In the coming months you may be eligible to receive rebates from your state or territory for the purchase of new ENERGY STAR-qualified appliances.The link to the Department of Energy's website announcing the program is here. A PDF of states with programs that have already been approved is here.
These rebates are being funded with $300 million from the American Recovery and Reinvestment Act of 2009. Under this program, eligible consumers can receive rebates to purchase new energy-efficient appliances when they replace used appliances.
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Each state and U.S. territory was allowed to design its own rebate program, and all 56 have submitted plans to the U.S. Department of Energy (DOE).
Corporate profits may rise or fall in any given year depending on the state of the economy, but a share of stock is a claim on a company’s long-term earnings and should be evaluated as such. And over the past century or so, there has been a pretty strong correlation between the 10-year p-e ratio and future returns. When the ratio shot above 20, as it did in the 1920s, 1960s and recent years, stocks were headed for a fall. When the ratio dropped well below its 100-year average of 16, as in the 1930s and the early 1980s, a bull market typically followed. (The average of the past 60 years is about 18.5)
What does the ratio say today? That perhaps the recent rally has gone a bit too far.
The proportion of U.S. homeowners who owe more on their mortgages than the properties are worth has swelled to about 23%, threatening prospects for a sustained housing recovery.
Nearly 10.7 million households had negative equity in their homes in the third quarter, according to First American CoreLogic, a real-estate information company based in Santa Ana, Calif.
These so-called underwater mortgages pose a roadblock to a housing recovery because the properties are more likely to fall into bank foreclosure and get dumped into an already saturated market. Economists from J.P. Morgan Chase & Co. said Monday they didn't expect U.S. home prices to hit bottom until early 2011, citing the prospect of oversupply.
Home prices have fallen so far that 5.3 million U.S. households are tied to mortgages that are at least 20% higher than their home's value, the First American report said. More than 520,000 of these borrowers have received a notice of default, according to First American.
Negative equity "is an outstanding risk hanging over the mortgage market," said Mark Fleming, chief economist of First American Core Logic. "It lowers homeowners' mobility because they can't sell, even if they want to move to get a new job." Borrowers who owe more than 120% of their home's value, he said, were more likely to default.
Mortgage troubles are not limited to the unemployed. About 588,000 borrowers defaulted on mortgages last year even though they could afford to pay -- more than double the number in 2007, according to a study by Experian and consulting firm Oliver Wyman. "The American consumer has had a long-held taboo against walking away from the home, and this crisis seems to be eroding that," the study said.
Even recent bargain hunters have been hit: 11% of borrowers who took out mortgages in 2009 already owe more than their home's value.
Many borrowers are so deeply under water that they can't take advantage of lower rates and refinance their mortgage. "We're declining hundreds of loans each month," said Steve Walsh, a mortgage broker in Scottsdale, Ariz. "The only way we will make headway is if we allow for a streamlined refinance where the appraisal is irrelevant."
The rule of thumb is that you'll need to replace 70% of your pre-retirement income on average once you retire, but evidence continues to mount that this assumption by many professionals and retirement savers is way off base.
Now, a new study by two professors casts further doubt on the idea that the widely used replacement-rate figure is a sound basis for building a retirement plan.
"The rule of thumb that replacement rates should be above 70% to maintain living standards in retirement is conceptually flawed," wrote John Karl Scholz and Ananth Seshadri, two University of Wisconsin-Madison professors, in their paper "What Replace Rates Should Households Use?"
In fact, no more than 15% of the population Scholz and Seshadri studied need to replace 65% to 90% of their pre-retirement income. And almost 50% of the population needed to replace less than 65% of their pre-retirement income.
In short, the authors said: More refined guidance is needed to serve households well.
Target replacement rates are less than 100% for three main reasons, according to the study published by the Michigan Retirement Research Center.
"First, upon retirement, households typically face lower taxes than they face during their working years, if for no other reason than Social Security is more lightly taxed than wages and salaries. Second, households typically save less in retirement than they do during their working years, so saving is a smaller claim on available income. Third, work-related expenses generally fall in retirement."
