Stocks vs. bonds: Can you risk less and make more?

By: Gordon Pape Building Wealth, 

It’s a tough time to be an investor. The stock markets have been on a two-year run, with New York’s S&P 500 hitting record highs. That’s great if you’ve been in the market for the ride up but now the big fear is that we’re overdue for a major correction. Who wants to buy stocks just before a plunge?

Normally, people would turn to bonds in this situation. But that doesn’t look like a great idea with interest rates apparently poised to rise. Higher rates translate into lower bond prices, as we saw in 2013. For the first time in several years, the average Canadian fixed-income fund finished in the red. It appears the long 30-year bull market in bonds is over.

So what to do? There’s been a running debate in the States for several years between two prominent author-academics who advise exactly opposite courses of action.

Prof. Zvi Bodie of Boston University, author of such books as Risk Less and Prosper, is of the opinion that stocks are too risky for long-term investing, particularly if you’re saving for retirement. His advice is to put almost everything into bonds, specifically U.S. Treasury Inflation Protected Securities (TIPS). Our equivalent would be Government of Canada Real Return Bonds (RRBs).

His point is that a portfolio that is top-heavy in stocks is always at risk, as we saw in the crash of 2008. Bonds may produce a lower return but the principal is guaranteed and, in the case of TIPS and RRBs, inflation-protected.

The opposing view is advanced by Prof. Jeremy Siegel of the Wharton School of Economics, author of the best seller Stocks for the Long Run. As the book title indicates, he advises people to put their money in equities, pointing out that over time, going back to 1871, stocks have outperformed bonds by more than three percentage points a year.

So here we have two highly respected economists offering entirely opposing views on how we should invest. Who do you believe?

In my opinion, neither one. Successful investing is not about extremes, it’s about balance.

One of the fundamental requirements of investing is to understand asset mix. This is simply the way in which your money is allocated.

Basically, there are three types of assets: cash, fixed-income (e.g. bonds), and growth (e.g. stocks). The higher the percentage of cash and fixed income investments you own, the lower your risk. But the corollary is you must settle for minimal returns. Prof. Bodie argues that the trade-off is worthwhile because your capital will be protected.

As you increase the percentage of growth securities in a portfolio, you add more return potential. But you also incur more risk. When a major market crash hits – and we have had two since the turn of the century – a growth-oriented portfolio will get slammed.

The impact of the credit crunch of 2008 offers a dramatic example of the value of a diversified portfolio. According to CNN, U.S. stocks fell 37 per cent that year while long-term U.S. government bonds gained 27.7 per cent and U.S. Treasury bills yielded 1.5 per cent.

So a $10,000 portfolio that was entirely invested in U.S. stocks (the Siegel approach) at the start of 2008 would have been worth only $6,300 at year-end, while a long bond portfolio would have grown to $12,770. But in 2013, with the bond market in turmoil and stocks soaring, the end result would have been completely different.

It’s fine for academics to talk about the long term but most people are uncomfortable with such financial fireworks along the way. That’s why I prefer a balanced asset mix of, say, 10 per cent cash, 40 per cent fixed income, and 50 per cent stocks. Using the CNN numbers, that portfolio would have lost only 7.2 per cent in 2008 and would have been well positioned for the stock market rally that began in March 2009.

So leave the extremes to the theoreticians. Investing is a balancing act. Get it right and you’ll do just fine.

Gordon Pape is editor of the www.BuildingWealth.ca Internet Wealth Builder newsletter. His new book, RRSPs: The Ultimate Wealth Builder,

Penny Stock Fraudster Gregory Ellis ordered to U.S. to face charges in connection with global $140M scheme

An Ontario judge has signed an order committing Gregory Ellis of Toronto to be extradited to the U.S. to face charges in connection with an alleged international penny stock ring that pulled $140 million from investors.

Justice Wailan Low of the Superior Court of Justice signed the order following a hearing on Friday.

Ellis, who represented himself during the hearing, said he was “a victim of circumstances,” and that he believed he was hired to do legitimate call centre work.

“I don’t have too much to say,” he told the court. “I was hired for a legitimate purpose. I’m a victim of not knowing the full scheme. I don’t believe this is enough evidence to convict me.”

In an extradition proceeding, the presiding judge does not weigh the evidence in the case, but considers whether it would be sufficient to lay charges in Canada if the events had taken place here.

