Friday, July 30, 2010

Investing for Smart Gardeners

I heard it said years ago that you should treat investments like you would tend to a rose garden; trim, fertilize and prune to gain the maximum beauty. I also remember the old investment strategy of cost averaging; owning a hand full of stocks, buying the stocks consistently at various times throughout the year at both high and low prices and holding the investment never selling, thus lowering the overall cost. In a volatile market where most investments are taking a pounding the question is, should we own stocks at this time?

The same can be said of the current real estate market. From 2007 to today real estate investment seems out of favor. It is over stocked with too many homes, values way too high given current affordability levels and too much additional inventory will be entering onto the market via bank owned foreclosures. Buying real estate at this time seems to be a fools game. But for those that are real estate investors these are very exciting times. We dream of times like these! Like good gardeners with years of experience we have seen down markets before(1973,1980,2000)and wish we would have bought up the market at 1/2 to 1/3 the price and watched ourselves make a killing a few years later.

Real estate as an investment delivers 5 financial benefits: Appreciation, Tax Advantages, Residual Income Cash Flow and Shelter. For the past 20 years or so real estate has delivered on all 5 benefits, but more so on the appreciation. In some of the best years (2004-2006) real estate delivered over 20% appreciation per year. That is unprecedented for a conservative investment! The same can be said with the stock market 1984-1987 and 1996-1999. These were the glory years where good luck rained down upon you like a ticker tape parade. It should also be said that the years following these huge upturns were very unpleasant for "greedy pigs" that stayed in the market hoping to continue their run on fortune. Like growing tomatoes in winter, the time is just not right.

Market volatility is part of the game. Prices rise and fall as investors jump from one pool of favor to the next. For now most investors are on the sidelines waiting to purchase at the bottom of the market. As for both stocks and real estate we are no where near the bottom. A good indicator will be when employment begins to rise without "artificial fertilizers" such as government subsidiaries or incentives. In the end, nature will take its course regardless how much we trim, fertilize and prune. Smart gardeners will buy seeds and plant regardless of the weather conditions. They will be the ones with the most fruit to sell when buyers come back to market.

Monday, July 26, 2010

The Truth About Inflation and Deflation

There are warnings from the economic forces that we are in a new period of deflation and there needs to be a mindset adjustment to survive financially. The past 20 years or so have been a blessed time where jobs were plentiful, companies sales volumes increased and stock prices rose accordingly. The next several years will be plagued with quite the opposite. In these times of economic contraction what skills do consumers need to stay afloat? First let's define inflation and deflation.

Inflation is a good and bad thing. The good thing about inflation is that companies are increasing prices because there is a scarcity of goods in the market place (demand is high). With the factory conveyor belt turning faster more employees are needed to process the goods being manufactured. More hiring means more cash streaming into the economy. That seems like a perfect scenario except most times wages do not keep up with rising prices. If you cannot buy enough groceries to feed your family with increased earnings are you truly better off?

Deflation is also a good and bad thing. During times were prices are falling your dollar will go further (you can buy more goods), but at the cost of decreased income. Economic contraction means the factory conveyor belt is turning slower so less employees are needed. If your dollar is buying more, but your wages are less are you truly better off?

The truth about inflation and deflation's affects are your ability to adjust spending. The mindset for the years ahead is to focus on saving money. Stay away from debt and unnecessary spending across the board. Commodities such as homes, cars and clothes that are currently sold at a premium will adjust down eventually as less are being purchased. In periods of economic contraction cash is king because there is less of it. Unlike times of inflation, in deflationary periods where prices are falling, a penny saved is really a penny saved. If you are a saver the next few years will be a blessed time. Be frugal and your piggy bank will be your new best friend.

Wednesday, July 21, 2010

The New Value

I have been reading articles lately how determining value is becoming an art form. How do you appraise an asset today when so many economic variables effect its value tomorrow? New appraisal repositories are entering the field of reference. A once easy task is becoming a sophisticated venture. When it comes to financial assets (houses, boats, cars, stocks, cash, gold) which is the best to hold when most hard assets are in decline?

