Types Of Risks

Ulli Uncategorized Contact

MarketWatch featured a story called “Point of no return,” which questions whether risk taking is worth the emotional cost for many investors.

Eight different types of risks are examined with the premise that there more of these are faced in a portfolio, the more diversified it is:

Let’s look at the types of risks mentioned:

1.Market risk is the big bugaboo, the chance that a downturn chews up your money.

2.Purchasing power risk, or “inflation risk,” is widely considered to be the “risk of avoiding risk” — the opposite end of the spectrum from market risk. It’s the possibility that you are too conservative and your money can’t grow fast enough to keep pace with inflation.

3. Interest-rate risk is a key factor in the current changing rate environment, where income may change drastically when a bond or CD matures and you need to reinvest the money. Goosing returns using higher-yielding, longer-term securities creates the potential to get stuck losing ground to inflation if the rate trend changes again.

4. Shortfall risk is about you, personally, more than it is the market, but it’s the chance that you won’t have enough money to make your goals. You can face shortfall risk by being either too conservative or too aggressive. The best way to address this risk is to save more.

5. Timing risk is another another highly personal factor, hinging on your personal time horizon. While experts agree that the chance that stocks will make money over the next two decades is high, the prospects for the next two years are murky, and if you need your money in two years, you should have concerns about your timing.

6. Liquidity risk has been the underlying issue in the mortgage and credit crunch, and it affects everything from junk bonds to foreign stocks. When the flow of money in credit markets changes for any extended period of time, holdings in those credit arenas tend to suffer.

7. Political risk is the prospect that government decisions will impact the value of your investments. In the current political environment, investors should worry about how the change at the White House may lead to new tax policies, which could trickle down directly into the pocketbook for investors. Tax-rule changes could make certain types of investments popular, and make others unattractive, and there’s always the potential to be caught somewhere in the middle.

8. Societal risk is ultra-big picture, looking at world events. This is what might happen in the event of terrorist attacks, war or catastrophe.

The theme of the story is is that “diversifying across the spectrum of risks — particularly pursuing investments that face different conditions so that their success or failure is not all tied to the same market characteristics — is widely considered the best way to build a portfolio that can be depended on in all circumstances.”

Sure diversification is an important part of any portfolio—up to a point. As recent market history has shown (as well as the last bear market), we are living in an era of instant communication and economic intertwinement where as a result a receding tide affects all ships. I have commented on that a year ago in “Where is the safe Haven,” as all asset classes took severe beatings.

Yes, diversification is important, but from my viewpoint it is not nearly as critical as having a defined entry and exit strategy designed to reduce volatility and protect a portfolio from severe downturns. Remember, most diversification attempts are based on a bullish (buy & hold) scenario, which can have severe consequences if the markets head the other way.

Sunday Musings: Using The Numbers To Suit Your Needs

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You may recall my book review last June with the title “Why Business People Speak Like Idiots.”

I am reminded of the stupid statements being pushed on to the public almost daily. One in particular that caught my eye a couple of days ago was a blurb by the WSJ MarketBeat called “AIG Slumps…If One Believes in Numbers.” Let’s listen in:

Beware of companies that find new ways to value assets while they’re sinking.

Where have we heard this story before? A company loses a bundle of money due to depressed values for its assets, and it says those valuations don’t really count.

That’s what has happened to American International Group Inc. today in its conference call, and not for nothing, but instead of bouncing in the aftermath of the company’s chat with analysts, the stock is tailing off, lately hitting its worst level of the day, down 8%.

The company lost $7.8 billion in the quarter. During the conference call, Steven Bensinger, vice chairman at the company, noted that the $19.3 billion unrealized loss estimate in one of its pools of collateralized debt obligations doesn’t jibe with their analysis, which should suggest a loss of $1.2 billion to $2.4 billion.

Naturally, the estimate to be ignored is the one based on accounting principles, as the company says that “during the first quarter of 2008 AIG developed a new methodology to estimate more precisely its potential realized losses from this portfolio.” Naturally, this new methodology “lowers” the “potential realized losses.”

They also ignore a third-party estimate of $9 billion to $11 billion in losses in this particular portfolio, saying “but because of the disruption in the marketplace we continue to believe that a market-based analysis is not the best methodology to use as a predictor of AIG’s potential realized losses.” Floyd Norris of the New York Times says the company is in denial, at a time when most institutions (even Citigroup) have tried to move past alchemy-based valuation techniques.

For financial institutions, it seems lower housing valuations (as determined by a market) are enough to alter lines of credit, raise certain interest rates or change insurance and loan terms. But market-based analyses of their own portfolios? Obviously hogwash.

Some analysts recently suggested that the improvement in certain credit markets in the second quarter would offset some of the first-quarter losses, and AIG mentioned this in the conference call, saying the commercial mortgage-backed securities market has improved, but that the residential mortgage and subprime securities have not. Still,
the firm says the ABX Index (which some believe does have problems) “is not very well correlated to our books,” and therefore should also be ignored.

