Investors, unfortunately, are far too quick to abandon winning strategies after short periods of under-performance, and the financial media shares no small part of the blame.  Consider the sensationalist pornography recently published by Vanity Fair,  hardly a bastion of level-headed financial news, regarding the Harvard endowment’s recent poor showing.

No Strategy Works All The Time

Harvard’s endowment, by far the largest in the nation, returned an average of 14.1% per year from 1990 through 2008, only to lose 30% of its value last year.  That 30% loss, according to Vanity Fair editor Nina Monk, was the result of excessive risk-taking and represent an unacceptable loss.  But is it really?  Even factoring in last year’s massive loss, the Harvard endowment has returned an average of 12.08% per year over the past 19 years.  Looked at from a long-term perspective, last year was hardly a catastrophe and Harvard’s long-term returns remain quite impressive.

So what’s wrong with Harvard’s strategy (the same one followed by David Swensen, manager of the Yale endowment and author of the groundbreaking book Unconventional Success)?  Nothing, it turns out, as Harvard’s long-term record clearly demonstrates.  So why all the bad press?  Simple, investors are obsessed with meaningless fluctuations in short-term performance and the financial media is more than happy to give the people what they want.

In A Crisis, Correlation Goes To One

I think Harvard’s plight illustrates an important concept most people ignore:  in a true crisis, the correlation of many normally-uncorrelated asset classes suddenly goes to one.  That is, asset classes whose returns normally bare very little resemblence to each other tend to all drop at once in a crisis.

This phenomenon has happened many times before, most notably during the drop of 1987 and The Great Depression, when many (though of course not all) otherwise unrelated asset classes dropped in tandem.  Unfortunately, it seems diversification fails us just when we need it the most.

The solution?  Stay the course, keeping in mind that no strategy, not even one as sound as the highly-diversified strategy the Harvard endowment was following will work all the time.  In investing, there is always risk and sometimes the chips simply won’t fall your way.  But that’s no reason to change a working strategy.

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GDP Doesn’t Tell The Whole Story

While the numbers above might be shocking for many Americans, it’s important to realize that numbers don’t tell the whole story.  Part of the conclusion comes from subjective judgments that “free” health care and longer vacations leads to a higher standard of living, which may or may not be true (in my opinion it is, but it’s certainly up for debate).  Additionally, the article goes on to note that per capita GDP only takes income into account, not cost of living.  In general, goods and services are significantly cheaper in the U.S. so that while Americans’ incomes may be slightly lower, those incomes still buy significantly more than what the average Brit could afford.  To me, standard of living should be measured by actual purchasing power, not just income.  To give an over-simplified example, if incomes are twice as high in London as in a small U.S. town but London is more than twice as expensive, the small-town citizen still comes out ahead in terms of purchasing power.   Of course, you must also take into account the fact that London has far more cultural and entertainment opportunities than a small rural town is likely to have and it’s probably true that easy access to cheap public transportation and major sporting events contributes significantly to quality of life.

On the flip side, Britain has its share of problems.  In a nation where fuel prices were already extremely high relative to America, the recent rise in oil prices has hit consumers there particularly hard, even in densely-populated cities with good public transportation options.  Additionally, much of Britain’s rise in economic output over the past decade is due to the expansion of London’s financial sector, which has been hit as hard as New York by the global market meltdown.

In conclusion, there is really no objective way to measure “living standards.”  It all comes down to how you prefer to live your life.  One thing is true, though:  our English brethren have higher incomes than we do, at least for now.

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A Good Sign

A large bank managing to turn out record profits in an economy like this is encouraging enough, but the kicker is that Wachovia, one of the hardest-hit banks in the country, contributed almost 40% of this quarter’s earnings.  Many skeptics are saying Wells Fargo will probably have to write down more bad loans associated with the Wachovia acquisition, and that may be true.  However, you could also make a good case that Wells Fargo actually over-compensated for the losses (a common tactic, known as a big bath) and may release past “losses” back into earnings in the future, boosting earnings and the stock price along with it.

Enthusiasm for bank stocks soon spread as other large banks such as Citigroup (C) also got a boost.  It looks like the good news has convinced many investors the worst is over and better times are just around the corner.  At the very least, the rebounds is an indication more investors than not believe we’ve reached a bottom for bank losses.  That’s not to say the recession has reached a bottom, however, as unemployment continues to rise as the economy sheds jobs.  But at least the light is at the end of the tunnel as far as billion-dollar write-offs are concerned.

Free Premium Analyst Reports On T Rowe Price Funds Until March 16th

In addition to their excellent free resources, Morningstar also offers a premium membership that gives you access to analyst opinions, fair-value estimates, and buy/sell recommendations.  Personally, I find the free account more than enough to meet my needs.  If I were a financial planner or had a large (seven-figure) retirement portfolio, I might find it worthwhile to shell out a little cash for the premium membership.  Since I don’t, I’m content with the free tools.

