Whether you’re new to investing, you’re an avid market-watcher, or you just want to take a more active role in managing your money, you may want to browse through the articles and see what you can learn. I’m new to Seeking Alpha, both as a contributor and a user, so I’m still learning about all that the site has to offer. There are tons of articles for you to read, comment on, or retweet if you so desire. You can choose to follow any contributors that you like and you can customize the information you see according to your investing interests. It’s free to use and free to join.

I will continue to write on a variety of topics here at Balance Junkie. You’ll still find articles on basic personal finance, investing and life balance as well as more in depth market analysis. I hope you enjoy the variety of information. If you want to follow me on Seeking Alpha, you can click on the logo and it will take you to my author page. (For the record, I don’t receive any compensation from SA for my contributions, other than the exposure it provides for Balance Junkie.)

As always, I welcome your comments. I would also be curious to know if any of you already frequent SA and have any thoughts you want to share.

Related posts:

1. Introduction to Balance Junkie
2. Balance Junkie on Twitter
3. Your Balance Sheet and Net Worth

A nickel ain’t worth a dime anymore.

~ Yogi Berra

When we looked at the current pros and cons of investing in commodities and real estate, it became quite apparent that there are some pretty good arguments on both sides of the debate. We often hear contradictory truisms. Cash is trash. Cash is king. Which is it?

The correct answer is likely “it depends”. There are times when it’s prudent to hold more cash, and there are times when it makes sense to move more money into riskier assets like the ones we’ve been discussing this week. Today, we’ll take a look at the case for each and hopefully help you decide where you want to be on the cash spectrum.

As in most debates, there’s a little truth in each extreme, but the greatest knowledge lies in the middle. Further, the best cash allocation for me may not be the best for you. A lot will depend on your unique financial situation and your views on the macroeconomic climate. With those disclaimers out of the way, let’s get right into the Trash vs. King debate.

Cash Is Trash

Here are the most common arguments for holding less cash, as opposed to other assets like stocks, bonds, real estate, or commodities:

• By far the most frequent (and valid) argument is that returns on cash may not outperform inflation, leading to negative real returns.
• You can achieve a much higher return on your money in just about any other asset class as long as the economy is performing reasonably well.
  
• Cash yields (especially in money market funds) are particularly pathetic right now, running anywhere from a fraction of a percent to 2% for some high interest savings accounts.
• If inflation spikes, the purchasing power of your cash will fall, so you will be able to buy less stuff for the same amount of cash.
  

Cash Is King

Here are the most common arguments for holding more cash:

• Cash is the safest investment, and often comes with a CDIC (or FDIC) guarantee. (Money market mutual funds are not guaranteed.)
  
• If deflation is the order of the day, cash is the place to be.
• Economic slowdowns and volatility can lead investors to reduce risk by selling other asset classes, thereby driving their prices down significantly. Cash doesn’t usually experience these big swings.
  
• If you don’t hold a decent amount of cash, you won’t be ready to buy when other asset classes get hit.

Royalty or Rubbish?

In the end, how much cash you choose to hold will depend on a few main decisions:

1. Your view on inflation vs. deflation.
2. Your views on economic growth.
3. Your risk tolerance.

There have been a number of good arguments put forth on the first two issues, with some arguing that the stock market is about to rally again, and others firmly staking their tents in the Japanese deflation camp. Your position on these pivotal issues will likely determine the percentage of cash that you will hold. But perhaps more important is your position on number 3.

Which is more important to you: preservation of capital or higher return on your investments? If we’re all honest with ourselves, we would probably unanimously agree that we really want both. Unfortunately, that’s not how it works. By determining your cash allocation, you’re really putting a number on each. Obviously, the older you are, the higher your cash allocation should be.

Regular readers already know that I favour capital preservation right now. I tend to be in the deflation now, inflation later crowd. I see the problems presented by high sovereign and consumer debt levels as a threat to the global economy and financial stability. I think it will take some time before we can work off the excess capacity and leverage in the financial system. While I definitely see the potential for reflex rallies in the markets, I still believe that capital preservation should be the order of the day until a) we understand the length and depth of the current deflationary turn and b) the global deleveraging process is closer to being completed.

The Ultimate Diversifier

I recently wrote that these markets currently offer no respite in diversification because of the increasing correlations within and between asset classes. That’s another reason I favour cash at the moment. It’s the ultimate diversifier. (I know that’s not a word, but if the President of the United States can say “decider”, I can coin the term “diversifier”.) The one certain way to reduce risk in your investments is to simply increase your cash allocation. Stocks, bonds, commodities and real estate can suffer large capital losses relatively quickly when risk levels are elevated, as I believe they are now.

I’ve heard the argument before that holding high levels of cash is actually riskier than holding a diversified portfolio of high quality stocks and bonds, but I’ve never been able to make myself believe it. Even if inflation rises, reducing the purchasing power of my cash, interest rates will rise to compensate for that. The interest rate-inflation differential would have to be pretty huge to compare with the 20% plus drop in stocks or other asset classes that is possible.

Now I’m not advocating a 100% cash position for everyone, although my personal accounts are close to that level at the moment. I’m just saying that there are some pretty substantial risks out there right now, so shuffling your mix of equities and bonds probably won’t offer the same risk reduction bang you can get by shifting more bucks into cash.

(Disclosure: I hold more than 90% of my money in cash at the time of writing.)

What’s your view on cash? Trash or king?

Related posts:

1. Stocks and Bonds: Pros and Cons
2. Interest Rates: 2010 Mid-Year Review
3. Commodities and Real Estate: Pros and Cons

No man acquires property without acquiring a little arithmetic also.

~ Ralph Waldo Emerson

We continue our look at the prospects for various asset classes in the current market environment today with a survey of the commodities and real estate landscape. Both of these are usually considered hard assets. As Dennis Gartman always says, “if you drop them on your foot, they hurt”.

Generally speaking, hard assets like commodities and real estate tend to appreciate during inflationary times and depreciate during deflationary climates. So your view on whether to allocate money to these two may hinge on your position in the inflation vs. deflation debate. I tend to be in the camp that says we are currently in a deflationary environment, and likely will be for some time. But there is definitely the potential for inflation to rear its head down the road depending on the actions taken by monetary authorities.

Commodities: Will It Be the Elevator or the Stairs?