As the economy contracts so does the value of most hard assets. Some will reduce in value greater than others. The most expensive of financial assets would be real estate. One of the main contributors to the housing decline (besides supply increasing and tight lending) is that most homes needs to be acquired through obtaining a loan. In a down economy shouldering excessive debt can make life challenging. The affordable homes market is not as affected (less debt) than the expensive home market (more debt) and therefore is selling easier. Other assets such as boats, autos, art, and jewelry have had a significant decline in value as well. Most investors at this time would rather hold cash that any of the above mentioned assets. In down economies cash is king.

We should also mention gold. It has been said that gold is the best asset to hold in a down economy. With declining value in cash and exchange rates of foreign currencies, investors are selling cash and buying gold. There has been a huge run on gold as investors sell other "cash like" assets such as commercial paper, bonds, stocks, and Cd's. In down economies gold has always been the counter-cyclical assets of choice. It is easy to sell and looks pretty on your finger.

So what is the most valuable of assets? It would be your health! Having good health will save you thousands of dollars on prescription medication, keep your medical insurance premium low, reduce sick days from work and generally make you a more pleasant person to be around. Health is the #1 asset to hold in any economy. So be a smart investor and take your vitamins, get on that treadmill, floss your teeth and cut back on the ice cream. The return on investment will last a life time!

Monday, July 19, 2010

Gains Are Found in the Highs and Lows

It is always insightful to see changes in the landscape. The feeling you get after a rain and seeing the flowers in full bloom. Being in the finance industry since 1985 I have gained much perspective (and a grey hair) in the highs and lows that come with investing. It is insightful as well to see the many changes that come when financial reforms are put into place. The feeling you get when you know the impact reforms will have on an industry will shift the balance of power.

During the meteoric rise of real estate values during the years of 2002-2007 it was insightful to see investors stumbling over themselves to scoop up houses to the tune of 20% annual appreciation. I had experienced the same unbridled consumption during my stock broker years in the 80's. Movies like "Wall Street" glamorized the edginess of being on the inside and capitalizing on fast money. Stocks were the rage and hot-shot money managers had rock star status predicting the next up and coming, million dollar, over night trade. Stock investors were earning 200% gains on penny stocks, new technologies were making the medical stocks rocket and even sleeper industries like retail companies were growing double digits. All good things must come to an end and as the SEC tightened rules after the market crash in October 1987 the balance of power shifted into tighter trading reforms.

What impact will the current reforms have on business? Reforms make the system contract as new rules fall upon the players. Regulations act like filters to decrease the pace of expansion. Business loans will become harder to fund, both "stay afloat" loans and "business expansion" loans, as businesses collateral-backed assets dry up. With less money to lend business will need to become more innovative to survive. There is a natural selection in process. Businesses that fail were targeted by the system to fail. It is the way it is meant to be. As the business landscape changes there will be new and innovative "rock star" business that will thrive. Just like flowers after a rain they will bloom brightly for all to see.

Saturday, July 17, 2010

One Step in the Right Direction

Very soon our president will sign into law the Financial Overhaul Bill of 2010. This 390,000 word document was created from the ashes of the 2008 banking collapse that brought the worlds financial systems to its knees. The bill, being released from the Senate next week, will be the heaviest piece of legislation ever created and the most sweeping reform bill since the great depression. Though the repercussions of the bill will not be felt for years, it stands to protect consumers from predatory lending, sets up systems to more heavily scrutinize financial institutions and generally make banking a more transparent operation.

This is not the first time the banking system has failed though. The Savings and Loan crisis of late 1980's was the first major event to call into question where banking executives bread was being buttered. Systems become corrupt when individuals that are being compensated by volume incentives are told to "ethically police" the system. Any organization managed only by its internal components is doomed to fail. Leaving the Rooster in the hen pen will not always make more chickens.

In my opinion the reform bill is a very good thing. Being an ex-mortgage banker myself and experiencing first-hand the rise and fall of the financial industry, banks need more scrutiny for their own good. Consumers will be the residual beneficiaries of the bill, but so will the global banking system. Initially, as in 1991 when the S & L Reform Bill came into law, there will be complaints, increased fees and substantially greater processing times, but over time the global banking system will be in better synchronicity. This is one step in the right direction.