Still, that ignores a whole host of issues related to coming up with the right replacement rate.
For instance, consider what effect children likely have on your expenses prior to and in retirement, the authors wrote. Most calculators use the same replacement rate regardless of the number of children in a household, the authors said. But the number of children you have matters when it comes to calculating your replacement rate. In fact, all things being equal, a household with lots of children will have a smaller replacement rate than a household with no children, because the couple with kids, once retired, will face far lower child-rearing costs than they did while working. (Of course, the kids' ages at the time of retirement will affect that calculation.)
What is needed for your real number is not back-of-the-napkin calculations but something the authors refer to as the life-cycle model. To be fair, the author's study did note that replacement rates -- even when using the life-cycle model -- did confirm some commonly held beliefs. Specifically, "replacement rates of low-income individuals and families would need to be higher than replacement rates for high-income individuals and families."
But even then you still need to take into account the effect of federal taxes, medical expenses, education, and what the authors call earnings shocks or -- in laymen's terms -- layoffs and big salary increases.
When all is said and done, the authors suggest that optimal replacement rates could range anywhere from 23% (for single parents with several children and a negative late-in-career earnings shock) to 240% (for low-income, married households with a few children and a substantial positive late-in-career earnings shock).
In other words, "conventional advice may overstate optimal targets by a factor of two, or understate retirement consumption needs by a factor of three depending on the idiosyncratic experiences of households," Scholz and Seshadri said in their study. See the study (PDF).
That's especially the case when it comes to online calculators, the authors said. With the life-cycle model, the replacement rate depends on factors often ignored by online calculators. "The savings requirements of two households with the same earnings profile, retirement age and life expectancy would be given an equivalent target by the online planning tools regardless of whether one household raised five children and other had none," the authors said. They said the optimal replacement rate for married couples is 75%, but just 55% for singles.
Put another way, if you're using an online calculator to plan your retirement, you might be under-saving or over-saving by a wide margin, though the consequence of over-saving might not be as bad as under-saving.
'Rules of dumb'
Experts, meanwhile, seemed to agree with the conclusions reached by Scholz and Seshadri.
"The use of replacement rates to form financial plans does not meet a reasonable fiduciary standard," said Larry Kotlikoff, a Boston University professor.
"Rules of thumb are, quite simply, rules of dumb," he said. "Their use violates the financial planner's Hippocratic oath: First do no harm."
Kotlikoff also said the model used in Scholz and Seshadri's study is not without its warts. "But it's fine for its purpose, which is comparing conventional financial planning with economics-based planning."
Rick Miller, a certified financial planner with Sensible Financial Planning, cautioned against using any rules of thumb. "Using rules of thumb can be very dangerous, if they significantly understate the requirement, or can risk significant regret, if they overstate the requirement."
Pay now or pay later? That is the question if you're weighing the pros and cons of converting your traditional individual retirement accounts to a Roth. The benefit of a Roth is simple: Once you're in, you don't have to worry about paying taxes on that account, ever. Tax-free income down the road, though, comes with a price. And that price can be hefty: In the eyes of Uncle Sam, what you convert is taxed as ordinary income.
A bigger tax bill is probably the last thing you need right now. But ironically, this tough economic environment may make it an ideal time to convert to a Roth. Those smaller IRA balances means you’ll owe less tax. (Talk about a silver lining.) Think your income disqualifies you? As of 2010 the $100,000 adjusted-gross-income cap on Roth conversions will disappear. And, next year — and next year only — investors will have the option of spreading their tax liability over two years.
Despite all of the excitement surrounding the Roth, converting doesn't make sense for everyone. At a minimum, says Chris McDermott, a certified financial planner and senior vice president of investor education at Fidelity Investments, investors should be able to answer “yes” to three key questions: Do you expect to pay a higher tax rate when you retire? Do you plan to hold the account for at least 10 years? Can you pay the taxes owed without tapping a tax-sheltered account?