There’s an old saying on the trading floors that commodities take the stairs up, but the elevator down. Uptrends are usually gradual and orderly, whereas corrections can be fast and steep. Over the past decade or so, however, it seems like commodities markets are a lot more volatile in both directions. I’m not sure if it’s the number and complexity of ways to gain exposure to commodities or not, but the rise in volatility does seem to coincide with the proliferation of ETFs and derivatives.

Your choice of investment vehicle for your commodity exposure may determine your success as well. You can buy stocks in companies that mine or harvest various commodities like oil, gold, copper, or grains, or you can trade futures on the individual commodities. You can buy ETFs that can track a basket of commodity-producing companies, or a single commodity like gold itself. Just be aware that funds that track commodities don’t always track them as closely as you might like.

Here are some reasons that you may (or may not) want to put money into commodities right now:

Pros

• Growth in emerging markets like China and India may fuel demand for everything from oil to potash.
• If central banks monetize debt in order to avert a sovereign debt crisis, inflation could spike, taking commodities with it.
• If the U.S. dollar (in which all commodities are currently denominated) falls, commodities usually rise.
• If investors lose confidence in fiat currencies, they may flock to commodities, especially gold.

Cons

• Commodities can be very volatile, and it’s easy to get shaken out of your positions.
• If deflation takes hold for an extended period of time and the economy fails to recover sufficiently, commodity prices will fall.
• If the U.S. dollar rallies because traders lose confidence in other currencies like the Euro, the Pound, or the Yen, commodities will likely suffer.
• If there’s even a hint of growth slowing in China or other emerging markets, traders tend to sell commodities first and ask questions later.

It would be easy to spill a lot more pixels on each commodity individually, as each one has unique characteristics. These are meant to be generic guidelines for investing in commodities. Given my view that deflation is the main worry right now, I favour a cautious approach to commodities. Still, the longer term growth story for commodities is undeniable. The supply of most commodities is, after all, finite.

If you don’t mind volatility and are a pretty agile trader, you might consider a small core position in your favourite commodity companies or ETF (bought on a pullback, of course). You can always allocate some cash to trade the swings as well, but there’s no shame in sitting out for a while if you don’t have a trader’s disposition, or can’t afford the increased risk.

Real Estate: Location, Location, Location

It’s hard to talk about real estate as a single asset class, as prices can behave very differently depending on the specific market you’re discussing. As we all know, the real estate markets in Canada and Australia did not take the hit that the U.S. market sustained over the past few years. Whether those two commodity-rich countries will be able to escape unscathed or are merely trailing their American counterparts remains to be seen. (Update: Interesting article asking Just How Risky Are China’s Housing Markets?)

We can also make a distinction between the residential housing market and the commercial real estate market. I’ve always been of the opinion that my home is just that: home. It’s not an investment to be gamed. It’s literally the roof over our heads, and should be treated differently than a commercial property or even a vacation cottage.

Of course, there are numerous ways to gain exposure to the real estate market without moving every two years. You can buy rental properties, invest in commercial real estate, buy the stocks of home builders and related industries, or simply buy a REIT (Real Estate Investment Trust) or two and collect the distributions.

Here are a few reasons why you may (or may not) want to invest in real estate right now:

Pros

• Home prices in the U.S. have already fallen so much that they may be ready to bottom.
  
• Canadian home prices may correct a little, but won’t fall off a cliff.
  
• Increased foreclosures may mean that you could find your dream home for a bargain.
• If inflation takes hold, real estate prices usually rise.
• Commercial real estate isn’t in as dire straits as some think. Securitization and financing are available.
  

Cons

• U.S. home prices have further to fall and it may take another 5-10 years before they experience a meaningful bounce.
• Canadian home prices are in a bubble and are due for a serious correction.
• Many commercial real estate loans are coming due over the next couple of years and they may not be able to roll that debt into new loans.
• The glut of homes on the U.S. market will only get worse as banks foreclose on more homes, driving prices down further.
• The expiration of the stimulative home buyers’ programs that have supported the market will mean lower U.S. home prices.
• If deflation really takes hold, prices in the U.S. could remain depressed for some time, and those in stronger markets could experience deeper corrections than many currently expect.

If you think it sounds like these two camps are looking at two different markets, you’re not alone. I’ve read articles and seen various interviews with pundits who have argued each of these conflicting points persuasively. Maybe the recent market gyrations actually make sense when you look at the cross-currents that seem to be present. So what’s an investor with available cash to do?

I tend to be very cautious, and there are enough concerns out there right now that I prefer to sit on the sidelines. As a result, I might miss the train as it leaves the station. But one thing I’ve learned about markets over the years is that there will always be another train and I’d rather catch the second than get run over by the first.

What are your thoughts on the current state of the commodities and real estate markets? Are you putting money to work, staying the course, or sitting on the sidelines?

(Disclosure: I don’t own any of the securities or investment vehicles mentioned in this article at the time of writing.)

Related posts:

1. Stocks and Bonds: Pros and Cons
2. Inverse ETFs: Pros & Cons
3. Cash: Is It Trash or King?

A dollar picked up in the road is more satisfaction to us than the 99 which we had to work for, and the money won at Faro or in the stock market snuggles into our hearts in the same way.

~ Mark Twain

I was going to do a single article on the pros and cons of investing in different asset classes right now, but I decided that there was too much information there, so I’m going to break it up into 3 articles which I’ll post this week. Today, we’ll take a look at the two asset classes you probably hear the most about: stocks and bonds.

The idea of this series is not to provide recommendations about which asset allocation is correct, but to provide you with some information you can use to make the determination that’s right for your situation based on the current state of the markets and the economy. If you are in your 20s, your choices will be different than those in their 40s or 50s. The amount of income you earn, your risk tolerance, your market knowledge and opinions will also affect your choices.

Stocks

Before I get into the pros and cons of putting your money in various types of stocks right now, let me just reiterate some facts about stocks in general:

• Money in stocks is money at risk.
  
• Stocks can go up or down by a little or a lot at any moment for any reason or for no apparent reason.
  
• Stocks can trade sideways for long periods of time too.
• No one knows for sure what stocks will do in any given time period.
• History is a guide, but you can crash and burn if you’re always looking in the rear view mirror.

For a more general look at the pros and cons of investing in stocks in general, see Should You Invest in Stocks?

