Here is an excerpt of my newsletter from last week. Enjoy!
Excerpt from David Korn's Interpretation of Moneytalk (Bob Brinker Host)
June 18-19, 2005 Newsletter
CYCLICAL BULL MARKET CONTINUES AND BOB'S CURRENT ADVICE
Brinker Comment: Bob told his listening audience that said since March 11, 2003, his conviction has been that we are in a cyclical bull market. That is important because it means we are in the midst of a major money making opportunity. As we speak, despite the whining bears who have been dead wrong, the S&P 500 has made another new recovery high closing at 1,216.96. That brings the total return for the S&P 500 since the lows of March 2003 to 52%, not including dividends. If you include dividends, the total return is about 55%. How sweet it is!
Caller: This 57-year old caller has $100,000 in cash and he thinks it should be invested in the market and wants to invest in one of Bob's Model Portfolios. Bob noted that you want to pick a model portfolio that is consistent with your risk tolerance. At age 57, you would generally not choose Model Portfolio I because that is designed for the aggressive investor. Bob noted that he is positive on the market at this time, but as far as adding new money into stocks now, Bob has not encouraged people to chase the market. When the S&P 500 was around 800, Bob recommended buying into the market. Last year, Bob looked for weakness and recommended looking for the S&P 500 below 1100. There were 25 opportunities between June and October of last year when the S&P 500 got below 1100. That was an opportunity to add on weakness. This year, again Bob recommended investing new money in when the S&P 500 went below 1160, which it did on a closing basis on May 12th and 13th and provided another opportunity to invest at a beneficial level. That has been Bob's approach, not to "chase the market." At these levels, Bob recommends dollar cost averaging into the market over time on a monthly basis. This is Bob's philosophy. You try to put a lump sum of money into the market on weakness. Now, with the market at the highest level its been during this cyclical bull market, is the time to adopt a gradual approach to putting your money to work.
EC: It is nice to see Bob be clear in his advice. In addition, his timing efforts this bull market have been excellent. Bob is officially in dollar cost average approach for new money, and I suspect he will stick with that recommendation until we have another significant correction (if we have one). Bob made one minor error in that we are a little shy of the highest level for this cyclical bull market, although not by much. In fact, the S&P 500 is less than 10 points away from its closing cyclical bull market high, which occurred on March 4, 2005, when the S&P 500 closed at 1,225.31.
OIL AND INFLATION
Brinker Comment: There is a lot of talk about the price of oil which reached an all time record closing level in nominal terms (today's dollars), not adjusted for inflation. The price of light sweet crude for July delivery closed at $58.47 on the New York Mercantile Exchange. This is the kind of oil that gets run through the refineries to produce gasoline which is so widely consumed by the U.S.
Even though this is the highest closing price of oil in the recent run, we are nowhere near the level to match the previous "real" high, as adjusted for inflation which occurred in 1981. If it were adjusted for inflation, the price of oil would have to go to $90 a barrel to reach a record high.
The oil price spike in 1981 was precipitated by a crises in the Middle East and here we are again, with war in Iraq and problems in the axis-of-evil states. In the late 1990s, the price of oil, adjusted for inflation, went as low as about $14 a barrel. When you consider the run up to the current price of $58, that is a big deal, as the price has quadrupled. People who are dependent on oil in their every day lives are being impacted. Certainly, the transportation industry, airline, truckers, etc. are being hurt by higher oil prices. Nevertheless, Bob said oil has not impacted the economy as much as it did 30 years ago when we had the oil embargo.
EC: A picture is worth a thousand ECs and the folks over at ChartofTheDay have a chart out this week showing the price of oil inflation-adjusted since 1970. The chart illustrates that most oil price spikes were a result of Meddle East crises and often preceded or coincided with a U.S. Recession. Worth a look in my opinion at the following url:
chartoftheday.com
Brinker Comment: We got the Consumer Price Index (CPI) report for the month of May this past week. Bob pointed out that the price of oil was declining during the month of May which helped lower the CPI. For the month of May, the CPI decreased 0.1 percent. Energy was the real mover in that report, down 2.0% for the month. The "core" rate of inflation, after being unchanged in April, rose only 0.1% in May. Year-over-year, the CPI is only up 2.8%, and it doesn't get much better than that. It had gotten up to 3.5% in recent months, but is back down to what Bob referred to as a "very very low number." Core inflation, on a year-over-year basis, is up 2.2% and remains "benign." Food prices are only up 2.4% on a year-over-year basis and have behaved very well.