Even if you do answer yes to all three, there are other considerations, notes Barbara Steinmetz, a certified financial planner in San Mateo, Calif. Among them, how will the conversion affect your overall tax situation? “Just a small amount could make the difference to bump you from one bracket to another,” she says. “My advice is to always run the numbers.”
“There is a sense of denial among the pre-retirees,” said Lynne Ford, head of Wells Fargo Retail Retirement.
Even after suffering significant losses last year, many remain overly optimistic about their investment returns and the ability of their savings to fund their expenses after they stop working.
Only 23 percent of pre-retirees are saving more for their retirement than they were a year ago, the survey found. Most, some 57 percent, are saving the same amount, and 20 percent are saving less.
Perhaps even more startling is the extent to which their savings are falling short of their goals. On average, these pre-retirees expected they would need $800,000 to fund their retirement. However, most had only saved about $300,000.
Despite their inadequate savings, nearly two-thirds of the group lack any formal plans for retirement savings or spending strategies.
Of the 35 percent of those who had a written plan for retirement, only slightly more than half — about 52% percent — say they had updated it in the past year during the market downturn.
Among the biggest mistakes people are making is over-estimating their investment returns and the amount of money that can safely be withdrawn each year in retirement.
In the survey, both those who were about to retire and those who already had said they expected their savings to grow by 8.7 percent each year, on average. However, the compound annual growth rate of the S&P 500 from 1958 through 2008 was only 6.6 percent.
People also under-estimate how long they will live in retirement, she said. A healthy person in their mid-sixties can easily expect to live into their eighties or even nineties. However, few people are prepared to support themselves in retirement for more than twenty years.
The U.S. government is spending $787 billion to stimulate the economy, the deficit is $1.4 trillion and Congress is debating costly changes to health care. The taxpayers’ bill to pay for it isn’t far behind.
“Something is going to have to be done to raise revenue unless entitlement spending is cut,” said Gerald Prante, senior economist for the Washington-based Tax Foundation.
While the final resolution of the competing aims is being debated, what is under discussion has pundits opining that Federal tax rates may rise in 2011 to as high as 39.6 percent, up from 35 percent (for those earning more than $373,650). The House version of the health reform bill sets an additional 5.4 percent surtax on adjusted gross income for high- income individuals. Long-term capital gains rates may reach 28 percent, from 15 percent today, Prante said.
“For many of our clients, particularly those who run their own businesses, there may be an opportunity to accelerate significant amounts of income -- even as much as $50 million to $100 million of taxable income,” said Mark Nash, a Dallas partner at New York-based PricewaterhouseCoopers Private Company Services, whose average client has assets of $150 million or more. The tax savings from moving income into 2009 or 2010 would be 4.6 percent of that amount, he said.
US CAPE and q chart
The US Flow of Funds data (“Z1”) have just been published (17th September, 2009) for Q2 2009. We also have 99% of the EPS on the S&P 500 for Q2 2009. On the basis of these data, and allowing for the 16% rise in the stock market since 30th June, 2009, US non-financials on 17th September, with the S&P 500 @ 1069.45, were 40.6% overvalued (using q) and the total market including financials was 36.5% overvalued (using the cyclically adjusted PE “CAPE”).
From being around fair value at the end of March, the US stock market has become significantly overvalued again. In the case of q this is largely because of the rise in the market, aided to a small extent by falling asset values, largely of real estate, and rising liabilities.
In the case of CAPE the increase in the overvaluation of the market is also largely due to the change in share prices but, as current EPS, measured at constant prices, are around half those recorded 10 years ago, the cyclically adjusted EPS is also on a downward path, which is likely to continue for some time.
Huey's designated beneficiary is his son Dewey. Huey dies in 2008, when he is age 70 and Dewey is age 40. Dewey's life expectancy is 42.7 (determined in the year following the year Huey died, when DDewey is age 41). This means that Dewey is able to stretch distributions over a period of 42.7 years. Dewey elects to stretch distributions over his life expectancy, and he must take his first distribution by Dec 31, 2009, the year-end following the year Tom died.
