The Dow has shed thousands of points and the global economy is in crisis.
So who wants to buys a house right now? Not many people, it turns out.
The National Association of Home Builders, for instance, has seen its contract cancellations spike recently to as high as 30%, compared with an average rate of about 20%. During the housing boom, as few as 5% of sales were cancelled.
"The events of the past couple of weeks have people's heads spinning," said Steve Melman, NAHB's director of economic surveys.
The National Association of Realtors estimates that about 25% of the clients its members are working with are staying on the sidelines. They're looking at homes and intend to buy at some point, but right now they're worried about their jobs, their declining investments and falling housing prices.
"You have to have a lot of confidence to make this kind of big-ticket purchase in the current environment," said NAR spokesman Walter Molony.
Real estate agent Bob Rose was helping one couple look for an investment property in battered Contra Costa County, Calif., hoping to find a bargain that they could sell in a few years.
Then, on Sept. 29 the Dow dove nearly 800 points and the couple decided not to buy. "They told me they had lost about a quarter of their retirement portfolio," said Rose, and that they could no longer afford it.
Even some buyers who are already in contract are managing to pull out of sales amidst all the economic turmoil.
Deal or no deal
Two weeks ago, one Washington state couple, Sharif Tai and Gaby Ghafari, went into contract on a new $450,000, three bed, three bath, house in central Seattle. Soon afterwards, the stock market began its steep descent.
"It wasn't that we lost money [in the market] or that we were worried about our jobs," said Tai, a software developer in his mid-20s. "We thought we could get a better deal, so we decided to wait."
The couple backed out of the deal by citing problems with the inspection, but they haven't given up on making a purchase.
"We're keeping our eyes out," said Tai. "We want to see how things shake out. If we see a great deal, we'll take it."
Other buyers are demanding sweeteners before they close a deal during such a rocky time. San Francisco agent Jim Holt had clients go into contract on Sept. 29, on a $750,000 home in town. But by the end of the week the Dow had lost over 800 points and the buyer demanded a whopping $50,000 price cut.
"Buyers are seeing the [market implosion] as an opportunity to get concessions," said Holt. In the end, the seller only agreed to reduce the price by $5,000 - but that's better than nothing.
Other house hunters are managing to wring more concessions out of sellers even on top of existing discounts.
Rich Machado, an agent with the Smart Homebuyer Team in New Bedford, Mass., had already helped one buyer get a seller to take $9,000 off the price of a house listed for $229,000, and throw in $6,000 in closing costs, $1,800 for an electric upgrade and $400 for a home service contract.
The deal went into contract two weeks ago. Despite that impressive array of incentives, "the buyer is balking," said Machado. "He's asking for another $10,000 off the price."
The seller hasn't caved in yet - but with demand drying up, he may be forced to come around.
As the losses mount on Wall Street - the Dow lost 678 points on Thursday alone - things will undoubtedly become even more difficult for sellers.
"In the midst of such chaos, everyone is just shaking their heads," said NAHB's Melman.
Friday, October 10, 2008
Thursday, October 9, 2008
Shorts blamed for Morgan Stanley plunge
Bank stocks sank across the board Thursday and some market watchers blamed the drop on expiration of the short selling ban on financial stocks.
Wells Fargo (WFC, Fortune 500), Wachovia (WB, Fortune 500) and Morgan Stanley (MS, Fortune 500) were particularly hard hit, with each posting double-digit percentage declines.
Morgan tumbled over 15% as of midday as the investment bank continued to be plagued by rumors that Japan's Mitsubishi UFJ (MTU) agreement to buy a 20% stake in Morgan was in jeopardy.
A Morgan spokesman dismissed such rumors, saying the deal will close this coming Tuesday under the same terms announced earlier this week.
Mitsubishi also said in a statement Wednesday morning that the rumors are not true and that it expects the deal to close next Tuesday.
A source familiar with the Morgan-Mitsubishi deal blamed the slide in Morgan Stanley's stock Thursday on the expiration of the short selling ban.
Jack Ablin, chief investment officer at Harris Private Bank in Chicago, also blamed the drop in Morgan's shares on short selling.
The Securities and Exchange Commission barred stock traders from shorting most financial stocks on Sept. 19 as the credit crisis unfolded. The SEC extended the ban last week and said that if a bank bailout bill was signed into law, the ban would end three business days after that.
Short sellers borrow stock at one price and sell it with the hopes of buying the stock later at a lower price so they can pocket the difference. Some have blamed short sellers for spreading false rumors about banks in order to send the stocks drastically lower.
But the ban was controversial, with some arguing that short sellers do a service to the market by identifying overvalued stocks and that prohibiting short selling was nothing more than an artificial manipulation of the market.
Still, even with the short selling ban in place, bank stocks took a beating. The S&P Banking Index plunged 30% since the ban took effect.
Short selling may not be the only thing weighing on bank shares Thursday. The U.S. government is also thinking about buying bank stocks, the White House said.