EC: Read the CPI report for May at the following link:
stats.bls.gov
Brinker Comment: The components of the CPI that are going up faster than the entire rate should come as no surprise. Energy prices are up 9.9% on a year-over-year basis and for the three months ending May, energy is up a whopping 28.7% on an annualized basis. Transportation, which is impacted by energy, is up 4.2% on a year-over-year basis. Medical care continues to be a big contributor to consumer prices, and was up 4.3% on a year-over-year basis. Housing is only up 3% on a year-over-year basis. Many people think the CPI understates the cost of housing because they use a rental equipment formula. However, Bob said there are signs that we are seeing a "cooling off" in housing price appreciation. There is some evidence of pricing levels topping off in Beverly Hills, California. Looking forward, with energy prices on the rise, it could be a big contributor to the June CPI.
EC: Remember two weeks ago I referenced the "Future Inflation Gauge" tracked by the Economic Cycle Research Institute (ECRI) which had reached a 10-month low? Looks like that indicator has been on the mark lately. It will be interesting to see if the upturn in the price of oil is reflected in the next projections from the big FIG Newton.
Brinker Comment: There is still a couple of weeks left in June during which oil prices could jump around some more. Bob referenced a recent guest to Moneytalk, Charlie Maxwell, who some think is the number one oil analyst. Mr. Maxwell said that he thinks that oil could remain in the 40s to 50s for some period of time; however, he believes that it will eventually go higher. Bob noted that it still is in the 50s, but close to breaking out. Mr. Maxwell said when oil does break out, it will break out to the upside.
EC: It will be interesting to see if Bob stops criticizing the people who have been predicting much higher oil prices. You may recall that Bob for a while was predicting that oil would not even go back into the $50s. He then gave the analyst from Goldman Sachs who was predicting a spike in oil above $105 a lot of grief on the show and scoffed at the notion that oil would ever go near that high. Well, now that oil is almost to $60, and one of his guests is predicting even higher oil prices, do you think Bob will change his tune? My bet is we get the "BH" -- a/k/a the Brinker Hedge. If oil falls back down, he can say "I told you so." On the other hand, if oil goes up, he can point out that this is exactly what a special guest on his show said. Either way, the BH makes the BB look just dandy!
Caller: Are you saying that oil will have to go to $90 a barrel before it presents a problem for our economy? Bob fumed a little and said he never said that. In fact, go to any airline and they will tell you that the price of oil is a problem right now. Oil prices have been a problem for a long time now for people in the transportation business. The caller said oil in the $50s is a problem for most people. Bob said oil at $58 is a problem, but it is not as big a problem as people expected. The fact remains that we had high oil prices in the first quarter of this year and we still had 3.5% real GDP growth. The caller noted that many farmers are getting hard hit, and would like to see oil go back to the $20s. Bob retorted that this is exactly why he mentioned food prices when analyzing the CPI and said that he was glad to see food prices up only 2.4% on a year-over-year basis.
Brinker Comment: Our economy grew at a 3.5% clip in the first quarter as measured by GDP which Bob refers to as the "sweet spot." We don't want an overheated economy. The growth that we have had keeps us from excesses in inflation, job growth and bottlenecks in the economy. We don't want a "boom" economy because they always lead to busts.
EC: Both the GDP and Inflation are important components that factor into Bob's long-term stock market timing model. As it stands right now, both GDP and inflation are looking good, which I think is part of the reason that Bob remains bullish at this juncture.