To determine the minimum amount that must be distributed, Dewey must divide the balance on Dec 31, 2008, by 42.7. If Dewey withdraws less than the minimum amount, the shortfall will be subject to the excess-accumulation penalty. To determine the minimum amount he must distribute for each subsequent year, Dewey must subtract 1 from his life expectancy of the previous year. He must then use that new life-expectancy factor as a divisor of the previous year-end balance.
There will be no cost of living increase for more than 50 million Social Security recipients next year, the first year without a raise since automatic adjustments were adopted in 1975, the government announced Thursday.
Blame falling consumer prices. By law, cost of living adjustments are pegged to inflation, which is negative this year because of lower energy costs. Social Security payments, however, cannot go down.
Thursday's announcement comes a day after President Barack Obama called for a second round of $250 stimulus payments for seniors, veterans, retired railroad workers and people with disabilities.
The payments would match the ones issued to seniors earlier this year as part of the government's economic recovery package. The payments would be equal to about a 2 percent increase for the average Social Security recipient.
SOMEONE with $100 million has nothing to fear, not even fear itself.
But not long ago, a client with such assets called and asked Bruce Bickel, her wealth adviser at PNC Wealth Management, to put her on a budget.
“She said we’ve never done this before, and we think we should,” said Mr. Bickel, managing director of private foundation management services at PNC. “It’s all relative. Their loss has put them in a fear response.”
The Boston Consulting Group predicted this week that worldwide wealth would not return to 2007 precrisis levels until 2013. It also said it found that the number of millionaires was down 18 percent and that, across the board, clients of wealth management firms had lost trust in their advisers.
Even though stock markets have rebounded from their lows this year, wealthy investors have not rushed back in.
Nancy Rooney, head of the Northeast investment business for J.P. Morgan private wealth management, which serves clients with $1 million to $25 million, said she has seen two types of investors become cautious in their investing.
The first have new money and had not experienced serious market swings before. They had been focused on their quarterly gains and largely ignored the risks. Having lost a lot more money than they thought possible, they are struggling with the shock of it.
Or, as Mr. Cochran put it, “Many people thought they were gunslingers.” Now, he said, “They’re not gunslingers any more.” Mr. Holley described the sentiment as a return to “meat and potatoes” investing.
Now, that group is focused more on the risk of an investment than its possible return. One result is they are poring through all the disclosures before investing, and they are not as worried about missing out if they are pressured to invest too quickly.
The second group is older and held wealth longer. They exhibited almost a knee-jerk reaction to the crisis and put a lot of money into cash early on. They continued to stand on the sidelines through the initial rebound. Only now are they looking to invest in safe assets, like preferred bonds secured by United States government obligations.
“We are very gradually working with them,” Ms. Rooney said. “For many of them, it was a loss of confidence in themselves as well as in the markets.”
The Treasury is allowing its year-old guarantee of money fund assets to expire, in one of the first big reversals of the government’s involvement to stem the financial crisis.
The unprecedented backstop was put in place a year ago after one of the nation’s biggest money funds, the Reserve Fund, suffered a run on assets because of losses tied to Lehman Bros. IOUs that it owned.
The government’s blanket guarantee of fund accounts had the desired effect: After a record outflow of $120 billion in the week ended Sept. 23, fund assets quickly stabilized. Confident investors soon began adding more cash to the funds -- even though the Treasury’s guarantee only covered industry assets as of Sept. 18.
After hitting a record high of $3.85 trillion in January money fund assets have been gradually declining, reaching $3.45 trillion this week. But the slide more likely is the result of investors pulling cash to invest in riskier assets (i.e., stocks and bonds) than because they’re worried about the U.S. guarantee expiring.
