In my 40-year career I have watched the herd mentality hit investors. Here is my point. Going back to 1871, the average rate of return for the stock market has been around 12-13%. Like a pendulum on a clock there are periods when the returns are greater than 13%, and, other periods with returns much less. (From a technical standpoint, the S&P 500 has a standard deviation of +/- 21%. So around 70% of the time you could expect returns of +34% to -8%. We could take these calculations out to three standard deviations but that is not necessary for this discussion.)

During the 1970s the S&P averaged a 5.9% return each year for those 10 years. In the 80s and 90s, it averaged around 21% each year (the low tax rates and high tech days). So you knew in advance that the years 2000-2010+ were going to be bad years…just to average things out. Well, it happened. Like all forces of nature, the market moves in cycles. Even though the public sees doom and gloom today, the markets will start the next trend line upward soon.

So how do you save and invest? Wade Pfau wrote a great paper, “Safe Savings Rates: A New Approach to Retirement Planning Over the Life Cycle.”

We all know about the safe withdrawal rate, namely, you should never take out more than 4% of your retirement account value annually in order to assure you will never outlive your income. Pfau assumed a 30-year accumulation period followed by a 30-year withdrawal period. Going back to 1871 he found using a 60/40 mix (60% stocks and 40% bonds) that one needed to save 16.67% of gross salary each year, adjusted for inflation. (So, if inflation went up 3% this year…next year would require 19.67% savings to make headway.) Now if your income went up every year by the exact amount of inflation, then, your rate would stay at 16.67%.

This formula plan would assure that you would have enough funding to live on 50% of your final year’s income level. Unfortunately, most Americans live on 91-95% of their final year’s salary in retirement…so, you will have to increase the rate of savings above 16.67% per year. I always suggest a person save at least 25% of gross income. That way, if you place your monies in a tin can in the back yard at a zero rate of return, you will have 10 years worth of money when you retire.

Read the article and insert the 25% under a 60/40 mix, and you will see the plan will amply fund your lifestyle.

Funny, it seems many of the people who did NOT want any part of stocks in 2008, when the Dow was at 7000, 8000, or 9000, are now deciding that Dow 12000 is the correct number to come back in. Many sold at Dow 7000 only to buy at Dow 12000. Ah, yes, emotion over logic. Buy high and sell low. It never changes. The stock market will always go through periods of depression and euphoria.

The unfortunate aspect is that the swings of fear and greed and the timing of downturns and rallies are impossible to predict.

On March 16th, 2009, Business Week’s cover story asked…”When will the bull be back? ”. The story explained that most signs point to more stock market pain. The S&P 500 hit bottom a week earlier at 667 on March 9th, 2009. Almost 2 years to the day the S&P 500 has doubled to 1350.

In the Business Week article, it said the Dow, which was at 7000, would bounce around over the next 2 years and it would be 6 years after that (a total of 8 years, 2017) before it reached 14000. The Dow almost reached 14000 within 2 years.

My point is that I have always been a contrarian my whole life and it has done wonders for me and my clients. When the “media” are promoting doom and gloom or this train will never stop…be sensible. Take a step back; evaluate the facts, not the emotion. See the herd instinct in action and stay away from the herd. Over time, equities beat out every investment class. Believe in the great companies of America and the ingenuity of Americans.

You know, when I was in college, (yes, there were colleges way back then), we did a study, over a 30 year period of “Time Magazine” cover stories and how it related to investment returns. If you did the complete opposite of what “Time” covers stated or implied you would have been wealthier beyond your wildest dreams. “Time” and other non financial publications look backward and always get it wrong. So, do not follow the crowd. The crowd left the stock market in 2008 and 2009, selling at huge losses at the bottom. Now, the crowd is buying back in at the top, before the next correction.

Another strong reason for the growth is that their stock buying population is growing faster. A great article in Barron’s on November 22nd, 2010, by Kopin Tan cited the following:

“Over the long run, certain emerging markets might be winners simply because their stock-buying population is swelling faster. A key metric to watch is a country’s proportion of people in their 40s to those in their 20s, which Ajay Kapur, Deutsche Bank’s Hong Kong-based strategist, dubs the Demi-Ashton ratio-after the 2005 pairing of the forty-something actress to her then-27-year-old sitcom star husband.