Occasionally, however, Morningstar offers free access to parts of their premium content, usually sponsored by some mutual fund company or another wanting to promote their funds.  Until March 16th, 2009, T Rowe Price has worked out a deal with Morningstar to give everybody free access to Morningstar’s unbiased analyst reports of T Rowe Price funds.  If you’ve ever considered buying  T Rowe Price fund, currently own one, or are just plain curious, now is the time to check it out.  Some of their funds have sterling reviews and others not-so-good, but Morningstar seems to have something useful to say about pretty much all of them.

I don’t believe it’s even necessary to have a free account to view the analyst reviews (although I highly recommend signing up for one).  All you have to do is visit the T Rowe Price analyst report page and browse around.

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While I can’t blame them, the rapid succession of rate cuts is worrisome because I fear it represents a rapidly-deteriorating view of prospects for an economic recovery in the short term. One would expect rates to start inching upwards once a recovery gets under way (and downward adjustments when economic conditions are worsening). That rates continue falling tells me the end of our current difficulties is not yet in sight.

If Buffett Can’t Win, What Hope Do The Rest Of Us Have?

The majority of these losses stems from Buffett’s large stake in the financial sector, which, if you haven’t been paying attention, hasn’t been faring too well of late.  Buffett isn’t selling, however.  He has maintained his stakes in troubled Bank of America (BAC) and bond rating agency Moody’s (MCO) in the face of significant losses.

So what gives?  Many investors are surely thinking that if the great Warren Buffett can’t even escape the crisis unscathed, they surely haven’t a chance and might be tempted to move to cash.  As many readers can probably guess, I would strongly advise against that.  Buffett agrees.  His now-infamous NY Times Op-Ed “Buy American, I Am” may have come at an inconvenient time, but the wisdom of his advice remains sound.

Be Greedy When Others Are Fearful

Buffett’s quip “Be greedy when others are fearful and fearful when others are greedy” applies now more than ever.  In his own words,

“…fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now…”

If you’re in the market for the long haul, as most investors should be, what happens today or even next year is of little consequence compared to what will happen 20 years from now.  While the economy is having a rough go of things now, this crisis can’t last forever.  Eventually, things will return to normal and those who’ve bought stocks at today’s prices will be richly rewarded.

What’s Going On?

According to this article on MainStreet.com, there is a very good reason for this discrepancy and it doesn’t involve oil speculators, hedge funds, or scheming politicians.  So what’s going on?  As it turns out, crude prices as quoted on the New York Mercantile Exchange are based on the price of West Texas Intermediate crude which is drilled, you guessed it, in West Texas.  The problem is that due to over-supply caused by freaky market conditions, West Texas crude is actually selling at prices below inferior-grade foreign oil.

This is an unusual condition, to say the least.  West Texas crude, being the high-grade oil that it is, practically always commands a premium price.  So unexpected is this turn of events, in fact, that no pipelines were ever built to transfer the stuff from West Texas to refineries in other parts of the country, which have traditionally relied on far more abundant, less-expensive imported oil sources.

The side effect of this, of course, is that refineries outside of West Texas are forced to continue buying lower-grade but more expensive foreign oil to refine into gasoline, oil that costs more than $10 per barrel over the quoted price.  So yes, the “price” of oil is currently around $34, but as it turns out, the quoted price is based on a benchmark that really isn’t a very good measure of what the stuff is actually selling for on the market, especially not under current market conditions.

So Why Not Just Build More Pipelines?

The primary reason pipelines aren’t being built right now to transport West Texas crude is the same reason none were built to begin with:  West Texas Intermediate crude is practically always more expensive and thus less economical to refine than importing from abroad.  Companies are understandably wary of investing the billions necessary in response to what is in all likelihood a temporary situation.  Eventually, markets will revert to the mean and West Texas crude will once again command a premium price.  If that happens, and it almost certainly will, any money spent on building new pipelines out of the area will prove to have been a massive waste of money.

So no, there is no conspiracy.  There is a very simple and logical economic explanation for why the price of gas continues to rise even as the “price” of oil continues to fall (remember, the real price of oil is much higher than the quoted price).  You can take off your tin foil hats now.

New Tax Cuts

• “Make Work Pay” Tax Credit – Single workers with an adjusted gross income (AGI) below $75,000 are eligible for a $400 tax credit, which is a dollar for dollar reduction in tax owed to the IRS (as opposed to a tax deduction, which merely reduces taxable income).  The delivery-method of choice for this rebate is to simply add it back to workers’ regular paychecks little by little over the course of the year.  Married workers with an AGI below $150,000 are eligible for a tax credit of up to $800.
• Mass Transit Tax Breaks – Users of mass transit can now pay for up to $230 worth of transit passes with pre-tax dollars, up from $120.
• Expanded Child Tax Credit – The lower income limit to become eligible for the $1,000 per child tax credit is now $3,000 instead of the former $8,500.
• Early Release of AMT Exemption Amounts – The exact amount of the AMT exemption is traditionally left to the last minute, but this year the numbers are being released early:  $70,950 for married-filing-jointly taxpayers and $46,600 for single and head-of-household filers.  No, this won’t actually lower your taxes, but at least you can plan a bit.
• $8,000 First-Time Home-buyer Tax Credit – Although less generous than the proposed $15,000 tax credit, $8,000 is nothing to sneeze at.  First-time home buyers purchasing a first home between January 1st and December 1st, 2009 are eligible.  The tax credit begins to phase out at an AGI of $75,000 for single home buyers and $150,000 for married-filing-jointly couples.
• The First $2,400 of Unemployment Benefits Are Tax Free – Unemployed people may also qualify for subsidized health insurance through COBRA.