With the Federal Reserve committed to holding short-term interest rates near zero indefinitely, the funds are earning little on the short-term corporate and government debt they buy. Their investors, in turn, are earning next to nothing, even though most funds are waiving all or most of their management fees: The average taxable money fund pays an annualized yield of just 0.06%, according to IMoneyNet Inc.
Imagine a couple that put $120,000 into a 529 tax shelter for a grandchild a year ago. If the market had continued to boom, that money would have grown tax-free. As long as it was eventually spent on qualified tuition expenses, no tax would have been paid on withdrawals. These 529 plans are terrific tax shelters for middle-class couples with children or grandchildren.
Obviously, though, investing has been a hazardous occupation of late. Imagine that same couple now looks at the 529 and realizes those investments have plunged to just $70,000 in value.
Yikes. That's a $50,000 loss.
The couple can close the account and withdraw the money. At that point, they may be able to deduct nearly all of that loss from their taxable income. That wouldn't restore all the money lost, but could at least soften the blow.
Many Americans may be missing out on this deduction. Most 529 plans are sold through financial advisors, but comparatively few know about this rule. (For those seeking more details, they can be found in IRS Publication 970, Tax Benefits for Education, page 51, and in the Federal Register, Vol. 73, No. 13, page 3445.)
There are lots of caveats. This is one of those things you don't want to try on your own with consulting your tax accountant.
The typical American household made less money last year than the typical household made a full decade ago.
To me, that’s the big news from the Census Bureau’s annual report on income, poverty and health insurance, which was released this morning. Median household fell to $50,303 last year, from $52,163 in 2007. In 1998, median income was $51,295. All these numbers are adjusted for inflation.
In the four decades that the Census Bureau has been tracking household income, there has never before been a full decade in which median income failed to rise. (The previous record was seven years, ending in 1985.) Other Census data suggest that it also never happened between the late 1940s and the late 1960s. So it doesn’t seem to have happened since at least the 1930s.
And the streak probably won’t end in 2009, either. Unemployment has been rising all year, which is a strong sign income will fall.
What’s going on here? It’s a combination of two trends. One, economic growth in the current decade has been slower than in any decade since before World War II. Two, inequality has risen sharply, so much of the bounty from our growth has gone to a relatively small slice of the population.
Why does anyone have a debit card? I am deadly serious about this question. Not long ago, I switched banks, going from one end of the spectrum to the other. I had been with US Trust, which has great service if you are doing anything complicated and can live with their 9-5 schedule, but costly if your needs are more plain vanilla. They were bought by Bank of America, the good people all left, and I figured if I was going to be with a regular retail bank, I might as well go with one that was cheap, had 24/7 service and good branch hours, and I wound up at Commerce Bank, now TD Bank.
Commerce tried foisting a debit card on me. It took some doing to get an ATM card instead. I do not know why people use debit cards, so perhaps readers can explain this mystery to me.
If your wallet is stolen, someone can pretty quickly drain your account and even go into overdraft. Unlike credit cards, where your losses are limited, you have no recourse. Having had my wallet taken more often than I care to recount and having had the perps run up truly impressive credit charges charges in a mere 10 minutes the last instance (they seem to be getting more savvy over time), the last thing I would want to carry is a debit card. The ATM pin affords you some protection; you have none with a debit card.
Now that would seem to be a sufficient reason not to carry a debit card. Then we have the fact that banks charge particularly aggressive over-limit fees on debit cards. From the New York Times:
When Peter Means returned to graduate school after a career as a civil servant, he turned to a debit card to help him spend his money more carefully.
Peter Means’s bank charged him seven $34 fees to cover seven purchases when there was not enough cash in his account, notifying him only afterward.
So he was stunned when his bank charged him seven $34 fees to cover seven purchases when there was not enough cash in his account, notifying him only afterward. He paid $4.14 for a coffee at Starbucks — and a $34 fee. He got the $6.50 student discount at the movie theater — but no discount on the $34 fee. He paid $6.76 at Lowe’s for screws — and yet another $34 fee. All told, he owed $238 in extra charges for just a day’s worth of activity.
