TURMOIL IN THE MARKETS

Need Someone To Explain the Turmoil To You? Don't look at me. It's horribly complex. I have talked to several who claimed to understand it and found out that they really only thought they understood it. One thing I do know is that the problem is a great deal more complex than some bad loans. My strategy is to conservatively manage my assets and do the same with client funds. One thing is apparent to me: Both "good assets" and 'bad assets are under selling pressure. Why the good assets? Because investors are selling things they might not normally sell in order to raise capital to make up for the bad assets. Whatever congress decides to do, there is little prospect for a quick turnaround.


Let's Talk About Something More Simple. Several companies have announced that they intend to repurchase their shares in the open market. Some clients have told me that they don't understand how share buybacks can benefit shareholders. Here is a simple explanation. Suppose you own 1000 shares of XYZ company. Suppose there are 9 other shareholders with 1000 shares each. If the company has a million dollars in assets, half of which is in cash, the asset value of each share is $100. Looking at income produced by the company, let's assume it is $250,000 per year or $25 per share outstanding. That means your 1000 shares earns entitles you to $25,000 of those earnings. If the stock is selling on the open market for 15 times earnings, the market value of each share is $375. Since the company has a half million in cash, it can buy 1000 shares on the market for $375,000 and still have $125,000 left. After the purchase, there will be only 9,000 shares outstanding and each share is entitled to $27.78 of earnings per year. At 15 times earnings, your stock would now be worth $416 per share. Hopefully, this tells you why a company might embark on a share repurchase program.

The Real Question Is The Best Use of The Excess Cash. Share buybacks are but one use of the excess cash a company has beyond that needed for reserves. In the previous example, the company could have distributed the $375,000 in excess cash to shareholders with each share receiving a $37.5 dividend. Your 1000 shares would entitle you to a dividend of $37,500, a 10% yield on your investment. The share repurchase increased the value of your stock by $41,600, only slightly more but you also have to consider the tax implications. There is no current tax on the increase in value but the dividend would leave you with a tax bill of $5625 at 15%. One of the main benefits of both dividends and share buybacks is that it keeps the cash from burning a hole in management's pocket. It seems that the better company executives are at managing the business, the worse they are at managing cash. Years ago Mobil bought, now bankrupt, Montgomery Ward. Arco bought Anaconda Copper just before metal prices crashed. Paying out dividends or buying back shares keeps management from doing something stupid with the money. (Part of the Data for this paragraph came from an article in the Wall Street Journal by Jason Zweig)

The Downside To Buying Back Shares. While it would seem that putting capital into the hands of shareholders is a good thing, we can't overlook the fact that companies often buy back shares when the company is producing cash and prices are high, only to need the money later when the business is weak and share prices are down. In 2006 and 2007, Washington Mutual bought back 6.5 billion worth of stock at $43+ per share. This spring, they had to issue new stock at a price of $8.75. Citicorp and Wachovia made similar moves. That will dispel the rumor that these executives are smarter than the rest of us.

Who's Buying Back Shares Now? Microsoft just announced that it is going to buy back $40 billion worth of stock. While they are only sitting on $21 billion in cash now, they have good cash flow and borrowing power for the rest. Hewlett Packard is going to buy back $8 billion with part of the 14 billion in cash they now have. The biggest share buybacks came from Exxon-Mobil with a total of $102 billion worth of shares bought back.

Denver Real Estate Market Better than Most. A leading indicator in the Denver real estate market is the number of homes for sale. In this regard, things have improved immensely. Last August, a buyer had 30,800 homes to choose from. This August, there were only 24,648 homes, a drop of 20%. This is highly significant. Part of the reduction is due to major decreases in the number of new homes being produced. My belief is that inventories will continue to shrink until demand catches up with supply. Buying a residential rental unit right now may not produce a quick increase in price but it appears highly probable that prices will begin to increase in the near future.

Trying To Finish Up In Colorado. It has been a busy couple of months here in Colorado. I still have some real estate business to clear up and I have been making considerable effort to understand this crazy market. I am anxious to see what unfolds in the energy business as we argue over how to break free of foreign oil. Hopefully, we can make some of the right moves in stabilizing our economy.

