Schwartz Financial Weekly Commentary 10/22/2012

The Markets

 

Twenty-five years later, are there any lasting lessons from the October 1987 stock market crash?

 

You may recall that on October 19, 1987, the Dow Jones Industrial Average plummeted 22.6 percent. This drop was far steeper than the 12.8 percent decline on October 28, 1929, the day many consider the start of the Great Depression and it “immediately raised fears of an international economic crisis and a recession in the United States,” according to the Los Angeles Times.

 

Although the crash was mind-boggling and is firmly etched in investment lore, on a long-term performance chart, it shows up as just a blip. In fact, in the first eight months of 1987, the Dow rose more than 40 percent, and, despite the crash, the Dow – amazingly – finished the year with a gain.

 

With the benefit of 25 years, here are a few investment lessons to remember:

 

1.   Don’t panic. The crash was painful, but the market was back to breakeven just two years later.

2.   Valuation matters. Traditional valuation metrics such as price earnings ratios and dividend yields were flashing red back in 1987 which suggested the market was ripe for a fall – so pay attention to valuation.

3.   Stay diversified. Even though correlation among asset classes tends to rise during times of market stress, it’s still important to own a variety of asset classes as over time, it may help balance your portfolio.

4.   Invest responsibly. People who borrowed money to invest in the stock market or made high-risk bets got burned when the market crashed. Always invest within your risk tolerance so a repeat of 1987 won’t put you out of business.

Sources: Los Angeles Times; The Motley Fool; Forbes

 

When asked what the stock market will do, the great banker J.P. Morgan replied, “It will fluctuate.” Indeed, as October 1987 shows, stocks do fluctuate – sometimes dramatically. Knowing that and remembering the four lessons above could help make you a better investor.

 

Data as of 10/19/12	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	0.3%	14.0%	18.5%	9.3%	-0.9%	4.8%
DJ Global ex US (Foreign Stocks)	1.9	9.8	6.6	0.0	-6.4	7.4
10-year Treasury Note (Yield Only)	1.8	N/A	2.2	3.4	4.4	4.2
Gold (per ounce)	-1.7	10.3	5.1	18.3	17.9	18.7
DJ-UBS Commodity Index	-0.4	4.1	1.0	2.3	-4.0	3.3
DJ Equity All REIT TR Index	1.5	17.4	29.5	20.6	3.2	12.2

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  N/A means not applicable.

 

HOW GOOD ARE YOU at predicting the future? Well, despite a bazillion bits of information at our fingertips and unbelievable computing power, humans are still pretty bad at it.

 

Let’s use an example that gets to the heart of the financial crisis. As described in Nate Silver’s book, The Signal and the Noise, back in 2007 Standard & Poor’s Corporation (S&P) gave investment ratings to a particularly complex type of security called collateralized debt obligation (CDO). For CDO’s that were rated AAA – the highest rating possible – S&P said the likelihood that a piece of debt within those CDO’s would default within five years was a miniscule 0.12 percent. That’s about one chance in 850.

 

Now, you probably know where this is going. Guess what the actual default rate was? According to S&P, it was around 28 percent. Simple math says the actual default rate was more than 200 times higher than S&P predicted and, as Silver wrote, “This is just about as complete a failure as it is possible to make in a prediction.”

 

It’s easy to poke fun at bad predictions; however, there is a larger point here. First, we can’t predict the future so we always need a plan B. And, second, we need to differentiate between risk and uncertainty.

 

Economist Frank Knight said risk involves situations where we can calculate the probability of a particular outcome. For example, actuaries can calculate the probability of a 60-year old male dying within 10 years because they have historical mortality statistics that don’t change much from year to year.

 

By contrast, uncertainty has no historical data to use as a solid basis for making a prediction. For example, predicting the outcome of war in Syria is not knowable because there’s no set of historical data or probability distribution on which to base the prediction.

 

It’s just our luck that the financial markets seem to contain elements of risk and uncertainty. However, we can try to use that to our benefit by being cognizant when the risk/reward seems to be in our favor while at the same time, having plan B in case uncertainty tries to spoil the party.

 

Weekly Focus – Think About It…

 

“It is a truth very certain that when it is not in our power to determine what is true we ought to follow what is most probable.”

--Descartes, French philosopher, mathematician, writer

Value vs. Growth Investing (10/19/12)

Name	1-Week	YTD	4-Week	13-Week	1-Year	3-Year	5-Year
US Market	0.40	15.63	-1.91	4.61	20.90	11.86	1.72
Large Cap	0.25	16.40	-1.76	4.58	21.41	11.40	1.21
Large Core	1.12	17.05	-0.66	4.92	23.81	11.61	2.64
Large Growth	-1.64	17.59	-4.86	1.56	19.21	12.42	2.32
Large Value	1.44	14.96	0.57	7.59	21.43	10.21	-1.60
Mid Cap	1.00	13.81	-1.90	5.08	19.16	12.96	2.56
Mid Core	0.64	13.48	-1.97	3.73	21.30	14.50	3.55
Mid Growth	0.69	13.45	-2.98	4.06	14.53	13.25	1.61
Mid Value	1.66	14.48	-0.68	7.46	21.61	11.00	2.32
Small Cap	0.28	12.55	-3.48	3.53	20.37	12.66	3.66
Small Core	0.33	11.38	-3.81	2.42	18.54	10.97	2.70
Small Growth	-0.43	11.70	-4.53	2.42	18.16	13.73	2.56
Small Value	0.94	14.63	-2.07	5.79	24.54	13.28	5.72
US Core	0.97	15.98	-1.13	4.52	22.97	12.27	2.98
US Growth	-1.11	16.32	-4.47	2.10	18.16	12.77	2.25
US Value	1.45	14.85	0.14	7.44	21.71	10.59	-0.31