The move would be an attempt to directly inject capital into banks - which have been starved of cash as homeowners default on mortgages and inter-bank lending dries up.
But banks would issue new shares for the government to purchase, diluting the value of existing shares for current stock holders. Also, analysts said the government would likely buy shares of the banks facing the most financial trouble, which isn't exactly a vote of confidence for the industry.
Wells Fargo (WFC, Fortune 500), Wachovia (WB, Fortune 500) and Morgan Stanley (MS, Fortune 500) were particularly hard hit, with each posting double-digit percentage declines.
Morgan tumbled over 15% as of midday as the investment bank continued to be plagued by rumors that Japan's Mitsubishi UFJ (MTU) agreement to buy a 20% stake in Morgan was in jeopardy.
A Morgan spokesman dismissed such rumors, saying the deal will close this coming Tuesday under the same terms announced earlier this week.
Mitsubishi also said in a statement Wednesday morning that the rumors are not true and that it expects the deal to close next Tuesday.
A source familiar with the Morgan-Mitsubishi deal blamed the slide in Morgan Stanley's stock Thursday on the expiration of the short selling ban.
Jack Ablin, chief investment officer at Harris Private Bank in Chicago, also blamed the drop in Morgan's shares on short selling.
The Securities and Exchange Commission barred stock traders from shorting most financial stocks on Sept. 19 as the credit crisis unfolded. The SEC extended the ban last week and said that if a bank bailout bill was signed into law, the ban would end three business days after that.
Short sellers borrow stock at one price and sell it with the hopes of buying the stock later at a lower price so they can pocket the difference. Some have blamed short sellers for spreading false rumors about banks in order to send the stocks drastically lower.
But the ban was controversial, with some arguing that short sellers do a service to the market by identifying overvalued stocks and that prohibiting short selling was nothing more than an artificial manipulation of the market.
Still, even with the short selling ban in place, bank stocks took a beating. The S&P Banking Index plunged 30% since the ban took effect.
Short selling may not be the only thing weighing on bank shares Thursday. The U.S. government is also thinking about buying bank stocks, the White House said.
The move would be an attempt to directly inject capital into banks - which have been starved of cash as homeowners default on mortgages and inter-bank lending dries up.
But banks would issue new shares for the government to purchase, diluting the value of existing shares for current stock holders. Also, analysts said the government would likely buy shares of the banks facing the most financial trouble, which isn't exactly a vote of confidence for the industry.
Friday, October 3, 2008
California asks Fed for $7B loan
California may need a $7 billion emergency loan from the Federal government for day-to-day operations and to pay teachers' salaries, nursing homes, law enforcement and every other State-funded service this month, Gov. Arnold Schwarzenegger warned in a letter sent Thursday to the U.S. Treasury secretary.
The California governor's letter, published in Friday's Los Angeles Times, was written on the eve of an expected vote in the U.S. House on the Federal bailout of the financial system.
"The federal rescue package is not a bailout of Wall Street tycoons - it is a lifeboat for millions of Americans whose life savings, businesses, retirement plans and jobs are at stake," Schwarzenegger said.
California State Treasurer Bill Lockyer issued a statement a day earlier saying because of the national financial crisis, California "has been locked out of credit markets for the past 10 days."
"Absent a clear resolution to this financial crisis that restores confidence and liquidity to the credit markets, California and other states may be unable to obtain the necessary level of financing to maintain government operations and may be forced to turn to the Federal Treasury for short-term financing," Schwarzenegger wrote.
California's governor warned that a number of states are facing the same cash flow crunch this month, but his state is "so large that our short-term cash flow needs exceed the entire budget of some states."
Schwarzenegger said his state would attempt to sell "$7 billion in Revenue Anticipation Notes for short term cash flow purposes in a matter of days."
Lockyer said that unless the national economic crisis subsides and California can secure private short-term loans "the State's cash reserves would be exhausted near the end of October."
"Payments for teachers' salaries, nursing homes, law enforcement and every other State-funded service would stop or be significantly delayed," Lockyer said. "And California's 5,000 cities, counties, school districts and special districts would face the same fate."
The Federal bailout, which passed the Senate Wednesday night, would permit the Treasury to buy up $700 billion of bad assets - most of which are backed by mortgages - from banks in an effort to clean up their balance sheets so that they can resume lending.
The credit crunch, a decline in state tax collections and a delay in adoption of a state budget have combined to aggravate California's cash flow troubles.
"The economic fallout from this national credit crisis continues to drain state tax coffers, making it even more difficult to weather the continuation of frozen credit markets for any length of time," Schwarzenegger said.
The California governor's letter, published in Friday's Los Angeles Times, was written on the eve of an expected vote in the U.S. House on the Federal bailout of the financial system.
"The federal rescue package is not a bailout of Wall Street tycoons - it is a lifeboat for millions of Americans whose life savings, businesses, retirement plans and jobs are at stake," Schwarzenegger said.
California State Treasurer Bill Lockyer issued a statement a day earlier saying because of the national financial crisis, California "has been locked out of credit markets for the past 10 days."
