When the Oldest Rule in the Book Stops Working

by Early To Rise (02/7/2008)

Issue #2272

  • WEALTHY: The flaw in your portfolio’s bulletproof vest (Andrew Gordon)
  • HEALTHY: A simple way to keep from letting yourself go (Craig Ballantyne)
  • WISE: Warren Buffett on diversification

ALSO IN THIS ISSUE:

  • 4 ways to make sure your business gets maximum profits (Michael Masterson)
  • Enlighten your mind and your belly (Suzanne Richardson)
  • It’s Fun to Know… about ice skating
  • Add "friable" to your vocabulary

== Highly Recommended ==

Imagine if There Were Only 6 Numbers to Choose from When Buying a Lottery Ticket!

Wouldn’t that be great?! Of course, the fewer the choices, the more likely your chance of success, right?

How many choices are there when buying and selling shares? Errmm… a LOT ! Hundreds… One of the reasons I enjoy such consistent success from trading is because I only have 6 options to choose from! Except this is even better in a way, because the lottery is pure luck…

… I only have 6 choices AND have a VERY good idea about which choice to make because of the insider signal. Click here to learn more…

" Wide diversification is only required when investors do not understand what they are doing." 

Warren Buffett

What Do You Do When the Oldest Rule in the Book Stops Working?

By Andrew Gordon

Diversifying your investments is like boarding up your windows against an approaching hurricane. It gives you some measure of protection, but isn’t going to prevent the roof from falling in.

Diversification is one of the fundamental and unquestioned rules of investing. It’s supposed to protect you from huge losses. But what if it doesn’t? You could be facing potential disaster. Could conventional wisdom be so wrong? And if it is, what can you do about it?

The idea behind diversification is intuitively compelling. If you spread your investments around, chances are not all of them will get hit at the same time or with the same severity.

But it’s not a bulletproof vest. You don’t necessarily get off injury-free. And the flip side is that when the markets are going strong, your gains are somewhat curbed. But giving up some upside is well worth the price of not losing your shirt in a free-falling market.

Or so the theory goes. The only problem is, it doesn’t work anymore. Or at least you can’t count on it working.

Just look at the sharp January 22 correction and you’ll see what I mean. When the U.S. market slipped the week before that, so did markets in Europe, Asia, the sub-continent, and Latin America. And the slide continued the following Monday, when the U.S. markets were off because of the Martin Luther King holiday. For a few days, even gold and silver fell. Oil didn’t escape. Nor did blue chips, tech, and small caps. In other words, practically everything went down.

Then, after the Fed cut the benchmark interest rate 75 basis points to 3.5 percent, everything went back up. The China market ticked up. Europe and Asia made up some lost ground, and the U.S. market rebounded. Oil stayed down, but gold and silver, copper, nickel, corn and wheat, and cocoa all rose.

Yes, practically everything went back up.

The China market has since wandered down a bit, but you get the idea. If everything pretty much goes down and up together, what’s the use of diversifying? Good question.

It seems that many of the correlations (corresponding and inverse) we’ve relied on for so long are deserting us. If you’re sensing that the markets are getting more and more unpredictable, that’s probably a big part of the reason.

Oil used to move in step with the market. (Because a thriving economy stimulates oil demand and allows the market to grow.) But oil prices declined as the Dow was reaching new highs over the second half of 2006, and went up last year as the economy showed signs of slowing down.

And gold is supposed to strengthen as the market goes (or threatens to go) into decline and vice versa. But the long-running bull beginning in 2002 saw gold go up. And, for a few days anyway, gold was unable to escape the recent downturn.

Why the heck are some of our most cherished notions of market behavior crossing us? Because the market has transmuted in some very fundamental ways. Four historic shifts have altered how the market behaves. As a smart investor, you need to know what they are.

1. The global reach of multinationals. Recent studies have shown that multinationals from different countries are becoming more and more correlated. It makes sense, doesn’t it? They’re in the same major markets, and the mix of minor markets they sell to in the developing world doesn’t have much of an impact on their stock prices.

2. The world is drowning in money. Global liquidity knows no national boundaries in either its origins or destinations. It comes from China ’s enormous one-trillion-plus dollar reserves, the carry trade (from Japan, Switzerland, and elsewhere), petro-dollar countries, and cheap credit from both east and west. And it ends up wherever there’s a quick (as opposed to safe) buck to be made.

Now I’m not saying that China invests the same way as Saudi Arabia. But all that money looking for a place to land has caused asset inflation in many markets and submarkets around the world. As these markets rise, investment flows into them at a sometimes furious pace because much of the money is leveraged. And at the first sign of the bubble bursting, the hot money leaves just as quickly.

3. Risk modeling reinforces herd behavior. Technology has made such synchronous investment behavior possible. As a common tool of institutional investors worldwide, computer trading based on risk models directs the flow of a great deal of money.

The problem is, the trend is toward more aggressive (and riskier) models, since they get the better returns… at least in the short term. It’s not so bad that funds are getting into rising markets at the blink of an eye. What worries me is that they’re getting so adept at fleeing markets first and asking questions later.