The judge also needs to be satisfied that the person being extradited is the same person being sought by foreign authorities.

The U.S. Department of Justice alleges that Ellis was among four Canadians and five Americans involved in a criminal conspiracy to defraud penny stock investors.

The other Canadians charged are Sandy Winick, Greg Curry, and his son Kolt Curry. All are in jail in the U.S. awaiting trial. Winick and Greg Curry were arrested by FBI agents in Thailand last summer after initially evading authorities. U.S. authorities allege the complex operation is one of the largest in history. They claim it included a pump and dump scheme where share prices were inflated and then dumped on unsuspecting investors, as well as an advance fee scheme that involved persuading investors to pay for services in connection with selling their stocks or pay taxes on the proceeds. “There is more than some evidence Mr. Ellis took part in a conspiracy to defraud investors,” Heather Graham, counsel for the Department of Justice, told the court. Kolt Curry is now co-operating with U.S. authorities and providing details, according to documents filed during the hearing. An undercover officer who worked on the case is prepared to testify that he met Curry and Ellis at an office in Canada, according to the documents. During the meeting, Curry worked out call scripts and Ellis talked about how he defrauded the same victim previously and planned to defraud him again with the same scheme, the officer alleges. Ellis didn’t react when the judge gave her decision. A few moments later, he turned to look at two supporters in the courtroom and shook his head. Ellis, who is being held in custody in Toronto, has 30 days to appeal the order.

Dow Signals A double bottom breakdown

A double bottom is similar, but in reverse. Prices fall to a certain level and then reverse because the demand outstripped the supply at that level. If prices fall again to the level at which they stopped before, it is called a double bottom. If prices continue to fall through that level, a double bottom breakdown is recognized by our alert system. The double bottom breakdown implies that the buyers who were supporting the price are no longer able to create demand that is more than the supply, and prices are breaking down

Investors ignore risks and sing 'Everything is Awesome'

Six Ontario residents charged in alleged $200-million investment fraud

Six Ontario residents charged in alleged $200-million investment fraud TORONTO — The Canadian Press Six Ontario residents are facing charges after RCMP say thousands of investors and the Canadian government lost millions of dollars in an alleged fraudulent investment scheme.

 The Mounties say their investigation began in April 2012 when they received information about people involved in a possible “tax avoidance scheme.” Investigators have determined that since 2004, at least six people enticed thousands of investors to participate in an alleged illegal tax shelter. RCMP say investors were led to believe they could legitimately purchase a company’s business losses that could then be used to lower their taxable incomes.

However, police allege many of these losses were fraudulent and resulted in substantial illegitimate income tax refund cheques being issued off the backs of taxpayers.

RCMP Assistant Commissioner Stephen White says the alleged fraud scheme cost the federal government more than $200-million. The six people have been arrested and each is charged with two counts of fraud over $5,000 and one count of commission of an offence for a criminal organization,

Charged are Vincent (Vince) Villanti, 66, of Whitby, Shane Davidson Smith, 46, of Peterborough, David Prentice, 52, of Oakville, Ravendra (Ravi) Chaudhary, 65, of Toronto, Andrew Lloyd, 42, of Pickering and Joe Loschiavo, 49, of Toronto. Police allege the companies used by the accused to run the scheme included Integrated Business Concepts, Synergy Group 2000, Cason Global Wealth Association and IBCA 2009. Police say the investigation is ongoing and further arrests and charges are possible.

Morning MoneyBeat: Dow Theory Flashing a Warning Signal

The market looked weak on Monday, saved only by a late spurt of buying that narrowed the losses. It may not be the last time it looks weak.

The much ballyhooed Dow Theory is flashing a warning sign: While the Dow Transports made a new high in March, the Dow Industrials did not. The latter’s failure to hit a new high is currently a red flag.

“This leaves a Dow Theory non-confirmation still in place,” said technical analyst JC Parets, founder of Eagle Bay Capital.

Why? Well followers of the century-old Dow Theory–popularized by Charles Dow–maintain the industrials and transports need to move in lockstep to confirm a market’s trend. A pattern of higher highs and lower lows serves as confirmation of the market’s move.

The theory is based on the thinking that making goods is one leg of the industrial economy and moving those goods around is the second leg, so their trends should be in sync.