Brinker Comment: Bob said he doesn't know anyone with any credibility that is expecting to see oil in the $20s anytime soon. Bob said it seems extremely unlikely to expect that kind of move. What is going on in the oil market is reflecting uncertainty in the oil pits. On Friday, there was a rumor of a terror threat in Nigeria. That is a big deal when it comes to oil because Nigeria is one of the primary supplies of light sweet crude -- which is the oil that gets to the refineries to make the gasoline that we all want. When you get a terror threat rumor floating around on the New York Mercantile Exchange on a Friday where it is a summer-type atmosphere, you can expect this kind of volatility. We import 1.1 million barrels of oil a day from Nigeria. Virtually everyone of those barrels translates into gasoline for U.S. consumers. Remember, we consume about 45% of all the gasoline that is consumed in the world.
Our voracious appetite for gasoline is supposed to be one of the reasons that oil prices are going up. The other nation to blame is China. However, Bob noted that Chinese oil imports declined in the first five months of 2005 by 1.2%. That was not expected. Traders in the oil pits on Friday simply became paranoid that Nigeria would be hit by a terror attack and that would create more problems with oil prices. If we continue to get these types of stories, you can expect further pressure on the price of oil. The good news is we are using much less oil as a percentage of the gross domestic product than we did 20 years ago. Of course, when you see these huge numbers in our trade gap, a lot of that is caused by our imports of oil.
EC: Another reason given for higher oil prices of late, was the Energy Department's weekly petroleum report which showed that gasoline demand in the U.S. has averaged nearly 9.5 million barrels a day over the last four weeks which is 3 percent above the same period last year
Caller: At the time of the last oil crises, the country of Brazil couldn't afford gasoline, so they started producing biofuel for motor vehicles which was alcohol, derived from the suger-cane they grow (a/k/a ethanol). Now, their cars have a switch that allows them to run on gas or ethanol. Why can't we do what Brazil has done? Bob expressed his frustration over the fact that the U.S. has not addressed their dependence on foreign nations for petroleum. Where is the leadership on conservation? Politicians apparently consider the term "conservation" as poison.
EC: The caller is right. Today, about 40% of all fuel the Brazilians pump into their vehicles is ethanol, compared with about 3% in the United States. The LA Times has an article out this week entitled, "Homegrown Fuel Supply Helps Brazil Breathe Easy." Its an interesting article, and I must confess my own ignorance until I read this article over how far Brazil has come on this front. Read it here:
tinyurl.com
Caller: This caller said he doesn't think too many people understand or are aware of our nation's Strategic Petroleum Reserve ("SPR"). Bob agreed. Generally, the SPR is only supposed to be used during national emergencies. We used it once under Bill Clinton. We haven't really seen it used by George W. Bush. In fact, the SPR is almost topped off. There is no indication that our administration will use it to impact the price of oil. If we did, it might have a short-term effect, but probably not the longer-term effect. Bob noted that the SPR only covers about 65 days of our entire nation's import of oil. In addition, it cost about $21 million to administer the SPR and there is quite a government bureaucracy just to maintain it.
EC: The Strategic Petroleum Reserve is our nation's emergency supply of oil stored in enormous underground salt caverns along the coastline of the Gulf of Mexico. Just last week, Secretary of Energy Samuel Bodman announced that the planned fill of the SPR will be complete in August, when the SPR reaches 700 million barrels of oil. More about the SPR at this link:
tinyurl.com
MORTGAGE AND PROPERTY QUESTIONS
Caller: This caller took out an "interest only" mortgage on a house that cost $184,000 because he is only going to be in the house for 28 months while he attends school. Did he do the right thing in purchasing a house for this short period of time? Bob said the first computation to do, is to figure out how much you would have paid if you had rented during this time. Based on what the caller said, Bob figured that it was pretty much a wash in terms of the out of pocket cost for renting versus purchasing the house, and as long as the property did not decline in value after the sale (including commissions), it would be ok to have purchased the house and taken out that loan.
EC: Bob generally recommends against interest-only loans, unless you are know that you are only going to be in the property for a very short period of time. Otherwise, you face the risk of interest rates rising. In this environment where long-term interest rates are very low, Bob likes to put the risk on the banks who are lending the money.
