Next -- Dow 15,000 or 10,000?

Stocks go up, stocks go down.

Do you feel poorer today than you did a week ago, thanks to the 700 pount loss in the Dow Jones Industrial Average?

If so, may I suggest that you need to rethink your investment strategy?
Another long time aphorism came to my mind in thinking about the latest decline in the Dow -- easy come, easy go.

The DJIA went from 13,000 to 14,000 in just 56 days.

Did that 7.7% rise in under 2 months reflect the American economy rising 7.7% in under 2 months? Of course not.

Yet a week ago, millions of investors were once again congratulating themselves on how smart they were to be buying stocks. I have o quarrel with that in general -- it's when you start thinking of market price rises as cash in your pocket, that I suggest you're out of touch with reality.

The truth is, we don't know the future. I don't know whether the market is going to rise or fall tomorrow, and neither do you. Nor do any of the paid commentators and talking heads.

What's more, we have no idea whether the DJIA has attained any unpenetrable "floor" . . . is there an absolute limit on how fair the DJIA can go down now that's at just over 13,000 and has been over 14,000?

We'd like to think that the DJIA will never see 10,000 or 7,000 or 1,000 again -- but we don't know. You have no guarantees. What if Al Quaida terrorists succeeded in setting off atomic or dirty bombs in multiple major American cities, including Manhattan where the New York Stock Exchange is based? How far down would the DJIA go? Who knows? Will that ever happen? I sure hope not. But we have no guarantees.

Nor do we have guarantees against biochemical terrorism, or a natural problem such as bird flu or natural catastrophes such as the flooding global warming allegedly will bring.

The trouble with called price rises in your stocks "capital gains" is that they all too often don't reflect real gains in REAL capital. The traditional economic definition of "capital" is not simply a profit made selling an investment -- that's the IRS's definition -- no, it's the productive assets of one kind or another.

Land, warehouses, forklift trucks, patents. Cash in the bank is simply the liquidity used to obtain capital assets or to pay the expenses associated with running them.

If the stock market were strictly rational, the price of a company's stock would go up only to the degree that the company achieved success in expanding its net capital assets. The price of the overall stock market would go up only to the extent that overall economic activity expanded the value of the country's net capital assets.

Obviously, the stock market is not strictly rational. Efficient, yes -- but not rational.

Of course, a strictly rational stock market would not go up or down in sharp, fast bursts. It wouldn't be so exciting, but you would still have the advantage of participating in the overall growth of the nation's economy. That's still a big advantage over money market accounts.

And if you buy only stock that pays dividends, then you get quarterly checks in your mailbox whether the market price is up or down. Use this drop in the Dow to buy dividend-paying stocks cheap.

They may never be this low again.

(Or maybe they'll get a lot lower -- but you don't know that, and you don't know when. So buy now to start collecting dividend checks now.)


Dow down 700
Dow down 700

What if . . . something unprecedented affects your investments?

Sometimes I wonder whether my way of thinking helps or hurts me when it comes to income investing and investing in general.

I think that if I were to try to get a "real" job in the financial world, I'd be at a disadvantage. That's because the general financial community accepts historical returns and situations, but I'm a long-time science fiction reader (and very minor writer) and therefore am used to asking, "But what if . . . ?"

For example, to the conventional, statistically savvy financial mind, the sun is not going to blow up tonight simply because it's been existence over 4 billion years and hasn't yet blown up. To most people, the sun going nova is simply an incomprehensible event.

But as a science fiction reader I'm used to thinking about suns going nova. If a particular star is about to go nova, it's going to go nova even though it's been in existence for billions of years, and therefore provided billions of mornings to any planets in its solar system.

My only comfort is my understanding -- hopefully not wrong or out of date -- that our particular G class, yellow sun is of a type that doesn't go nova. I put more faith in the findings of astronomers who've studied many stars that have gone nova or not than I do in the narrow, statistical viewpoint of, it hasn't happened in the past 4 billion years so it's not going to happen.

Sorry, but if there's something inside the sun that's about to make it go nova, all the statistics in the world won't stop it.