Is This The “Change” We’ve Kept Hearing About?

Robert Gibbs, the soon-to-be White house Spokesman, said the issue was a “common mistake.”  Bollocks.  In the age of abundant CPAs and inexpensive tax software, it is very, very, very, very unlikely this type of “mistake” could be made “accidentally.”  The forms are fairly easy to follow (and you have to fill out a certain form for self-employment income, so it’s not like he could have accidentally filled out the wrong form).  I sincerely doubt this was anything more than simple tax evasion.  I could be wrong, but I doubt it.

According to the story, Gibbs “quickly addressed the issue when he became aware of it,” but that very same story clearly states that he didn’t amend his 2001-02 returns until after he was nominated by Obama for the position.  But wait, the IRS audited him and charged him a penalty for this identical behavior in 2006 for tax years 2003-04.  I find it difficult to believe Geithner had no idea he didn’t make the exact same mistake in 2001-02 (how could he not realize it unless he was a complete idiot?).  Thus, he quite probably knew he owed additional taxes and penalties but didn’t do anything about it for over 2 years until the nomination.  At that point, he probably knew the nation would be going over his affairs with a fine-tooth comb and he wouldn’t be able to avoid paying those taxes any longer.  Rather than give up a huge promotion, Geithner decided to just pay what he owed.

Is this the change you’ve kept promising us, Mr Obama?

Are Unemployment Statistics Manipulated?

Similar to the CPI, there are many misconceptions and falsehoods floating around about the BLS’s unemployment number and concerns they are manipulated by the government.  However, it is unlikely the government could get away with manipulating job figures even if they wanted to (and we must assume they do) for a multitude of reasons.

1. The data is publicly-available – Don’t trust the government?  Nobody is asking you to.  The data sources are publicly-available.  Anybody with an understanding of statistics could verify the numbers themselves (and many, many do).  It’s a safe bet the government isn’t engaging in any outright mathematical fraud based on how many independent people and organizations are running the numbers searching for any inconsistency.
2. The methodology is publicly-available - The methodology used by the BLS is also publicly available.  In fact, the model is very often debated by some of the most brilliant economic and statistical minds in academia, both within the U.S. and abroad.  You can certainly argue that the methodology used is inaccurate (there is no such thing as a perfectly-accurate system), but you absolutely cannot honestly and with a straight face argue that the government is intentionally withholding or manipulating anything.  It’s all right there.  If you choose not to double-check it yourself or think critically about all the issues involved, that’s your problem.  But the opportunity is available to every American.  A charge of manipulation requires intent to deceive.  If the system is completely transparent, how can you attribute to the BLS an attempt to “deceive” anybody?

What Problems Do The Nay-Sayers Have With It?

1. It doesn’t count discouraged workers - Well, are discouraged workers who quit looking for work REALLY unemployed in the sense meant to be portrayed in the official unemployment statistic?  That is certainly open for debate and both sides make good points.  The problem I have is when people like John Williams claim “well, before 1994 discouraged workers were counted as unemployed” as if the pre-1994 statistic was the epitome of perfection.  I call BS on that argument and here’s why:  it relies on everything in the past being a golden age, a model of perfection.  Since no statistical system of any complexity can ever be perfect, William’s assertion can be soundly rejected as nostalgic crap.  Who’s to say the statistic before 1994 was correct?  If you want to make that argument, you must logically first prove the previous methodology was the superior one.  Otherwise, you are guilty of basing your entire argument on a false premise.  Simply asserting something as a fact doesn’t make it true.
2. It doesn’t count people who aren’t collecting unemployment – Yes it does.  This is a very common misconception for some reason.  Read the unemployment FAQ for more info.

Why The Discrepancy?

As it turns out, there are actually a lot of different ways to define “unemployment.”  The primary mistake most malcontents seem to make is insisting their definition is the only true and correct definition.  This is pretty arrogant and for that matter, unnecessary.  The actuall number, whether 7.2% or 7.5% is fairly irrelevant.  What really matters is the trend.  Three months ago, the rate was 6.2%.  Today, it’s 7.2%.  Since the methodology hasn’t changed at all, we can conclude unemployment is significantly worse today than in September.  Is this number exact down to the 9th decimal place?  No, but neither are John Williams’ number.  What matters is the trend.  As it turns out, so long as the methodology is consistent, transparent, and applied in a disciplined manner, it yields valuable information.

I leave you with a classic appeal to authority fallacy by my favorite fake statistician:

“…If you don’t think the system is political, you don’t know the system…”

Right, because you are the only one who knows the system and what’s more, you know it perfectly.  Always.  Yes, that conclusion is much more likely than simply assuming you’re full of crap.

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