BULLETS FLYING EVERYWHERE

Looking For A Place To Hide? If you find one, call me. I have long warned my readers that it is impossible to correctly predict market directions with a high degree of accuracy. I also warned that, if you can't anticipate the future, the next best thing was to be resilient and ready to persevere when negative events happen. In my thirty years as an entrepreneur, I went through a number of negative events and watched clients and colleagues do the same. Those that fell by the wayside were the ones who blamed others for their misfortune and expected someone else to bail them out. Successful people realized that they created their own existence and were responsible for correcting the situation. By resiliency, I don't mean that you should sit where you are and do nothing. That also is a recipe for disaster. What you have to do is assess the situation and develop a coping strategy. Of course you could be like Bill O'Reilly and blame everyone from the oil companies to the "speculators" to the government. His most stupid comment was that the President had the responsibility to monitor the financial markets and warn "the folks" when a disaster like the present one was coming. Can you imagine what would happen if the President called a news conference and warned that certain companies were doing things that put the system at risk. If there wasn't a panic before, that would certainly start one.




The Two Best Things You Can Do. One of my clients suggested that he might purchase a mountain condo which he could use for business purposes. He has $70,000 in cash for a down payment. My advice is one that I would give most everyone: Keep a Cash Reserve and Guard it With Your life. Now is not the time to speculate on anything, much less a mountain condo. I don't mean that you should have all your money in cash, only that you should have enough to see you through a crisis or take advantage of opportunities that may arise. The next point is Take A look At your spending habits and eliminate expenditures for which you don't receive adequate value. I am a good example of someone who needs to do that. I bet I could cut $500 a month from my expenditures and barely notice it. While that doesn't sound like much, in this market it would take $100,000 in capital to produce that kind of income at a reasonably safe rate. I am going to work on that while I am in Denver.



Hospices, Hurricanes, and Other Unfortunate Events. It's been a difficult summer. I just spent two weeks taking shifts in a hospice watching Betty's brother go through the trauma of dying. He was only a year or so older than me. It was hard on everyone. My son-in-law lost his mother to pancreatic cancer. She was a beautiful person who will be strongly missed by all of us. A hurricane blew into the Southeast Texas area and left a lot of my family members without power. My brother-in-law's barn was virtually ruined in the wind and one of my neighbors on the lake lost virtually his whole house when the roof blew off and the inside soaked with 12 inches of rain. I lost a few trees, none of which hit the house, gazebo, or boat house. I am lucky but I guess I hurt for all these people. The trauma of the current financial markets is certainly secondary to what happened to lots of other folks. I can little afford to quit fighting at this point. It's what I've done for most of my life. I am reminded of a joke one of my buddies used to tell because it reminded him of me. It is about a man who fell from the top of a 60-story building. When he passed the 30th floor he looked at the people watching and said, "So far, so good." I guess my friend, who died 12 years ago, was right about me. Next week, I'll have some comments about the markets with an emphasis on energy.

BETWEEN IRAQ AND A HARD PLACE.

Why Our Oil Companies Won't Drill. Those who oppose new drilling in so-called environmentally sensitive areas often call our attention to the fact that oil companies already have 60+ million acres of leases that they could be exploiting to increase our supply of domestic oil reserves. Why are they spending their capital on buying back their stock instead of exploration and production? Why aren't companies willing to invest more money in order to find more oil to sell at $120+ per barrel? We all know that the cost of locating and producing crude oil has increased dramatically; but surely at these prices it's worth it. Or is it? I recently read an article in The Economist about the potential for oil production in Iraq. Currently they are producing 2.4 million barrels per day with the potential for producing up to 6 million. Their proven reserves are 115 barrels, third largest in the world behind Saudi Arabia and Iran and these are only the proven reserves. They have hundreds of promising geological structures where no wells have been sunk. Only 2300 wells have been drilled in the entire country compared to over a million in Texas alone. The most important feature is the cost of additional production from existing fields. The state owned Iraq National Oil Company estimates that the new production will cost from $1-3 per barrel. Some time ago I called your attention to what happened in the early 80's when the oil producing countries flooded the market with oil and dropped the price by 80% leaving oil companies with a huge inventory of producing wells that could not compete at existing prices. No one worried about their sub-standard profits at that time. I was bombarded with comments calling my attention to the fact that it is different this time. Of course, its different this time because its different every time. Would you be enthusiastic about exploring for oil that costs $15-20 a barrel to produce when you know your competitor can put you out of business with their $1-3 per barrel oil? But our government can solve the problem. How about a windfall profits tax? That should get us a lot more new oil. Right?????????????

I Bet You Wonder Why I Defend These Greedy Oil Companies? Surely I can't defend the fact that Rex Tillerson, CEO of Exxon Mobil makes $11.3 million a year in salary, bonus, and "other" compensation. That's almost 1/4 of what they pay Judge Judy ($45 mil). Maybe some of these observations can explain why Exxon Mobil earned $40+ billion last year only to lose twice that much when the value of their stock dropped from $485 billion to $400 billion.

Economy Better Than We Thought? Our Gross domestic product grew by 3.3% this past quarter. This is much better than anyone anticipated. Perhaps the main reason was an increase in exports by 13% and a decrease in exports of 7.6%. The stock market rebounded some 200+ points. I guess I can't get too excited; however, I have stopped raising cash and am ready to start buying selected conservative issues a little bit at a time.

Fourteen Days At The Hospice. Nothing like 14 days at the hospice to let you know how precious life is. The medical personnel all say they wouldn't work anywhere else. They feel honored to be chosen to help patients and their families at such an important time. They are truly special people.

THE TIME VALUE OF MONEY

How To Make Any Financial Decision. The key is a thorough knowledge of the time value of money. In six plus years of post high school education no one ever taught me that concept. I was in my late 30's when I was introduced to the concept and I immediately felt that I had the "key to the vault." With a $75 calculator and a thorough knowledge of this concept, you can make any financial decision from the right mortgage to finance a property, to whether to lease or buy a car, or which investment is appropriate for your circumstance. Further, there are assumptions you make which are different for everyone, allowing you to customize an answer for any client's situation. I won't go into detail but suffice it to say that 30 years after I learned about this concept, I decided it was not nearly as empowering as I thought. In order to modify the statement to make it more important, you simply have to turn the words around. It's not the time value of money that counts, it's the money value of time. That insight occurred to me this year when I turned 70. It became even more important this week end as I visited the hospice where my brother-in-law is ready to call his earthly journey to an end. It's sad to realize the time we've wasted worrying about things that don't matter in the least. Time isn't money, time is your life. Don't waste a minute of it.

A Word About Those Evil Oil Companies. Most of us have trouble holding down our anger every time we fill our gas tank lately. Even Bill O'Reilly accuses the oil companies of gouging consumers by holding prices at unfair levels. Surely a company like Exxon with a value of some 400 billion can force prices to levels that won't cripple our economy. Guess what. America doesn't have any big oil companies. Exxon with all it's billions is dwarfed by the really big oil companies, all of which are owned by foreign governments or government sponsored monopolies. In reality, Exxon is only the 14th largest in the world. Exxon buys 90% of its oil from the really big oil companies who, by the way, control 94% of the world's oil. Surprised? I was.

What About Those Windfall Profits? Oil companies are earning a lot of money, and the owners are getting rich. Sure, Exxon earned 43 billion this past 12 months bet those owners are rolling in dough. Don't believe it. The market value of a company is easily determined by multiplying the number of shares outstanding by the current share price. Since the first of the year, Exxon's value has decreased from $485 billion to $400 billion. That's 17.58%. They aren't the only one. Marathon Oil, a smaller $62 billion company has dropped to less than 45 billion, a 28% drop. Conoco-Phillips and Chevron-Texaco show similar trends. Of the four companies I researched, the total loss in market value since the first of the year, was $128.13billion, runs into real money sooner or later. Despite their huge earnings, they must have problems of which the public is unaware.

I Am Not A Huge Fan Of These Companies. Their executives obscene amounts of money but so do Rush Limbaugh, Al Gore, Bill Clinton, Shawn Hannity, and Carmelo Anthony. It is impossible for most of us to comprehend how anyone can be worth that much money. Some oil company executives are guilty of fraudulently taking money from their constituents but so are some politicians, communication company executives, and investment bankers. When our economy has problems, there is a rush to find out who is at fault. After all, it can't be us. It has to be someone else. In this case, there blame for enough people to go around, not the least of which is the "man in the mirror."