Thursday, July 15, 2010

Is the Truth Black, White or Grey?

Many mixed signals are coming from Wall Street. Every day we get peppered with positive and negative reports. On one channel we get that unemployment is increasing (bad) then another channel reports that the unemployment "trend" is improving (good). I turned on the radio and heard that mortgage rates are the lowest that they have been since 1963 (good), but home foreclosures outpace new home sales (bad). Oil giant British Petroleum capped the gushing oil well in the Gulf (good), but the Gulf Coast may take centuries to recover ecologically (bad). I guess it is how you see things that make you either smile or frown.

For home buyers or home sellers the recent drop in property values can be seen in two perspectives as well. If you are a homeowner selling the home you have lived in for years then you are probably thinking "Why didn't we sell years ago when values where higher". The other perspective could be "Look at how cheap homes are now! When we sell we can buy a bigger home cheaper than what we owe on this home". Home buyers are pummeled with decisions. The shear volume of properties that are hitting the market daily is overwhelming. For a home buyer, in this crazy market, it is hard to hit the bulls eye when the target keeps moving.

Fact is that value is very subjective. Each human is in a slightly different space and sees value proportionate to their interests. Mixed signals, whether they come from Wall Street or Main Street, are a way of life. I was told long ago to never believe anything you hear and only half of what you see. Most feel that news is presented with some form of bias and we must go with our gut and find the truth out for ourselves. Bad news sells newspapers and over-dramatization is the norm. We are taught that truth is black or white, but in today's media, truth is somewhere in the grey.

Monday, July 12, 2010

Eliminate Mortgage Interest Tax Deduction?

I have read recently that in an effort to increase government revenue the Obama Administration is considering eliminating the mortgage interest tax deduction. I can only imagine what a quagmire government cash flows must be in from funding such colossal projects as the 2008 banking crisis, the ongoing and escalating expense of the Afghanistan war, Haiti relief efforts and now the Gulf oil spill. Trying to understand the myriad of government economics would take a brain much larger than mine. Given that there are big brains on government payrolls I am sure there must be better ideas on the plate that nixing the mortgage interest tax deduction. What are they thinking? Hasn't the real estate industry had enough impact? Even the consideration of such drastic measures would deliver a knock out punch to an industry barely hanging on to the ropes.

In an effort to better understand the "Robin Hood" mindset of taxing the rich and giving to the poor, what would elimination of the tax credit render the average American? If you had a $200,000 mortgage and were claiming $10,000 a year in mortgage interest deduction you would now pay taxes on $10,000 of income that was shielded by the deduction. If you were in the 25% income tax bracket you would have to pay $2,500 additional in taxes per year ($208 per month). In a down economy with national unemployment just under 10% how is that going to stimulate consumer confidence? Talk about a regressive tax. This would kill the economy, unfairly burden the homeowner and hurt everyone employed by or associated with the housing sector.

Might I suggest a more progressive attack. If you want to go after the rich (I mean the really rich) start by taxing capital gains more aggressively. Then go for the ultra rich by taxing drug and oil companies. How about manufactures who produce products that damage our water, air and soil like tobacco, plastics and pesticides. How about a tax on the fast food industry that create products that produce high blood pressure, cholesterol and diabetes. Leave the homeowner alone. Yes, Robin Hood would be very proud of all that.

Sunday, July 11, 2010

How European Woes Effect You

The European debt crisis is showing new signs that its credit problems are far from over. The European Nations, being one of the largest buyers of US mortgage backed securities manufactured from 2004-2007, is beginning to face the fact that their exposure to sovereign debt could haunt them for years to come. In 2009 US banks imposed “stress tests” on their ability to adequately provide sufficient liquidity during an emergency run on assets and avoid another round of government bank bailouts. European banks are now implementing similar tests.

