China's Advancement

According to a scholar and an investment manager I just saw interviewed, both of whom are experts on China, 300,000,000 Chinese people will move into the urban/suburban middle-class in the next 15 years.

That's as many people as we have in the entire USA. That's almost 400,000 people per week.

China will need houses, roads, bridges, hospitals, schools, water-treatment, telecommunications, electricity, cars, computer systems...

My clients and I are and will continue investing in China, both in China-based firms and firms that do business with China.

Chasing Returns vs. Identifying Skill: Picking Good Mutual Funds

We are often advised to not "chase returns" when looking for mutual funds. Don't go for the funds that are doing great in the past year--they're ripe for a fall.

Fair enough. But that does not mean we should avoid those funds. We just need to see more info before deciding.

When I choose mutual funds for the portfolios I run for clients (and myself--I eat off of the same plate from which I serve), there are many factors and data points I consider. One is the relative performance history over numerous, not just recent, time periods.

Almost every mutual fund I use has been a top-quartile performer in its category in the 10-year, 5-year AND 3-year periods. Every fund can have a good or bad stretch, but the ones that are basically always doing better than most of their peers... those are appealing.

The process is rigorous. If you can do it yourself, great! If not, though, it is worth the money to hire someone like me to do it for you.

Top-Down Bears vs. Bottom-Up Bulls

Where will the stock market go now? There is a battle between the Bulls and the Bears. Bulls think we have good things ahead, and Bears think otherwise. This is normal. Reports are that pessimism was palpable, but not insurmountable, at the recent Morningstar Investment Conference.

Given the state of the U.S. economy, portfolio managers who take a top-down view, looking at economic conditions as the primary basis of their investment decisions, were gloomy. In short, they see that the U.S. government has become dangerously overlevered in order to bail out a number of fatally overlevered private institutions.

But some managers who take a bottom-up view, searching for good investments to make now, regardless of the bigger picture, are optimistic. Recent volatility has presented the chance to buy some high-quality stocks at good discounts to their fair value.

While bigger and more intractable, macroeconomic problems are not as imminent as the dangers of the subprime-catalyzed credit crisis that started to boil over in 2007. That means we might still have time to get in while the getting is good, as long as we are flexible and can be nimble.

This is not the time to have a static portfolio. We need to use funds and managers with flexible and global mandates. They need to be able to go to the sidelines or change their game plan as conditions require.

The Top-Down Bears are probably right that the economy is precarious and investment opportunities dubious right now. But the Bottom-Up Bulls intend to take advantage of great opportunities nonetheless.

Newsflash: It Was Not Just "Sub-Prime"

It never was, but it was easy for pundits, and more convenient for politicians, to say it was.

Saying it's just the "sub-prime" borrowers that are defaulting allows Left-wingers to manufacture a victim in this mess, and it enables Right-wingers to blame it on the less-able or more lazy among us.

But get this: one in seven mortgages over $1mm is "seriously delinquent", while only one in 12 mortgages below $1mm fit that bill.

You read that right. The more affluent borrowers are almost twice as likely to be up a creek on their mortgages than everyone else.

From a "what the heck were the banks thinking" standpoint, Sub-Prime is a much larger share of this mess, and so that issue is not to be ignored. But what does it say about the direction and mindset of our country when the more successful among us are more likely than the masses to do the wrong thing with their financial lives?

"The Index": Should You Really Own It?

According to William Hester, CFA and Senior Financial Analyst at Hussman Funds:

"The shares of companies deleted from the S&P 500 have consistently outperformed those that took their place. Since the beginning of 1998, the median annualized return of all stocks deleted from the index and held from their exit date through March 15 [of 2010] was 15.4 percent. The median annualized return of all stocks that were added to the index was 2.9 percent."

Many pundits and advisors advocate "owning the index""--saves ya money, keeps ya diversified, takes the emotion out of investing...

The most popular ways to "own" an index in your portfolio is via an "index fund" or an "exchange-traded fund (ETF)". The most popular ETF is the SPDR S&P 500 (SPY). The second-most popular index fund is Vanguard 500 Index (VFINX or VFIAX).

Lots of people are missing a lot of opportunities by using just index funds. Especially those who are only using the S&P 500.

Mutual Fund Costs: Saving Money While Making Money

Most of us use mutual funds for our investment portfolios. We get professional management and diversification that way. If we had millions of dollars, we could afford private portfolio management in order to obtain those important benefits.

Either way, there are costs. Some funds, or managers, are more expensive than others. But funds and managers generate unique investment performance, and they establish unique track records. So, cost alone is not the right factor to consider when selecting our investments.