EC#2: A mortgage is "interest only" if the monthly mortgage payment does not include any repayment of principal for some period. Thus, during the period you are paying only interest, the loan balance remains unchanged. Can you handle an interest only mortgage? If you aren't sure, check out this article that attempts to answer the question for you:
tinyurl.com
Caller: This caller has rental property in Florida and is thinking of selling it to take advantage of high real estate values, plus he is a little gun-shy after all of the hurricanes to hit the Florida coast. He bought the property 15 years ago at $89,000 and he can sell it now for about $230,000. There is no mortgage on the property It is a single-family home in a great neighborhood. The net rental per year is about $7,000. Bob noted that if the caller could live in the property for two years as his principal residence, he could take the gains tax free. The caller said he had no plans of living there, which Bob wasn't too thrilled about, noting that he would then be obligated to pay 15% taxes on the gains as a rental property, plus any adjustments for depreciation expenses. Bob urged the caller to seriously consider making the rental property his principal residence for two years to avoid the tax consequences.
EC: For people who have a second home, here is an article entitled, "Selling that vacation home: How to avoid capital gains tax" which you can access here:
tinyurl.com
Caller: This caller is considering purchasing a resort timeshare Villa in Cancun, Mexico for $35,000 which entitles her to access it one week per year. Bob noted that this would give the property the equivalent value of $1.8 million! Bob asked what you get for this? The caller said it was a one bedroom, one bath, and Bob said he couldn't believe what he was hearing. Bob said he would rather be the seller, not the buyer. Think of what you could do with $35,000. This could buy you quite a few weeks in Cancun. Even if it cost you $3,500 to stay at a first class hotel, you could do it for 10 years. Moreover, you could put the $35,000 in a fixed-income investment and since you aren't going to use all the money at once, the income you generate could be used for other purposes. The caller said she was also looking it the timeshare as an investment that could pay off down the road. Bob said if it was a stand-alone unit, he could understand; however, the historical resale value of timeshares has not been pretty.
EC: Here is a link to the "Timeshare User's Group" web site:
tug2.net
YIELD CURVE
Caller/Brinker Comment: A caller brought up the point that short term and long term rates are getting pretty close. Bob noted that there is still in excess of a 100 basis point spread between short and long rates. Although historically, an inverted-yield curve is something to get your attention, at this juncture we don't even have a flat yield curve, much less an inverted yield curve.
EC: Two weeks ago, I referenced the seminal 1996 article written in the Journal of Economics and Finance, entitled, The Yield Curve as a Predictor of U.S. Recessions. For a more recent analysis of the current yield curve, check out this site which has some interesting views on the issue:
tinyurl.com
MUTUAL FUND, INDEX FUND AND EXCHANGE TRADED FUND QUESTIONS
Caller: This caller is invested in poor performing mutual funds and wants to know what kind of funds Bob would recommend. Bob said their are mutual funds that track index funds and even exchange traded funds that track the indices. Bob mentioned the S&P 500 Index Depository Receipts a/k/a "Spiders" which trade under the ticker symbol, SPY. They have a very very low expense ratio and are very liquid. They track the S&P 500 Index and pay dividends on a quarterly basis. In fact, they just paid a dividend this past Friday of a little over 48 cents per share held. This represents the dividend paid by the S&P 500, less a very small expense ratio that comes out. There is also an exchange traded fund that tracks the Wilshire 5000 which trades under the symbol, VTI. It also gives you the dividend on a quarterly basis. In addition, you can purchase index funds through the major fund families.
Caller: If a fund reports a "total return" of 9%, but has a 1% annual expense ratio, does that mean you walk away with 9%, or do you get 8%? Bob said if the mutual fund company is claiming total return, that should mean the return including any expenses. However, that isn't he end of the story. Each shareholder has to compute his tax liability. If you are in a tax-deferred account, you won't know your tax liability until retirement. If you have the money in a Roth IRA and follow the rules, you won't ever have to pay taxes. If you have money in a personal account and hold the money long term, the maximum federal rate is 15%. When a mutual funds reports "total return" that is supposed to be the money earned (or lost for you) after expenses.
