Financial

A Fool’s bet

I subscribe to Fool.com‘s commentary on specific stocks.  One feature I especially enjoy is "Dueling Bulls," where two Fool commentators virtually duke it out over a particular stock.  One chooses a bullish outlook, and the other chooses to be bearish on a particular stock.  Recently the "Dueling Bulls" focused on whether to buy a share of Google or an ounce of gold.  On November 30, Rick Aristotle Munarriz argued that a Fool should invest in a share of Google.  The next day, Robert Aronan countered that it is better to buy an ounce of gold.  On December 5, I argue you should buy neither, because you can earn a better return on your investment and diversify your portfolio by buying several shares of stock with the same amount of money you would spend to buy a share of Google or an ounce of gold.  I enjoy Fool.com’s commentaries and have no doubt they are a smart group of investors, but sometimes I find their recommendations way off the mark.  Their recommendations on Google and gold are exhibits A and B.
 
On Friday, Google (GOOG) closed at $417.70 per share.  Gold recently closed at over $500 per troy ounce.  With so many analysts rating Google a buy or strong buy, it’s likely that Google will be on its way to $500 per share, putting it at near parity to an ounce of gold.  Is a piece of Google worth its weight in gold?  I doubt it.  That contention is debatable.  However, what is becoming increasingly clear is that the upside for both gold and Google is shrinking.  There is no guarantee that either will continue to rise or retain such high valuations, and the more expensive they become, the more likely they are to lose value.  Gold has not flirted with such high valuations since 1987, when the stock markets crashed (remember Black October?).  Just 16 months ago, Google went public at $85, and many analysts, including Rick Aristotle Munarriz and my idol, Bambi Francisco, believed it was overvalued at the time.  In fact, I sold my shares of Google at $200 per share, believing that they could not rise much higher than $235 per share.  At the time, my bearish sentiment was reinforced by many of the same analysts who now say that Google shares are on their way to $500.  I now believe a target price of $300 for Google is sustainable, but $500 per share?  I wish I had kept my shares and enjoyed the ride to $417, but I still would have sold a long time ago.
 
The value of a dollar is more than it was in 1987, so gold may very well be on its way to $600, and Google’s share price will probably continue to rise over the short term.  However, the risk associated with a return of 20%-25%, which many bullish analysts are predicting for Google and gold in the next year, is very high.  I would much rather take $500 and put it into several equities.  If I wanted to buy some Google, I might buy shares of Bill Miller’s Legg Mason Value Fund, which owns shares and is on the verge of beating the Standard & Poor’s 500 for the fifteenth year in a row.  If I wanted to buy gold, I might choose to purchase a couple shares of StreetTracks Gold, an exchange traded fund (ETF).  The ETF also saves you the trouble of buying and physically holding gold under your mattress. 
 
I would be more apt to invest my $500 in other equities and funds diversified by industry, market size, and region.  I prefer to invest my money in promising companies and sectors not pumped up by speculation, as is now happening with both Google and gold.  Gold may be alluring, but buying a diverse range of metals and materials is a much better bet.  A hypothetical $1 million metals portfolio I developed on Marketocracy two years ago has returned over 50% since inception.  The fictional portfolio includes a variety of mining companies and an assortment of materials manufacturers.  As for Google, it may eventually swallow up all of techdom and bring the mainstream media (MSM) to heel, but for now I think it’s wiser to spend investing dollars on Yahoo, Ebay, Dell, Oracle, Microsoft, Amazon, and any number of top tech companies with far lower stock prices.  For example, you could buy 125 shares of Sun Microsystems for about $500, and it would need to increase by just 85 cents per share to earn a 25% return.  In October alone, Sun increased 65 cents per share.  While I don’t recommend buying shares of Sun Microsystems, I believe it’s a safer bet than buying Google now.  Buying Google or gold now is a Fool’s bet.