"Absent a clear resolution to this financial crisis that restores confidence and liquidity to the credit markets, California and other states may be unable to obtain the necessary level of financing to maintain government operations and may be forced to turn to the Federal Treasury for short-term financing," Schwarzenegger wrote.
California's governor warned that a number of states are facing the same cash flow crunch this month, but his state is "so large that our short-term cash flow needs exceed the entire budget of some states."
Schwarzenegger said his state would attempt to sell "$7 billion in Revenue Anticipation Notes for short term cash flow purposes in a matter of days."
Lockyer said that unless the national economic crisis subsides and California can secure private short-term loans "the State's cash reserves would be exhausted near the end of October."
"Payments for teachers' salaries, nursing homes, law enforcement and every other State-funded service would stop or be significantly delayed," Lockyer said. "And California's 5,000 cities, counties, school districts and special districts would face the same fate."
The Federal bailout, which passed the Senate Wednesday night, would permit the Treasury to buy up $700 billion of bad assets - most of which are backed by mortgages - from banks in an effort to clean up their balance sheets so that they can resume lending.
The credit crunch, a decline in state tax collections and a delay in adoption of a state budget have combined to aggravate California's cash flow troubles.
"The economic fallout from this national credit crisis continues to drain state tax coffers, making it even more difficult to weather the continuation of frozen credit markets for any length of time," Schwarzenegger said.
Manhattan real estate: Pricey but headed for a fall
The crisis on Wall Street hasn't hit the high cost of Manhattan real estate, but the economic slowdown has curbed the number of deals in the Big Apple, according to reports out Friday.
Sales figures from four major New York real estate agencies showed the average price for a Manhattan apartment rose in the third quarter over last year. At the same time, the number of apartments sold in the quarter declined sharply.
"The events of the second half of September in the financial markets and Washington have not shown up in the market data for the quarter, aside from the lower level of sales activity compared to last year's record levels," said Jonathan Miller, president of New York real estate firm Miller Samuel.
The average price of a Manhattan apartment ranged from $1.4 million to $1.48 million in the third quarter of 2008, according to separate reports released Friday by Brown Harris Stevens, the Corcoran Group, Halstead Property and Prudential Douglas Elliman. That represents an increase of anywhere between 8% and 12% over average apartment prices in the third quarter of 2007.
But the rise in third quarter sale prices was skewed by a large number of deals in new luxury buildings, which went into contract as much as a year or two ago, before economic conditions deteriorated, but only closed recently, according to Corcoran Group CEO Pamela Liebman.
"The average sales price is going to trend down," Liebman said. After soaring to unprecedented heights in 2007, "we're going to get back to a more normal range," she added.
Dwindling deals
Already the number of properties sold during the quarter saw a steep decline from the record highs hit in the third quarter of last year.
Corcoran sold fewer than 3,000 properties last quarter, down 45% from the nearly 5,500 properties the agency sold in the third quarter of 2007.
At the same time, the number of properties on the market is increasing. Listing inventory rose 34% during the third quarter, according to Miller's research.
"Clearly, inventory is moving higher as sales activity has fallen," said Miller, who attributed the slowdown at least in part to the fact that mortgages have become more expensive and harder to get.
And economic turmoil in Europe has crimped the flow of overseas buyers to the city. Miller estimates that foreign buyers made up one-third of all purchases in new developments in New York last year.
While the labor market in New York has remained relatively stable, the fallout from the crisis on Wall Street, and the corresponding rise in unemployment in the financial sector, will probably further undermine the city's real estate market.
"We're going into an uncertain economic period with volume at low levels and a low likelihood of new development," Miller said.
Miller said the direction of the real estate market could hinge on Washington's proposed financial intervention, which is currently being debated in Congress and the outcome of this year's presidential election.
One of the main goals of the bailout plan is to free up the frozen credit markets, which have been a major drag on economic activity - particularly in the housing market.
"The question of housing is almost moot unless you get a handle on where credit is going," Miller said.
Sales figures from four major New York real estate agencies showed the average price for a Manhattan apartment rose in the third quarter over last year. At the same time, the number of apartments sold in the quarter declined sharply.
"The events of the second half of September in the financial markets and Washington have not shown up in the market data for the quarter, aside from the lower level of sales activity compared to last year's record levels," said Jonathan Miller, president of New York real estate firm Miller Samuel.
The average price of a Manhattan apartment ranged from $1.4 million to $1.48 million in the third quarter of 2008, according to separate reports released Friday by Brown Harris Stevens, the Corcoran Group, Halstead Property and Prudential Douglas Elliman. That represents an increase of anywhere between 8% and 12% over average apartment prices in the third quarter of 2007.
But the rise in third quarter sale prices was skewed by a large number of deals in new luxury buildings, which went into contract as much as a year or two ago, before economic conditions deteriorated, but only closed recently, according to Corcoran Group CEO Pamela Liebman.
"The average sales price is going to trend down," Liebman said. After soaring to unprecedented heights in 2007, "we're going to get back to a more normal range," she added.