©2004 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) is not warranted to be accurate, complete or timely. Morningstar is not responsible for any damages or losses arising from any use of this information and has not granted its consent to be considered or deemed an “expert” under the Securities Act of 1933. Past performance is no guarantee of future results.  Indices are unmanaged and while these indices can be invested in directly, this is neither a recommendation nor an offer to purchase.  This can only be done by prospectus and should be on the recommendation of a licensed professional.

 

Office Notes:

Many Pre-Retirees Lack Retirement Income Plan, Survey Says

 

Most U.S. households with between $100,000 and $500,000 in investable assets have not developed a formal retirement income plan, nor consulted with a financial advisor, according to a survey by Cerulli Associates.

"It means that some investors are entering retirement without an income plan for the next 20 plus years of their lives," Tom Modesto, associate director at Cerulli said.

 

Does this scenario fit you?  If so please pay special attention to the following: 

 

Have you ever heard of a retirement calculator?  They’re handy little gadgets you can find on the internet that help estimate how big of a nest egg you’ll need to retire—and how long your egg will last. 

Retirement is one of the most important issues we have to deal with in our lives.  How to take care of ourselves and our loved ones when we no longer have a job to rely on can be a scary thought … unless we plan ahead.  Whether we’re young or old, it’s never too early to start. 

A good way to start planning is to use a retirement calculator.  Now, these calculators aren’t authoritative, and you shouldn’t base financial decisions on them, but they’re useful tools nonetheless.  A good retirement calculator can give you an idea of how much money you’ll need to retire—which could end up either being a wake-up call or an encouraging sign that you’re on the right path. 

Most retirement calculators work by taking your income (from your job, your investments, retirement accounts, etc.) and comparing it to your estimated expenses after retirement.  If your expenses are greater than your income, it will tell you how much money you need to make up the difference.  Simple, right? 

However, some calculators are more sophisticated than others.  The best calculators might make suggestions as to how much money you can afford to withdraw from your retirement savings, or even recommend different asset allocations for your investments.  Again, you shouldn’t rely on these recommendations, but they’re a nice reference point to use when planning your retirement. 

To get started, it’s not a bad idea to see what kind of Social Security benefit you’ll qualify for.  For that, go to the U.S. Social Security Administration’s calculator webpage, where you can find plenty of different calculators to help you calculate your retirement benefits.  Find them at http://www.socialsecurity.gov/estimator/.

As you can imagine, the most elaborate retirement calculators aren’t cheap, but there are good free ones on the Internet. 

For example, the Employee Benefit Research Institute^® has one called Ballpark E$timate^®, which is helpful.  You can find it at http://www.choosetosave.org/ballpark/.

In our offices we have probably the best Retirement calculator on the market, feel free to contact the office to schedule either a phone or regular interview to make use of this calculator. 

No matter where you go first, take the time to experiment with different calculators.  Compare the results to arrive at an average.  And remember: While retirement calculators aren’t crystal balls, they’re a great way to kick-start planning for retirement, because whether you’re young or old, it’s never too early to start.

 

Regards,

,

Michael L. Schwartz, RFC®, CWS®, CFS

 

P.S.  Please feel free to forward this commentary to family, friends, or colleagues.  If you would like us to add them to the list, please reply to this email with their email address and we will ask for their permission to be added. 

 

Michael L. Schwartz, RFC®, CWS®, CFS, offers securities through First Allied Securities, Inc., A Registered Broker/Dealer,  Member FINRA-SIPC.  Advisory Services offered through First Allied Advisory Services, A Registered Investment Advisor.

Schwartz Financial Service is not an affiliate of First Allied Securities, Inc.

 

This information is provided for informational purposes only and is not a solicitation or recommendation that any particular investor should purchase or sell any security. The information contained herein is obtained from sources believed to be reliable but its accuracy or completeness is not guaranteed.  Any opinions expressed herein are subject to change without notice.  An Index is a composite of securities that provides a performance benchmark.  Returns are presented for illustrative purposes only and are not intended to project the performance of any specific investment.  Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly.  Past performance is not a guarantee of future results.

 

* This newsletter was prepared by Peak Advisor Alliance. Peak Advisor Alliance is not affiliated with the named broker/dealer.

                           

* The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.

 

* The DJ Global ex US is an unmanaged group of non-U.S. securities designed to reflect the performance of the global equity securities that have readily available prices. 

 

* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.

 

* Gold represents the London afternoon gold price fix as reported by the London Bullion Market Association.

 

* The DJ Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.

 

* The DJ Equity All REIT TR Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.

 

* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.

 

* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.

 

* Past performance does not guarantee future results.

 

* You cannot invest directly in an index.

 

* Consult your financial professional before making any investment decision.

 

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