Think about it: In our 20s, we spend what little money we have on necessities like rent, tuition loans, bourbon and Eames chairs. Only when we grow older, wiser and wealthier-hopefully by the time we hit 40-do we allocate serious money to stocks and plan for retirement. No surprise then that as baby boomers came of age, the Demi-Ashton ratio in the U.S. shrank from 102% to 56% between 1960 and 1980-a nifty time for rock ‘n roll but drab decades for the stock market. By 2000, however, this ratio would rebound to 109% in a heady ascent that paralleled stocks’ boom.

While our Demi-Ashton ratio is projected to shrink slightly over the next two decades, the 40s-20s horde will surge to many emerging economies-to 84%, from 63%, in India; to 105%, from 73%, in Brazil; to 166%, from 78%, in Poland, and to 125%, from 99%, in China. Of course, things like valuations, financial crises, reforms and busts matter, too, and will create variations from this theme, Kapur notes “but there is no escaping the power of demographics.” He reckons the Demi-Ashton ratio will rise the most over the next five to 10 years in Indonesia, India and the Philippines within Asia; and in Brazil, Mexico, Poland and Turkey elsewhere.”

Just remember back to Hula Hoop, Transitor radios, Mustang, personal computers, cell phones, etc. You have an opportunity of a lifetime. The old adage was watch the baby boomers as they set buying trends. Don’t you wish you could have been the first investor in all the above trends? Well, you can… The emerging markets are going to do a replay of what we experienced.

Ah…discipline or regret!

“One of the most remarkable developments over the past year is that the economy has been weaker than I and most people expected, to say the least.
I don’t think there’s a double-dip at all now, and I was not in that camp. But certainly I expected there to be a more robust recovery. Yet, despite that, earnings are higher than what I predicted and what almost all analysts predicted a year ago.

Think about this. The economy is much weaker, but earnings are higher. You can ask, ‘Well, how can that happen?’ It happened in two ways. First of all, it was because of strong global growth and the fact that so much of corporate profit, particularly for the S&P 500, comes from global sales. It was also because of remarkable cost-cutting and efficiency gains that were made by corporations.

What are the two things we know are the most important ingredients in determining stock price? It is earnings and interest rates. Earnings are higher than expected. Interest rates are lower than expected. So, when I look at the fair market value now of the market, I see it appreciably higher than our current levels, and I can easily see the market growing 10-20% over 2011.
And, by the way, I even see a nice gain through the end of 2010.

Margins are great. Certainly, we’ve done most of the cost cutting, and now we need the sales to increase. The leverage is huge. If firms can make profits with sales being as sluggish as they’ve been this year, think how much profit they’ll make if sales start going up. I’m one of those people who, whenever they announce the earnings and others say, ‘Oh my God, yeah, they topped their estimate on earnings, but they didn’t make their revenue,’ I say, ‘Hey listen, that’s not bad.’ I’d much rather they top on earnings and miss on revenue than fall short in earnings and make more revenue. If revenue is above what they expected and they can’t make their earnings, that’s not a good sign.

So, corporate America is levered up in such a way that when we do get that boost in spending, which I think will come in 2011, we will definitely get more profits.”

Although the new Republican Congress cannot make major changes with an Obama veto…I hear from business leaders they feel things will be more business friendly. If businesses are less restricted, this leads to more profits, which leads to more hiring and capital spending, which translates to more jobs and more consumers spending. All in all, in the depths of the financial crisis, the S&P 500 stood at 666. It has almost doubled since 3/09 to 1200. Jeremy is right on, so enjoy the ride.

Individuals preparing their documents for tax reporting on stocks sold during the year always hit a wall. That wall is trying to find out when they bought the stock and how much they paid for those shares. The amount paid is known as their cost basis. On top of that, to determine their total cost basis, they must add in all dividends earned and capital gains to the cost basis (also known as tax basis). They add these items in as they have already paid tax when the dividends and gains were earned. The cost basis calculations have been a nightmare for some, but, it has been a benefit for others. You see, to date, the IRS had no way of knowing how much you paid to buy a stock or mutual fund. Only recently, brokers have reported only selling prices. So, an individual was left to tell the IRS their cost basis. Technically, one could create a gain or a loss without anyone knowing the truth. (I am not advocating anyone should do anything illegal). Hmm! What is the difference between tax avoidance and tax evasion ?…. about 20 years in the “big house”!