Dwindling deals
Already the number of properties sold during the quarter saw a steep decline from the record highs hit in the third quarter of last year.
Corcoran sold fewer than 3,000 properties last quarter, down 45% from the nearly 5,500 properties the agency sold in the third quarter of 2007.
At the same time, the number of properties on the market is increasing. Listing inventory rose 34% during the third quarter, according to Miller's research.
"Clearly, inventory is moving higher as sales activity has fallen," said Miller, who attributed the slowdown at least in part to the fact that mortgages have become more expensive and harder to get.
And economic turmoil in Europe has crimped the flow of overseas buyers to the city. Miller estimates that foreign buyers made up one-third of all purchases in new developments in New York last year.
While the labor market in New York has remained relatively stable, the fallout from the crisis on Wall Street, and the corresponding rise in unemployment in the financial sector, will probably further undermine the city's real estate market.
"We're going into an uncertain economic period with volume at low levels and a low likelihood of new development," Miller said.
Miller said the direction of the real estate market could hinge on Washington's proposed financial intervention, which is currently being debated in Congress and the outcome of this year's presidential election.
One of the main goals of the bailout plan is to free up the frozen credit markets, which have been a major drag on economic activity - particularly in the housing market.
"The question of housing is almost moot unless you get a handle on where credit is going," Miller said.
Venture firms brace for cash crunch
Harold Bradley manages $2.1 billion for the Kansas City, Mo.-based Ewing Marion Kauffman Foundation. If you are a venture capitalist looking for a new limited partner, he's got something to tell you. "Don't stop in here," he says. "Don't try and sell me on a new fund, and good luck trying with everyone else."
Venture capital, as every VC is happy to tell you, operates on seven-to-ten-year cycles. Firms don't, for the most part, use debt to fund their companies. So in theory they should be shielded from the financial mess that has laid waste to some of the largest financial institutions in the world. But no one is getting out of this unscathed, and certainly not the gang that occupies Sand Hill Road in Silicon Valley.
The conversation among limited partners in VC funds these days is all about liquidity, Bradley says. Who's got it, and who doesn't. Hiding your money in illiquid venture capital funds looked pretty good six or 12 months ago. But if you are an endowment or pension fund with a huge exposure to a mega-buyout firm that is cratering, a hedge fund that is being wiped out or a venture fund that is on a seven-year runway to returns (in a market with no exits), what you want is cash now - not a one, three or five year wait to cash in.
So what does the financial crisis mean for VCs and for startups? For starters, if you are a second or third-tier venture firm trying to raise another fund, you can, as Bradley suggests, forget about it.
Before the market meltdown it might have been OK for a pension fund or university endowment to park money in an underperforming VC fund as a limited partner. But going forward, all bets are off.
Venture capital operates via commitments. A limited partner pledges a certain amount to a fund, and as the VC firm needs it, it makes capital calls to get that money to fund its portfolio companies. If you don't pony up when asked, you typically lose all your prior investment and are frozen out going forward. After the dotcom crash, capital calls came from VC firms and some limited partners simply said no - whether it was because they were wiped out in the Internet implosion, or they didn't want to throw good money after bad.
It could be worse this time around. "My expectation is that it will start first in some private equity funds, that there will be a substantial miss on a capital call, and we'll see it next in venture capital," says Paul Kedrosky, an investor and academic focused on the future of risk capital and writer of the business blog Infectious Greed. "No one is going to stiff Kleiner Perkins, but the second or third-tier guys will get stiffed all day long."
If you are a startup backed by a VC firm with loads of limited partners that are exposed to the Wall Street meltdown, or are mostly funded by angel investors without the deep pockets, now is when you start to worry and need to consider a future without that next round of funding.
"Any LP can be at risk," says Mark Tluszcz, co-founder and managing partner at one of the leading European venture firms, Mangrove Capital. "If there is a big LP, whether it is a bank or an insurance company, if they are facing serious financial issues they are going to cut back on their commitments."
Says Warren Weiss, a partner with Palo Alto-Calif.-based VC firm Foundation Capital: "If you are a company with a big cash burn, you are in for some pretty tough times. We're going to see more fire sales than mergers. You'll see a lot of companies in the $200-$400 million range that can't go public now, get acquired. The weak will get weeded out."
With hedge funds, buyout shops, even venture debt funds mostly on the sidelines, money is about to get really tight. The pressure will fall on VCs to decide which of their portfolio companies live and which die. Weiss believes liquidity is the key to navigating the next 12 t 18 months. "If you are a startup or a limited partner, it's no cash, no company," Weiss says.
Bryan LeBlanc, CFO of Portland, Ore.-based startup Jive Software, agrees. "If you are not cash-flow positive you are in a tough spot right now," says LeBlanc, whose company develops collaboration software for the workplace.
Jive is in relatively good shape, because it has significant revenue, was bootstrapped for the first six years, and only recently raised its first round of funding from Sequoia Capital. "To the extent you haven't figured out your business model yet you are in trouble, because it's going to be hard to get another round," LeBlanc says. "You aren't going to get a second life this time."