Another odd wrinkle, and maybe this is just a confidence ploy, is this: the company has decided to raise its dividend. The insurance giant is going to raise $12.5 billion in capital, some of which will then be used…to pay current shareholders more money. They’re borrowing from Peter to pay Peter, really. Mike Shedlock of Sitka Capital wrote recently of companies borrowing money to pay dividends. “It does not make economic sense to borrow money at 8% to pay a dividend of 5%,” he writes, surmising that perhaps there would be an adverse reaction if dividends were cut.

AIG apparently feels this way, but it isn’t working so far. Bank of America analysts wrote in research today that “over time, we believe the company will have to dial down its leverage and risk profile, which is likely to put pressure on operating earnings.”

[Emphasis added]

I have to admit, reading this left me pretty much speechless. I can’t remember ever having heard this much denial, numbers manipulation and BS by one company since maybe the Enron days.

This type of garbage is being unleashed on the public almost daily, maybe not to that extreme; however, if you invest in individual stocks (I don’t) and follow their news releases, make sure you understand what is really being said.

If I were a stockholder in AIG, I would definitely review my reasons for having invested in this company in the first place.

Shoring Up Money Market Funds

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Just because its not headline news, does not mean that all is well in “money market land.” I have repeatedly advised not to play the sucker’s game and invest idle cash in high-yielding money market accounts, since they are the biggest investors in toxic Subprime slime.

On that topic, MarketWatch reported that Legg Mason swings to quarterly loss. Here are some highlights with my emphasis added:

Legg Mason Inc. posted its first quarterly loss as a public company in what its chief executive said was among the toughest periods it has ever seen, as the investment manager also announced plans to raise $1 billion through an equity offering.

Legg Mason said the results for the three months ended March 31 included a $291 million charge related to previously announced support for money market funds hit by the credit storm. The company has buttressed troubled structured investment vehicles, or SIVs, that are held by money market funds.

Other investment managers, such as Bank of America Corp. and Wachovia Corp. have been forced to provide support to their money market funds to prevent them from “breaking the buck,” or falling below a net asset value of $1 per share. Legg Mason has cut down its exposure to SIVs, which were threatened by liquidity issues.

Legg Mason’s moves to support its money market funds have been “prudent and proper,” and the company “will stay vigilant,” Fetting said. He acknowledged the lagging performance of the U.S. equity managers, and getting them to “return to form” is a “top priority.”

Of course, support of money market funds is prudent and proper. The alternative is that investors would be leaving in droves if a company “breaks the buck.” The unknown simply is who has how much exposure and will other troubled companies be cash-rich enough to bail out their money funds?

You don’t want to wait to find out, which is why I recommend to move idle cash to a U.S. Treasury only money market fund at your custodian (minimum is usually $100k). You have to realize that keeping cash in a money market fund will never make you rich; it is only a temporary parking place during times of great uncertainly where you want absolute safety with no risk.

Once market trends resume, we will look for new opportunities to make our money grow.

No Load Fund/ETF Tracker updated through 5/8/2008

Ulli Uncategorized Contact

My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

Continued sideways activity kept us away from a new domestic Buy signal.

Our Trend Tracking Index (TTI) for domestic funds/ETFs has moved now +1.35% above its long-term trend line (red), which means we remain close to breaking out to the upside of the neutral zone (+1.50%).



The international index dropped to -2.81% below its own trend line, keeping us in a sell mode.



For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

Riding The Roller Coaster

Ulli Uncategorized Contact

Today, the major indexes meandered sideways with an upward bias; however, they closed higher recouping some of yesterday’s losses.

Our Trend Tracking Indexes (TTIs) recovered as well and the domestic TTI broke out of its neutral zone (+1.50%) and currently sits +1.58% above its long-term trend line. Yes, I feel like I sound like a broken record when repeating again that we need to see this level supported for a couple for trading days before making new commitments to the domestic arena.

After today’s close, the world’s largest insurance company laid an “AIG” by reporting that it suffered a $7.81 billion first-quarter loss, its second big loss in a row. While this should pressure the markets tomorrow, you never know these days, as some might interpret this as the worst being over and good times are here again.

Shifting Back To Neutral

Ulli Uncategorized Contact

If you find the constant lack of direction and follow through that the market has been throwing at us maddening, you’re not alone. Yesterday’s broad retreat was a reminder again how fickle this market has become and that at any given time any event can derail the upward momentum.

While we were within striking distance of a new domestic buy signal, our Trend Tracking Indexes (TTIs) have now again retreated into the neutral zone, which is an area defined as a range of -1.50% below its long-term trend line to +1.50% above it.

Yesterday’s sharp pull back has positioned our TTIs as follows:

Domestic TTI: +0.96%
International TTI: -2.57%

Internationally, nothing has changed since our sell signal on 11/13/07.

Domestically, as you know from my weekly updates, we have been waiting for a new buy signal, which almost, but not quite, materialized several times over the past few weeks.

We’re now back to the drawing board waiting for this uptrend to show some legs before making any further commitments. On average, we’re about 70% in cash with the balance being invested in those areas that have generated good upward momentum independently of the domestic U.S. market.