Mr. Means, who is 59 and lives in Colorado, figured employees at his bank, Wells Fargo, would show some mercy since each purchase was less than $12. In addition, a deposit from a few days earlier would have covered everything had it not taken days to clear. But they would not budge…
This year alone, banks are expected to bring in $27 billion by covering overdrafts on checking accounts, typically on debit card purchases or checks that exceed a customer’s balance.
In fact, banks now make more covering overdrafts than they do on penalty fees from credit cards.
I don’t get it. Debit cards are inferior to ATM cards (less security) and in some cases, higher fees (at my bank, if you have a line of credit established, you do not incur an overdraft charge if you go into the credit line). So why does anyone have a debit card? Is this a perverse example of behavioral economics, where the bank offers the worst “opt in” alternative (debit card) and consumers have to take the energy to opt out and get the better products?
And these debit cards, which ten years ago were deemed to be losers for the industry, have been redesigned into cash cows:
Debit has essentially changed into a stealth form of credit, according to critics like him, and three quarters of the nation’s largest banks, except for a few like Citigroup and INGDirect, automatically cover debit and A.T.M. overdrafts.
Although regulators have warned of abuses since at least 2001, they have done little to curb the explosive growth of overdraft fees. But as a consumer outcry grows, the practice is under attack, and regulators plan to introduce new protections before year’s end. The proposals do not seek to ban overdraft fees altogether. Rather, regulators and lawmakers say they hope to curb abuses and make the fees more fair.
Yves here. But we are already getting the usual defenses:
Bankers say they are merely charging a fee for a convenience that protects consumers from embarrassment, like having a debit card rejected on a dinner date. Ultimately, they add, consumers have responsibility for their own finances.
“Everyone should know how much they have in their account and manage their funds well to avoid those fees,” said Scott Talbott, chief lobbyist at the Financial Services Roundtable, an advocacy group for large financial institutions.
Yves here. I bet you he does not keep a running balance on his checking account. Back to the story:
Some experts warn that a sharp reduction in overdraft fees could put weakened financial institutions out of business.
Michael Moebs, an economist who advises banks and credit unions, said Ms. Maloney’s legislation would effectively kill overdraft services, causing an estimated 1,000 banks and 2,000 credit unions to fold within two years. That is because 45 percent of the nation’s banks and credit unions collect more from overdraft services than they make in profits, he said.
Yves here. Garbage in, garbage out. Does not distinguish between debit card overdrafts and check overdrafts. The two are mingled. Back to the story:
For years, banks had covered good customers who bounced occasional checks, and for a while they did so with debit cards, too. William H. Strunk, a banking consultant, devised a program in 1994 that would let banks and credit unions provide overdraft coverage for every customer — and charge consumers for each transgression.
“You are doing them a favor here,” said Mr. Strunk, adding that overdraft services saved consumers from paying merchant fees on bounced checks.
Yves here. Favor? Banks are not in the favor business. This is an insult to the reader’s intelligence. Here is a key bit:
But many of the nation’s banks have found that overdraft fees are easy money. According to a 2008 F.D.I.C. study, 41 percent of United States banks have automated overdraft programs; among large banks, the figure was 77 percent. Banks now cover two overdrafts for every one they reject…
Most of the overdraft fees are drawn from a small pool of consumers. Ninety-three percent of all overdraft charges come from 14 percent of bank customers who exceeded their balances five times or more in a year, the F.D.I.C. found in its survey. Recurrent overdrafts are also more common among lower-income consumers, the study said.
Just wait. The next argument in defense of these practices will be that it is cheaper than payday lending.
"As many advisers have looked to expand their practices, they have realized that their highest value activity is spending more time with their existing clients and acquiring new clients," according to CA, which produced an analysis of its survey for FPA Insight, a research newsletter for institutional members. "As they search for ways to better focus their activities, they have looked for the things that were essential to their practice and those that they could outsource. For many advisers, this meant looking to the outside for help with portfolio construction."