Brian Jacobs, a partner with San Mateo, Calif.-based Emergence Capital, is anticipating a shakeout. "There will be some realignment among firms and startups," he says, "but the bottom line is it just got a lot harder to make money in the venture capital business than a year ago - and maybe that is the way it should be."
Venture capital, as every VC is happy to tell you, operates on seven-to-ten-year cycles. Firms don't, for the most part, use debt to fund their companies. So in theory they should be shielded from the financial mess that has laid waste to some of the largest financial institutions in the world. But no one is getting out of this unscathed, and certainly not the gang that occupies Sand Hill Road in Silicon Valley.
The conversation among limited partners in VC funds these days is all about liquidity, Bradley says. Who's got it, and who doesn't. Hiding your money in illiquid venture capital funds looked pretty good six or 12 months ago. But if you are an endowment or pension fund with a huge exposure to a mega-buyout firm that is cratering, a hedge fund that is being wiped out or a venture fund that is on a seven-year runway to returns (in a market with no exits), what you want is cash now - not a one, three or five year wait to cash in.
So what does the financial crisis mean for VCs and for startups? For starters, if you are a second or third-tier venture firm trying to raise another fund, you can, as Bradley suggests, forget about it.
Before the market meltdown it might have been OK for a pension fund or university endowment to park money in an underperforming VC fund as a limited partner. But going forward, all bets are off.
Venture capital operates via commitments. A limited partner pledges a certain amount to a fund, and as the VC firm needs it, it makes capital calls to get that money to fund its portfolio companies. If you don't pony up when asked, you typically lose all your prior investment and are frozen out going forward. After the dotcom crash, capital calls came from VC firms and some limited partners simply said no - whether it was because they were wiped out in the Internet implosion, or they didn't want to throw good money after bad.
It could be worse this time around. "My expectation is that it will start first in some private equity funds, that there will be a substantial miss on a capital call, and we'll see it next in venture capital," says Paul Kedrosky, an investor and academic focused on the future of risk capital and writer of the business blog Infectious Greed. "No one is going to stiff Kleiner Perkins, but the second or third-tier guys will get stiffed all day long."
If you are a startup backed by a VC firm with loads of limited partners that are exposed to the Wall Street meltdown, or are mostly funded by angel investors without the deep pockets, now is when you start to worry and need to consider a future without that next round of funding.
"Any LP can be at risk," says Mark Tluszcz, co-founder and managing partner at one of the leading European venture firms, Mangrove Capital. "If there is a big LP, whether it is a bank or an insurance company, if they are facing serious financial issues they are going to cut back on their commitments."
Says Warren Weiss, a partner with Palo Alto-Calif.-based VC firm Foundation Capital: "If you are a company with a big cash burn, you are in for some pretty tough times. We're going to see more fire sales than mergers. You'll see a lot of companies in the $200-$400 million range that can't go public now, get acquired. The weak will get weeded out."
With hedge funds, buyout shops, even venture debt funds mostly on the sidelines, money is about to get really tight. The pressure will fall on VCs to decide which of their portfolio companies live and which die. Weiss believes liquidity is the key to navigating the next 12 t 18 months. "If you are a startup or a limited partner, it's no cash, no company," Weiss says.
Bryan LeBlanc, CFO of Portland, Ore.-based startup Jive Software, agrees. "If you are not cash-flow positive you are in a tough spot right now," says LeBlanc, whose company develops collaboration software for the workplace.
Jive is in relatively good shape, because it has significant revenue, was bootstrapped for the first six years, and only recently raised its first round of funding from Sequoia Capital. "To the extent you haven't figured out your business model yet you are in trouble, because it's going to be hard to get another round," LeBlanc says. "You aren't going to get a second life this time."
Brian Jacobs, a partner with San Mateo, Calif.-based Emergence Capital, is anticipating a shakeout. "There will be some realignment among firms and startups," he says, "but the bottom line is it just got a lot harder to make money in the venture capital business than a year ago - and maybe that is the way it should be."
Wednesday, October 1, 2008
What investors should do now
It's time to panic.
Okay, now that we've got your attention, let's be clear: We're exaggerating - at least a little. We don't think the financial system is on the verge of collapse. But the complacency exhibited by many market pundits in the wake of the most wrenching episode in modern financial history is sufficiently shocking that it almost demands some scare-tactic response.
By our count some 300 articles were published last month telling investors "don't panic" or "not to panic." Urging calm is one thing. But too much soothing talk implies that there are no lessons to be learned. What's the use of a vertigo-inducing bout of market turbulence if the only conclusion is "stay the course"?
At the very least, it's a good reminder to take a hard look at your financial plans and to reevaluate how much market risk you can truly withstand in your portfolio. Because - don't panic! - this might not be completely over.
Richard Bernstein, the chief investment strategist at Merrill Lynch, worries that investors still don't appreciate the scope of the credit crisis.