Dividend-Paying Stocks

We discussed this a bit in Friday’s post on No Respite in Diversification, but I’ll try to make the pros and cons clearer here:

Pros

• Companies that pay dividends are usually larger, more successful enterprises that have been around for a while.
• You can earn anywhere from a fraction of a percentage point to 6% or more from dividends, depending on the type of business.
• Because they are usually relatively stable companies, these stocks sometimes fall less during bear markets.

Cons

• As discussed on Friday, markets can sometimes become highly correlated (as they are now). During these types of bear markets, dividend stocks can get hit just as hard as all the others.
• Companies sometimes cut their dividends. This can happen if an individual company encounters problems, or if we enter a vicious bear market and/or a very poor economy. If the dividend is cut, you will lose some or all of your dividend income and the share price will likely get clobbered to boot. (The clobbering usually happens before the dividend cut is announced, and the stock price sometimes recovers after the actual announcement.)
• Companies with very high dividend yields should be avoided as that’s often a warning sign of pending trouble.

Other Types of Stock Allocations

I don’t have the space here to go into a great deal of detail on all of the different ways you can split your equity (stock) allocation, so I’ll just go through some of the basics and a few pros and cons for each:

• Large Caps vs. Small Caps: Some investors like to diversify their stock holdings by market capitalization (ie. how big the company is). Large caps have the advantage of a proven track record and more stable stock price, but sometimes lack the growth boost that you can get from small cap stocks. You may find the next Apple in the small cap basket, but you’re more likely to go through a few companies that don’t pan out or even go bankrupt before you find that diamond in the rough.
  
• Growth vs. Value: Some investors like to buy stock in companies experiencing very high growth rates, expecting the share price to increase quickly. The trouble with growth stocks is that, by the time everyone realizes they are growing quickly, that growth is already reflected in the share price. If you’re a little late to the party, you can get hurt. Other investors prefer to invest in stocks that they perceive as undervalued according to whatever metric they might use. The problem with this approach is that companies sometimes trade at low valuations for very good reasons. Perhaps growth is slowing, or they are encountering an operational problem.
• Sector Allocations: Some investors like to diversify according to sectors like energy, utilities, consumer staples, consumer discretionary, etc.. This can be an effective way to spread risk, unless markets become very highly correlated. The key to this strategy is to remember that diversification within equities isn’t total diversification: you still need to hold other asset classes like bonds, cash, etc. to be truly diversified.
  
• Geographic Allocations: Some investors believe they can achieve diversity by allocating capital to different regions like North America, Europe, or emerging markets. While it’s true that investing in fast-growing markets like the BRICs (Brazil, Russia, India, China) can add a little kick to your portfolio, you also need to be aware that they can fall quite precipitously as well. You may not like where you get kicked if that happens.
  

These are just a few of the ways you can split up your equity allocation. But, as I mentioned on Friday, stocks are becoming more correlated lately, and it’s something to note if you’re looking to put money to work right now. Diversification within your equity allocation may be quite elusive until that correlation eases. You may want to lower your exposure to stocks for a while to reduce your overall risk.

Bonds

There are many ways to diversify within your bond allocation as well. Here are some general considerations in the current environment for bonds:

Pros

• Currently, deflationary forces seem to be more prevalent, so there is still some room for bond prices to climb.
  
• Bond prices tend to fluctuate less than stock prices.
• Bonds provide interest income that is guaranteed, but only if the issuer doesn’t default and you hold the bond to maturity.
• Even if bond prices are at or near a top, bond tops can last 2 – 14 years.
• Inflation-protected bonds like Real Return Bonds in Canada, or TIPS in the U.S. can provide a good inflation hedge.
• Although corporate bonds are often seen as more risky, some corporate balance sheets look a lot healthier than many sovereign balance sheets right now.
  

Cons

• Bond prices have been rising steadily since the early 1980s, so the bull market may be getting a little long in the tooth. There may not be a whole lot left in the way of capital appreciation.
  
• With very low yields, new bond purchases are not going to offer much income.
• If inflation rears its head, bond prices may fall precipitously, causing significant capital losses.
• The capital protection provided by buying individual bonds is at least partially lost if you buy a mutual fund or ETF.
• Bond supply is huge right now, with sovereign and corporate entities vying for investors’ money. If bond traders start to demand more yield for their money, that would cause bond yields to rise and prices to fall. This idea of sovereign issuers crowding out banks and corporations that depend on the bond market to finance their operations has been a worry for quite some time. It hasn’t happened yet, as investors have become disenchanted with equities and can’t seem to get enough bonds. That may change at some point, and it could happen abruptly.

I’m sure I must have missed some of the pros or cons for stocks and bonds that are relevant in today’s market. Can you think of any others?

Related posts:

1. Commodities and Real Estate: Pros and Cons
2. Inverse ETFs: Pros & Cons
3. Should You Invest in Stocks?

Invest a few moments in thinking. It will pay good interest.

~ Author Unknown

We’ve been talking about bubbles all week. So far, we’ve outlined 5 financial bubbles and 5 socioeconomic bubbles that could affect your money and your quality of life. It looks like we may have a bubble of bubbles on our hands. Does that have to be a bad thing? How can we prepare for the popping of these bubbles? What does all of this mean for your investment strategy?

Traditional Advice

One perennial piece of advice is that diversification can smooth out fluctuations in your investment returns. Don’t put all your eggs in one basket. That way, if you have 3 baskets and one is dropped or otherwise damaged, you’ll still have the eggs in the other two.

There are a couple of “defensive” investment strategies that are often recommended for long term investors, especially during trying economic times:

1. Invest in High Quality Dividend-Paying Stocks: The idea here is that you will “get paid to wait”. So if we hit an air pocket in the economy and the stock market, at least you’ll be able to collect 1% – 5% in dividend income. The assumption here is that the value of these stocks will not fall as much during a bear market because they tend to be of higher quality. You should just wait it out because stocks always rebound eventually.
   
2. Stick to Your Asset Allocation & Rebalancing Plan: This approach is often used by passive index investors. They simply choose a stock allocation and a bond allocation, and periodically rebalance by buying some of the asset class that has fallen and selling some of the one that has risen. The assumption here is that stocks and bonds are usually not highly correlated, so if stocks are going up, bonds are probably going down. This is how diversification is supposed to help you spread out your risk.
   

