|
Have you taken a look to see which of your stocks could be impacted if General Motors files for bankruptcy? What about the impact of higher mortgage rates … or a slumping economy … or a new war in the Middle East? Whether you like to admit it or not, you may be incurring risks that you havent thought about … or you may have excess fat that you need to get rid of. The Big Five-O This is especially true for portfolios of baby boomers. Many have accumulated so much stuff over the years, theyve long forgotten why they bought in the first place. So they just let it sit there, regardless of warning bells that may be ringing. Im a perfect example, and Im not talking about my money. Im talking about my health. Im not quite 50 yet, but my half-century mark is right around the corner later this year. Darn! How in the heck did I get so old so fast? I try to fool myself into thinking that the Big Five-O snuck up on me. But then I remember the gray hair on my head and spare tire around my mid-section. To add insult to injury, one of my best friends sent me a diet/exercise book for Christmas … and my wife mercilessly pestered me to go in for a full-blown checkup, especially a stress test. That actually turned out to be a good thing. The doctor gave me a clean bill of health … but only after he scolded and lectured me to lose some weight (well, actually, lots of weight). He says Im one of the healthiest fat guys hes ever seen, but unless I change, the healthy part is not going to last for long. Ditto for your money … The Must-Do Stress If you havent done so already, the time for your portfolio stress test isnt next year or next month. Its right now. Here are the three risks that worry me the most:
Plus, this leads me to one more risk which I think Im more aware of than most people because of my own technology business … The Risk of Major Technical Glitches Unlikely? Only happens once every century? Baloney! We had two incidents just this month. In fact, I personally experienced one hairy situation exactly 11 days ago, on January 20. I knew something was wrong two minutes after I sat down at my desk that Thursday morning. My voicemail box was overflowing with messages using colorful four-letter words, and my inbox was stuffed with e-mails saying URGENT! and HELP! in the subject line. The reason is my software company had transmitted thousands of erroneous pieces of stock data to all my customers. My customers use my data and software Monocle Systems to analyze and trade stocks, ETFs, and mutual funds. So the consequences of incorrect data can be missed opportunities … The good news is that I was able to quickly correct the errors and get everybody back up and running in less than half an hour. The bad news is that I wasnt alone. Databases all across the globe were pouring out bad data for over 1,500 stocks listed on the New York Stock Exchange and American Stock Exchange. Worse, 81,000 trades in the last 20 minutes of trading on the Nasdaq were not visible on non-Nasdaq computer terminals. The culprit was a computer glitch that pushed bad stock prices onto financial websites for most of the day on Thursday. MSN Money, Fidelity, Google, CNBC, Yahoo Finance, E-Trade and Charles Schwab all received the same bum data that I did. AMR was quoted as surging by $1.84. In reality, it went up by only 16 cents. United Technologies was quoted for a one-cent loss. But it actually went UP by 34 cents. Result: Anybody who used the bad data as part of their decision making may have been very unhappy. Garbage in, garbage out!
If you think thats scary, look at what happened to the Tokyo Stock Exchange earlier this month: It shut down and suspended all trading. Why? Well, if you listen to the experts, the cause was investor jitters about a widening criminal investigation of shareholder fraud at Livedoor.com, a Japanese Internet stock that had been surging like a rocket ship. Livedoor had experienced blazing-fast growth through a series of takeovers and had mushroomed into a company worth 730 billion yen ($6.3 billion U.S.) before the news hit: Greatly overstated profits and more than $1 billion yen of previously undisclosed losses. But Livedoor wasnt the cause. It was just the trigger. And the more important lesson to be learned is the techno-glitch lesson: Nervous investors started selling in droves. In fact, the selling stampede was so heavy and so relentless that the Tokyo Stock Exchanges trading system was on the verge of a complete meltdown. Thats why they had to shut down. The system was designed to handle four million transactions in a day, and the authorities figured that was plenty. But the Livedoor news created such a wave of panic selling that it pushed the system to its limit. After racking up 3.5 million transactions, with still an hour or so to go before the close, exchange officials had no choice but to halt trading or risk pandemonium. But the action by the authorities worries me as much as the glitch that they were reacting to. It means that no matter how badly investors wanted to sell (or buy), Japanese trading was frozen in time. This combination of … (a) temporarily zero liquidity and … could someday kill portfolios faster than the bursting of the dot-com bubble.
A concern only in Japan? Heck no! After the Crash of 1987, investors and regulators started clamoring for protection against precisely this kind of situation in the U.S. They identified the so-called program trading (automated buying and selling by computers) as the primary culprit. And the end result is a series of circuit breakers that kick in after the Dow Jones passes pre-determined limits based upon 10%, 20%, and 30% declines of the Dow Jones. There are various quirks and kinks in the system, but in general terms, it works like this: If the Dow Jones Industrial Average falls 10%, trading is halted on the New York Stock Exchange for one hour. If the Dow falls 20%, trading is halted for two hours. If it falls 30%, trading is halted for the entire day. What do they do if the Dow surges by similar magnitudes? The answer: Nothing! Thats right. There are no curbs for a one-day rise in the Dow Jones of 10% let alone 20% or 30%. In practice, I dont think youll ever see the day that will happen. But, in theory, if it makes sense for circuit breakers to interrupt a plunge … it should make equal sense for them to interrupt a surge. One without the other makes no sense whatsoever to me. Heck. Everyone knows the real cause of crashes isnt program trading and computer overloads. Its mostly related to the euphoric buying that comes before the crash. The Fed, which is meeting today to do its thing with interest rates (probably another quarter-point hike), has been thinking more about these asset bubbles these days. Some Fed members are even talking about it in public speeches. But real action to try to tame the bubbles? Zilch! My view: Most regulators dont give a darn about real causes. They just like to deal with patches to make the public feel good.
