Making Money Alert
A "Show-Me" Market
08/22/2007
The way I am approaching this market, you'd think I was born and raised in Missouri. That's because the "Show-Me" state's famous motto of skepticism is how I think any smart investor should respond at this critical market juncture.
In last week's Alert, I told you that many of my radio show listeners and many subscribers to my various advisory services have been asking me just what direction I think this market will take. Well, over the past few days the questions I've received have been more along the lines of "is the correction over?"
Certainly, the market has shown signs of being a lot more stable of late. In fact, we actually bounced off of the 1375 level on the S&P 500, a level I told you last week was the real key to determining if we would descend into a full-blown bear market or just remain in merely a correction phase.
One glance at a chart above of the recent wild ride in the S&P 500 clearly shows that rebound from the 1375 level. This recovery is encouraging news for the bull camp, especially because stocks have fought their way back to the all-important 200-day moving average (red line).
The way I see it, if the S&P 500 can continue fighting its way back above 1490, we might be able to declare the end of this recent correction. As I write this Alert, the S&P 500 is pushing its way back to 1460, so the direction is certainly positive for the bulls.
The Fed now has come to the aid of the market, first with its injection of billions of dollars in liquidity and then via last week's 50 basis-point discount rate cut -- a cut that should set the stage for at least a 25 basis-point cut, if not 50 basis points, on the more important federal funds rate when the Fed meets again in September.
I say that the jury is still out on the direction in stocks, and I think that even if the worst is now over, we are likely to see a lot more volatility over the next month or so. When it comes to calling the bottom on this market, I'm adopting Missouri as my home state and simply saying, "Show me!"
THE LIQUIDITY CRISIS AND YOUR REAL ESTATE
For the past two weeks, I have run a great article by mortgage and real estate expert Josh Lewis on just what is happening now in the mortgage market. Josh is at it again this week, with another brilliant piece on what the current liquidity crises means for your real estate holdings, your mortgage and ultimately your wealth.
If you've been fretting about what to make of all of the liquidity crunch talk on CNBC and elsewhere, I encourage you to read Josh's insightful perspective. I guarantee that it will clear things up for you, and it might even keep you from making any mistakes with your mortgage or real estate.
Doug
By Josh Lewis
Two weeks ago, I wrote an overview of the mortgage market meltdown for Doug's Alert readers. I'm following up today to explain more about what has expanded beyond the mortgage markets and become the "liquidity crisis."
The current drama unfolding in the financial markets has been referred to as a "Minsky meltdown" in honor of economist Hyman Minsky. Minsky became famous for his theory on market bubbles, which Wikipedia explains as follows:
"Minsky found that in prosperous times, when corporate cash flow rises beyond what is needed to pay off debt, a speculative euphoria develops, and soon thereafter debts exceed what investors can pay off from their incoming revenues, which in turn produces a financial crisis. As a result of such speculative borrowing bubbles, banks and lenders tighten credit availability, even to those that can afford loans, and the economy subsequently contracts."
Many of the folks I talk to ask some variation of this question: "I understand subprime loans disappearing but why is it that creditworthy borrowers can't qualify for a mortgage?"
The answer is that the period of prolonged stability and speculative euphoria has ended. We saw home prices skyrocket in the last decade. This made it almost impossible for a homeowner to lose their home to foreclosure and by extension that meant it was almost impossible to lose money lending to homebuyers and owners on nearly any terms. Zero down? No problem. Negative amortization? No problem. Can't prove your income? No problem. After all, if you can't make your payments you'll sell the home, repay the lender and no harm is done.
At the same time, for reasons too numerous to list here, the global markets were awash in funds looking for an investment. For anyone who has ever taken Economics 101, you know what happens when demand greatly exceeds supply. Prices go up. When prices of bonds, such as mortgage-backed securities go up, their yields come down in the form of interest rates. This was the perfect storm for borrowers as the hurdle to cross in qualifying for a loan simultaneously dropped to the floor while the cost of borrowing plummeted as well.
To put it in perspective, a borrower in 2000 with a 580 credit score would have needed at least a 10% equity position and proven in some way that she had an income sufficient to repay the loan. IF SHE MET THOSE TWO CRITERIA, she would pay a premium interest rate 2-3% above the going "prime rates."
By 2005, that borrower could get 100% financing, stated income (no income documentation) with no more than a 1% premium to prime rates. The reason is that the long period of stability had led investors to believe there was no risk of losing their capital as home values always rise. The investors were also happy to receive a 1% premium since prime rates produced such a little return.
Over the last year, bit by bit, the markets have woken up to the actual level of risk in mortgages and we find ourselves now in a "period of hyper instability." Nobody wants to sell the mortgages they have on their books because they will have to sell at a discount. Once those loans sell at a discount, all of the loans on other investors' books then will be "marked to market" and the losses will be realized for accounting purposes whether the loans are sold or kept on their books.