It’s a worldwide meltdown waiting to happen, feeding on its own out-of-control momentum rather than reason (even besotted reason). That makes me very nervous.

4. U.S. and China rule. In the political and military realms, the U.S. dominates. But as far as investment goes, it’s a bipolar world. Despite its huge economy and robust consumerism, the U.S. has to share the stage with China - with its huge appetite for energy, technology, and raw materials. 

These two markets exert so much influence over individual companies as well as major country markets worldwide, it begs the question: Can we avoid a bear market if either of these two economies seriously stumbles?

I don’t believe so. Let’s imagine for a second that the U.S. can’t control inflation at the same time as the economy encounters serious headwinds. Where can we invest? How about Australia ? Their economy is commodity-driven and they don’t rely that much on the U.S. to buy their exports. But they do feed China a big chunk of raw materials.

Safe bet, yes? Not exactly. China fills the shelves of American stores from Wal-Mart to Lowe’s. If these stores begin milking their existing inventories and stop buying from China, China ’s economy would downshift from fifth gear to second virtually overnight. And Australia would have just lost its main customer.

The period culminating in the sharp January 22 downturn could have been the "perfect storm," a scenario in which markets everywhere crashed when the economies of China and the U.S. encountered big problems at the same time. It turned out to be a false alarm, but only because the Fed cut interest rates that day.

The real day of reckoning still lies ahead of us. But we did get a hint of what could happen to the markets… and to your portfolio.

China and the U.S. are supposedly dealing with opposite problems: China ’s economy is growing too fast, and the U.S. economy is growing too slowly. I don’t buy that view. When you look a little deeper, you see that both are suffering from too much liquidity and asset inflation. 

So what can you do about all this? A few things.

* Convert your holdings to cash.

You could take your money out of your IRA or 401(k) and put it into your savings account or a CD, but why subject yourself to the stiff tax penalties? Instead, look for money-market options or mutual funds that invest in short-term (1-2 year) Treasuries. If you’re having trouble finding them, call up your IRA or 401(k) administrator and ask, "Do you have money-market accounts?" "Do you have 1-2 year Treasury investments?" Any decent 401(k) plan should give you a choice of several such cash offerings.

* Invest in funds that invest in dividend-paying companies.

Companies that pay dividends are the only ones that can withstand a sudden or serious market downfall and still fork over the cash. Since 1965, the cash payout of the S&P 500 has never fallen significantly. And in the brutal crash of 2001-2, dividends dropped just six percent (compared to the 50 percent downturn in profits).

Don’t confuse "income" or "dividend" funds with funds that invest in dividend-paying companies. Income and dividends can come from bonds and other debt instruments too. Most of the funds I’m talking about come with even more specific mandates - like investing in blue-chip dividend-paying companies.

Most likely, your 401(k) or IRA will give you a choice of dividend company funds to choose from. In general, they’re all safe. It’s a matter of personal preference. But keep in mind that overseas dividend-paying companies could be a little more volatile than domestic ones.

* Go with what you know.

Even if what you know is one thing (which, of course, is the opposite of diversification). The business or sector you choose to specialize in may not be immune to a bad fall. But you’ll have such a good feel for it that you should be able to see any downturn a mile away and get out in plenty of time.

In such circumstances, there’s no shame in holding your investments in cash until the nastiness blows over. That’s pretty much how legendary billionaire Warren Buffett invests, and it’s made him more than $52 billion.

It’s better than employing a diversification strategy that’s showing signs of becoming less and less reliable.

[Ed. Note: ETR's Investment Director, Andrew Gordon, is the editor of INCOME, a monthly financial advisory service that uncovers income-generating stocks that promise safety (first and foremost), along with much-higher-than-average profit potential.]

== Highly Recommended ==

Turn Your PC Into an Automatic "Deal Magnet"

As nationwide foreclosure rates soar to all-time highs, it’s getting harder and harder to sort the best deals from the duds. And it’s only going to get worse as the sub-prime mortgage mess plays out.

But there’s no reason for you to waste time pounding pavement, searching for the diamonds in the rough. (Leave that to your competitors.) Self-made multimillionaire Marko Rubel will reveal his proven system for making profitable deals come to you with just a few clicks of your mouse each week.

Click here to learn how you can put $20,000… $30,000… $50,000 or more in your bank account every month, using an automated system that does all the time-consuming "busy work" of foreclosure investing for you.

The 80-20 Rule of Binge Buying  

By Michael Masterson

Twenty percent of your customers will be responsible for 80 percent of your profits. This is a business truism that no smart businessperson should ignore. 

So, to make sure your business gets all the profits it can get, you have to: 

  1. Identify the potential big spenders among your customers.
  2. Market to them aggressively as soon as they make their first purchase.
  3. Make sure your marketing stimulates their psychological desires, not their physical wants.
  4. Keep selling to them until they spend themselves out of their frenzy.

[Ed. Note: The above is an excerpt from Michael Masterson's latest book, Ready, Fire, Aim: Zero to $100 Million in No Time Flat, published with permission of John Wiley & Sons. In the book - which has already hit #1 on Amazon's list of best-selling books - Michael shows how veteran and rookie entrepreneurs alike can take their businesses to the next level. You'll learn how to identify and solve the problems that crop up during each stage of a company's growth... and how to take advantage of profit opportunities along the way. Order your copy of Ready, Fire, Aim now.]