Why Diversification Will Be Less Effective in This Environment

So the idea of diversification is to spread your money among asset classes that are not highly correlated. In many cases, putting your eggs in different baskets may be a good strategy. But what if all 3 baskets fall off the truck at once? That can happen to your money too.

The strategies above would have worked pretty well during the secular bull market of 1982-2000. During that time period, stocks largely moved higher, and cyclical bear markets were buying opportunities. Many believe (myself included) that a secular bear market began in 2000. For that reason (and few others) the strategies mentioned above won’t work as well, if at all. Danielle Park, money manager and author of Juggling Dynamite, recently offered some very good reasons why we need to sell to avoid losses. I’ve incorporated many of those here:

• Contracting PE Multiples: One hallmark of a secular bear market is that price to earnings ratios tend to contract. That means that investors are willing to pay less for $1 of earnings. So even if your favourite dividend-paying company manages to maintain or increase its earnings, the stock price could still fall – perhaps by quite a bit. The same goes for the stock indices. A 3% dividend is cold comfort if your capital has depreciated by 40% or more.
  
• Increasing Correlations Within Asset Classes: If stocks of various sectors, geographies, and capitalizations trade up or down together, the argument for diversification within asset classes falls apart pretty quickly. In fact, there has been a lot of noise made lately about how the stocks in the S&P 500 are now 81% correlated with the index. When everything trades in the same direction at once, diversification doesn’t work. Another article asks What Is Correlation Telling Us? This one discusses the role of government backing of certain bonds and rates being held very low as factors that have lead to higher correlations among certain types of credit in the bond market.
  
• Increasing Correlations Between Asset Classes: Historically, stocks are not highly correlated with bonds. In fact, they are usually inversely correlated. But since the middle of the 1980s, stock and bond prices have moved in the same direction – mostly up. We would normally expect that, as stocks rose from 1982 – 2000, bond yields would have risen too.(Remember that bond prices and yields move in opposite directions.) A chart comparing the 10 year U.S. treasury yield to the S&P 500 shows the opposite. In fact, bond yields fell as stocks rose. That means that bond prices rose in tandem with stock prices. That would have made a traditional rebalancing approach much less effective.
• HFT (High Frequency Trading): Many large trading and investment firms now use computer algorithms to execute trades. A lot of these computer models are based on similar technical patterns, so the market can sometimes look like a herd of cattle stampeding in one direction and then the opposite one. We’ve definitely seen a lot more of that lately. (If you’re interested in more particulars on the effects of HFT on markets, read this article on Correlations Among Asset Classes.)

I should say that recently, bond prices have actually been rising as investors have reverted to their traditional view of bonds as a safe haven in falling stock markets. My point was simply that hearing someone say that stocks and bonds always move in opposite directions and investing your money according to that historical precedent may not always be a great idea. You still need to look at each asset class individually. Where is it trading relative to its own unique cycle and relative to the overall economic cycle? Stock cycles tend to be shorter than bond cycles, so it’s possible that the secular bull market in equities ended in 2000, but the bull market in bonds could keep going for a while longer.

The Dangers of History & Tradition

A lot of the investment guidance out there is based on historical precedent and clichés that may not be effective in the current market environment. That’s not to say that there’s no place for the tried and true. But there’s no substitute for independent thinking and due diligence. (See Ignorance Makes You a Better Investor and Other Money Losing Fallacies.)

There are so many aspects of today’s financial markets that are unprecedented, including the interference of governments and central banks, that it would be foolhardy not to at least review your investment approach. (See Today’s Markets: Not Business as Usual.) Although it’s less likely that all 3 of your baskets will fall off the truck at once, that doesn’t mean it won’t happen. And if the weather’s bad and the truck driver is intoxicated, you might want to keep more cash instead of investing in so many eggs.

If asset classes are becoming more highly correlated, and those in the economic driver’s seat may need a driver’s ed refresher, where can you put your money? On Monday, we’ll take a look at the different asset classes and the pros and cons of putting money into each of them right now.

Do you think diversification will always provide better or safer returns?

Related posts:

1. Stocks and Bonds: Pros and Cons
2. 5 Financial Bubbles: Are We Facing a Bubble of Bubbles?
3. Modern Portfolio Theory: Fact or Fiction?

Socialism failed because it couldn’t tell the economic truth; capitalism may fail because it couldn’t tell the ecological truth.

~ Lester Brown

Update: This article was selected for the Best of Money Carnival #61 posted at Canadian Personal Finance Blog. Thanks Big Cajun Man!

On Monday, we looked at 5 financial bubbles floating around our economy and asked whether the proliferation of bubbles could mean that we’re in a bubble of bubbles. We defined a bubble as a structurally tenuous entity with nothing of substance at its core. Today we’ll look at 5 socioeconomic bubbles that could easily be viewed as both causes and effects of those financial bubbles.

The current version of capitalism seems to be based on the idea that growth is always good. Is that realistic? Is it desirable? Is it even capitalism? The very fact that much of our culture is based on the idea that more is better would seem to indicate that we are indeed in the midst of a bubble of bubbles.

The Bubble Roster – Part II

There are many trends over the past few decades that could easily be called bubbles. Here, we’ll take a look at 5 socioeconomic bubbles that are still inflating:

5 Socioeconomic Bubbles

1. Growth: One could argue that growth itself has become a bubble. Over the past 30 years or so, governments seem to be willing to do whatever it takes to avoid a slowdown in growth. But growth, unchecked, can become cancerous. Sustainable growth requires balance. We cannot have more, more, more without consequences. Whether you’re talking about biology or economics, a balance between resource capacity and utilization  is paramount. Cells that grow out of control sap the resources of the organism, eventually killing it. The same is true of economic resources.

If we use up all of our resources in order to sustain growth, that growth, and the economy itself, will eventually stagnate and die.  The concept sounds so simple – and yet we have failed to grasp it. We, the electorate, continue to support the cancerous policies that promote growth at any cost. We are willing to take on unprecedented amounts of debt in order to support failed corporations. We’ll max out our credit lines to have the newest, biggest and best. We’ll worry about paying for it all later. It’s a perfect example of how one bubble feeds another.