Hedging the future

Tonight topic is financial planning, one aspect of the Whole Lifestyle Model I wrote about on August 28.  The model is one I’ve pondered as a way to look at life as a whole, rather than focusing too much some aspects of life at the expense of others.
 
I often wonder what the future will hold for me and my family.  Will I continue what I am doing until I retire, or will I do something else down the road?  Do I want to live the expatriate’s life for the next two decades, taking my family around the world?  There are positive and negative reasons for doing so.  Do I want to continue working in an atmosphere that becomes increasingly stressful as I move up the corporate ladder?  What will my wife do?  What will my son do?  I’m living my dream right now, but will it be the dream I want in 10 years, or in 20 years?  I’m still not sure, but I’m keeping my options open. 
 
One option I have been mulling for a couple years is starting my own company.  I am entrepreneurial, but I don’t think I want to start something and jump right into it.  I want to build it one brick at a time while I am still doing what I am doing now.  The model I’ve been pondering is a bit like a hedge fund such as Cerberus or private investment firm such as ESL Investments, the majority owner of Sears Holdings, holding company for Sears and Kmart.  I was especially struck when I read about Cerberus’ humble beginnings as a $10 million fund in 1992.  According to BusinessWeek Magazine, Cerberus now controls companies with total annually sales of $30 billion, making it larger by sales volume than Cisco, Coca-Cola, or McDonald’s.  That’s absolutely mind-boggling, especially when one considers that virtually no one outside Wall Street has even heard of this obscure firm.
 
I don’t aspire to mirror the success of Stephen Feinberg, founder of Cerberus, or Eddie Lampert, founder of ESL Investments.  If I did, I would have found a job in Lower Manhattan a long time ago and started working as an associate for one of those two-word investment houses.  Instead, I chose a different path and don’t mind if the future "World Adventurers Investments" (or whatever it will be called) stays small and grows conservatively.  I look at all of our current assets as investments.  If you have a 401(k) or Individual Retirement Account (IRA), you have an asset.  If you own a home, you have an asset.  If you have a car, you have an asset.  Do you know how much your financial assets are worth?  Have you ever thought you could leverage these to increase your assets?  Many people leverage their home equity to buy amenities such as boats or pay off credit card debt.  What about leveraging this equity to invest it in something else, like a second home or a mutual fund?  What about scaling back assets that depreciate quickly, such as automobiles or home theater systems, and putting it into something that earns a better return?  Most people don’t look at their financial assets as assets and don’t think strategically when it comes to the mix of assets they own. 
 
Where the Whole Lifestyle Model is applicable in financial planning in that it reminds you that making money is not the ultimate goal in life, and it shows where financial planning is intertwined with other important aspects of life, such as donating to charity, putting your children through college, being debt-free, and having enough money to hire a personal training to whip you into shape.  In the case of financial planning, it encourages you to look at everything you own as assets and manage them well.  In my case, I see our assets as the seed for what could become something even bigger.  I’ve put our investments in play to help them grow, and I’ve looked to diversify them.  We have some real estate, some equities, some bonds.  I’m in touch with a couple of contacts and may invest in some petroleum ventures next year.  It’s part of a longer term strategy to develop a portfolio of assets that at the very least will free us from having to work in the future, and at best could serve as the foundation of a new investment firm or hedge fund.  I don’t know if either goal will ever be realized, but if we manage our assets well, I think we can achieve it within a decade.
 
Market Note:  The market took the recent news of the recent increase in the Federal Reserve’s target overnight lending rate from 3.75% to 4.00% in stride.  The market is anticipating that the Fed will continue to raise rates perhaps as high as 5.00%.  Fortunately, the news had little overall affect on the markets.  If the Fed doesn’t start signaling that it is near the end of rate increases soon, the market could overreact.  I hope not.