Well, a new federal law requires brokerage firms and mutual fund companies report their customer’s cost basis, gains/losses and holding period to the IRS when certain securities are sold.

There is a 3 year phase, in that this information must be sent to the IRS:

1) On January 1, 2011 – Equities only (excludes Regulated Investment Company stocks (RIC) and those Dividend Reinvestments Plans (DRIP).

2) On January 1, 2012 – Mutual funds, RIC stocks and equities enrolled in DRIP.

3) On January 1, 2013 – Fixed income, options, warranties, rights, derivatives and commodities.

So, read between the lines…You may want to make some purchases or changes to your portfolio to take advantage of an open window here – while it still lasts in 2010.

Discipline or regret!

During the 1980s and 1990s the S&P 500 averaged a rate of return approaching 19% per year. So we had 20 years of returns well above the 13% average. Whether you call it “regression around the mean” or “what goes up….must come down,” prudence dictated that we would have many years of sub-13% performance. And so it was from 2000 to 2010.

This action in the stock market is not unusual; rather, it is a cyclic movement in the market as investors search out the most efficient position of their portfolios.

When all things seem to point “no place to go but straight up,” well you know a fall is coming in the market (like in 1999). When doom and gloom is the order of the day (like in 2010) and people declare….”I’m never going into the market ever again,” well, we are somewhere near the bottom.

There was a study of rolling 10-year monthly returns back to 1926, and, there are 776 of those monthly 10-year returns. But only 29 of the 776 were negative, or less than 4% of the total. You basically had a 1-in-25 chance of having negative returns. What is more interesting, though, is the subsequent 10-year returns after those negative returns. They averaged 9.8% with a high of nearly 15% and a low of 7.2%. (See Barron’s, September 6, 2010, page 38).

So, keep your powder dry and start your research into opportunities for future investment gains. It is not today or tomorrow that things will explode upward but in the near future. Don’t wait for the train to leave you at the station. After 40 years of advising I have heard the same stories at the top and bottom of each market. The words are always the same. The only difference is the faces.

But beware….a powerful lame duck Democratic congress could steamroll insurmountable legislation through from November to January. All of the bills passed in the last two years will require multiple years to restore business and employment back to the previous higher levels, unless they are overturned.

Be prepared, as an investor, to change your thinking pattern of investing over the next few years because of the following:
• The large monetary and fiscal stimulus that was previously applied is running out of steam. (Most of the money was used to shore up union jobs and pensions. Very little was used for any new jobs.)
• Tightening of financial conditions.
• Leading indicators slowing down.
• Public and private deleveraging.
• Higher taxes, more regulation, trade tensions.
• European countries have slowed economically.
• Corporate profitability blossomed due to reduced expenses, but that is over. Consumer demand has fallen off, so corporate profits will drop.
• Deflationary pressure is coming on not just for prices but also for wages.
• Since fiscal and monetary stimuli have been used to the full extent, then another financial crisis will only lead to excessive money being printed.

Watch for the stock market to move sideways for a while with periodic deep drops. Gold will stay steady. Look at dividend paying stocks and short term bonds. By all means, begin moving into tax free, not tax deferred investments that provide guaranteed protection against loss with upside participation.

Watch the stock market during the week before the election. It will tell you which party will win.

According to Howard Silverblatt, senior index strategist at Standard & Poor’s, the S&P 500 index returned about 1.0% in the 1930s on an average annualized basis. Through the end of March 2008, the index sported a minuscule gain of 0.6% so far this decade.

Of course, this follows two decades of astonishing equity gains-the index rose 17.6% during the go-go 1980s and 18.2% in the tech-fueled 1990s. It’s understandable that such a robust period like that would be followed by an epoch of lackluster returns.

Broadly speaking, both the 1930s and 2000s were characterized by crises in financial institutions, which led to equity price declines and a desperate need for liquidity. Last summer, liquidity dried, as banks refused to provide additional loans, slowing down commerce.

In the early 1930s, bankers similarly closed up shop to prevent a run and commerce practically ceased. Franklin Roosevelt, then newly-elected as president, ordered the Treasury to print a couple billion dollars worth of notes and made them available to the banks. Restoring liquidity was not all that different from what the Federal Reserve and foreign central banks have been doing by injecting billions of dollars into their financial systems in recent months.

There is another basic similarity between the two periods. In the 1930s, leverage, correlated directly to stock purchases, escalated in an environment of relatively low regulation and low equity.