March Madness

Spring 2008

Some people correctly pick the winner of the NCAA basketball championship well ahead of the tournament. A few people come up with the right final four teams and fewer still, if any, end up having perfectly selected brackets by the last buzzer on Monday night of the final game.

Why? In a word, UPSETS – the NCAA equivalent of what Wall Street calls volatility. It would be pretty boring if the same teams won year after year. Eventually, fans, advertisers and teams would all just ‘fahgit about it’. Quite the opposite happens in real life however. “Cinderella teams” actually knock off “sure things” and the number of eyeballs watching per game goes up. Sooner or later the word UPSET is repeated across America.

Upset? Well, partially yes and mostly, no. Like volatility, upsets are likely to happen. Only the outcome (which teams actually win or lose) is unpredictable. (I’ll bet some of you even had upsets predicted in your brackets.) Wall Street’s upset this past quarter was that the volatility I spoke of in January’s letter exceeded just about everybody’s expectations! In fact, the stat guys over at Standard & Poors say 2008’s market is the most volatile one in 70 years1. I recently ran across a quote from 1st century BC philosopher, Syrus Publilius, who said, “Anyone can hold the helm when the sea is calm.”

True, but some boring would be just fine right now.

News

The good news this quarter is that market bottoms often occur near the time volatility peaks. More on that latter. The reasons for the current market swoon are numerous and unfortunately over hyped in endless media loops, but I’ll attempt a summary of the players and to score each; for both good and bad.

  • Some investment banks Bad. Particularly one whose name had the misfortune of containing the word ‘Bear’ in it.
  • A lot of mortgage lenders Really bad. Especially those who lent money to people on ridiculous terms and on “stated” incomes. Turns out, having to prove your source of income makes darn good sense given that more than 70% of applicants “misspoke” with more than 50% of those innocents inflating their incomes greater than 50%. Shocking!
  • The media All I can say is that if there weren’t the most entertaining presidential primary smack down running concurrently, the media would have us all fighting for ledge space on the Brooklyn Bridge.
  • The Fed Good. Gentle Ben and his posse looked more like the “A Team” acting with speed and precision that the political branches could only envy. In one remarkable week in March, the Fed:
    1. Averted moral hazard (a run on the market) by engineering the fire sale of Bear-Stearns.
    2. Offered emergency loans to securities dealers with terms normally reserved for banks only.
    3. Slashed the key short term interest rate by ¾ of a point – the 6th cut since September.
    4. And all these steps followed on the heels of huge cash infusions to financial institutions all in an effort to keep the system from seizing up.
  • The American Entrepreneurial Spirit A+. World wars, 9/11, bear markets and even the Great Depression didn’t stop this country from achieving even further greatness and neither will these events.

No surprise then that all the major indices tracking stocks in the US (down 9.6%) and overseas (down 9.3%) were all in the red zone, with only bonds (up 2.2%) in the black at the end of Q1. Remember that while this current downturn is certainly part of a larger economic cycle, it was largely triggered by the unveiling of the subprime monster back in August 2007.

Commentary

This brings to mind what one dismal scientist (read: economist) said tongue in cheek, that the market had predicted 9 of the last 5 recessions.4 Pretty funny… for an economist. In other words, markets are forward looking. News agencies, on the other hand, report on what has happened sometimes with significant time lag. Take for example the recession we are undoubtedly in right now. The bean counters will tell us some months from now that we HAD a recession and give us all the details. The stock market will have been in recovery mode by then, confidence will be increasing and we will think… we’ve been here before.

Indeed we have, even as recently as the back-to-back bear markets of 2001-2002. Unlike those recent bear markets, this one has had few places to reap positive returns. Largely fueled by speculators, the only positive areas have been gold and commodities. My guess is that these limited alternatives present a real risk of reverting to the mean as the economy begins to pick up steam.

Our advice then mirrors our course of action this time – long term financial goals should not be funded based on reactions to short term moves in the markets. However, making adjustments within the framework of your goals, increasing credit quality and rebalancing are appropriate tools we discuss with you at review meetings and work on behind the scenes. To be sure, there will be much hand-wringing and hole-lotta hearings up on Capitol Hill. Necessary reforms to the financial markets will be made and confidence will come back to a bedrock element of American democracy – home ownership. It’s worth noting in closing (on an up note) that the S&P 500 rose 24% on average in the 6 months following 10 of the last 11 recessions!5 Your portfolios are well positioned to take advantage of a similar rebound that Fed actions and government stimulus will certainly create.

Ideas

The idea for this quarter’s newsletter can be filed under “Mistakes the government made in OUR favor.” Similar to the 529 college savings legislation that gave parents and grandparents a powerful tool for tax free savings along with numerous other benefits, so too does the law that permits individuals in all tax brackets to convert IRAs into ROTH IRAs in 2010. The biggest beneficiaries will be higher income workers who are currently ineligible to do so. We have mentioned before that it might make sense for some of these individuals to make non-deductible contributions to an IRA and then convert the account into a ROTH in 2010. Only the earnings on contributions will be taxable so it will be an almost pain free way to get money into a ROTH.

The new law even makes it easy to handle the conversion tax bill. If you convert in 2010, you can spread your tax bill over two years- 2011 and 2012. (You can also choose to convert smaller amounts over as many years as you want as a way of minimizing your tax bill in any single year.) Once you convert the money, it grows tax-free. And if for whatever reason in 2016 (five years after your conversion) you happen to need money, you can withdraw any amount from your converted Roth IRA up to the amount contributed without any additional tax or penalty, even though you’d only be 45 years old.

If you do need the money in retirement, it comes to you tax-free! Even better; if you don’t need the money in retirement, you can just let it sit untouched for your heirs to eventually inherit. Additionally, you must start making withdrawals by age 70½ in a Traditional IRA – not so with the ROTH. There are other factors that should be considered when thinking about using this strategy. Please feel free to call us if you are interested in knowing more about it. Remember, the government doesn’t make these mistakes very often.

 

Greg Busch

Gregory T. Busch, CFP
Clarus Financial, LLC

1 As measured by the daily change of 1% or more to the S&P 500 Index. Source: Standard & Poors (www.standardandpoors.com)
2 “Investors Endure Hairpin Turns” USA Today March 21, 2008
3 “In the Fed We Trust”, AP story March 23, 2008
4 Attributed to Paul Samuelson; Author and 1970 winner of the Nobel Prize in Economics
5 Standard & Poors
6 Money Matters, Yahoo Finance November 30, 2006

This newsletter and the ideas expressed herein are my own and is provided for informational purposes only, and does not constitute an offer or solicitation to buy or sell any security discussed herein.

Information and any statistical data contained herein is obtained from other sources which we believe to be reliable, but we do not represent that they are accurate or complete, and they should not be relied upon as such. All opinions expressed and data provided herein are subject to change without notice.

Quarterly Newsletters

Summer 2008 »
It’s Déjà Vu All Over Again

Spring 2008 »
March Madness

Winter 2008 »
Year In Review 2007

Autumn 2007 »
Roller Coaster Ride ’07

Mid-Summer 2007 » A Mid-Quarter Briefing From Clarus Financial

Summer 2007 » Mission Accomplished

Spring 2007 » Our Interests May Not Always Be The Same

Winter 2007 »
The Year In Review

Autumn 2006 »
FILL’ER UP

Summer 2006 »
Summer Doldrums?

Spring 2006 »
Presidential Cycle: market indicators for an uncommon 2nd term president