Since the Dow Transport hit a year-to-date high of 7627.44 on March 7, both the transports and industrials have sagged. The Dow Transport closed at 7510.38 Monday, while the Dow industrials finished at 16276.69.

To see another buying signal, the Dow industrials would have to cross above its early March levels, while the transports would need to maintain its momentum.

“It would take a close above 16588 in the Dow (industrials) this week to corroborate the new high in the transports and clear the way for more near-term U.S. broad market strength,” wrote the team at Asbury Research. “Until then, this warning signal remains intact.”

A sell signal would be triggered if both made new lows, and Mr. Parets pointed to the Feb. 3 lows, 15373 for the industrials and 7054 for the transports, as the critical levels. “This would tell us that the trend has changed,” he wrote. “Until then, it’s more of a red flag (a big red flag).”

Asbury thinks the market is at a “minor inflection point,” and if new highs aren’t made between now and the end of the month, the market could turn back down (they pointed to 1825 on the S&P 500 as a key level), and it would be “the beginning of an overdue correction.”

Morning MoneyBeat Daily Factoid: On this day in 1911, in New York City, a fire began in a rag bin in a factory building. The workers, almost all teenage immigrant girls, began to leave the building. The one working elevator held only 12 at a time. Then it broke down. The fire spread. The increasingly desperate women tried other avenues of escape, like a narrow stairwell, only to find the doors padlocked. Many simply jumped from the windows to their deaths. Fully 145 women died at the Triangle Shirtwaist Co. factory in lower Manhattan that day, one of the worst industrial disasters in U.S. history. It was an event that galvanized union forces and led to lasting changes in the workplace.

-Paul Vigna

Following Smart Money Or Getting Back Into The Markets At The Highs

 

Should retail investors continue plowing into stocks or follow the smart money?

North American stock markets Sell Off Due To Fed US Bank Comments

North American stock markets backed off Wednesday amid worries that the U.S. Federal Reserve could end up raising interest rates as soon as the spring of next year.

The S&P/TSX composite index lost 34.94 points to 14,334.04 as the Fed moved to clarified its guidance on when it might raise short-term interest rates at the end of its two-day policy meeting.

The Fed reaffirmed its plan to keep short-term rates low. But it no longer mentions a specific unemployment rate that might lead it to eventually raise rates.

Instead, it will monitor a wide range of economic data before approving any rate increase.

Later, Fed chair Janet Yellen signalled that the central bank could begin raising short-term rates six months after it halts its bond purchases around year’s end.

The greenback and U.S. Treasury yields appreciated sharply after the Fed announcement while losses for the Canadian dollar deepened, with the loonie closing down 0.86 of a cent (U.S.) at 88.93 cents.

Billionaire Buffett gets 15% hike in compensation

OMAHA— Warren Buffett’s compensation from Berkshire Hathaway Inc. rose 15 per cent last year to $485,606, although the billionaire’s salary remained $100,000.

Buffett leads the Omaha, Neb., based Berkshire Hathaway conglomerate that owns more than 80 subsidiaries in a variety of industries, including insurance, utilities, railroads, retail and manufacturing.

It also has major investments in such companies as American Express, Coca-Cola Co. and Wells Fargo & Co.

Last year it bought a big stake in H.J. Heinz, the ketchup and soup maker.

The increase came in “other compensation,” which includes company-paid costs for Buffett’s personal and home security.

As usual, Buffett reimbursed Berkshire $50,000 for personal costs such as postage and phone calls.

Buffett, 83, is the Omaha, Neb., company’s chairman and chief executive.

Most of Buffett’s wealth comes from his Berkshire stock. The share price rose 32 per cent in 2013.

The salaries of Buffett and vicechairman Charles Munger have been set at $100,000 for more than 25 years, and Buffett doesn’t want or expect a raise, the conglomerate said in a regulatory filing Friday.

Unlike many other companies, Berkshire Hathaway doesn’t grant stock options to executives.

Ukraine is more about energy control rather than freedom...

Sadly, the bottom line is that the battle in Ukraine is more about energy control between the East and West, than it is about freedom. Ivan Lo    The Equedia Letter

While many - especially Canadians - are relaxing in the comfort of their homes, the rest of the world is in a state of instability. 

The battle in Ukraine is setting up for a dramatic chain of events between the East and West, while China is working hard to contain a financial breakdown amidst a falling market and economic slowdown.