Highly publicized economic events show stress on the system such as Greece’s public revolts against reforms as the government slashed programs and raised taxes to cover their mounting debts. Germany and Spain are also engaging economic reforms restructuring debt, reducing political banking appointees and branches. The Bank of England, in similar fashion, recently increased their “capital cushions” to protect banks liquidity.

How do European credit woes affect you? Banks are trying to avoid another liquidity crisis by increasing reserve requirements. These reforms have made rates banks lend to each other (over night funds) increase. Tighter banking reforms will drain the system of liquidity. Less liquidity will hinder banks ability to lend freely. Underwriting guidelines will become tighter and loan application scrutiny will increase. If you haven’t applied for a loan in a few years get ready for a new experience. Tighter regulation will not only affect the amount of information you will have to provide, but also lengthen the process, increase costs and ultimately may hinder your loan approval. Over the long term these reforms will provide a more stable global financial structure with significant safety valves, both high and wide, to protect itself from another melt down. Over the short term there will be more pain and less gain.

Saturday, July 10, 2010

The New "Downsized" Real Estate Forecast

There are new economic forecasts pouring in from Wall Street that there will be another down turn in home values in the months to come. Economists are predicting decreases between 3% to 5% nationally, but some markets could see greater declines. This should come as no surprise as new home ownership economic stimulus money dried up in April of this year, employment is sluggish at best and consumer confidence is in steep decline . It is sad but true that without government incentives people are just not that optimistic about purchasing real estate. You would think with mortgage rates at historic lows, home prices 35% off their market highs (much more in some areas) and plenty of seller incentives on the table, buyers would be flocking to home ownership. Fact is in down economies cash is king and most are holding on to cash for necessities and emergencies. People feel in their gut that we will be in a down economy for several more years and gambling on home ownership is not a option at this time.

What drove the boom in real estate values from 2001 to 2006 were market speculators, investors and huge Wall Street REIT pools. There was plenty of cash to be made and everyone wanted in on the game. Cash was everywhere flowing like a river. Like all good things must come to an end, in August of 2007 financial markets froze and the party was over. There is an old adage that greedy pigs get slaughtered. Most "pigs"who participated in the speculation are now broke or slowly becoming broke. Real estate can be a good investment depending on what time frame in the economic cycle you hold it.

The bottom line is that real estate is in essence shelter. Along with food, air and love we all need somewhere to lay our head at night. There have been decades where real estate was never seen as an investment, but as a home to raise your children and shelter your family from the storm. Purchase real estate not on speculation, but on becoming a member of the community and laying down roots. Owning a home adds value to everyone that surrounds you, not to mention tax advantages and a potential for appreciation. Renting will never feel as good as owning and owning now is cheaper than it has been in 10 years.

Friday, July 9, 2010

Why We Drill Offshore and Pay $3.00 for Gas

It is a very sad moment when you suddenly realize that we are all just being led down the chute like pigs in the poke. As individuals we like to feel that our contributions helps the world somehow and what we do everyday matters. Then you read an article that sets you back a few feet and makes you question what really is the big picture? Who is really running the show? Is our world run by a planet of individuals or is it run by governments and corporations back slapping, cigar filled, back-room hand shake deals.

We have all been led to believe that the world of goods and services runs on a system of supply and demand. Prices for these goods and services are determined by how much we demand and how much is available (ie, higher prices if what we demand is a scarce resource). Then you find out that prices of something that everyone on the planet demands is not calibrated that way. Maybe the world as we know it is not as we know it. Maybe governments and corporations have back-door agreements that artificially fix prices so that they can benefit financially while the rest of us suffer.

Imagine how much better we would be economically if gas prices were allowed to be a true supply/demand market price. How much better would your bank account look if it only cost $25 to fill your gas tank instead of $60? How much lower would your power bill be? How much would air fares go down? Fact is gas prices have a HUGE impact on us all and not just at the gas pump. High gas prices ripple through the economy like waves, effecting everything in its path. Though there are other artificially priced industries due to government subsidies, tariffs, fines and taxes, none that impact us as much in the pocket as gasoline. The article below says it all. Time to squeal...

Tuesday, July 6, 2010