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Junk Bonds as Market Indicator

I’ve been in a 100% cash position with my retirement portfolio for a while now and I’ve been asked a “couple” of times (I don’t get a lot of readership), how will I know when it’s time to “get back in”?

Retirement Portfolio Of course, I don’t have the precise answer people are looking for, or even seem to expect. It’s market-timing plain and simple and I’m just using my own intuitive judgment based on what I see, hear and read concerning the economy. I haven’t found a good reason to change my mind. To me, as a whole, everything seems to point to a weakening economy, not one on the rebound.

But, one gauge that I use to evaluate whether the stock market is “really” reversing it’s trend is the junk bond market, specifically, the Vanguard Group’s High-Yield Corporate Fund, Investor Shares (VWEHX) because it contains “higher-grade” junk.

My reasoning is that junk bonds prices are directly correlated with stock market prices. If both stock and junk bond market prices continue to rise, then it could be indicative of a turn-around. If stock market prices leap, but VWEHX falls or remains the same, I view it as short-term speculative movement, not a reversal of course.

For example, the stock market really bounced back at the beginning of the week, and like most investors betting on a bear market, it caused me a little concern. But, my anxieties were allayed once I saw that VWEHX didn’t move at all. As a matter of fact, VWEHX is at historic lows, and the outlook for junk looks pretty grim. According to a Bloomberg.com article today:

Aug. 7 (Bloomberg) — The global default rate for speculative-grade company bonds may rise to as much as 10 percent over the next year as the economy slows, according to Moody’s Investors Service.

Defaults may reach 6.3 percent in 12 months, the highest in more than five years, and could be higher should the housing slump lead to a “protracted U.S. recession,” the New York- based rating company said in a report today. The failure rate increased to 2.5 percent in July from 1.5 percent a year ago.

That speaks more to me than any short-term stock market gains.

Posted 07 August 2008 † Guzzo § Bond Market § Commentary § Market Timing ‡ Comments (0) ° Tagged: ,

New Frugality or Old School?

I happen to discover Donna Freedman’s post today at MSN Moneyblog Smart Spending site, entitled: How long will the ‘new frugality’ last?. I like the way Donna thinks. She has a lot of smart things to convey about personal finance, debt and frugal living, and she presents it well.

Well, I haven’t heard this phase “the new frugality” before so I decided to Google it to see if anyone else was using it, and lo and behold, I found out that I’m a little out touch (go figure). It’s the new catchphrase describing consumers’ financial adjustments to this current economic downturn.

We’ve all heard it described before in previous economic crises, except it went by different names such as: cost-cutting, downsizing, retrenchment, rightsizing, and even voluntary simplicity. There’s always a new name for each new crisis.

According to an excerpt from Donna’s post:

Will consumers keep going to thrift stores and eating at places that offer buy-one-get-one coupons? My sources say “no.” I’m betting that a whole bunch of people will go right back to their spendy ways, just as they did after the 1970s energy crisis. We didn’t learn a thing back then, and I’m betting we won’t learn this time, either.

Although Donna considers herself pessimistic concerning her viewpoint, I’d like to think that she’s just being realistic.

It takes a lot of effort for people to change their behaviors. The simple inconveniences some of us are experiencing today are just not serious enough to make an impact on someone’s psyche. It’s just human nature not to learn if there are no long-term consequences.

Migrant Mother An economic downturn, a bear market, moderate inflation or even an outright recession may even not be serious enough to make an impact. It’s only when something dire happens that we’ll adjust our attitudes. It’s only when we don’t have enough money to pay our bills, not enough to eat, or a place to live, when we decide to change our ways.

Collectively, we haven’t reached that point in decades, and that’s the reason why we return to our spendthrift ways.

We haven’t yet experienced the hardships that most Americans faced during the Great Depression, or the voluntary hardships people incurred during World War II.

This Great Generation knew the value of a dollar. They knew what is was like to do without. They’re the folks who first coined the term “frugality”.

I prefer to describe them as “old school”.