Earlier this year, I talked about the mysterious chain of deathssurrounding the financial community.  

This week, Edmund Reilly, 47, a trader at Midtown's Vertical Group, jumped in front of a speeding train.   

The deaths/suicides of financial workers continue.  

Markets on Thin Ice

The U.S. market has enjoyed a very long and sustained bull market since the crash of 2008.

While fundamentals, such as cost-cutting measures, played a role in the rise of the American market, it was the injection of financial liquidity that proved to be the main culprit. 

The mistake is believing that this "printed money" is free; that it somehow just enters our monetary system with a small inflationary price tag.

Unless you're the Fed, there's no such thing as "free money."

A Rapid Rise in Debt  

I am about to show you some very interesting charts.  

Before I do that, let's go back to my letter, How the Government Borrows Money, and review how "free money" enters our system:

The United States is a world power and a first world nation. It has to spend money to maintain this status by building roads, providing healthcare and public services, and funding wars.

But all of this money has to come from somewhere.

Historically, most of this money came from taxes and government-owned corporations. But as the world power grew - through wars and economic activity - so did its spending habits. Taxes were no longer enough to cover all of the bills. So - like every one else - when you don't have enough money, you borrow it.

When the government spends more than it brings in, it's called deficit spending.

How the Government Borrows Money

The U.S. treasury, the department of the U.S. government that manages all of the Federal finances, borrows money by issuing a bond.

A bond is simply a piece of paper - a promissory note - that says if you give me money now, I will pay you back in X amount years, with interest.

These pieces of paper are then sold through a bond auction where the world's largest banks participate in buying part of this national debt.

The banks then sell these bonds to other investors, such as investment funds and countries like China and Japan.

Take a look at this chart:

  

In the last five years, America has more than doubled its debt to foreign investors. That means America now owes more money (and interest payments) than ever to foreign countries such as China, Japan, and even Russia.

The Russian Time Bomb?

This week, a whopping $104.5 billion of marketable U.S. Treasury Securities (UST) left the custody of the Fed:

 

Here's what the change looks like in millions of dollars:

  

Foreign custody holdings of UST at the Federal Reserve have fallen almost every week over the past few months as emerging market central banks liquidated their UST to support their own currencies.

However, the recent $104.5 billion exit this week was the biggest drop of Treasuries held by the Fed on record.

Does that mean foreigners are dumping U.S. paper? Or Russia is dumping to support the ruble, as sources such as Zerohedgesuggest?

Not so fast.

Before we jump to conclusions, let's take a look at the facts.

A Better Rationale 

When UST are sold, they are sold in US dollars.  

Emerging market nations looking to prop up their currency could sell UST in exchange for US dollars, then dump those dollars to buy their own currency. This removes supply of their own currency from the market and increases the supply of the dollar.  

Think of it as a share repurchase.  

Therefore, when someone sells UTS in large amounts, we should see it affect both the currency and bond market.

A large sale of $104.5 billion worth of UTS would have shocked the market and likely pushed the benchmark 10-year yields higher by at least 30 basis points.  

That didn't happen.

Instead, the 10-year yield, which moves inversely to price, dropped to 2.61 per cent on Friday, down sharply from last week's peak of 2.82 per cent.

The currency market was also relatively quiet - too quiet - for such a a massive dump of UST.

Furthermore, if Russia did indeed dump more than half of their UST holdings (which they claim to have $200 billion worth), it would likely not have held the proceeds in US dollar, but rather used it to prop up its ruble.

But for the week ending March 12, Russia only bought 154.97 billion rubles - or roughly US$4.3 billion.

If Russia was the culprit for the dump, where's the other $100 billion?

What do you think happened?  

Preparing for Conflict

Tensions between the East and West have grown stronger than they have ever been since the Cold War.

On Monday, Obama threatened to impose penalties on Russia unless it withdraws its military forces from Crimea. The next day, Russia reportedly called troops on military exercises back to their bases.

Then it was announced that for the week ended March 12, $104.5 billion worth of UST have been moved away from Federal Reserve custody.

Since little reaction was seen in the currency and bond market, a transfer of holdings was likely the culprit - and not a sale. 

U.S. recently threatened economic sanctions against Russia. In preparation, Russia could have removed its UST holdings away from American custody; thus preventing Obama from freezing Russian dollar assets in America.