"It's weird - the canary in the mineshaft has fallen over, and now everyone thinks there's a problem with canaries," says Bernstein, who, despite sounding the alarm about a global credit bubble as far back as 2006, could find himself out of a job after Merrill's forced sale to Bank of America. (Too bad Bernstein's Merrill bosses didn't heed his warnings.)
In Bernstein's eyes, the canary is the U.S. mortgage market, but the silent killer of loose credit was an international epidemic. "I don't perceive that most investors fully appreciate either the depth of the credit bubble or how broad-reaching it was in terms of emerging markets and hedge funds and commodities and all these other inflated asset classes that were dependent on easy credit," he says.
If consumers suddenly can't refinance their mortgages and credit cards and if more corporations can't issue bonds or tap lines of bank credit, their ability to weather any slowdown will be diminished. "The fundamentals are still extremely scary," says star financial-sector analyst (and recent Fortune cover subject) Meredith Whitney of Oppenheimer & Co. "It all gets down to how much liquidity will be created for consumers and corporations, and at the moment there's still less and less by the hour."
Here's another reason to be concerned: The professionals managing your money haven't gotten this market right. Consider that at the market low on Sept. 17, only five diversified U.S. equity mutual funds - out of a universe of 9,100 - had positive total returns for the year, according to Morningstar. FIVE! Even after the market rebounded, there were still only three funds with returns this year of 10% or better: Parnassus Small-Cap, Heartland Value Plus, and Forester Value.
If you haven't heard of any of those funds, that's the point. The investing world's best and brightest appear to be just as confused as the rest of us. Like Bill Miller. His streak of beating the S&P 500 now a distant memory, the Legg Mason Value Trust manager is down 35% this year. CGM Focus's Ken Heebner, whom Fortune dubbed "America's hottest investor" in June, is down 16%, while FPA Capital's Bob Rodriguez ("the best fund manager of our time," according to our sister magazine Money) is down 3%.
So how did the three 10%-plus returners beat the odds? One common thread is that they all stayed away from bank stocks. Beyond that, each went his own way. Thomas Forester, who runs his eponymous $20 million fund out of his study in suburban Chicago, made a successful bet on consumer staples - names like Anheuser-Busch, J.C. Penney, and Wal-Mart (WMT, Fortune 500). Brad Evans, manager of Heartland Value Plus, got into and out of oil stocks at the right times.
And Jerome Dodson, the 65-year-old manager of Parnassus Small-Cap, was king of the contrarians, earning his double-digit returns with an assist from the unlikeliest of sectors: homebuilders.
"Every one of my analysts said, 'Don't do it,'" Dodson says of his early-year decision to buy the builders. But Dodson was convinced that the companies' stocks would bounce back long before their plummeting earnings did. He wound up taking sizable positions in Pulte Homes and Toll Brothers, which are up 40% and 17%, respectively this year. Dodson himself admits he got a little lucky.
You can't count on hitting that kind of jackpot. But by taking a hard look at your portfolio, you can minimize your losses and prepare yourself to take advantage of new opportunities. And this is one time when following simple financial-planning tips could be worth more to your bottom line than picking the right stocks or funds. So let's start with some strategy before we get to our specific investment recommendations.
Take some tax losses. If you buy and sell stocks in a taxable portfolio, it's likely that you have some holdings trading for well below what you originally paid. Our advice: Sell your losers pronto and book the capital losses.
Those losses can be carried forward from one tax year to the next (and the next and the next) and thus used to offset future capital gains whenever the market rebounds. Not only that, but Boston accountant Gale Raphael of Raphael & Raphael points out that taxpayers can deduct up to $3,000 in capital losses from ordinary income. That amounts to a tax savings of $990 a year to someone in the 33% tax bracket.
What if you think your losers are about to rebound? IRS rules prevent you from buying them back for 30 days. But if you can't wait, try using the proceeds from your tax-loss sale to purchase stocks similar to the ones you're selling.
If you take a loss on United States Steel, for instance, replace it with rival steelmaker Nucor (NUE, Fortune 500). John Maloney, who manages high-net-worth accounts with M&R Capital in New York, says the IRS rules even allow you to take a tax loss on, say, Schlumberger, and replace it right away with an oil-services exchange-traded fund in which Schlumberger is a major holding. Says Maloney: "It won't trigger an objection unless it's materially the same security
Okay, now that we've got your attention, let's be clear: We're exaggerating - at least a little. We don't think the financial system is on the verge of collapse. But the complacency exhibited by many market pundits in the wake of the most wrenching episode in modern financial history is sufficiently shocking that it almost demands some scare-tactic response.
By our count some 300 articles were published last month telling investors "don't panic" or "not to panic." Urging calm is one thing. But too much soothing talk implies that there are no lessons to be learned. What's the use of a vertigo-inducing bout of market turbulence if the only conclusion is "stay the course"?
At the very least, it's a good reminder to take a hard look at your financial plans and to reevaluate how much market risk you can truly withstand in your portfolio. Because - don't panic! - this might not be completely over.
