Dream On

Every time I look in the mirror
All these lines on my face getting clearer
The past is gone
It goes by, like dusk to dawn
Isn't that the way
Everybody's got their dues in life to pay

"Dream On" by Aerosmith

Well I guess it's time for the mega banks to pay their dues. Silly them for dreaming that borrowing money from the government would be just like borrowing from one of their peers...you know, you borrow money, you pay it back with interest, and the transaction is over. So they borrowed (via TARP), payed it back and let the government report a nice gain, and thought that would be the end of it. Nope! The dream bailout has turned into a nightmare. First it was controls on compensation, then an added fee/tax (even though there was nothing in the fine print), and now this. Today, reeling from the knock-out punch thrown by Massachusetts voters, President Obama announced new limits on the size and trading practices of big banks. "Never again will the American taxpayer be held hostage by a bank that is too big to fail," Obama said. Clearly trying to tap into the publics anger over bailouts, Obama proposed new rules that will prohibit a bank from investing in or sponsoring a hedge fund or private equity fund, as well as barring the institutions from proprietary trading (trading for their own accounts). Guess what happens to bank stocks when you take away one of their most profitable lines of business??? Thats right, Citi -6%, JPM -5%, BAC -6%, and GS -6%. He went on, "In recent years, too many financial firms have put taxpayer money at risk by operating hedge funds and private equity funds and making riskier investments to reap a quick reward." Now I may be wrong but I'm pretty sure that only the Federal Government can put taxpayer money at risk! It was the government that agreed to bail these institutions out, not the taxpayers. In fact, almost every taxpayer I know believes that individuals and companies that over-lever themselves, to live beyond their means or stretch for outsized profits, should be allowed to fail when those dreams vaporize. Yes, the fear of failure is a powerful deterrent, not this constant manipulation of the rules. Even though the banks are earning record profits by borrowing at zero, the stocks are falling because of the constantly changing rules coming out of Washington. Markets hate uncertainty and that is exactly what they are getting from D.C.. A year ago, January 30, 2009, Obama criticized Wall Street saying, "there would be a time for them to make profits, and there will be a time for them to get bonuses. Now's not that time." A year later and it clearly is still not the time... everybody's got their dues in life to pay.

Why does this matter? Because, not only are the big banks and Wall Street the lubricant that keeps all things financial flowing in this country, but they are also one of the largest sectors in the stock market. If the financials struggle the entire market will most likely struggle too. Our equity market indicators are still all in the bullish range, but we are seeing weakness develop in some sectors (i.e. Financials).

While we're still on the subject of dreaming, I am always amazed when I read surveys of what investors return expectations are, and not just individuals but financial planners and institutional investors as well. A nationwide survey last year found that investors expect the U.S. stock market to return an annual average of 13.7% over the next 10 years. Another survey of leading financial planners were asked what they thought returns would be after inflation, fees and taxes (net-net-net returns) and their average was 6%, with some as high as 9%. These return expectations are dreams, historically net-net-net returns of 3-4% were great, and returns of 1-2% are pretty normal. Now, in a country where tax increases are going to be the norm, and higher inflation is a distinct possibility, we should probably dream of meager returns. This is also why we strive to find the lowest cost ETF's, that give us are desired exposures. Several investing experts were asked what guaranteed net-net-net return they would take to sell all their current assets. William Bernstein of Efficient Frontier Advisors would take 4%. Laurence Siegel, former head of investment research at the Ford Foundation would take 3%. John C. Bogel, founder of the Vanguard Group would take 2.5%. Elroy Dimson of the London Business School, an expert on the history of market returns would take 0.5%. Ask your financial advisor what net-net-net return you should expect. If he says anything north of 2% see if you can lock it in. If its anything north of 4%...Dream on, dream on, dream until your dreams come true.

Chris Wiles

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.