Back in 1957, after the Soviet Union invaded Hungary, Moscow-based Narodny Bank transferred dollars from the U.S. and deposited them in its branch in London, leading to global credit and dollars held outside of the US.

On Friday, after the report of the massive UST dump/transfer, Russia warned that it was prepared to intervene in eastern Ukraine - ignoring the threats of economic sanctions.

In short, when America threatened economic sanctions against Russia, Russia backed off. Then, after a massive transfer of UST, Russia comes back and threatens intervention in Crimea.  

The Real Reason for War in Ukraine 

The tensions between Russia and America are getting worse, as I mentioned they would in my strings of letters regarding Syria. 

While America remains a world power, its ability to control the world is diminishing - especially in Europe. As Obama continues to threaten Russia with economic sanctions, Russia continues to flex its political strength, with energy as its muscle.

America is the largest exporter of currency, while Russia is the largest exporter of natural gas on the planet.

Russia is also Europe's largest supplier of energy:  

  

In order for Western economic sanctions to work, the EU will have to be on board.

Russia supplies about 30 percent of Europe's natural gas, which means Russia could slowly cut off supplies to European nations if economic sanctions are imposed. On the other hand, given that 70% of Russian gas imports go to Europe, cutting supply to Europe will also hurt Gazprom.

Sadly, the bottom line is that the battle in Ukraine is more about energy control between the East and West, than it is about freedom.  

Like Syria (see The Real Reason for War in Syria: Pipeline Control), the control of Ukraine is about energy; controlling Ukraine means controlling a network of Soviet-era pipelines that carry more than half of Russia's gas exports to the European Union.

While Syria has slipped down the agenda of Western media, the nation is still very much in conflict without resolution and the battle for energy control in both Syria and Ukraine is becoming more dangerous.   

If Russia did indeed transfer such a large amount of its UST holdings away from the Fed, then it is likely preparing to defy America.

That means we should prepare for conflict escalation. 

Prepare for More

According to a senior adviser to the Kremlin, via Ria Novosti:  

An adviser to Russian President Vladimir Putin said Tuesday that authorities would issue general advice to dump US government bonds in the event of Russian companies and individuals being targeted by sanctions over events in Ukraine.

Sergei Glazyev said the United States would be the first to suffer in the event of any sanctions regime.

"The Americans are threatening Russia with sanctions and pulling the EU into a trade and economic war with Russia," Glazyev said. "Most of the sanctions against Russia will bring harm to the United States itself, because as far as trade relations with the United States go, we don't depend on them in any way."

Glazyev noted that Russia is a creditor to the United States.

"We hold a decent amount of treasury bonds - more than $200 billion - and if the United States dares to freeze accounts of Russian businesses and citizens, we can no longer view America as a reliable partner," he said. "We will encourage everybody to dump US Treasury bonds, get rid of dollars as an unreliable currency and leave the US market."

These comments sparked the possible outbreak of war, sending the ruble down last week.

While other senior Russian officials have slammed Glazyev's comments, the thought of Russia persuading others to dump the US Dollar in trade is closer to reality than most would think (see The Brink of War).

China, the largest foreign holder of U.S. debt, has already been dumping UST and has increasingly made agreements to settle foreign contracts in currencies other than the Dollar.  

The Dollar is already being replaced by other currencies in world trade. As such, the demand for U.S. debt will continue to diminish. 

Given that the majority of U.S. debt is already being purchased by the Fed (See How the Government Borrows Money), what will become of America and the dollar?  

More importantly, what will become of your money? 

The Bright Side 

Uncertainties around the World are leading to a renewed interest in safe haven investing. Gold is now nearing $1400 - a number that could revive the profitability of gold miners and trigger a renewed bull market in gold mining stocks.

As I mentioned early January, I expect gold stocks to do very well - better than gold itself.

Here is a 3-month chart of the Market Vectors Gold Miners ETF, the GDX, up over 25% YTD:

YTD Chart, GDX

Here is a chart of the GDXJ, the junior gold stocks ETF - which I expected to outperform the GDX - up over 36% YTD:

YTD Chart, GDXJ

Gold is now up 6 weeks in a row - the longest win streak since the run into the Aug 2011 highs.

You may be tired of hearing about gold, but you won't be if it starts to climb higher.

And higher is where I expect it to go.