The Road Ahead

So what’s the outlook for 2012?

For the record, we believe that next year will bring a continuation of the modest growth we’ve seen since the recession. The economy will grow around 2 ½ percent, as we work off the excess housing stock brought about by the boom and bust. Interest rates will be largely unchanged, and the stock market will reflect the economy’s modest recovery.

There are risk’s to this scenario, particularly from Europe, which appears to be in a mild recession right now—brought about by a credit crunch, as banks there deal with the sovereign debt crisis. But there are significant risks to the upside as well: a housing recovery could emerge here ahead-of-schedule; manufacturing in the US is growing due to higher costs overseas; new energy supplies provide some insulation from supply shocks; mobile technology and smart phones are boosting productivity and investment; and Congress seems to be stumbling toward greater fiscal responsibility.

As these factors come together analysts give little or no credence to their likelihood. Current stock prices assume a coming collapse in earnings. High profits now are deemed to be unsustainable, even as the companies in the S&P 500 continue to do better than expected. Future cashflows are being discounted at a higher interest rate than we see right now because everyone expects rates to rise.

But you can’t have it both ways. If rates rise because the economy strengthens, then earnings will strengthen, too. If rates stay low, those future cashflows are more meaningful today as discount rates are lower. Either way, stock prices should rise.

Here’s hoping that 2012 will bring good news, and that our cautious optimism will be tested—to the upside.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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Hypothetically Speaking

The game is rigged.

That’s one lesson from MF Global. Because brokerage accounts are designed by and for the broker, customers agree to all kinds of things without knowing what they’re signing up for. One of these is margin—by borrowing against your securities, you give the broker the right to use your securities for other purposes. Another is securities-lending, where the brokerage can lend out the customer’s stocks or bonds to a short-seller, in exchange for cash which can earn a small spread.

The thing is, many brokerage customers agree to these provisions without knowing it. Lots of accounts are in an “opt-out” form, like Facebook privacy settings. So unless clients tell the firm otherwise, their own securities can be used to “hypothecate” the broker’s own positions. And dealers who receive those securities can re-hypothecate them to cover their own borrowing.

Thus is violated one of the primary principles of fiduciary conduct: the customer’s assets must remain dedicated to the customer’s purposes. The same assets are pledged against multiple loans, and if the firm fails before the loans are unwound, the customer goes to the back of the line as a senior unsecured creditor.

This is all disclosed—in 6-point type at the back of a brokerage agreement that you need a microscope to read. It’s another reason why all our accounts are cash accounts—no borrowing is done, and no one borrows against our client funds. Because when it comes to customer cash, the rule is simple: it’s their money.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
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www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Trusting the Experts?

Expert knowledge is at a premium.

In colleges, there’s the US News rankings. In investments there’s the credit rating agencies. And in football there’s the USA Today Coaches Poll.

During the regular season USA Today polls about 60 coaches each week to determine the ranking of the top 25 college football teams. The polls are closely watched by millions of fans, and the final poll is especially important because it is used to determine the eligibility of teams for the Bowl Championship Series.

Because each coach’s ranking is public, people can see how they rate themselves, teams in their conference, and teams in other conferences. There are lots of ways to game this system: if you rate the teams you beat higher, it improves your standing; if you rate your own team higher, it helps you, and so on. Hundreds of millions of dollars are at stake: football budgets often go up when a team is ranked higher, and many coaches have contracts that pay them more if they play in a bowl game.

By examining the ballots, researchers found that the greater the financial incentive, the greater the distortion this had on a coach’s rankings. This was especially of the teams ranked 11 to 25, where there’s a lot of jockeying for position to make into the top 10. And rankings changed a lot in 2005, when each coach’s ballot was made public. But the bias persisted

Because the results are so visible, the conclusions are clear: experts, even well-intentioned ones, respond to incentives. Transparency helps, but only so much. It’s important to understand this, since we rely on experts for so many things. Getting the incentives right is the real Super Bowl of finance.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
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www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

The 5% Solution?

Have you seen a good movie lately?

According to the latest data, fewer of us have. Ticket sales are down 5% year-over-year between 2011 and 2010. This is in spite of a glut of 3D movies, kicked off by the hit Avatar. 3D movies can cost 20% to 40% more to go see. Clearly, attendance has fallen. Is this an early-warning sign of an economic downturn?

Certainly movie-going is a discretionary purchase. When consumers cut back, entertainment is typically one of the first things to go. And there were a host of blockbuster sequels—Pirates of the Caribbean, Harry Potter, Mission: Impossible—that are usually dependable earners. So the downturn is a little surprising.