But, as I mentioned, I'm sure that pension fund managers charged with obtaining optimal performance at a given degree of risk are not interested in statistically highly improbable "long tail" events that may make their forecasts based on historical results irrelevant.

Yet the world is always changing, and sometimes the statistically improbable happens. In 1998 the Long Term Capital Asset "hedge" (I use quotes because they did not hedge their trades, but rather leveraged them 100 to 1 or more) fund placed a lot of money -- huge amounts of it borrowed -- on a derivative contract based on the historical relationship between United States and Danish government bonds.

In the summer of the 1998, a "what if" occurred that they didn't think of, despite their Nobel prizes in Economics and PhDs and Masters . . . The sun didn't go nova, but the Russian stock market did "melt down" -- losing about 90% of its value. This, following the Asian currency crisis of 1997, frightened people in developing countries around the world so much that the shipped all the cash they could to the United States and bought United States Treasury bonds, driving their price far past its historical relationship with Danish government bonds.

Net result -- Long Term Capital Asset not only lost all its investors' money and went bankrupt, the New York Federal Reserve Bank had to intervene to prevent a massive breakdown of the United States (and, probably, world) financial systems.

So . . . what if millions of retiring baby boomers start selling their non-dividend paying, "growth" stocks?

What if . . . ?
What if . . . ?

Dow 14,000, and on up!

I meant to mention it earlier, but I did notice that the Dow Jones Average closed above 14,000 for the first time in history. Hip, hip hooray!

If you're accumulating stock, you should be sorry that the shares you are going to be buying now will be more expensive -- but only Warren Buffett and I seem to have figured that out. It seems to be immutable human nature in everyone else to place more importance on the total value of the stock shares they've already bought than on the price they're going to pay in the near future.

One reason is that we celebrate capital gains over dividends is the difference in tax treatment. This was alleviated by President Bush's tax cuts of 2003, but unfortunately that law is temporary. If Democrats are in charge in the future, they've made it known that they'll allow the lower tax rates on dividends to expire.

This would be bad, but I still advise investing for income. To get the preferential tax treatment on capital gains, you still have to realize those capital gains by selling them. And with many stocks after the baby boomers start to retire, you may not have any capital gains.

But the run up to Dow 18-20,000 foretold by Harry S. Dent seems to have begun.


DOW 14,000
DOW 14,000

Austrian School economic prophesy

Is the world and U.S. economy in a bubble which will inevitably break?

This article maintains that it is, based on the work of the Austrian School of economics:

Austrian economics

I don't know, of course. And just because the current leaders of the Austrian school think we're in a worldwide bubble, doesn't mean Hayek and van Mises would think so if they were still alive.

The dislocations which the author mentions all result from the drastic lowering of the value of the U.S. dollar. Perhaps India's stock market is valued more than the U.S. stock market in part because so many financial newsletters, including some from Agora, Inc -- the author's employer -- emphasize how much India and China's economies are growing in relation to the rest of the world.

If India were as economically developed as the U.S., its stock market obviously would be worth a lot more than the U.S., since India has 3-4 times as many people.

The advice to put 20% of your portfolio into gold, I think is crazy. Especially after reading Peter Bernstein's book The Power of Gold, which is a terrific argument against everything "gold bugs" such as this author say.

My own advice is to put all of your portfolio into income-generating investments such as stocks that pay dividends, if if you need to use DRIPs (Dividend ReInvestment Plans). Gold is just a metal -- it doesn't write you any checks, and it costs money to store safely.

I'm not saying the price of gold won't go up in the future -- perhaps tremendous just as the gold bugs are predicting.

But the problem with that is the same problem I have with buying stocks and other investments for capital gains. You can't realize your profit without selling the gold/stocks. And then you miss out on future gains, plus you must pay capital gains taxes.

There's at least one gold mining stock -- BHP Billiton -- that does pay dividends. If gold goes up, its dividends will likely go up. So you could buy shares of that company if you want to hedge your portfolio with gold.




Austrian doom and gloom
Austrian doom and gloom

Smart Capitalist blog

I found a website with a great domain name. I wish I'd thought of grabbing it -- Smart Capitalist.

