Bonsai Investments

With the government showing that it is adamant about clearing the bad debt off of bank's books and the housing market showing some signs of recovery, the markets are likely to begin a major improvement over the next 6 months to 1 year. If your IRA or 401k is sitting in cash, now would be a good time to start allocating more of it towards stocks. Particularly small capitalization stocks. Indexing would work well with ETF's like SPY (S&P 500 index) for large-cap stocks, and IWM (Russell 2000 index) and IWN (Russell 2000 value index) for small-cap stocks. You could also invest some money (maybe 20%) outside the US. Based on my research, I have come up with 1 country per continent that I like based on valuation, political risk, and growth. They are Australia (EWA), Brazil (EWZ), Japan (EWJ), Canada (EWC), and the Netherlands (EWN) if you are comfortable with this strategy. A good way to allocate more money towards stocks is to move a certain amount each month or 2 months until you reach your allocation.

If you want to invest in fixed income investments, steer clear of long-term government bonds or gold. If you want bonds, stick to short-term (1-2 years) or inflation-protected bonds because of the potential for inflation going forward. Bank CD's and investment grade corporate bonds would work well, too. Note that while fixed income will provide a stable return, over the next 10 years, stocks will likely outperform this asset class by a significant margin. So if you're looking to grow your money long-term rather than produce immediate income, this asset class shouldn't be a large part of your portfolio.

The current bubble in the economy is clearly gold (notice the cashforgold.com commercials on TV?). I even saw an article the other day about people having gold parties with friends where an appraiser would come to their house and buy their old jewelry. All we need now is a reality TV show about investing in gold, and the bubble will be complete.

There is still risk for the market to continue going down for another year because the housing market still has too much inventory and the government could implement trade quotas/tariffs or other restrictions, but we will most likely recover late this year and missing the train is worse than getting on early and waiting for it to leave the station.

Many analysts believe in technical analysis where the goal is to find the current trend and jump on the bandwagon much like a lemming. And up until they go over the cliff, they all think they are correct because everyone else is doing the same thing. The most recognizable example of this is when everyone thought technology companies would grow at 50% per year forever.

The housing market is a good example of analysts extrapolating to the downside. In the attached spreadsheet I have analyzed the kind of foreclosure numbers that would be required to come up with a popular estimated loss from mortgages of $1 trillion (for reference, banks have written-off around $400 billion so far). I also have an analysis of expected foreclosures, which shows a wide disconnect.

Some analysts have even estimated losses well in excess of the $1 trillion number I used. It's almost like a financial analyst reality TV show where the only way to get noticed is to one-up the other guy. So if you want to find an analyst to listen to, ignore the one shouting from the highest rooftop.

"If you can't make money investing, become an analyst."
--Will Howard

What if I were to tell you the safest investment you could make right now is stock in a specific financial company? You would probably think I’m crazy. How about if I said buying gold right now isn’t safe?

The questions above are relevant because of the situation. Picture a brick on the side of the road. It’s completely harmless. Now picture the same “harmless” brick being dropped over the side of a building. It has now become a potentially lethal projectile. The only difference is the situation.

If you were to buy gold in 1987 where inflation adjusted prices were similar to today, you would have lost over half your investment over the next 14 years. If you adjust for inflation, you would have lost over 75% of your buying power. So if your investment in 1987 would have bought 4 hamburgers, in 1991, it would have only bought about 1. Clearly gold is not resting safely on the ground at current prices.

Now consider General Electric (ticker: GE) and Wells Fargo (ticker: WFC). These two financial institutions (GE’s Consumer and Commercial finance units provide a significant amount of their earnings) are AAA rated by the major credit ratings agencies, have two of the best CEO’s in the world in Jeffrey Immelt and Richard Kovacevich, and currently trade close to the lowest price to retained earnings ratios in the past 20 years. Their dividend yields alone provide a better return than 10 year government bonds. Now this is the kind of investment that I would call “solid gold”.