It really should be about "cost-justification". I've said this here before, but I just read yet another magazine article that I think sends the wrong message: "Shop around for inexpensive investment options in order to maximize returns."

That's dubious advice. When put that simply, it will lead folks to use only the cheapest funds.

Let's compare two very popular mutual funds and test that advice: PIMCO Total Return C (PTTCX) vs. Vanguard Total Bond Market Index (VBMFX), both of which are bond-oriented mutual funds intended to provide broad exposure to income-producing, low-volatility fixed-income investments. Neither charges a front-end sales "load", and they have almost the same amount of volatility/risk.

PTTCX has a pretty high "expense ratio" of 1.65%. This would make Suze Orman pretty emotional.

VBMFX has a very low "expense ratio" of .22%. This would make Suze Orman pretty happy.

PTTCX vs. VBMFX over the past 10 years? 6.46% per year to 6.10% per year. PTTCX wins!

Over the past five years? 6.29% to 5.55%, and PTTCX wins again.

Three years? 9.77% to 7.45%. PTTCX, again.

The last 12 months? 10.82% to 8.00%. PTTCX

And how about the last month? 1.33% to .84%. Yes, PTTCX won again.

(all of those returns are inclusive of the "expense ratio", or "net of fees")

That's a great example of "cost-justification vs. cost alone". And something else to consider is this: VBMFX is an index fund that must stay fully-invested all the time in a specific group of investments, while PTTCX can keep money on the sidelines or move around within the fixed-income arena to avoid problems or take advantage of opportunities. While that would be a problem if PTTCX "bets wrong", that fund has an extremely long and successful track record.

Now, this is the rare case, but don't let its rarity deter you. You should pursue the best product available. Sure, about 80% of mutual funds fail to beat their benchmarks, but you can find out on your own which ones do beat their benchmarks.

Or, you can hire a financial advisor to figure that our for you. Not all of us are diligent about it, but some of us really are, and it's to your benefit.

Troubling Signs: The No-Go Re-Fi

More signs pointing to economic trouble ahead... A client was rejected, flat-out, this week in two attempts to re-finance the mortgage on an investment property. Surprised? No. But this is not good news.

In short, the condo he bought as a bachelor is now an investment property he rents-out. It pays for itself, and then some, from rental income. It is also worth about twice what he owes on it. His credit rating is top-shelf, and his wife's is even better. They make enough money to do all the things they do, and they carry no debts other than their mortgages.

Nonetheless, he was rejected. The superstar mortgage broker he went to, who is one of the best salesmen you'll meet and a great guy, looked at his situation and said, "no dice." Then he went to Morgan Stanley Credit Corp, where the mortgage is right now. No dice--"we don't do any investment condos right now".

Folks, under Bush, and now Obama, Bernanke's Fed and Paulson's/Geithner's Treasury have flooded our economy with liquidity to get it going again. It comes in the form of actual money being sent out of government coffers, in the form of absolute rock-bottom interest rates, and in the form of regulatory adjustments. The intention is to spur the economy in the right direction.

It may well have prevented a Great Depression II so far, but it's not working beyond that. If this guy's own lender won't let him re-fi a loan that has a spotless record when he's in better financial condition than at the outset of the loan years ago, and when--get this--he was basically offering to pay them MORE money, something is not working. That's right, he wants to re-fi out of a 30-year loan and into a 15- or 20-year loan that would give them a higher interest payment from him each month. Since most mortgages don't last more than 5-10 years, it's arguably irrelevant that they'd normally rather have him for 30 years than for 15 years.

My point? Drop your politics and look at the reality on the ground. Whatever "They" have been doing so far is just not working. The economic activity in this country depends greatly on confidence and credit. When banks won't even make solid bets on existing customers who are willing and able to pay more, we're not yet back on track.

Debt-to-GDP Ratio: Great Recession vs. Great Depression

The US government entered the current "Great Recession" with $65 of debt for every $100 of Gross Domestic Product. That ratio has exploded to 90%. Meanwhile, household debt (the sum of the personal debts of all of us individually) hit close to 100% of GDP early on in the Great Recession and has dropped to about 92% as the Great Recession has continued.

At the beginning of the "Great Depression", on the other hand, the debt-to-GDP ratio was 16%, and it was 44% when the Great Depression ended. But while household debt was around 100% at the onset, like it was recently, it went down to about 20% as Americans deleveraged themselves.

In one scenario our government borrowed less than the other scenario. And, respectively, We the People unwound a lot more of our personal household debt then than we have thusfar.

Problem: the measures taken by the government to stimulate the economy have, arguably, the desired result for a period of time, but they then lead to significant economic contraction. When the economy slows, individuals may have the option to leverage-up their personal balance sheets to pick up the slack... if they have room to spare.