2. Consumption: Our insatiable desire for more has fueled the growth and debt bubbles. The 1200 square foot home in which we grew up isn’t good enough for our kids. We need it bigger. Last year’s gadgets are so passé. We need the new ones. Our old T.V. still works great, but we’ve got to have that new giant screen model with HD and hundreds of channels. (Never mind that the quality of content on those channels is in a deflationary spiral, perfectly representing a culture with “nothing at its core”.)

While all of this inflated consumption has lead to economic growth, we must remember the foundation of these purchases: a growing pile of debt. That can go on . . . until it can’t go on any longer. Charles Hugh Smith sums up the consumption conundrum perfectly in a recent article entitled Oversupply of Old Failed Ideas, Undersupply of New Pragmatic Ideas:

“Beyond a modest level, consumption is the classic example of diminishing returns: you keep spending more but enjoying it less. At the end, ennui, alienation and exhaustion replace enjoyment.”

If we insist on growth at any cost, we’re going to have to be prepared to pay up. But it seems like most of us want the growth without the cost. Not only is that impossible, it’s undesirable. Too much of anything becomes toxic.

3. Complexity: Is it just me, or is everything a lot more complicated than it used to be? Ordering a plain cup of coffee is boring. Our cars are so computerized that the backyard mechanic can’t fix it himself anymore. Our financial system, tax system and legal system are comprised of a web of information so complex that the average person has neither the time nor the expertise to untangle it all.

Perhaps that’s how Fannie and Freddie are still in existence. Perhaps that’s why no substantial regulation or transparency exists in the $600 trillion derivatives market. Perhaps no one in a leadership position even understands the structure and implications of these ticking time bombs. Is it a coincidence that the only people who fully understand them are the ones making loads of money from them while taxpayers foot the bill when they blow up? If that’s the case, perhaps they shouldn’t exist – at least not until we can figure out how to keep them from destroying our economy or until those who play in those markets are ready to fully shoulder the risks associated with them.

The Paradox Of Choice is a book by Barry Schwartz which postulates that more is less. Too much complexity and excessive choice don’t lead to greater satisfaction. Rather, they can hinder our ability to make effective decisions.

4. Complacency: It seems we have a complacency bubble on our hands too, and it feeds the other bubbles as well. Back in 2006 many experts told us that it was OK that U.S. housing prices had gone parabolic because demographics supported the rise in prices, etc., etc.. We might see a correction, but no crash was in the cards. We believed them. We were complacent. After all, nothing bad had happened yet, right? Again, it continued until it couldn’t.

Right now, we are hearing similar shushing from experts who tell us not to worry about the massive (and growing) heaps of debt on the books of countries and consumers worldwide. Don’t worry. We’ll grow our way out of it, they say. All we have to do is borrow a few more trillion to help consumers buy another home, car, or iGadget they don’t need and we’ll be back in business. Really?

I would contend that we’ve already borrowed so much consumption and growth from from future generations and that it will take those generations quite a while to pay the bill for our profligacy. I wonder when the complacency bubble will pop? I’m not sure, but I guess it will probably happen right about the same time the other 9 bubbles we’ve outlined here start to pop. Who knows? Maybe I’m off base on this. After all, it hasn’t happened yet, right?

5. Narcissism: I’ve often wondered if my perception that people are a little more self-interested than they used to be was just a factor of growing older and becoming a little curmudgeonly. Unfortunately, recent studies have shown that people are indeed becoming more narcissistic. A new book called The Narcissism Epidemic: Living in the Age of Entitlementdetails research that shows that we have a narcissism bubble too.

So it seems that we are a society addicted to consumption and growth. But we’re too complacent to do anything about it because it’s all just too complex for us and we don’t care anyway because it hasn’t affected us personally – yet.

Enough Is Enough

Having described 10 bubbles over the past two articles, it seems like we can conclude that we have a bubble of bubbles on our hands. If that’s really the case, then society itself has become a structurally tenuous entity with nothing of substance at its core. But these bubbles have been building for many years and could conceivably continue for many more.

Still, it feels like we are approaching the “enough” point. That’s when we collectively decide that we’ve had enough – enough growth, consumption, complexity, complacency, and narcissism. Like the child who eats one too many chocolates or the imbiber who indulges in one too many cocktails, we are reaching the point at which we realize we passed Enough 2 drinks (or chocolates) ago and we’ve now crossed into the land of Too Much.

What will the catalyst for this realization be? Who knows? Maybe it will be more stories about Goldman Sachs and Wall Street getting rich while starving the poor. Maybe it will be the simultaneous popping of several bubbles that finally ends the tyranny of the capital markets.

What comes next may not be pretty. But like the hangover from any other overindulgence, it will pass. Then we’ll swear to never do it again. And we probably won’t. But our great grandchildren might.

Do you see any evidence of bubbles where you live? How do you think this will all turn out?

Related posts:

1. 5 Financial Bubbles: Are We Facing a Bubble of Bubbles?
2. A Dozen Good Reasons to Move to Canada
3. How To Sample Wisely From the Noise Buffet

Economic advance is not the same as human progress.

~ John Clapham

Update: This article was included in the Carnival of Personal Finance #267 at Beating Broke. Thanks!

We’ve heard a lot about bubbles in the economic world over the past decade – so much, in fact, that it seems like we might be facing a bubble of bubbles. But what does that mean to the average person? We’ll take a look at some of the issues and implications of our bubblicious culture this week and try to figure out how to handle it all.

What’s a Bubble?

The term bubble has been tossed around pretty liberally of late, with just about every asset class having been labeled a bubble at one time or another. All the while some analysts keep insisting that some of these bubbles are just bugaboos – symbols of success rather than excess. But what is a bubble?

Here are two different definitions from my old dictionary:

bubble: n. 1, a thin film of liquid holding gas or air.  2, an unsound project or idea.

So it seems that bubbles are structurally tenuous entities with nothing of substance at their core. How does that strike you? Do you think that accurately describes any part of our economy, financial system, or cultural zeitgeist? It’s been my contention that it very accurately describes all three. It seems to me that we’ve embarked on more than one “unsound project or idea” over the past few decades. As the opening quote hints, we can have long periods of economic advance that do not necessarily accompany any progress of substance for humanity.

