AskDong

Yeah, I’ve been a slouch on my investment update.   I’ve kept my own files up to date, but haven’t posted an update in a long time.  The markets have treated me well, though not as well as the indexes in the last few months.   I’m not fully invested, and still have a few outstanding hedges in place.  I’ll take what I can get though.

While I have trailed the indexes in this recent upswing, I’ve managed to stay ahead of them ever so slightly for the year.  I didn’t swoon as bad earlier in the year.

The last 2 months in the stock market have felt like a return to the heydays of 1996 when Alan Greenspan so famously spooked the market with his proclaimation of “Irrational Exuberance.”  Of course the market quickly forgot and rode one bubble (the tech) to the next (real estate).

I can’t but feel that we’re taking a mule ride up a rather unsteady path in the dark of night, not knowing if the next step is off a cliff.   There is legitmate good news on the economic front.  We are not facing another great depression, it seems as we have learned some economic lessons from the last.  The economy is only contracting at lesser rate than it was a few months ago.  The Economy is not healed, it’s just not losing as much as blood.  I think this should be obivious when you have less people employed, it’s hard to lay off as many people.

The stock market has responded to the less dire news with glee and joy.  We’re nowhere near the highs from early last year, but we’re far above the lows of mid March.   Who knows if we rally further from here or test new lows?   I certaintly don’t.   Still, my gut feeling is that we’ll pullback as investors realize while things are not as bad as they may have looked, they’re still not good.   That’s a good thing.   I wish the economy the best, but I also want economy to recover slowly via increased savings, and healthy investment in business.  I don’t want another bubble, sustained by excess consumer spending and uncontained speculation.

I’ve been an investor in VMATX which is Vanguard’s Massachusetts Municipal Tax Fund over the last 2 years. A few years back, I had thought about constructing my own bond portfolio, but found it too much of a hassle. The commissions were expensive, researching bonds were difficult, and it was unclear what benefit I really gained.  Certificates of Deposits yielded similar rates.  Bond funds such as VMATX performed better but not that much better.

In the last 9 months, the pros have begun to outweigh the cons.  CD rates have plummeted as the economy has soured, and the fed has lowered rates. VMATX is intermediate term bond fund meaning it holds assets on average with a maturity of 5-10 years. The current climate of fear and potential budget shortfalls have made municipal funds risky, and this risk translates into lower prices on the underlying bonds that make up VMATX.  This risk is real, but I think it has been somewhat unfairly applied across the board on all bonds, regardless of issuer.  As a result VMATX and many other bonds funds have taken a hit in price.  VMATX continues to steadily make it’s dividend payments.  The price of the fund has however been uneven over the last year.

Fixed income instruments vary with the general interest rate environment or with the individual risk of the debt issuer.   Typically as interest rates decline as they have over the last year, bonds increase in value.  This is not what has happened this past year.   Bonds of all varieties, corporate and municipal, have decreased in value.  The only exception have been Federal treasuries.

People have fled to the safety of Federal debt, fearing that corporations and municiplalities will end defaulting on their obligations.  Some of this fear is rational, and some overdone.   As a result corporate bond yields have widened.  Safe bonds such as 6 Month Bell South bonds yield less than 1% while Citigroup bonds of the same duration (6 months) yields nearly 33 percent.   I’ve quoted those based on the offer side, yields based on what sellers of the bond are will to take.   If anything the bigger issue currently is the very wide bid/ask spreads.  The bid is what someone is willing to pay and the ask is what someone else is willing to sell at.  For example the bid ask spread on the Citibank bond I cited above is 48%/35%.   The buyer demands a yield of 48% while the seller is only willing to give 35 percent.

The high yields, and the wide bid ask spreads are reflective of bond market that remains uneasy.   There is fear on the street.   Bonds and stocks have both taken a beating, and there are opportunities in both.   I’m still trying to figure out how to best construct my own portfolio.  How to pick bonds that will pay good returns without defaulting.  In this light, it’s very similar to my foray on prosper.com

I’ve been a bit derelict in my investment update. I completely missed the January update. Given the state of the markets, my comment would’ve been the same as it is this month. It wasn’t good.

2009 is turning out to be as brutal as 2008. Personally, I don’t expect a bottom anytime soon. I don’t think this a bad thing. The fact is the markets cannot continually rise. Yes, we’re back at 1996 levels, but given the huge bull market run between 1980 and 1996 still means we’re still at “highs.” The continued rally of the late 90s and rerally in the mid 2000s have to be taken for what they actually were, smoke and mirrors.

The late 90s were marked by the Internet bubble, and mid 2000 rally was a product of financial wizardry rather than real productivity growth. I think it’s easy to understand what happened in late 90s. It was wild speculation through and through.  People brought higher because it “might” go higher. Not all that different from a Ponzi scheme.

The rapid recovery of the market in the mid 2000s is a more interesting story, and one I’m still trying to unravel. The market followed generally speaking, corporate earnings growth which is sensible enough. The problem with much of this earnings growth, especially in the financial sector was that it wasn’t real in any sustainable way. There are generally two ways to grow earnings. 1) Find new areas to profit in 2) Expand the current business and sell more product at a lower prices.  Both ways are valid, but 2nd method for a financial institution can be dangerous especially when coupled with high amounts of leverage.

Banks and other financing firms effectively grew their businesses by issuing debt, and then pushing out risky financial products to consumers (mortgages) and other companies (CDOs, CDs, etc).   Poor credit risks who would never have gotten mortgages in any other era were getting mortgages because this was only way Banks could turn the excess money they were borrowing into earnings.  It didn’t matter how poor the risk were or the rate or return.  The magic of leverage allows someone to make investment that returns a mere 1% percent look like it has 100% return just by borrowing 100 times over.

The poor performance of the market, and my portfolio these two past years is merely a sympton of that unraveling of the schemes of the last 10 years.

Let’s hope this year’s chart turns out much better for all of us….

2008 was awful year for investing, but the last month did at least end on a high note.   December showed marked improvement from November.   These small gains however are dwarfed by the lost ground from the previous 12 months.

The fact that I’m only down 17.3% across my portfolio is truly a bullet dodged.   The S&P is down about 40%.  Of course, when the market eventually rallies I will probably not participate in those gains as much.  I have still have my puts in place, and much more in cash than I really want to be.   I’m beginning to outline my plan for investing in the next year.  That investment plan does not involve dumping everything back in the market all at once.

Let’s hope this year’s chart turns out much better for all of us….