In essence, we have a standoff where the markets have frozen. Nobody owning mortgages wants to sell them because they don't want to know how little they are worth. Absolutely nobody wants to buy mortgages for the same reason. Lenders, not having anyone to sell their closed loans to, have simply decided not to lend to anyone or to offer such high rates that they can't lose money selling them once a market materializes for them.
The ONLY exceptions currently are loans underwritten to the standards set by the government (VA/FHA) or Government Sponsored Enterprises Fannie Mae and Freddie Mac. That means only loans under $417,000 are being offered at good terms and only for full documentation, prime credit loans.
At some point, a market for non-conforming loans will re-emerge. The guidelines will not be nearly as generous and the rates will be higher, but there will be a return to normalcy that will look much more like 1998 than 2005.
In the meantime, this is causing SERIOUS problems, especially in high-priced markets throughout the country including most of California. According to RBS Greenwich, $27 billion of subprime loans per month will be facing an interest rate reset as their fixed period ends. Since the fixed period on most of these loans was two years, most of these loans were taken out too late in the cycle to build up enough equity for the borrower to qualify under the new tighter guidelines. Even if they could qualify, they would face terms that would likely make the payment too high to manage.
This doesn't count the Alt-A and prime loans that will be facing rate resets. These shouldn't be in as bad of shape because most were fixed for three-to-five years and as a result have built up some equity. These loans also were made to borrowers with higher scores who "should" have some options in today's markets.
The last group of folks facing a day of reckoning are the stubborn few who have held on to their Pick-A-Payment Option ARM's as the rates climbed from a low in the 3% range to the low 8% level today. Why would anyone do this? Because the negatively amortizing, minimum payment was still much lower than the interest-only and fully amortizing terms available in the market. With stated income loans on the shelf for the near future, the window for getting out of these loans may have closed.
I will leave you today with the same advice I had two weeks ago. If you are in anything other than a fixed rate loan with at least 20% equity in your property, you need to be consulting with your mortgage professional to see what your true risk is and what options exist for safer financing. If you do not have a trusted mortgage advisor, I will be happy to walk you through the process and to help you build a game plan for securing your financial future.
You can reach my offices at 888-944-JOSH (5674) ext. 1 or via e-mail here.
BLOGS AWAY: MARKET UPDATE & ETF NEWS
On this week's audio blog, I'll get you up to speed on the latest rumblings in this ultra-volatile market. Plus, hear about three new "Super Sector" ETFs that I'm eyeing.
To listen to the audio blog, simply click here.
POSITION SIZING AND YOUR WEALTH
My son David recently encountered a gentleman who was upset that his 401(k) had taken a pounding in this market correction. This situation is quite common, as nearly all 401(k) investors likely have seen a big reduction in the value of their 401(k) accounts.
What was very interesting about this gentleman's particular situation is that a significant portion of his 401(k) was tied up in his own company's stock. As it happened, the company he works for was taken down hard by the mortgage market meltdown, and that left his company stock, and by extension his 401(k), in shambles.
I bring this up because I suspect many of you have a significant portion of your 401(k) either in your company's stock, or in one company or one sector of the market. This may have served you well up until now, and in fact, it may still be serving you well. But the downside here is that (forgive my abuse of clichés) having all of your eggs in one basket subjects you to disastrous results.
If you have super-sized one position in your 401(k), the time has come to diversify. You simply cannot afford to have a significant percentage of your retirement money subjected to just one stock or one market sector. A 401(k) must be prudently managed the same way any kind of money is managed, with an eye toward minimizing risk.
It is absolutely essential that you employ what we call a "position-sizing" strategy in your 401(k) and/or your taxable accounts. This simply means that you if you are too overweight in one stock or one market sector, you should pare that holding down, which will reduce the overall risk in your portfolio.
If you have any questions about how to go about the process of position sizing your assets, we are here to help.
I encourage all of my Alert readers to take advantage of our wealth coaching sessions. In this session, I can help you to learn how to implement a sound wealth management strategy that protects you when the market is in turmoil, and that allows you to maximize your portfolio's potential.
For more information on how to schedule your very own coaching session, call David Fabian at 800.391.1118, or e-mail him.
DON'T APOLOGIZE FOR TRUTH
"Never apologize for showing feeling. When you do so, you apologize for the truth."
—Benjamin Disraeli, British statesman and novelist
Anybody who's listened to me on the radio or seen me speak at a live event knows that I am truly passionate about my purpose in life, which is to help you create and keep your wealth. I show a lot of emotions and feelings, especially when I'm advocating you take protective action with your money. Once I was told I shouldn't be so "animated" when talking about money. I say forget that! I will opt to live by the words of the great statesman and literary figure Benjamin Disraeli, who recommends that you don't apologize for showing emotion because in so doing, basically you are apologizing for truth.
May the truth live on!
Wisdom about money, investing and life can be found anywhere. If you have a good quote you'd like me to share with your fellow Alert readers, send it to me, along with any comments, questions and suggestions you have about my radio show, newsletters, seminars, or anything else.