The Trick to Keeping Weight Off

By Craig Ballantyne

"I let myself go" is a phrase we hear all too often at the gym. It comes from people who have allowed months to go by without taking stock of their physical condition.

Hey, we all get busy. And time seems to fly by between workouts. But if you let yourself get "too busy" with work or family demands, the next thing you know you can’t fit into your lounge-around-the-house sweats. That’s when you know you’ve got to get your weight under control - and it can be simpler than you think.

Researchers from Drexel University and Brown Medical School studied 3,003 members of the National Weight Control Registry who had already lost 30 pounds. Their goal was to determine the impact of consistent "weighing in" on weight maintenance.

Just over 36 percent of the subjects reported weighing themselves every day, a habit that was initially associated with a lower body mass index. At the end of one year, these subjects also tended to gain back less weight (an average of 1.1 kg) than those who weighed themselves less frequently (4.0 kg).

Consistently monitoring yourself after you’ve lost weight is clearly a key component of keeping it off. To stay on track, I recommend purchasing a Tanita Body Fat and Bodyweight measuring scale. (It costs about $49.) Then weigh yourself every day, preferably under the same conditions.

[Ed. Note: Fitness expert Craig Ballantyne is the creator of the Turbulence Training for Fat Loss system. For a free online source of information, motivation, and social support to help you improve your health, lose weight, and get fit, sign up for ETR's free natural health e-letter.]

Living Rich: The Best Food in the Best Museums

By Suzanne Richardson

"Nothing will enrich your life as much as the appreciation of art," says Michael Masterson. "If you want to Live Rich, you have to - absolutely have to - include art in your life."

And, by making a few smart choices, you can kill two birds with one stone.

A recent Forbes Traveler list of "Best Museum Restaurants" recommends nine high-quality museums that also offer the creme de la creme of cuisine. Which means you can improve your mind, expand your cultural reach, and fill up on top-notch food… all in the same place.

And you don’t have to fly to Paris or Vienna to get the combined benefit of fine art and fine dining. Next time you visit New York, Los Angeles, Seattle, Denver, or Minneapolis, stop by one of these spots:

  • The Modern at New York ’s Museum of Modern Art. You can dine in either the elegant Dining Room or the up-tempo, less expensive Bar Room. (I’ve eaten at the Bar Room, and the garlic gnocchi with crispy sweetbreads was unbelievable.)
  • Palettes at the Denver Art Museum. After checking out the museum’s permanent collection of African art, dine on Colorado lamb or mustard-roasted pork loin.
  • Taste at the Seattle Art Museum. Chef Christopher Conville serves up fresh-market fare made from sustainably harvested ingredients, dishes including black olive polenta and duck leg cassoulet.
  • 20.21 at the Walker Art Center in Minneapolis. Wander through the nearby Minneapolis Sculpture Garden - one of the largest in the country. Then pop into Wolfgang Puck’s 20.21, named for the Walker ’s extensive collection of 20th and 21st century art.
  • The Restaurant at LA’s Getty Center. General admission to the museum is free, so you can wander through its European art and American and European photography exhibits to your heart’s content. Then enjoy The Restaurant’s "California-Mediterranean" food and beautiful views of the Santa Monica Mountains and Pacific Ocean.

It’s Fun to Know: Ice Skating on Water?

It may surprise you to learn that ice skaters are technically skating on water, not ice. At it’s freezing point (32 degrees Fahrenheit), ice has a liquid surface 40 billionths of a meter thick. If that layer was much thinner, a skater’s blades would stick instead of glide gracefully.

(Source: That’s a Fact Jack! )

== Highly Recommended ==

When the CAR gets stuck in a rut you can call AAA - But who do you call when YOU get in a rut?

Feeling like your life has stalled? Wondering where all the excitement has gone? Don’t worry, you’re not alone. All of us get dragged down in a rut now and then.

But you’ll get back out on the highway of life a LOT faster if you have a friendly “towing service” looking out for you 24×7.

So put on your seat belts, rev up those engines… and let’s get going with our motivational kick-in-the-pants program.

- Charlie Byrne

Word to the Wise: Friable

Something that’s "friable" (FRY-uh-bul) is brittle, easily crumbled or broken. The word is from the Latin for "to rub away."

Example (as used by Kathryn Harrison in a New York Times Review of Diary of a Bad Year by J.M. Coetzee): " Diary of a Bad Year is not the first among J.M. Coetzee’s works of fiction to force readers to consider the friable boundary between fiction and nonfiction."

[Ed. Note: Become a more persuasive writer and speaker ... build your self-confidence and intellect ... increase your attractiveness to others ... just by spending 10 VERY enjoyable minutes a day with ETR's new Words to the Wise CD Library.]

Copyright ETR, LLC, 2008

Similar Articles:


Posted to Daily Issues

Did you especially enjoy this issue of ETR? Why not share it with the world?
with a friend…

Return to the newsletter directory

No comments yet… Be the first.

Leave a reply: