Notes starting from February 28, 2008

Updated: April 6, 2008.

Secular Bear Market

We are in a long lasting (secular) bear market. A glance at Professor Robert Shiller's P/E10 data makes this obvious. So does a glance at Ed Easterling's book "Unexpected Returns" and his Crestmont Research web site. Here is an excellent article along the same lines by Dr. John Hussman.

Secular Bears by Dr. John Hussman

My Mom's retirement portfolio

Read this latest Letter to the Editor.

February 12, 2008 Letters to the Editor

Dividend Quality

Dividend investors should pay attention to the quality of dividends. Here are several factors to consider.

Dividend Quality

Thank You, David

for notifying me of a problem with my Yahoo Briefcase. Everything is OK now. May God bless you.

Nearing Retirement?

Preserving capital is the most important task for today.

Expect valuations to improve dramatically (lower prices relative to earnings and dividends) over the next decade. Treat cash and cash equivalents with respect. Dividend yields will rise dramatically.

Even today, it is easy enough to withdraw 5% of the original balance (plus inflation) continually by using a dividend blend strategy. Combine a high yielding portfolio with a portfolio with rapid dividend growth. Excess cash from the high yielding portfolio fills in the gap in the early years until the fast growing portion takes over. The downside risk with adequate diversification is that the buying power drops temporarily to 4% (plus inflation).

Non-dividend approaches do not do so well. They can end in bankruptcy.

Treat annuities (single payment immediate annuities SPIA) with respect. They meet a need without requiring constant attention. This becomes important as we age.

Today’s Market Outlook

Today’s market (March 10, 2008) is signaling stagflation. The inflation protection of TIPS is commanding a premium. Stock market returns have been lousy since 2000.

Looking forward, we can expect a 2.0% (plus and minus 6% at the outside) real return from the stock market 10 years from now based on today’s valuations (P/E10=23).

The Gordon model’s projections are most accurate at Year 10. The range of applicability is from Year 5 through 15. Using William Bernstein’s assumptions, the Gordon model predicts a return of 3.5% at Year 10. This is well within my confidence limits.

This market makes sense to me. People are seeking capital preservation. The big spread in favor of junk bonds reflects the inertia of moving from one asset class to another. The spread should tighten. Stocks appear vulnerable in the short term (which I do not forecast). They are definitely vulnerable within a decade.

The Dividend Advantage

Some people assert that, because dividend cuts are possible, dividend based strategies are worthless. Nothing could be farther from the truth.

The Dividend Advantage

TIPS Interest Rates

Short term TIPS interest rates have fallen to zero. TIPS principal adjusts to match inflation. At zero percent real interest, TIPS preserve the buying power of cash and nothing more.

Bloomberg Interest Rates

Crestmont Research Updates

Ed Easterling has updated his Crestmont Research site with data through 2007. Ed Easterling wrote “Unexpected Returns,” which I gave a favorable review. His site is well worth visiting.

Crestmont Research

Dollar Cost Averaging Basics

The easiest way to understand dollar cost averaging is with an example.

Dollar Cost Averaging Basics

Plus Inflation

You do not simply add the inflation rate to the withdrawal rate to adjust for inflation. I have made that mistake before. You multiply the withdrawal rate by (1+inflation rate). If your withdrawal rate is 5% and inflation is 3%, your withdrawal amount increases to 5%*(1+.03) = 5.15% of the original balance.

One way to keep up with the inflation rate is to buy long term TIPS. Divide the current year’s interest amount by the original coupon amount. This gives you the cumulative inflation adjustment.

TIPS Interest Rates

Except for those using TIPS as a baseline, very little changes at today’s low TIPS coupon (real interest) rates. This is readily apparent if you use the Scenario Surfer.

Some of my earliest articles examined the effect of lower TIPS interest rates. The withdrawal rate changes slightly, but little else.

Current Research A

Having a Strategy

Just having a strategy is a great comfort. Having a sound strategy is even better. Not needing cash, I choose the Delayed Purchase approach.

I do own a few stocks, not many, as suggested by my experience using the Scenario Surfer. There is always an outside chance that the market could rise even from today’s valuations. The odds are much stronger, of course, that it will continue to drift downward or, possibly, fall sharply. Owning a few stocks, as suggested by Rob Bennett and Benjamin Graham, continues to make sense. It satisfies our emotional needs when stocks rally. It protects us against the less likely outcome.

Value Informed Indexing (VII or Lucky 7) is the indexer’s equivalent. It makes a lot of sense. I am comfortable owning individual stocks. Many are not. An index provides diversification, which can be important.

For those needing current income, the Dividend Blend strategy or a straight income strategy makes sense. The income stream is secure enough and it will continue indefinitely. With a diversified portfolio, the downside risk in buying power is about 25% (to 75% of the original income stream). It is becoming easier and easier to exceed a withdrawal rate of 5% of the original balance (plus adjustments to match inflation).

For those seeking maximum security, a TIPS only approach still makes a lot of sense. Use the TIPS table to determine the appropriate withdrawal rate. At 1% interest, the TIPS only approach still delivers the 30-year 3.9% Safe Withdrawal Rate that was claimed in the older, conventional studies that ignored valuations.

For those older than 65, low cost Single Payment Immediate Annuities with an inflation clause make a lot of sense. They raise current income for individuals since they can take advantage of life expectancy statistics. They protect against declining mental capabilities as we age.

Passive Investing Is Dangerous

Rob Bennett has come up with another winner. Read his latest.

Passive Investing Is Dangerous

A Monte Carlo Simulator with a Difference

The Scenario Surfer uses a Monte Carlo model. But it is much different from a standard, run of the mill Monte Carlo model. It features two forms of mean reversion. It adjusts returns according to stock market valuations.

A standard Monte Carlo model is much too pessimistic under normal circumstances. It reports an excessively high probability of failure from stocks. This is something to watch out for.

Scenario Surfer results are very similar to those found in the historical record.

Dividend Growth or Dividend Yield

Should you seek dividend growth or dividend yield in a retirement portfolio?

Dividend Growth or Dividend Yield

Total Return versus Dividends

Too many total return investors focus on the good times. Yet, when it comes to safety, the bad times dominate. They determine portfolio survival. How much spending can a retiree cut? How long can he coast via cash reserves? A look at the 1965 and 1966 sequences shows what has happened during exceedingly stressful circumstances. Stock sales can reduce the safe withdrawal rate even below that of money market funds. Cash reserves help. But they run out.

Dividend strategies have done better. Business growth has been stable when smoothed over four or five years. Dividend cuts do happen. But dividends do not fall nearly as much as prices.

Just Suppose

I do not have all of the FACTS. Yet, I believe that these insights are relevant to some important studies.

Just Suppose

Dollar Cost Averaging

Read about Dollar Cost Averaging in the latest Letter to the Editor.

March 29, 2008 Letters to the Editor

Notes Index Starting from November 23, 2007