The Bubble Roster – Part I

If our economy and our culture are essentially a bubble of bubbles, it seems like there should be a lot of them out there. Wednesday, we’ll take a look at some of the social trends that have been become bubbly. Today, we focus on some financial factors that have been stamped with the bubble moniker over the past few years:

5 Economic & Financial Bubbles

1. Real Estate: This seems like an easy one, as it would be pretty hard to argue that the U.S. residential real estate market was not in a bubble over the first half of this decade, given that it has already popped. Questions remain, however, about whether or not the U.S. commercial real estate market is the next real estate bubble to pop – or maybe it will be the Canadian housing market, or, heaven forbid, China’s.

2. Bonds: The bond market has been in a secular bull trend since the early 1980s, with U.S. Treasury prices rising and yields falling. At what point does a bull market become a bubble? Many have been calling for bond yields to rise for years now, and yet yields across various maturities continue to fall as worries about debt deflation mount.

Louise Yamada’s analysis seems to make the most sense out of any that I’ve read so far. She explains that secular bond cycles tend to last about 30 years. While bottoms (like the one in 1981) tend to reverse very quickly, tops (like the one we’re going through now?) tend to take 2 to 14 years to unfold. If that’s the case, we could be looking at lower bond yields for quite a while longer. In fact, Ms. Yamada points out that bond market tops are often associated with economic depression.

3. Commodities: Commodity prices might have been called a bubble before they got whacked (along with everything else) in the credit crisis. Since then, oil, agricultural commodities, and especially gold, have rebounded sharply. The argument for higher commodity prices often centres around emerging market (especially Chinese) demand. While I can see how that might be a long term driver of commodity price inflation, I tend to worry more that the popping of some of the other bubbles mentioned here (especially debt) will swamp commodity prices.

4. Stocks: Some stock bubbles are pretty obvious – like the NASDAQ bubble in 2000. Others are less so. Most won’t be identified as such until it’s too late and they’ve already popped. Are stocks in a bubble right now? Most people would say that stocks are neither grossly overvalued nor undervalued right now based on current earnings estimates. But if those estimates are wrong, all bets are off. If the other bubbles mentioned here start to pop, whether one at a time or all at once, those estimates will become meaningless. This is a time for caution and capital preservation.

5. Debt: Debt, both at the consumer and sovereign level, is probably the biggest, and possibly most dangerous, bubble of them all. Back in December of 2009 I identified debt as “one of the biggest factors in determining how the economy and markets perform in 2010“. So far we have experienced tremors in the credit and stock markets due to sovereign debt excesses in many European countries as well as deteriorating economic fundamentals. Unemployment remains elevated, making it difficult for already over-leveraged consumers to spend more – as if that’s always a good thing. U.S. sovereign debt levels are very close to hitting numbers that many consider dangerous.

Not only is debt a problem in and of itself, but it limits our options for fixing the structural problems we face. We have continued to dance to the Keynesian drumbeat, “solving” one crisis after another with ever-increasing doses of debt in a dangerous game of musical chairs. When will we find some leadership that’s willing to acknowledge that the music needs to stop? Shoveling debt on top of debt is not working. We need to put plans in place for the inevitable scarcity of chairs as we change the rhythm to one that everyone can dance to.

The Trouble with Bubbles

The trouble with bubbles is that they can continue to grow larger for longer than anyone expects. When they pop (and they always do), it usually comes as a surprise, sometimes even to those who have been predicting it for awhile. Whenever a bubble pops, the collateral damage is usually directly proportional to the age and size of the bubble. Everyone always thinks they will get out before the bubble pops, the music stops, or whatever metaphor you prefer. Few actually do.

If we stick with our earlier definition of a bubble as a structurally tenuous entity with nothing of substance at its core, then I would have to say that debt is at the core of our current financial bubbles. Growth built on debt is not real, especially when that debt is used to support corporate entities that are already insolvent. Debt can only lead to progress when used in moderation to support the real growth of viable businesses.

Given the bubble of bubbles that seems to be floating around right now, it seems like a relatively cautious position is prudent. Bubbles can pop very quickly, and often unexpectedly. Preventive measures and contingency plans are best made while bubbles are forming, and not while they’re popping. As I always tell my sons when they want to continue a potentially risky practice, just because it hasn’t happened yet, doesn’t mean it won’t.

What do you think about the bubbles mentioned here? Can you think of any others? How are you planning your finances and investments in light of this bubble of bubbles?

Related posts:

1. The Culture of More: 5 Socioeconomic Bubbles Ready to Pop
2. No Respite in Diversification
3. Stocks and Bonds: Pros and Cons

Financial News Roundup: Too Big for Your Britches Edition

This past week was pretty eventful in the world of finance and economics, so I thought I might try to sum up the relevant information for you here. As I went through some of the key events for the week, a sort of too big for your britches theme seemed to emerge:

• The economic data took a decided turn for the worse, giving the double dippers more fuel for their fears. I guess the rebound rally in the stock market was, at least for now, too big for its britches. This week alone, we had disappointing data on U.S. retail sales, consumer sentiment, the New York Empire Manufacturing Index, the Philly Fed, and Canadian home sales. The Baltic Dry Index, a measure of commodity shipping rates, fell for 35 days straight, the longest sequential decline in 15 years, before finally registering a gain on Friday. Even the U.S. Federal Reserve downgraded its economic forecast. This is just a sampling. The past couple of weeks have also seen a deterioration in U.S. housing and employment data. The one gleaming bright spot of late was the release of the Canadian employment numbers last week.
  
• Corporate earnings started rolling in and looked pretty good at first glance. But the southerly trend in economic data seemed to have investors wondering if those results could be replicated in coming quarters. Markets seemed disappointed with revenue growth even though most companies beat on the bottom line. They were also concerned with the fact that banks in the U.S. reported a contraction in the amount of loans they’re granting. If you haven’t heard enough of the word “deleveraging” yet, get ready. It seems being buried in debt isn’t as fashionable as it used to be. As a result, banks will make less money on loans in the future.
  
• Goldman Sachs, the Wall Street golden child, received an ostentatious slap on the wrist from the SEC to the tune of $550 million dollars. I’m pretty sure they can easily make that up with a fractional increase in fees charged to their flock, allowing them to continue God’s work. After all, $550 million is only 3.4% of their 2009 bonus pool. When the fraud charges against GS were initially announced back in April a lot of people wondered: Is the Stock Market Rigged? I feel a whole lot better now, don’t you? (The Reformed Broker pretty much called this outcome back in April.)
  
