this is that FDR's increase in government spending was not enough, and it took the increase in government spending associated with WWII to bring unemployment down.

This chart on the left maps the same as above, but for a smaller period of time. As can be seen, it was Clinton who brought government spending down with a mostly Republican congress.

Conclusion

Current levels (before stimulus) of government spending are not at historic highs, even by post war standards. That should give us room to spend and borrow. Surely, cutting spending now is not evidenced by the charts. In fact, the case could be made that we need MASSIVE federal spending in addition to what has been budgeted so far. Conversely, the best years of prosperity have come when we have decreased spending after a period of elevated spending. Interestingly, I suppose this makes the case for massive military involvement, like a new war. There is no theoretical argument that says a dollar spent on guns is better than a dollar spent on solar panels, for example, but this should breath new life into the Neocons who want to invade Iran.

Another point to consider is absolute levels of government spending as differentiated from the changed in government spending. Since today government spending as a percentage is bigger than it was in 1930, perhaps it is not necessary to increase by as much.

In short, I conclude the stimulus package will help overall. If it fails to deliver the results, it will be because it is too small, rather than too big. However, to get prosperity back, we will need to quickly reduce government spending in the future so as not to crowd out private spending and investment. Currently, interest rates are extremely low, although the standards for getting loans are much higher, both for individuals, and for corporations. So there is not much crowing out going on currently.

Socialism for Bankers-- a Libertarian's view

Donald Luskin claims to be a libertarian. However, his own words would indicate something else. In a recent blog post, he rails against both the limitation on pay and bonuses to TARP receiving bank executives and the federal money going to those home owners facing foreclosure. In other words, money going from the Treasury to a stupid home buyer who paid too much for a house is bad policy that rewards people for poor decisions. However, money going from same Treasury to a stupid banker who created the financial tools of our own destruction is money well spent, and we should not limit their pay to something under the millions.

Donald Luskin already has revealed himself to be an idiot when he announced that we were not heading for a recession the day before Lehmen brothers went bankrupt:

"Anyone who says we're in a recession, or heading into one — especially the worst one since the Great Depression — is making up his own private definition of "`recession.'"

The Washington Post, Sept. 14.

Now he exposes himself as bourgeois, elitist, and socialist. Government bailouts are only good for the extremely rich, not anyone else.