Portfolio construction is a part of an adviser's practice that has only grown in complexity. During the bear market of 2000-2002, many advisers were forced to accept that their core talent was not managing client assets. In addition, there are more products available than ever before for financial advisers.
The mutual fund universe alone boasts more than 8,000 choices before taking into account a growing selection of separate accounts, exchange-traded funds (ETFs), and alternative investments. Added up, it presents a dizzying array of choices for the financial adviser.
Our survey results confirm advisers' feelings on this topic. More than 75 percent of advisers agree that portfolio construction has grown more complex.
In addition, more than 70 percent of advisers report using a wider range of products, changing their product allocations, and using more complex products. One can see how an ever-widening product universe would affect the complexity and volume of products used by advisers. In fact, the most common reason given by advisers about why portfolio construction has grown more difficult is that it has grown so time consuming.
Outsourcing this task, however, is not a widespread trend. Just over half of the advisers responding to this quarter's survey stated that they never outsource any portion of the portfolio construction process. There are a number of reasons advisers have resisted making this move. Despite an industry move to more holistic planning and deeper client relationships, many advisers are offering many of the newer products in an effort to distinguish themselves. In addition, clients are more sophisticated and, in some cases, are demanding these new products. Finally, many advisers come from a deep investment management heritage and may have begun their career recommending individual stocks.
Although the reasons may differ from adviser to adviser, the net effect is the same-this is not a task over which many advisers are willing to completely give up control.
Although advisers have a stated objection to fully outsourcing this task, a different picture emerges when examining their daily activities. More than half of advisers report using third-party tools to help determine asset allocation. For those advisers associated with a Broker-Dealer (B-D), exactly half report using platform tools to determine asset allocation.
These same advisers report getting help from their B-D in the form of model portfolios, research and due diligence, training and education, and integrated product platforms. Although these advisers might not consider themselves outsourcers of portfolio construction, many of these are activities that leverage outside expertise in order to help save them time.
CA believes these shifting product trends will only continue. When asked what products they use in constructing a core satellite portfolio, ETFs ranked as a popular option for both the core and the satellite portions of the portfolio. This reflects the flexibility of this emerging product. Advisers can deploy the product as a low cost, indexed option at the core of a client portfolio.
However, as product development accelerates, many advisers are seeing the advantage of using more narrow offerings or taking advantage of intraday trading. Not surprisingly, more than half of the advisers surveyed reported that they plan to increase their allocation to ETFs in the coming year.
What we have (in Chart 14 of The Nature of Risk) is essentially a graphical representation of the manic depressive moods typically experienced by market participants as a function of time and price in one complete sentiment loop. There are two areas in a typical loop where the market does something that traders describe as "churn" or "chop", and two areas where directional trends are found.
RETURNING CONFIDENCE
On the upside, the area where churning takes place is in between the Returning Confidence phase and the Subtle Warning phase, after a significant advance has already taken place. This often appears in the form of a head and shoulders top on weekly or monthly charts. By the time confidence returns, the market has already been going up for ages while the retracement patterns become ever larger, each one scarier than the last.
To technical traders, this type of price action tells us that the market is getting tired. Perceived bull market volatility excites investors. They waited forever on the sidelines for fundamentals to confirm that the move up was "real". The coast is finally clear and they jump in with both feet. This phase typically ends with a failure on test of top, and the big, super scary "buy the dips" pullback begins.
BUY THE BIG DIP
The public continues to pour money in, lured by glowing good news and economic data. After the long move up, finding attractive stocks becomes difficult for technical traders and market veterans. Traders chase momentum where they find it. Investors believe that the game is back on, and they are willing to take big risk and buy big dips. This Big Dip usually comes after a failed test of top in the Returning Confidence phase. The Big Dip typically takes price below the 50-day simple moving average and quite often, to the 200-day moving average. This is where ABC Corrections are typically found.