LOOKING FOR A PORT IN THE STORM.

Protecting Portfolios From Volatility. Dividend paying stocks are historically less volatile than those that don't pay dividends. My strategy is to emphasize these stocks for a number of reasons. Unfortunately, the recent market has not worked that way. Mainly, this is due to the crisis in the financial and real estate markets. I have also said that the best strategy has been to "stay the course, " collect dividends and wait for these stocks to recover. For the most part, that strategy works; however, I know how difficult it is to tolerate large reductions in the market price of our portfolios. I have occasionally raised cash in portfolios via carefully selected sales of stocks and retention, rather than reinvestment, of dividends. That reduces volatility; however, the yield on cash is less than two per cent, a guaranteed way to lose in the current inflation environment. I continue to search for ways to get better returns with less volatility. While there is no sure-fire strategy, there are a few that I think have merit in getting somewhat higher yields without at less risk. Here are some of them.

Health Care Stocks. I recently bought Pfizer at 17.78 per share. This is a major drug company which has dropped from the 50's over the past 5 years. They have some problems in that patent protection on many of their major drugs is expiring during the next few years; however, the aging population should provide a growing market for many of their products. The dividend of 7.19% is not a barn burner but it should more than justify the risk. I will continue to seek out similar health care investments.

Preferred Stocks. These are becoming more popular as investors seek stable yields. You can find yields in the 8-10% range. While there is limited upside, you have much less worry about dividend cuts since the preferred dividend has to be paid before any dividend can be paid to common share holders. Preferred shares on real estate investment trusts appear to be particularly attractive since they are bought primarily for dividends and companies strive to maintain high dividends to keep from losing investors. An example is First Industrial Reality, a REIT that has industrial properties world wide. At present they pay a dividend of 11.68%. I wouldn't buy the common stock because of the potential for a dividend cut; however, the preferred has a yield of 9.54% and the potential for a dividend cut is greatly reduced.

Combination of Preferred and Health Care. Someone recently called to my attention is a REIT called Biomed Realty Trust. It is a company that buys properties for lease to companies in the life science industry. They currently pay a 5% dividend on their common stock. While that isn't bad, you can buy the preferred stock at a yield of 9.54% and there is little danger of a dividend cut. There are a number of similar opportunities out there which offer higher dividends combined with lower volatility. You won't double your money but you can sleep better with some of these in your portfolio.

I Have To Brag A Little. On July 13, I told you that oil prices had to come down. At that time, oil was selling for more than $140 per barrel and many were saying the next stop was $200. Today, the price is $115. There are a number of reasons this has happened to include a world-wide reduction in demand, a renewed pressure in congress to open up more areas for exploration and production, and an a heightened awareness among Americans of the magnitude of the problem and the consequences of continuing like we are. The debate rages as to how to deal with this problem. Suggested solutions run from putting more air into our tires, to batteries, to wind energy. These solutions fall into three main categories: Conservation, finding more fossil fuels, and finding alternative (mostly renewable) sources. My recommendation: All of the above. One last comment: Before you finally decide whether the fault lies with OPEC, China, India, President Bush, futures market speculators, or those evil oil companies, go down and look in the mirror. We build bigger houses than we can possibly use, buy huge cars with little regard for the energy they consume, and we borrow on our houses to buy consumer goods we really don't need (forcing the value of our dollar lower).

I will Be In Colorado For Longer Than I Had Planned. Should be here for the next two months. I am looking forward to meeting with many clients and friends during that time.

PTL, para XYLENE AND THE PRICE OF OIL.