Richard Bernstein, the chief investment strategist at Merrill Lynch, worries that investors still don't appreciate the scope of the credit crisis.
"It's weird - the canary in the mineshaft has fallen over, and now everyone thinks there's a problem with canaries," says Bernstein, who, despite sounding the alarm about a global credit bubble as far back as 2006, could find himself out of a job after Merrill's forced sale to Bank of America. (Too bad Bernstein's Merrill bosses didn't heed his warnings.)
In Bernstein's eyes, the canary is the U.S. mortgage market, but the silent killer of loose credit was an international epidemic. "I don't perceive that most investors fully appreciate either the depth of the credit bubble or how broad-reaching it was in terms of emerging markets and hedge funds and commodities and all these other inflated asset classes that were dependent on easy credit," he says.
If consumers suddenly can't refinance their mortgages and credit cards and if more corporations can't issue bonds or tap lines of bank credit, their ability to weather any slowdown will be diminished. "The fundamentals are still extremely scary," says star financial-sector analyst (and recent Fortune cover subject) Meredith Whitney of Oppenheimer & Co. "It all gets down to how much liquidity will be created for consumers and corporations, and at the moment there's still less and less by the hour."
Here's another reason to be concerned: The professionals managing your money haven't gotten this market right. Consider that at the market low on Sept. 17, only five diversified U.S. equity mutual funds - out of a universe of 9,100 - had positive total returns for the year, according to Morningstar. FIVE! Even after the market rebounded, there were still only three funds with returns this year of 10% or better: Parnassus Small-Cap, Heartland Value Plus, and Forester Value.
If you haven't heard of any of those funds, that's the point. The investing world's best and brightest appear to be just as confused as the rest of us. Like Bill Miller. His streak of beating the S&P 500 now a distant memory, the Legg Mason Value Trust manager is down 35% this year. CGM Focus's Ken Heebner, whom Fortune dubbed "America's hottest investor" in June, is down 16%, while FPA Capital's Bob Rodriguez ("the best fund manager of our time," according to our sister magazine Money) is down 3%.
So how did the three 10%-plus returners beat the odds? One common thread is that they all stayed away from bank stocks. Beyond that, each went his own way. Thomas Forester, who runs his eponymous $20 million fund out of his study in suburban Chicago, made a successful bet on consumer staples - names like Anheuser-Busch, J.C. Penney, and Wal-Mart (WMT, Fortune 500). Brad Evans, manager of Heartland Value Plus, got into and out of oil stocks at the right times.
And Jerome Dodson, the 65-year-old manager of Parnassus Small-Cap, was king of the contrarians, earning his double-digit returns with an assist from the unlikeliest of sectors: homebuilders.
"Every one of my analysts said, 'Don't do it,'" Dodson says of his early-year decision to buy the builders. But Dodson was convinced that the companies' stocks would bounce back long before their plummeting earnings did. He wound up taking sizable positions in Pulte Homes and Toll Brothers, which are up 40% and 17%, respectively this year. Dodson himself admits he got a little lucky.
You can't count on hitting that kind of jackpot. But by taking a hard look at your portfolio, you can minimize your losses and prepare yourself to take advantage of new opportunities. And this is one time when following simple financial-planning tips could be worth more to your bottom line than picking the right stocks or funds. So let's start with some strategy before we get to our specific investment recommendations.
Take some tax losses. If you buy and sell stocks in a taxable portfolio, it's likely that you have some holdings trading for well below what you originally paid. Our advice: Sell your losers pronto and book the capital losses.
Those losses can be carried forward from one tax year to the next (and the next and the next) and thus used to offset future capital gains whenever the market rebounds. Not only that, but Boston accountant Gale Raphael of Raphael & Raphael points out that taxpayers can deduct up to $3,000 in capital losses from ordinary income. That amounts to a tax savings of $990 a year to someone in the 33% tax bracket.
What if you think your losers are about to rebound? IRS rules prevent you from buying them back for 30 days. But if you can't wait, try using the proceeds from your tax-loss sale to purchase stocks similar to the ones you're selling.
If you take a loss on United States Steel, for instance, replace it with rival steelmaker Nucor (NUE, Fortune 500). John Maloney, who manages high-net-worth accounts with M&R Capital in New York, says the IRS rules even allow you to take a tax loss on, say, Schlumberger, and replace it right away with an oil-services exchange-traded fund in which Schlumberger is a major holding. Says Maloney: "It won't trigger an objection unless it's materially the same security
In debt markets, the cost of buying insurance against a U.S. default is rising.
What odds would you lay that Uncle Sam is going to be a deadbeat?
Until a few weeks ago, that sounded like a ludicrous question. And even amidst bailout insanity, the market has shown that the vast majority of investors still hold the view that U.S. Treasury bonds are the safest of safe havens, the kind of investment you'd bring into your bunker in the event of a nuclear attack.
But a few skeptics are willing to put money their money where their doubts are.