Since the Feds arent doing much about all this, the burden for protection falls back squarely on your shoulders. How would your portfolio fare if it were put under extreme stress? How much of its value would it lose if were right about oil, inflation, interest rates, housing? And how would it do in a major stock market glitch? For many investors, the answer is: very badly … especially if they have a lot of old fat in their portfolio … or if they dont respect these eight cardinal rules: 1. Say no to margin. If youre using borrowed money to goose your portfolio returns, you could be playing with fire. Consider reducing your holdings to raise the cash you need to pay back the debt. 2. Say no to high beta. High beta means high volatility. So if your portfolio is filled with volatile, high-beta stocks, I think youre again asking for trouble. There may be some exceptions, especially in solid, fundamentally-driven sectors like energy, gold and basic materials. But in most cases, the highest beta stocks are tech stocks, which is one sector that Im especially cautious about. Ignoring special situations for a moment, my general rule of thumb is this: Get rid of your 1.5 beta stocks and replace them with sub-1.0 beta stocks instead. 3. Say no to stocks and bonds that are vulnerable to the big risks weve been telling you about. That includes airlines, auto companies, and many financial stocks. It also includes long-term bonds of any shape or color. 4. Say yes to natural resource stocks. If your portfolio doesnt include any energy, precious metals or natural resource stocks or mutual funds, youre probably unprepared for one of the most powerful trends you may see in your lifetime. Just yesterday, for example, ExxonMobil posted the biggest profits for any company in history $10.71 billion for the fourth quarter and $36.13 billion for the year. The Energy Select SPDR (XLE) jumped by over about 2% again! to a new all-time high. And the Oil Service HOLDRS (OIH) surged even more, also to its highest level in history. Gold, meanwhile, jumped $7 yesterday, taking it within less than $3 of its 25-year highs. 5. Add a little zig to your zag. When I look at most peoples portfolios, I often see one-trick ponies. I see stock portfolios that only make money when markets are rising or bond portfolios that only make money when interest rates are falling. I think everyone, especially investors with a big fat stock and bond portfolio, should have at least some protection using investments that dance to a different drummer … Like Rydex Ursa (protection against falling stock prices) or Rydex Juno (protection from rising interest rates). These funds havent done well while stocks and bonds have been rising. But thats precisely because theyre designed specifically for falling markets. Along with some put options, they can be good insurance policies. 6. If you want to have some fun, add some pizzazz to your portfolio. This is not for your keep-safe money. But if you want to add fire power to your portfolio, one great vehicle is LEAPS. LEAPS are options. But unlike most options, they are long term with durations of one year, two years, even three years. I put them more or less in the same category as small-cap stocks. If they work, great. If not, write them off. And right now, Larry Edelson has found one heck of an attractive situation in LEAPS on major oil companies. Hes picked out big oils selling for as little as half the P/Es they were selling at during the 1990s. That means to get back up to a fair valuation, they’d have to double in value. Since this isnt going to happen overnight, hes using one-year LEAPS to play it. For more details, see Larrys latest report on oil stock LEAPS or call 877-719-3477. With Exxon’s mega-profit announcement yesterday, the timing couldn’t be better. 7. Save! While Exxon’s news was great, the news from the U.S. Commerce Department yesterday was worse than bad: America’s savings rate in 2005 fell into negative territory to the tune of 0.5%. In other words, for every $100 people are taking home in earnings, they’re spending $100.50. How is that possible? Well, first they’re saving a big fat zero. Then, on top of that, they’re digging into their savings (or they’re borrowing) an additional 50 cents! There are only two other years on record when the savings rate was this low: 1932 and 1933. But back then, businesses were failing left and right, and people were being laid off by the hundreds of thousands. So it made sense. But now, it’s not the pressure of bad times. It’s a borrowing-spending binge to buy luxury cars, bigger homes, and more. Don’t get sucked into this madness. Stash a big chunk of your cash and pile it up for a rainy day or for more great opportunities down the road. 8. Stay alert. Youve probably been through some turbulent times and great times. And were bound to be through a bunch more this time, I hope, together. In any case, dont just let the fat pile up in your portfolio year after year. Monitor the vital signs of the world around you. Stick with the best performers. And cut out the rest. Best wishes, Tony Sagami About MONEY AND MARKETS MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Beth Cain, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others. 2006 by Weiss Research, Inc. All rights reserved. |
Vital Stress Test
Have you checked to see what might happen in your bond portfolio if oil hits $70 per barrel? What about $100? 
The Livedoor Shock
One-Way Circuit Breakers
Does YOUR Portfolio Previous post: State of Shock
Next post: Fed getting tougher? OPEC losing control?