Almost 50 Years Ago. I had the honor of working at one of the premier chemical research laboratories in the country, the DuPont Experimental Station just outside Wilmington, Delaware. My first assignment was as part of a team working on a substitute for para xylene, a starting material for Dacron, polyester fiber. The main reason a substitute was needed was the high price of para xylene. Virtually every oil company was swimming in the stuff, yet the price was deemed way too high for the existing demand. Our project was focused on para tolualdehyde (hereinafter called PTL). Our initial lab work in obtaining high yields of this compound was very promising and economic projections indicated that we could produce this material for substantially less than we were paying for para xylene. As I worked on this project, I was puzzled that DuPont allowed publication of some of our work, directly opposite to the air of secrecy that surrounded most of our research. Because of the success of the laboratory work, a pilot plant was constructed to demonstrate the feasibility of producing this material on a commercial scale. Again, press releases told the world of the success of this pilot plant operation. I was doing lab work in support of this project when one day our department manager walked into my laboratory and told me to cease all work on the project, it was being abandoned. Why? Because the price of para xylene had steadily dropped to the point that we could no longer make PTL at a price to compete with para xylene. Several years later, I worked in research for a major oil company and was told that para xylene was no longer the high profit compound that it had been before DuPont forced the price down by their PTL project. Finally, a light bulb went off and I discovered that DuPont never really wanted to make PTL, although I'm sure they would have if their hand had been forced. The main objective was to be able to buy para xylene at a much lower price. This objective was accomplished without ever making a single drop of PTL on a commercial scale.



Why Did I Tell That Story? Because I get so weary of the political arguments, one of which says that even if we did exploit all the energy resources at our disposal it would make a difference of only 2 cents per gallon of gasoline. If DuPont can force a huge drop in the price of a commodity by initiating a project to manufacture a substitute, what could the world's largest consumer of petroleum do if they convinced their suppliers that they were no longer going to be held hostage by suppliers who would do whatever they can to disrupt our way of life?



Lawmakers are Split Along Party Lines. I have always said that this is a scientific issue and shouldn't be a political one. I am doing some research on both sides of the argument and trying to be objective. One conclusion is definite. Al Gore's statement that the debate over global warming is over makes no sense. I have read arguments by very credible scientists that call into question the statement that man made carbon dioxide is responsible for global warming. I have recently read an argument that says we have experienced no global warming during the past 10 years. It's hard to get enough of the raw data to determine who is right but it is obvious that the debate is not over. Each side seems so entrenched in their opinion that it is unlikely that even the most objective of scientists, much less politicians, can ever be open minded enough to look at the data objectively.



Look At My Post of July 13. I told you that oil prices would come down, or at least stabilize. Before I brag too much, I have to tell you that I didn't have a clue when or how much. We all know that world-wide demand is falling in response to high prices. While it may rebound some, I believe the overall trend is down. I am still going to maintain some exposure to energy stocks. I don't think we need $140 per barrel oil to make some, if not most, of these companies favorably priced. I am still in high dividend stocks. I recently added Pfizer to some portfolios, including my own. At less than 10 times earnings and increasing demand from aging baby boomers, firmly entrenched health care stocks appear to be a "port in the storm."

WHISTLING THROUGH THE GRAVEYARD.

I'm Not Afraid. Like hell I'm not. Its been a tough market and there are several sticky problems that just won't go away. This situation could be with us for awhile. On the other hand, there are some who are in a state of panic to the point that they believe that our country is rapidly declining and in danger of becoming a second rate power. John McCain's economic advisor Phil Graham said last week that we aren't in a real recession, just a psychological one. Shades of President Carter and his "crisis of confidence" speech. While I don't necessary agree with Dr. Graham, he has a point. This recession, like many others before this, is accompanied by a feeling of gloom and pessimism. While I don't want to understate the problem we're having, it may not be all that bad compared to others. I did a bit of research to compare our financial markets with several other large countries. You can draw your own conclusions as to how we are doing.

We Aren't The Only Ones With Falling Markets. Several of our clients have urged us to move money from the US markets to overseas markets, especially China and India. Here are some statistics to consider.
Using the S&P index as a guideline, our stock market has dropped 15.9% year-to-date.
The Chinese market has dropped 45.7%
India's market is down 34.9%
Great Britain is down 18.5%
France is down 27%
Germany is down by 23.7
So much for transferring our investments overseas. Our gross domestic product, while not growing as rapidly is more than the next three countries combined.