The perfect Halloween costume

Inflation!  Boo!  Did I frighten you?  No?  I just scared Wall Street.  Stand on Wall Street in Manhattan between the Federal Reserve and the New York Stock Exchange and tell passersby, "I’m worried about inflation!"  You’ll likely elicit a panicked reaction.  The past week has seen the markets absolutely devastated by the looming specter of inflation, wafting from a wicked witch’s brew of high energy prices and the economic impact of hurricanes Katrina and Rita.  The fear is real, but it is much too overblown by Wall Street.  The price of a barrel of oil is down nearly $6 per barrel since Hurricane Katrina struck.  The devastation of Hurricane Katrina, while still immense and tragic, is not as great as initially feared.  Hurricane Rita did not impact the country as much as anticipated.  Juxtapose these disasters against the recent earthquake in Pakistan, and it’s easier to visualize that the effects of the hurricane season were muted compared to what could have been.  So why are investors so worried, and why do the markets react so negatively to the prospect of higher inflation?  Three reasons–the delay in publishing economic indicators, the shortsightedness of the markets, and the Federal Reserve.
 
I’ll admit–it’s been a bad week for my investment portfolio, which weighs more heavily in favor of NASDAQ (read technology) stocks.  My recent purchases I lauded in previous blog postings, including Caribou Coffee and Cogent Technologies, have been clobbered over the last seven days.  I believe both equities are being dragged down by the market, not by their fundamentals, and I am still bullish on their longer-term prospects.  Once the market turns upward again, I think they will recover.  So I’m sour grapes when it comes to investor panic over inflation fears that have not yet materialized.  The seers of Wall Street determine market momentum partly based on reports such as Consumer Confidence and manufacturing output published monthly and quarterly by many organizations, including the Federal Reserve.  These reports guage past data and help indicate future economic prospects.  Unfortunately, the delay between when the data is gathered, say in September, can be misleading when it is published in October and the data are influenced by large, volatile swings.  September’s data were impacted by high energy prices in September, but prices has come down in October.  The one- to three-month delay in publishing economic indicators leads the market to react to news that happened the month or quarter before, not when it is currently happening. 
 
The markets’ overreliance on periodic economic reports, corporate earnings announcements, and on the spot price of raw materials such as crude oil creates knee-jerk reactions on Wall Street.  It causes the market to be too short-sighted and panic at any hint of bad news.  For example, the price of crude oil falls substantially over the previous month and the market shrugs, yet when it goes up 50 cents a barrel in one day, the market plunges.  Apple Computer’s fourth quarter profits rise 400%, yet the company misses analysts’ targets, causing the stock to tank, taking the entire technology sector down with it.  The market transforms aggressive analyst targets for companies such as Apple into referenda on the future growth prospect of the entire sector.  This is extremely short sighted.  Call it "irrational exuberance" or "irrational trepidation."  Of course, good news can have the same, irrational effect on markets.  As one who prefers stable markets, I would rather sacrifice higher potential reward for less volatility.
 
Finally, the Federal Reserve is agitating the markets by insisting that inflation is the nation’s biggest economic concern, and it insists that it will continue to raise interest rates to combat inflation.  The market now fears that the Fed may continue to raise rates indefinitely.  I’m not sure I completely trust Fed Chair Alan Greenspan and the Federal Reserve to properly set interest rates this time around.  After all, the Fed was widely criticized following the 2000-2002 dot.com bust for holding interest rates too low for too long, causing the U.S. economy to overheat and resulting in the 2000 stock market crash.  Many now say that the Fed is moving too aggressively to raise interest rates, needlessly hampering a vulnerable, tepid economy.  If the Fed isn’t careful and overshoots the ideal rate, the next bubble to burst won’t be the technology sector–it will be the U.S. housing sector.  A housing crash would be very bad indeed.  Fighting inflation is important, but the Federal Reserve must handle it so that the economy comes in for a soft landing, not a crash.
 
And so, during this Halloween season, when you are looking for that perfect costume to wear on Halloween, I recommend that you dress up as Federal Reserve Chair Alan Greenspan and wear a bright, white shirt with one word painted across the front and back of the shirt in bright, red letters–"INFLATION."  That will be the scariest costume of all this Halloween season.