One day after the failure to pass a Wall Street bailout plan sent the bond market into convulsions, skittishness about Uncle Sam's prospects was felt in the market for credit default swaps, insurance-like contracts in which buyers pay a premium and sellers agree to compensate them in the event of a specified event - most often the default of a bond.
In New York trading Tuesday, prices rose to a record 31.3 basis points (each basis point is 1/100 of a percentage point) to "insure" Treasury debt, compared to as little as 7.5 basis points in January, according to information provided by CMA DataVision.
In other words, it would've cost you $7,500 per year to protect $10 million in Treasury bonds in January - but $31,300 today. Of course, even the latter figure remains negligible compared to, say, the $2 million up front - plus $500,000 per year - that you would have needed to pay for the same amount of default swap protection on Morgan Stanley (MS, Fortune 500) bonds when the firm was under fire two weeks ago. But the increase is telling nonetheless.
A wild market
Credit default swaps are a wild, unregulated market - see "The $55 Trillion Question" - in which participants make bets on the failure of corporate bonds, municipal bonds and, yes, U.S. government bonds.
Default swaps on U.S. bonds have been bought and sold for at least four years, says Simon Mott of CMA DataVision. But the market is still little known. One prominent trader in U.S. debt, when asked about swaps on Treasurys, expressed surprise and started asking co-workers, "Did you guys know that there are credit default swaps on U.S. bonds"? (The other traders seemed to know, though one could be heard saying "it's the biggest joke" in the background.) U.S. government issues are not the only sovereign debt covered by swaps. Large banks such as JPMorgan Chase (JPM, Fortune 500) will match swap buyers and sellers for, say, U.K. debt or Icelandic government bonds.
Prices on U.S. government swaps may have peaked - at least for a day or two. The underlying market for U.S. bonds seemed to be stabilizing Tuesday, according to Tom di Galoma, the head of U.S. Treasurys trading at Jefferies & Co., as investors began anticipating that the government will provide some form of relief for the holders of toxic mortgage debt would pass. "We've seen the low in yields," di Galoma says. "Who else can go out of business at this point?"
Of course, if the past month has taught investors anything, it's how unsettling the answer to that question can be. But the U.S. failing to make its payments? Now that would be a shocker (yes, a Moody's spokesman confirms that it re-affirmed the U.S. government's AAA rating last week). And if it did, the swap player who bet the right way may not feel much like celebrating
Until a few weeks ago, that sounded like a ludicrous question. And even amidst bailout insanity, the market has shown that the vast majority of investors still hold the view that U.S. Treasury bonds are the safest of safe havens, the kind of investment you'd bring into your bunker in the event of a nuclear attack.
But a few skeptics are willing to put money their money where their doubts are.
One day after the failure to pass a Wall Street bailout plan sent the bond market into convulsions, skittishness about Uncle Sam's prospects was felt in the market for credit default swaps, insurance-like contracts in which buyers pay a premium and sellers agree to compensate them in the event of a specified event - most often the default of a bond.
In New York trading Tuesday, prices rose to a record 31.3 basis points (each basis point is 1/100 of a percentage point) to "insure" Treasury debt, compared to as little as 7.5 basis points in January, according to information provided by CMA DataVision.
In other words, it would've cost you $7,500 per year to protect $10 million in Treasury bonds in January - but $31,300 today. Of course, even the latter figure remains negligible compared to, say, the $2 million up front - plus $500,000 per year - that you would have needed to pay for the same amount of default swap protection on Morgan Stanley (MS, Fortune 500) bonds when the firm was under fire two weeks ago. But the increase is telling nonetheless.
A wild market
Credit default swaps are a wild, unregulated market - see "The $55 Trillion Question" - in which participants make bets on the failure of corporate bonds, municipal bonds and, yes, U.S. government bonds.
Default swaps on U.S. bonds have been bought and sold for at least four years, says Simon Mott of CMA DataVision. But the market is still little known. One prominent trader in U.S. debt, when asked about swaps on Treasurys, expressed surprise and started asking co-workers, "Did you guys know that there are credit default swaps on U.S. bonds"? (The other traders seemed to know, though one could be heard saying "it's the biggest joke" in the background.) U.S. government issues are not the only sovereign debt covered by swaps. Large banks such as JPMorgan Chase (JPM, Fortune 500) will match swap buyers and sellers for, say, U.K. debt or Icelandic government bonds.
Prices on U.S. government swaps may have peaked - at least for a day or two. The underlying market for U.S. bonds seemed to be stabilizing Tuesday, according to Tom di Galoma, the head of U.S. Treasurys trading at Jefferies & Co., as investors began anticipating that the government will provide some form of relief for the holders of toxic mortgage debt would pass. "We've seen the low in yields," di Galoma says. "Who else can go out of business at this point?"
Of course, if the past month has taught investors anything, it's how unsettling the answer to that question can be. But the U.S. failing to make its payments? Now that would be a shocker (yes, a Moody's spokesman confirms that it re-affirmed the U.S. government's AAA rating last week). And if it did, the swap player who bet the right way may not feel much like celebrating
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