Even Gasoline Hasn't Increased That Much. We're all nervous about the high price of fuel and how badly it is going to affect our economy. In 1974 we were paying 40 cents per gallon. Now we're paying four dollars. Sounds horrible doesn't it. In fact, an increase of that magnitude amounts to only a 7% compounded rate of return. The real difficulty is that the increase has not been gradual but has occurred in the past 2-3 years. I sound like Phil Graham when I say that much of the impact has been psychological. We've stuck our heads on the sand and took advantage of unrealistically low prices. We squandered our money on great big cars and bought houses that were way too large and luxurious for our needs. Many, like myself decided they could have two homes. Its been fun but now we have to pay for it. Reminds me of a song written in the 70's when gas prices rose rapidly. It was written by Jerry Jeff Walker and entitled, "Goodbye Easy Street." We thought our way of life was ruined back then but it turned out not to be not such a big deal after all.

I Believe Oil Prices Will Come Down or Level Off. This will happen either for the wrong reasons or the right ones. The wrong reason will be a huge drop in demand due to a worldwide recession. The right reason will be similar to what occurred in the 1980's when the car companies increased the mileage of the cars they produced. Many small measures were taken by consumers to reduce their energy consumption and exploration and production activity increased dramatically. We can do this again. In addition, we can get serious about renewable energy sources.

All Is Not Sweetness and Light. I am aware of the seizure of Indy Mac Bank. I also know the Federal Reserve has announced strong measures to prevent the failure of Fannie Mae and Freddie Mac. This is unfortunate but not a total disaster. Remember the RTC (Resolution Trust Company) formed to deal with the Savings and Loan crisis of the late 80's. Strong measures are often called for and these don't mean that we are "going to hell in a handbasket".

My Investment Policy Remains Intact. 1. Emphasize investments that provide cash flow. 2. Increase cash allocation. 3. Re-invest prudently. I am currently diversifying into areas expected to be more recession resilient ( I bought Pfizer at 17.5 and a 7+% yield). We are buying REIT preferred stocks. (These have higher yields than most stocks and a preferred claim on earnings to be distributed as dividends). Like many others, I will spend more time at home. (I have virtually everything I want right here.) I will be back in Colorado at the end of August for an extended stay. Contact me by e-mail or call our office if you want to arrange a meeting.

WHEN YOU WISH YOU WERE WRONG.

The Markets are Still Volatile. In my last post I talked about the markets and the investing environment. I questioned the rally that had occurred and predicted that the new levels wouldn't hold. I was right but I wish I had been wrong. It's been difficult to make a buck in any markets lately as consumers are overwhelmingly pessimistic and investors are following suit. The vast majority believe they were better off five years ago and 70+% are pessimistic about the future. When it takes 60-70 bucks to fill your gas tank, you aren't real anxious to go to the mall and spend money. Still, economists are not predicting a recession in the classic sense, which is two straight quarters of negative growth. The consensus seems to be that growth will slow to about 2% growth per year and unemployment will gradually increase to 5.9%. We used to believe that 5.9% was right at full employment. Based on those numbers, things might not be as bad as they seem. Still, the adjustment from the frenetic levels of the past few years can be painful.

Is It Real Estate Or Energy. It appears that energy prices have replaced real estate as the main concern for consumers. No doubt, residential real estate has dropped drastically in many areas; however, real estate recessions generally create their own recovery as builders quit producing new product and the excess inventory is absorbed. Of course, you can say its different this time and you would be right but it's different every time. The real question is how is it different? I have been watching builder production and the amount of new homes produced has slowed to a crawl as builders are more concerned about disposing of spec inventory than they are about opening new projects. As of March, year-to-date single family building permits were down 43% from last year. Condo and townhouse permits were down almost 70% from last year. Considering the fact that 2007 was also a down year, this could be highly significant. Land values are also dropping as a result of these changes. It may take awhile to start, but I believe residential prices will be recovering over the next two years.