It's a blog, and of course I was attracted to the article on High Income Investment Cash Cows.

I like the general thrust, but take issue with a few items. One, although energy and pharmaceutical companies are in the news a lot, that doesn't mean they're not cash cows, so they're not in the same category as high tech stocks. Some energy and pharmaceutical companies return a lot of cash. Obviously, oil and natural gas and energy itself are rising in price. And pharmaceutical companies have a good business in that once they find an effective drug and get it approved, it's a high margin business. The drug itself is almost "digital" in that it can be replicated very cheaply. The high price is not due to the ingredients, it's to pay for the research. So once a drug makes back its research costs, it's a big money maker.

He mentions insurance, too. I don't recall seeing insurance companies in the high dividend paying lists, but maybe they're just behind the biggies (REITS, consumer goods, utilities, banks). After all, Warren Buffett bought Geigo Insurance for Berkshire Hathaway, so he expected it a large cash flow from it. They buy a lot of clever and entertaining radio ads, so I assume they're still making good money.



smart capitalist
smart capitalist

The Gold Standard Not So Golden?

Reading The Power of Gold by Peter Bernstein makes me think again about gold as the money standard. I posted before my misgivings about how mining gold apparently creates wealth, instead of the formation of new, better and cheaper goods and services. Bernstein's story dramatize the effect of gold (usually negative) on economies through history, including what happened when Spain stole so much gold and silver from the New World.

And if the economy activity of a country increases, how does that automatically increase the supply of the gold metal? It obviously doesn't.

Yet the concept of hard money is still very popular. Conservative talk show hosts like to promote gold-buying services. I remember when Laura Ingraham interviewed Ron ?, a popular economic commentator and analyst (his own radio show used to be carried here in St Louis on Saturday night, but unfortunately they dropped him). She was surprised that Ron joked that everybody should own enough gold to "bribe the border guards."

The price of gold can go up, but this is not the same as the benefits of a passbook savings account. It's solid metal that doesn't itself pay any money or interest.

Bernstein is building a strong historical case for saying that gold is a liability rather than an asset, at least when you take it beyond its function as decorative jewelry and an electrical component. It's not money, is the message I've gotten from the book so far. And when you try to make it money, it's dangerous.

And the glory years when the world was on the gold standard? This was not the norm. The gold standard in the sense of pegging a country's currency to a fixed price for gold and saying that your paper currency is always redeemable into gold -- that's a product of the 19th century through the beginning of World War I. As somebody during that period said, and which Bernstein quotes enough times to make it clear he agrees, the gold standard was not the cause of the world's prosperity during that period -- it was a result of it.

I'm looking forward to reading what he has to say about modern times and finances.



gold standard
gold standard

MAKING 36% by Dr. Terry F Allen

Fuller Mountain Press sent me a small book for review: MAKING 36%: Duffer's Guide to Breaking Par in the Market Every Year In Good Years and Bad by Dr. Terry F Allen.

It's basically a lead generator book. That is, if you read it, get excited and want to begin its program -- but you're understandably intimidated by the work involved -- you can enroll in his email trade notification service.

Basically, he advocates making 36% by putting on calendar spreads. These are option trades that take advantage of the difference in volatility between LEAPS (Longterm Equity AnticiPation Securities) and short term options.

Unless you're already an accomplished options investor, I know that's as clear as mud. I've read about calendar spreads before, but I found his explanation somewhat difficult to read in detail. Yet, I know reason to doubt that it works. I'm simply doubtful that too many people can put on these trades and also make the necessary periodic adjustments simply from reading this book. I'd certainly hesitate to risk my money on that. But again -- that's all the more reason why you need his email service.

So far as I know, his method his standard. He does confine his calendar spreads to one particular equity -- one which I wouldn't have guessed, so it's not fair of me to reveal it here.

Plus, he provides a great service by giving us the name of a broker that allows us to do option trades within an IRA. That is terrific news for all of us saving for retirement.

For more information, go to Terry's Tips



calendar spreads book
calendar spreads book