Caller: What does it mean if a mutual fund charges a 5.7% load? Bob said that is very sad. It means you paid 5.8% of your investment when you purchased it (known as a front-end load), or on the day you sell (known as a back-end load). This is an extremely high load. For example, if you invested $107,000, you would pay the fund $5,750 just in expenses. Unfortunately, the load funds often report the "total return" which does NOT include the load charge in the performance. That is why Bob only invests in no load funds.
EC: The U.S. Securities and Exchange Commission publishes a free periodical about mutual funds that I referred to a lot when I was first learning about investing. Entitled, "Invest Wisely: An Introduction to Mutual Funds" you can read it without paying any expense ratio at this url:
sec.gov
Caller: Why did the Vanguard Tax-exempt Money Market Fund have such a big decline in its yield? Bob said if you look at the tax-exempt funds in general, you can see what happened. A lot of the bond/tax anticipation notes that were issued by municipalities in anticipation of the tax money coming in was paid off. The yield was pretty ridiculous, and almost as high as the taxable money market fund which was a condition that could not last forever. The yield on that fund is now about 2.1% and on the taxable it is about 2.8%. It is still yielding about 75% of the taxable, so for people that are paying federal taxes above 25%, they are still better off in the tax-exempt fund, assuming no state tax liability. Right now, there is a more normalized relationship between the tax-exempt and taxable fund. Bob added that the tax-exempt fund is very high quality, with about 85% of its investments in the top grade paper.
EC: The Vanguard Tax-Exempt Money Market Fund (Ticker: VMSXX) is now yielding 2.09%. The Vanguard Prime Money Market Reserves Fund (which I use for part of my newsletter portfolio cash reserves) is yielding 2.84%.
MONEYTALK GUEST - DAVID L. SCOTT
On Saturday's broadcast, Bob introduced David L. Scott, author of the book, "Wall Street Words: An Essential A to Z Guide for Today's Investor." A synopsis of the salient points follows.
Brinker: Bob expressed his dismay that our educational system does little to teach students about personal finance.
Scott: Its not only in high school, but also at Universities and even in graduate programs that personal finance education is ignored. There are many students, even in business school, that don't have a clue about personal finances, credit cards and insurance.
Brinker: One thing that should be taught is the notion of expenses associated with investing.
Scott: Agreed. The majority of people who have financial difficulties, have them on the expenditure side, not the income side. People who make good income, still end up in financial distress because they do not curb their spending habits in a variety of areas.
Brinker: We had a caller who didn't realize that the load charged by the fund came out of the total return. What message did you want to send out when you published the book, "David Scott's Guide to Investing in Mutual Funds"?
Scott: Part of the problem is many people don't understand mutual funds, and therefore rely on the advice of the people selling their find which is not always advice given in your best interest. Part of what I try to do in my books is present complicated topics in an easy to understand way. I emphasize the importance of selecting a fund that meets your investment objectives, and minimizing fees. These are basic books on financial topics that people can understand.
Brinker: What do you think about "false prophets" who promise they can beat the market?
Scott: We all get greedy and we get caught up in the idea that we can beat the market, but its not easy.
EC: Note to Scott -- that's Bob's mission as a market timer.
Brinker: John Bogle expressed the idea that many funds as they get bigger, charge even higher expenses, when it should be the other way around.
Scott: Its sad but true. For example, the 12b-1 fee was designed to help a fund attract new investors. It hasn't worked out that way. As mutual funds have become more popular, the managers have found they can charge higher fees and get away with it.
EC: Here is a link that provides some good background information about 12b-1 Fees:
ici.org
Brinker: Bob noted that David Scott had recently published a book entitled, "David Scott's Guide to Investing in Bonds" and then opened the phone lines.
Caller: This 54-year old caller wants to know if now is a good time to start investing in bonds?