ENTHUSIASM
Once it is widely accepted that economic and corporate fundamentals are supporting higher prices, a bell goes off. The bull survived The Big Dip. Those who had previously been afraid now have plenty of reasons and "proof" that it is safe to go back into the market and buy again.
At this point, we detect a subtle change in psychology, a shift from the fear of loss to the fear of missing out, and the appetite for risk becomes evident. Investors buy on faith, bolstered by analyst and media reports projecting the trend to continue. As price rises to new highs, they all scream, "It's a breakout!". They are supremely confident that the best is yet to come.
The high made in the Returning Confidence phase typically marks the "point of breakout" and becomes an important psychological number. We know this high is where sellers showed up before, and if price should sink below this area, traders and investors might come to the conclusion that the breakout failed, and therefore, begin selling in case the uptrend is approaching the point where it starts to bend.
At some point, all the buyers who want to be in the market have bought, and they stop buying. Smart money begins to take some off the table. The net result is rotation of buying and selling from sector to sector, causing the major stock indexes to stop going up in any meaningful way and price charts to churn and chop. In the old days, they called this "distribution", marking the transfer of stock from smart to dumb money, from strong to weak hands. This area is where a buildup of participants in position to write sell tickets takes place. If price fails to move up or it comes back under the point of breakout, selling begins.
DISBELIEF
The market fails to go higher, and indeed many of the early leaders have broken down under the 50-day moving average, giving technicians the Subtle Warning. This marks the beginning of the "something is not right" gut feeling, but in the absence of bad news, investors hold on to hope. Not only are they heavily invested in the market, they are psychologically invested in being right and they ignore anything that does not go with their worldview. Indeed, they even wonder aloud why their beloved stocks cannot go up amidst good news, higher earnings guidance and analyst upgrades.
OVERT WARNING TO PANIC
The area of sustained directional trending price action to the downside takes place is between the Overt Warning and Panic phases. There will be some sort of catalyst. Perhaps it is an earnings warning or some point of economic data that leads the crowd to finally clue in that the nagging negative price action they have been watching is the beginning of something big and bad.
The 200-day moving average is broken, and CNBC alerts investors. Everyone knows that the ship is sinking. Those who bought in the churning top realize they are holding the bag and stop buying the dips. Smart money shorts each failing bounce. Stop losses are hit, and margin calls force liquidation. Supply simply overwhelms demand and price action becomes a one-way street.
DISCOURAGEMENT AND AVERSION
After a long price slide, the area where churning takes place is between the Discouragement and the Aversion phase, after a significant decline has already taken place. Often, this appears as a head and shoulders bottom, a cup and handle or a saucer dish pattern. As the public continues to dump stocks, short sellers become bold and bearish. Their views are supported by bad news and poor economic data. Prognostication of lower prices to come is undoubted. This is when everyone knows that the market cannot ever go up again, and that anything, even cash, is preferable to owning stocks.
WALL OF WORRY
While the broad indices are still going down, certain sectors will have bottomed. At some point, everyone who wants to sell has done so, and the selling stops. Low prices and relative value returns, and early buyers with deep pockets begin to nibble at the market. The net effect is that the major stock indexes stop plunging and begins to dribble or moves sideways.
This area is where we find a buildup of participants in position to write buy tickets, producing potential buy pressure. With sellers gone, the market even goes up on bad news. Rallies are labeled as "technical bounces" or are written off as "short covering" Short positions add more on every bounce, confident that lower prices are around the corner. When good news trickles in, it is summarily dismissed as aberrations, subject to revision next month.
AVERSION TO DENIAL
Sustained directional trending action to the upside begins between the Aversion phase and the Denial phase. As the market slowly creeps up, the shorts start to sweat while those who don’t own a piece of the action vow to themselves that they will get in on the next dip that they believe is sure to come. The market continues higher and does not let them in.
More and more bids materialize as buyers show up again while shorts begin to cover. Since there are not many sellers overhead, the move up can be big and fast, and on low volume. If it keeps going, eventually those left behind in the dust have to get in again, and the loop continues.