But there are other factors. First, sharply higher ticket prices for 3D movies may have reached the point of diminishing returns. People only have so much cash in their wallets. If that gets consumed by watching spaceships fly past the audience, there’s less available for another movie. Also, there’s a lot of competition for those dollars. The video-game “Call of Duty” sold $400 million in the first 24 hours.

So my inclination is to say no, this isn’t the first in a long string of negative data. The movie business is notoriously fickle. Even Pixar, which released “Cars 2,” had a relatively poor year compared to 2010, when “Toy Story 3” became the seventh best selling film of all time. And you can’t get blood from a stone: Higher prices sometimes lead to lower sales.

Good movies always rise to the occasion. But the ongoing drama of consumer spending power is definitely worth watching.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Slick Politics

Is oil bad for democracy?

Looking at the circumstances, you’d be tempted to think so. From Saudi Arabia to Nigeria to Venezuela, the leaders of countries that have great oil wealth seem to be political strongmen with significant state power.

It’s known as the resource curse: the tendency of resource-rich countries to have poor economies. They’re tied to a single, volatile commodity and the money from the dominant resource tends to corrupt the political system and distorts the economy.

But the counterfactual is Norway: a liberal democracy that steadily invests its oil wealth into a diversified portfolio of assets. Norway is a case-study in the right way to handle newfound wealth.

But absolute wealth tends to corrupt absolutely. Many studies have shown the relationship of resource wealth with political hegemony. This depends, though, on what society was like before oil was discovered. If it was a democracy before striking oil, little changed; democracy endured. But if the country was a dictatorship, the strongman was strengthened.

So don’t go looking for North Dakota to become a one-party state any time soon. It’s still a cautionary tale, though. Because like oil and water, oil and politics don’t mix very well.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Housing Futures

When will the economy get back to full employment?

During the downturn companies shed some 8.8 million jobs from February 2008 to January 2010. The economy has since created about 3 million. By contrast, state and local government employment peaked in September of 2008 and is still falling. It’s lost some 600 thousand jobs. This makes sense: government employment lags behind private employment.

So where have those jobs gone? Why is this recovery so anemic? Usually, by this time, the economy is accelerating and has fully recovered the number of lost jobs. What’s wrong this time?

A big answer is housing. During the boom, we were building some 2 ½ million new homes a year. That’s dropped to half a million and just stayed there. But normally we build a million homes a year just to cover new households that are forming. Unlike many Western countries, our population is still growing. Add to that replacing old homes that have become decrepit, and we should be building some 1 ½ million new homes a year.

Well, if it takes two people to build a home in a year—or a gang of 12 a year to put together 6 homes—that’s 3 million jobs. Add to that at least one job per home to manufacture, ship, and sell the appliances that go into a house, and you’ve got almost 5 million jobs. That pretty much covers the employment gap remaining in our economy.

That’s why many people have said that housing is the key to the recovery. If we can address the current housing depression—the overhang leftover from the bubble—our economy’s growth would be rather healthy. But we have to get there from here.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Global Opportunity

It’s not just in America.

Around the world, business scandals seem to be everywhere. Whether it’s Olympus Corp using overpriced acquisitions to conceal trading losses from the ‘90s; or German financial companies paying high-performing sales staff to visit orgies and brothels in Budapest and Rio; or Siemens executives paying hundreds of millions in bribes to Argentine officials to secure a lucrative business deal—the level of deception and corruption are astounding.

In the US we’re livid, and rightly so, when the officials at MF Global seem more concerned about their shareholders or their employees’ jobs than they do in the $1.2 billion in customer cash that’s gone missing. We’re outraged when Bernie Madoff or some other fraudster perpetrates his Ponzi scheme on unsuspecting investors. But we tend to think that the problem is our system, or that Americans are especially greedy. It isn’t and they aren’t.

There have been fraudulent deals as long as there’s been trade and commerce. By some accounts, misstatements and false accounts are what brought the former Soviet Union to its knees. When you shoot the messenger for delivering bad news, don’t be surprised when the news becomes uniformly good—and universally false. It’s not the system that’s at fault, it’s people who game the system and maybe cut a few corners on the way.

The problem is—and will always be—one of incentives. When the rewards for a little compromise are large and the downside seems limited, it’s easy look the other way or maybe pad an account. The line separating honest accounting from false books doesn’t run between companies, or between countries—but right through every human heart—and through all human hearts.

It’s important to appreciate this as we close the year. Scandals will always be with us. But truth—and honest accounting—generally wins out.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Housing Futures

When will the economy get back to full employment?

During the downturn companies shed some 8.8 million jobs from February 2008 to January 2010. The economy has since created about 3 million. By contrast, state and local government employment peaked in September of 2008 and is still falling. It’s lost some 600 thousand jobs. This makes Continue reading Housing Futures