Posted 03 August 2008 † Guzzo § Commentary § Personal Finance ‡ Comments (1) ° Tagged: ,

Subprime Responsibility

I was reading Treasury Secretary Paulson’s: Remarks on U.S. Housing Market before FDIC’s Forum on Mortgage Lending to Low and Moderate Income Households, and wanted to point out an excerpt from that speech which negatively caught my attention:

..Due to the lax credit and underwriting standards of the past years, some people took out mortgages they can’t possibly afford and they will lose their homes. There is little public policymakers can, or should, do to compensate for untenable financial decisions. And in the midst of rapid price appreciation, some people bought homes anticipating an immediate profit. Now that their investments have not turned out as they had hoped, these people may walk away, even though they can afford their mortgage payment. These borrowers can and should be living up to their mortgage commitment - government intervention here would be inappropriate..

Now I don’t know about you, but when I read this, I get a little irritated.

It’s not the fact that what he says is true. It’s the fact that the Treasury Secretary did not have any problem supporting the bailout of Bear Stearns, Freddie Mac, Fannie Mae, and (or soon to be) numerous other commercial banks and thrifts, without the same type of criticism. Even though he cites lax credit and underwriting standards, it seems to me that he’s shifting blame onto the mortgage holder.

Indirectly, what he’s saying is that it’s okay to bailout the investment banks, the mortgage brokers, and the commercial bankers who created, supported and marketed the risky CDOs, SIVs, and such that led to the subprime crisis. But, it’s not okay to bailout the individual American who also went along with this scheme. It’s okay for big business to “anticipate an immediate profit”, but not the average Joe who was probably encouraged to take on these loans. Of course the many individuals who took out these loans knew that they couldn’t possibly afford their mortgages, but so did the bankers or brokers who approved those loans. Blame should be equally shared all around, even with the regulators.

It’s this type of contempt for the average American that really disturbs me. But, then again, I should remember that before coming to the Treasury in 2006, Secretary Paulson was Chairman and Chief Executive Officer of the investment bank, Goldman Sachs.

That being said, I do agree with Secretary Paulson in that people should be held responsible for their own actions. Just as I think the loan originators and investment banks should be held responsible, so should the mortgage holders. So, if you’ve fell victim as a willing participant in this whole subprime scheme, I want you to look closely into a mirror and repeat the following:

http://www.youtube.com/watch?v=5YRFnKRG-CU

Posted 31 July 2008 † Guzzo § Commentary § Financial § Sectors ‡ Comments (0) ° Tagged: , ,

GDP Revision

According to today’s report on MarketWatch.com:

The U.S. economy contracted in the fourth quarter of 2007, the first quarter of negative growth since the 2001 recession, the Commerce Department said Thursday in its annual revision to gross domestic product.

Real GDP fell 0.2% in the quarter; a 0.6% increase had previously been reported. Many economists who think the economy is in recession believe it began in the fourth quarter.

Wow, does this mean things are as rosy as we are being led to believe? How can that be? There’s no way the current administration would lie to us, would they?

Posted 31 July 2008 † Guzzo § Economic ‡ Comments (0) ° Tagged:

New Brokerage Account

If you remember my post from the end of last year, I closed my brokerage account in order to pay off my home. I also wasn’t too happy when Vanguard (VBS) didn’t proceed correctly (they said it wasn’t their fault) with an arbitrage transaction, and I lost a little money. So, I also directly-registered some stocks that I wanted to keep and had the certificates sent to me.

In the meantime, I’ve been maxing out my (2007/2008) Roth IRAs, added to my DRIP account, and been saving to open another brokerage account.

This past week I decided to open a new brokerage account. I evaluated every brokerage firm available to me. I’ve had multiple bad experiences with TD Waterhouse (now TD Ameritrade) and Scottrade, so I dismissed them right off the bat. There are a few free-trade and low-trade brokerages that seemed interesting, but each had some limitations or requirements that I couldn’t live with. There are also some full-featured brokerages to choose from, but they were either too expensive or I didn’t trust them.

Vanguard Brokerage Services Can you figure out where I’m headed with this? Yep, I decided to go back with Vanguard’s Brokerage Services (VBS).

My decision came down to three things:

1. attitude, 2. trustworthiness, and 3. cost and convenience.

1. Attitude reflects on me. I’ve resigned myself to the fact that there are dumbasses at all firms and that eventually someone’s going to screw something up. If I want to have a brokerage account then I’m going to have to accept that I’m at their mercy and have little recourse. I’ve lowered my expectations.