• Apparently, Apple is not perfect - at least not according to Steve Jobs. (I guess that whole getting a life-saving liver transplant on the sly and telling investors about it later thing didn’t count.) I’m always amazed at the brouhaha surrounding every peep (or lack thereof) surrounding this company. Either way, words like “arrogant” were floating around again this week as Steve Jobs himself held a press conference to outline Apple’s response to Antenna Gate. If you Google that term, you already get 24 million responses. If that doesn’t scream too big for your britches, I don’t know what does. Either way, the markets took no heart from Mr. Jobs’ presentation. After all, what is this world coming to if Apple can’t even get it together?
• BP (for now) stopped the flow of oil  gushing into the Gulf as of Thursday. Here’s another example of a corporation that’s large enough to have more influence on its regulators than any company should have a right to. It has actually tried to bill itself as “green”, claiming that BP should really stand for Beyond Petroleum. I’m pretty sure the Gulf coast residents – human and otherwise – wish it wouldn’t take decades for them to get beyond BP’s petroleum.
  
• The U.S. Senate passed the financial regulatory reform bill. It sounds like this bill is also too big for its britches: It’s very long-winded, but does nothing to actually solve any of the problems that lead to the ongoing financial crisis. There is no fix for Fannie Mae and Freddie Mac, nor is there anything to prevent the 600 trillion dollar derivatives market from torpedoing the global financial system.

With the exception of the economic data, most of the news for the week looked positive on the surface. And yet the S&P 500 fell 2.88% and the TSX, 1.55% on Friday. Could it be that even the most optimistic observers are finally ready to look below the surface? Could be. But I still wouldn’t be surprised to see Goldman and BP announce record bonuses and I would be even less surprised if Apple still attracted long lines of people willing to sleep out in the cold to be the first to buy their next gadget – whether they can afford it or not.

What’s your take on this week’s news?

Related posts:

1. Your Money Ratios Winner & Weekend Reading
2. Free Book: Smart Tips for Estate Planning
3. Book Review: All Your Worth

Failure is only the opportunity to begin again more intelligently.

~ Henry Ford

Update: This article was featured in the Carnival of Money Stories – Starting a Sideline Edition posted at The Financial Blogger. Thanks!

If only the government had followed the advice of Henry Ford when it came time to decide whether or not to let GM and Chrysler fail. I recently made the case that a failure to fail has made a pretty big contribution to our current financial problems and I pointed to the auto bailouts as an example of this unhealthy trend. I live in Windsor, Ontario, traditionally a huge employment centre for the big 3 automakers. Mr. Cents and I both grew up here. We lived in various parts of the GTA (Greater Toronto Area) for about 5 years, but returned home 12 years ago. (Has it been that long already?)

Unions carry a pretty big stick in this city. Many of my relatives, neighbours, and friends are directly or indirectly employed in (or retired from) the auto industry. There is a prevailing, if somewhat shaken, support for unions in general and the CAW (Canadian Auto Workers) specifically. Many people here support the idea that we should all buy vehicles made by GM, Ford, or Chrysler.

Out of a Job Yet? Keep Buying Foreign.

I’m not sure what it’s like where you live, but I can’t hit the road in Windsor without coming face to face with numerous bumper stickers carrying slogans like the one in the title of this section. I felt terrible when the financial crisis hit and decimated our local economy – not that you couldn’t have seen it coming the way the auto industry was proceeding.  A lot of folks here were out of work for a long time while Chrysler and GM were in bankruptcy.

Still, I can’t help but feel upset when I see those bumper stickers. After all, the majority of us don’t have the inflated wages or gold-plated benefits and pension packages that many of these employees enjoy. Further, our tax dollars have gone to bailing out GM and Chrysler, as well as the jobs, benefits, and pensions that go with them.

A lot of other people lost their businesses and jobs. They received no government loans. They have no pension. And now, as these big 3 supporters drive down the road in their subsidized vehicles, they also want to tell us which car we should buy – or else.

That doesn’t sit well with me. I’m sure I’m not alone, but it’s not advisable to make opinions like that known in these parts. You can become persona non grata (or worse) pretty quickly.

Still, there are those, even in this city, who draw a direct line from the government loans given to Chrysler and GM, to the growing government deficits and debt, to the new HST here in Ontario. They see it as no coincidence that, less than 2 years after the auto bailout, they are being hit with increased expenses as a result of the Harmonized Sales Tax, which went into effect in Ontario on July 1st, 2010. Oh Canada.

What’s a Foreign Car?

I guess the idea is that we should support our local economy by buying domestic vehicles. But what is a domestic vehicle? What if your GM car is built in Mexico? What about a Toyota that’s built in the southern U.S., or even a few kilometres down the 401 in Woodstock, Ontario? What if it’s assembled here, but all of the parts come from offshore, or vice versa? What about the fact that Chrysler is mostly owned by Fiat (an Italian car maker)?

I actually do like the idea of supporting local businesses whenever possible. But I think I would be more likely to buy their products if I actually felt like they were superior to the alternatives. I’m less likely to want to support a company with a history of shoddy management which I already support through generous government loans, or one that uses coercion or veiled threats to get me to buy.

Should I patronize a restaurant owned by a friend even though the service isn’t very good and I don’t like the food? The whole idea of capitalism is that the cream is supposed to rise to the top. If your company makes a product that suits my needs at a price I can afford to pay, and offers consistently higher quality and service, I’m going to buy from you rather than your competitor. If your competitor offers the better product, service or experience, I think I should be free to buy from them without a guilty conscience.

Do you think it’s wrong to buy a car from anyone but the big 3? Does it factor into your purchase decision at all?

Related posts:

1. 10 Ways to Save on Insurance
2. Your Balance Sheet and Net Worth

The problem is not that there are problems. The problem is expecting otherwise and thinking that having problems is a problem.

~ Theodore Rubin

Update: This article was included in the Carnival of Personal Finance – Gettin’ Hot in Here Edition posted at Nerd Wallet. Thanks!

I’ve mentioned inverse ETFs a couple of times lately, so I thought it might be a good idea to explain what they are and how to use them for those who aren’t already familiar with them. Inverse ETFs are exchange traded funds that rise in value when the index that they track falls in value. If you believe the markets are going down, you can buy shares in an inverse ETF just like an individual stock. If you’re right, your shares will rise in value. But if the market rises, the share price of your inverse ETF will fall.