Scott: Bonds have a place in most people's portfolios. Scott qualified his comments by admitting that he was wrong over the last year in that he thought interest rates were going higher. For most people, the way to buy bonds is through mutual funds. If you are wealthy, you can probably get individual bonds. Scott said that he still has been unwilling to invest in bonds or bond funds with long maturities. If you are going to invest, he would go with short or medium term maturities. Everyone can benefit from some bonds, it just depends on your age and need for income.
Brinker: What do you think has kept long-term interest rates down over this past year?
Scott: I think part of the reason is the foreign investment money that is flowing into U.S. Treasuries. Also, nobody is certain our country's economy is all that strong. I see nothing good about interest rates -- especially long-term rates. I am concerned about the balance of payments. I am concerned about the federal deficit. Basically, we have foreign investors financing our consumption. At some point in time, this will end and interest rates will go up. In fact, I thought they would have gone up by now.
EC: A rather grim outlook, but one that is shared by several other heavy hitters in the investment community. The Boston Globe had an article out last month entitled, "Are declining long-term rates in our best interest" which explores some of these issues. You can access it at this url:
tinyurl.com
Brinker: What do you think of the I-Bonds. The base rate is even beating the TIPS, and you get the tax deferral.
Scott: I like I-Bonds so much, I own some. They are very easy to buy and a good deal for investors. The tax is deferred until you cash in the bonds. Of course, you shouldn't put all of your money in them, but for fixed-income investors, they are a real attractive investment.
EC: I-Bonds earn 4.80% when bought from May through October 2005. I agree with Bob and David Scott. They are very attractive for a conservative fixed-income investment. Learn more about the current rate, and how to buy them at this url:
publicdebt.treas.gov
Brinker: What's your feeling on buying new issue bonds?
Scott: Its always better to buy new issues of bonds because the commission is absorbed by the seller not the buyer. However, if a broker calls me about a new bond and they quote what they think the rates will be -- especially if its a municipal bond -- I will always ask them to look in the secondary market to see if there are any better deals. There usually aren't, but once in a while if you are buying a small amount of bonds (like $5,000 or less), some broker dealers want to get rid of inventory because they don't want to hold a very small amount which can result in a great deal for you. Most of the time, however, you do want to try and get new issues if you can.
EC: Interesting piece of advice. That is something I never thought of, but I checked with a broker I know, and he confirmed that they will occasionally offer deals to get rid of the bond "crumbs" as he calls them. These are small dollar amounts, but can be exactly what an individual retail investor is looking for.
Caller: What do you think of closed-end mutual funds that can be bought like a stock and traded like a stock on the NYSE, for example Nuveen and Eaton? The caller said he has bought these closed-end funds using a discount brokerage account, and they offer him income, and many are insured.
Scott: It depends. If you buy stocks on the NYSE, you have to pay a commission and sometimes it would be better just to buy a fund. It also depends on what tax rate you are in.
EC: Frankly, I didn't think Scott really understood closed-end mutual funds, or he wasn't really listening to the question. The caller was referring to the Nuveen New Jersey Investment Quality Municipal Fund (Ticker: NQJ) and the Eaton Vance Tax-Managed Buy-Write Income Fund (Ticker: ETB). Here is a recent article about closed-end bond funds from TheStreet.Com which is worth reading:
tinyurl.com
EC: David L. Scott is a Professor of Finance at Valdosta State University. You can learn about him, and even e-mail him, by going to his home page at the following link:
valdosta.edu
- David Korn, editor of begininvesting.com
e-mail: mailto:davidk555@earthlink.net
DISCLAIMER: This e-mail is neither sanctioned by, nor written under the auspices of ABC Radio Networks, Moneytalk or Bob Brinker. This e-mail is not a substitute for listening to Moneytalk, it is only my interpretation and commentary of some of what is discussed on Moneytalk, along with additional educational information that I include, editorial comments about the market and helpful financial links. If you want to know what was said verbatim on Moneytalk, listen to the show live or subscribe to "Moneytalk on Demand" which allows you to listen to the show in case you missed it live. The web site, bobbrinker.com has all the links to the ABC Radio Network stations that broadcast the show live. Copyright David Korn, L.L.C. 2005. |