2. Trustworthiness. I trust Vanguard with their fee structures. I know that they would be the least likely to increase, add or change fees once I open an account with them. For the most part, I also trust them to address any problems and fix their mistakes.

3. Cost and convenience. VBS isn’t one of the cheapest brokerages, but there aren’t any hidden fees and I get a small discount for being a Voyager client. Vanguard’s Prime Money Market Fund is also consistently one of the highest yielding sweep accounts available. I’m not a frequent trader and this sweep account is where I keep my emergency funds, so a high yield, ease of access, and check-writing capabilities are important to me. Having all of my investments with Vanguard is also convenient for record-keeping and tax purposes.

Next week I’m planning on sending back my stock certificates and moving my drip account to VBS.

Posted 28 July 2008 † Guzzo § Investment ‡ Comments (0) ° Tagged: ,

Neuroeconomics

A Case For Immediate Gratification

The concept of delayed gratification is that we succeed in life when we put off what’s immediately most pleasing and sacrifice for a better tomorrow. The Marshmallow Experiment has shown those who learn to master the habit of delayed gratification are the ones who increase their chances for a more productive and enjoyable life.

Makes sense, right?

Then why is it that we sometimes make self-defeating choices like the fellow above? Why can some people easily delay gratification while others have absolutely no self-control?

Many economists (and laymen like me too) consider the inability to delay gratification use of normal reasoning processes, but lack of willpower. We believe that we are cognitively in control of our decisions, whether they are rational or irrational.

However, fairly-recent collaborations between both neuroscientists and economists (Neuroeconomics) have found that two separate portions of the brain are activated when presented with a choice of immediate-reward or delayed-reward. These two areas of the brain appear to compete for control over behavior when a person attempts to balance near-term rewards with long-term goals.

According to the pioneers in this field:

Data from neuroscience experiments provide a potential explanation for these observations: short-run decisions engage different brain systems from long-run decisions. Using functional magnetic resonance imaging (fMRI), Samuel McClure, George Loewenstein, Jonathan D. Cohen, and I have shown that decisions that involve at least some short-run tradeoffs recruit both analytic and emotional brain systems, whereas decisions that only involve long-run tradeoffs primarily recruit analytic brain systems.(1) These findings suggest that people pursue instant gratification because the emotional brain system - the limbic system - values immediate rewards but only weakly responds to delayed rewards.

Also, according to the same authors:

The extent of collaboration and competition between cognitive and affective systems, and the outcome of conflict when it occurs, depends critically on the intensity of affect (Loewenstein 1996; Loewenstein and Lerner 2003). At low levels of intensity, affect appears to play a largely “advisory” role. At intermediate levels of intensity, people begin to become conscious of conflicts between cognitive and affective inputs. Finally, at even greater levels of intensity, affect can be so powerful as to virtually preclude decision making. No one “decides” to fall asleep at the wheel, but many people do. Under the influence of intense affective motivation, people often report themselves as being “out of control” or “acting against their own self-interest” (Baumeister, Heatherton, and Tice 1994; Stephen Hoch and Loewenstein 1991; Loewenstein 1996). As Rita Carter writes, “where thought conflicts with emotion, the latter is designed by the neural circuitry in our brains to win” (1999).

“Our results help explain how and why a wide range of situations that produce emotional reactions, such as the sight, touch or smell of a desirable object, often cause people to take impulsive actions that they later regret,” Loewenstein said. Such psychological cues are known to trigger dopamine-related circuits in the brain similar to the ones that responded to immediate rewards in the current study. As described in Randall Parker’s FuturePundit, excitation of the dopaminergic neurons “make us do what we ought not do”.

Hmm.. maybe we don’t have as much control over our decisions as we think.

Accordingly, these findings not only shed light on impulsive decision-making, but they may also aid the understanding of neuropathologies, such as drug addiction and gambling that are characterized by a decreased ability to wait for a large reward.

Neuroeconomics: Decision Making and the Brain, the first handbook of Neuroeconomics, is being published for release in September 2008.

Related Links:
What is Neuroeconomics?
Natural Rationality Blog
Neuroeconomics at Caltech
Why Logic Often Takes A Backseat
Paths to Happiness Survey

Posted 25 July 2008 † Guzzo § Economic ‡ Comments (0) ° Tagged: ,