Inverse ETFs for Canadians

Inverse ETFs are a relatively new product. Some of them haven’t even been around for a whole year yet. As a result, they may have very low volume and limited chart records for you technicians out there. American readers have access to an even wider variety of inverse products. Some of them are very liquid. I won’t cover them here, but a simple Google search will point you in the right direction. For Canadians, here are a few inverse ETFs that trade in Canadian dollars on the TSX:

Single Inverse ETFs

• HIX (Horizons Beta Pro S&p/TSX 60 Inverse ETF): This is a single inverse ETF that gives you 1x the daily movement of the TSX 60 Index. So if the TSX 60 is up 1% on the day, HIX will be down roughly 1% on the day, and vice versa.
• HIU (Horizons Beta Pro S&P 500 Inverse ETF): This is a single inverse ETF that gives you 1x the daily movement of the S&P 500 Index. This is also hedged for currency fluctuations “to the best of its ability”.
• HIF (Horizons Beta Pro S&P/TSX Capped Financials Inverse ETF): This single inverse ETF gives you 1x the daily movement of the S&P/TSX Capped Financials Index.
• HIE (Horizons Beta Pro S&P/TSX Capped Energy Inverse ETF): This is a single inverse ETF that gives you 1x the daily movement of the S&P/TSX Capped Energy Index.
• HIG (Horizons Beta ProS&P/TSX Global Gold Inverse ETF): This single inverse ETF gives you 1x the daily movement of the S&P/TSX Global Gold Index.
• CIB (Claymore Inverse 10 Year Government Bond ETF): This is the brand new Claymore ETF that allows you to effectively short the 10 Year Government of Canada Bond – a bet that interest rates will go higher. Canadian Couch Potato recently offered a critique of this new offering.

This is just a sampling of some of the main inverse ETFs available to Canadians. There are others that track individual commodities like crude oil, natural gas, gold and silver. These are also offered by Horizons Beta Pro, but are very volatile and very thinly traded. Proceed with caution.

Leveraged Inverse ETFs

Leveraged ETFs give you more than 1x the daily movement of an index. If you bought a double inverse ETF and the index it tracked went down 1% on the day, the ETF would be up roughly 2%. There are a number of double inverse ETFs out there, and even some triple inverse ETFs in the States. That seems like overkill to me, but if it works for some traders, I guess it’s OK.

There have, however, been some pretty strident critics of leveraged ETFs – both the bull and the bear (inverse) forms. Some have even speculated that the use of these ETFs may have contributed to the Flash Crash of May 6, 2010. I don’t know enough about the mechanics of these and their effects on the markets to render an informed opinion on the matter. I just thought I would let you know that the issue is out there, as it could lead to some type of new regulation of these products.

Here are a few examples of double inverse ETFs for Canadians:

HXD (Horizons Beta Pro S&P/TSX 60 Bear Plus ETF): This double inverse ETF gives you 200% of the daily inverse move in the TSX 60. If the TSX 60 is up 2% on the day, your HXD shares will be down about 4% and vice versa. (The bull version of this ETF trades under the symbol HXU.)

HSD (Horizons Beta Pro S&P 500 Bear Plus ETF): This double inverse ETF gives you 200% of the daily inverse move in the S&P 500 Index.

HQD (Horizons Beta Pro NASDAQ 100 Bear Plus ETF): This double inverse ETF gives you 200% of the daily inverse move in the NASDAQ 100 Index.

Leveraged ETFs, whether regular or inverse, should be approached with caution and are not for novice investors or those who have a longer term outlook. They are strictly in the realm of the short term trader, as they will not accurately track the progress of an index over more than a few days.

Pros of Inverse ETFs

Here are a few reasons you might want to incorporate inverse ETFs into your overall investment strategy:

• You can make money in a down market: Markets move in both directions. Why be a slave to the upside?
  
• You can use inverse ETFs to hedge your portfolio: If you see a big dip in the markets on the horizon, but you want to keep some of your core long positions, you can mitigate some of the losses on your longs with gains from your inverse ETFs. In this sense, these effective short positions can act as a sort of portfolio insurance. For some people, this might make it less likely that they will panic out of core long positions.
  
• Inverse ETFs are a lot easier to use than other methods that allow you to profit from a down market like shorting, which requires a margin account (ie. investing with borrowed money) or using options strategies, which can be pretty complicated for the average investor.

Cons of Inverse ETFs

Here are a few reasons inverse ETFs might not be for you:

• As with any other investment, you can lose money if you’re wrong.
• Inverse ETFs, especially the leveraged ones, do not always track the underlying index very closely over long periods of time.
• Inverse ETFs, like regular ETFs, involve trading commissions. You will pay your broker a fee each time you buy or sell shares. If you’re using a discount broker, this might be as low as $4.95 per transaction, but it’s something to factor into your decision.
• Inverse ETFs have higher MERs (Management Expense Ratios) than their regular counterparts. For example, you can go long the S&P/TSX 60 via the XIU (iShares S&P/TSX 60 Index Fund) for a management fee of just 0.17%. Going effectively short the TSX 60 via the HIX, however, will involve a management fee of 1.15%. Those fees are already included in the price of the ETF, and account for some of the discrepancy between the ETF and the underlying index.

Are Inverse ETFs for You?

I can’t tell you for sure whether inverse ETFs are for you or not. It depends on your investment knowledge and your views on the stock market. I can tell you that I traded HXD briefly during the 2008 market downturn and experienced some whiplash because of the huge market rallies that punctuated the steep declines. I would much rather use the single version of the inverse TSX 60 ETF (HIX) as it’s less volatile than its leveraged cousin. The HIX, however, was not introduced until March of 2009 – just in time for the big market comeback.

There are those who will tell you to avoid inverse ETFs altogether. That may be good advice for some investors. But I think they can be a valuable tool if you take the time to do some research and truly understand how they work. Then again, I would say the same thing about any other investment as well.

(Disclosure: As of this writing, we own a small position in HIX.)

Do you have any experience or advice on the use of inverse ETFs? Do you have a strategy that has worked for you?

Related posts:

1. Commodities and Real Estate: Pros and Cons
2. Stocks and Bonds: Pros and Cons
3. 10 Ways to Protect Yourself from a Double Dip