What About Energy? While I doubt the dire predictions about the effects of "global climate change," I can't say I'm not concerned. My position is that there is little we can do about it. Even the most pessimistic of scientists, admit that we are in a position to control less than a third of these changes. What I am more concerned about is the fact that we are sending billions of dollars to the middle east where most people hate Americans and their way of life. Sending our president to beg OPEC leaders to increase oil production is futile when we do nothing to exploit our own energy reserves. Those opposed to exploiting these reserves have little input as to how we can control our own destiny without huge effects on our way of life. Those of you who believe in government regulation to reduce fuel consumption have only to look at some of the things they have tried in the past to get an idea of how effect these regulations are. Consider the 55 mile per hour speed limit that we imposed during the 70's crisis: On a 1000 mile trip, driving 55 instead of 70 increases travel time by 3.9 hours. If we assume that gas mileage increases from 20 miles per gallon to 25, we save 10 gallons of gas, $40 dollars at $4.00 per gallon. This amounts to slightly over $10 per hour. If there are two people in the vehicle, that is $5 per hour each. Very few of us work that cheap. Other maneuvers include going to daylight saving time year round. I fail to see how that saved any energy at all. Then we have ethanol, which has received the benefit of thousands of dollars of government subsidies. When we consider the energy it takes to produce ethanol and it's reduced fuel efficiency, we realize that the overall effect is negative. All we have done is driven corn prices out the roof and decreased the world's food supply.

Potential Solutions. 1. Consume less energy. Higher fuel prices will cause this to occur naturally, not only in the energy markets but in numerous other markets as well. While some reduction in consumption is a good idea, the real question is what will it do to our economy? It could be devastating if reduced consumption is the only answer. 2. Drill for more oil and natural gas. The majority of Americans are in favor of this but face stiff opposition from those who believe it will harm the environment. The most effective argument I have heard against opening up new areas for exploration (Anwar and offshore) is that oil companies aren't utilizing many of the areas available to them now. Instead of exploiting these fields, the oil companies are repurchasing their own stock. Those who wonder why this is happening need only to think back to the late 80's when OPEC flooded the market with oil in order to eliminate marginal producers. Oil prices dropped by 80% and oil companies, who had invested billions in new fields, could not utilize that production because it cost them more to get the oil out of the ground than it was worth in the marketplace. That could happen again since middle eastern oil costs $6-10 per barrel to produce. This is a fraction of what it costs for our domestic reserves. 3. Utilize nuclear energy. That could be a tremendous benefit but many environmentalists are opposed to this idea. 4. Use more coal. Again, we have a tremendous opposition from environmentalists but we have a lot of coal and wider usage could reduce our dependence on foreign oil by a large amount. Which of these paths should we take. My opinion is that the only correct answer is all of them. Our current dependence imported oil is too dangerous to be allowed to continue. We have to do every thing we can to reverse these trends or our way of life will disappear.

How Do These Trends Affect Our Investments. I am wary of the stock and bond markets and am sitting on more cash than ever. Of those investments I hold, most are high dividend stocks which have been hammered in the current downturn; however, dividends remain solid at this point. I am investing in the energy markets. Companies such as Marathon Oil are heavily involved in exploration in the Bakken Field which is touted by some as having huge potential. I still want some exposure to the oil service industry. Companies in this area aren't cheap but they can profit heavily from increased drilling activity when, and if, it occurs.

June Has Been A Busy Month. I have been heavily involved in things like my daughter's wedding, selling a long-held real estate investment, and concern over serious illness of a family member. I have not posted on this site as much as I would have liked. I am still available to visit with any of our clients who need extra help.

THE GORILLA IN THE MARKETPLACE.

A Full Blown Energy Crisis? It seems like oil prices have only one way to go. Up! This spring has been brutal on oil prices. We worried about $100 a barrel oil and $3.00 gasoline but we passed those barriers like they weren't even there. All this time, we've had a totally unexpected rally in the stock market. I can only say that I didn't expect it and I doubt that these levels can hold. My position is that the market hasn't figured out the difficulties that our economy will face because of these price levels. Although I am leaving day-after-tomorrow to drive to Colorado, I doubt there are very many families who plan to travel this spring or summer with fuel prices at these levels. Hotels, restaurants, and tourist related business haven't even begun to feel these effects yet. Truck drivers can strike all they want to but the only way they can cope is to raise their own prices. Some airlines will have to raise their prices to compensate and have already begun to do so via imposing a fee for all checked baggage. Retail stores and restaurants have been closing stores due to reduced traffic. This is bound to have an effect on the stock market. Don't expect the current prices to hold. Stay invested in dividend stocks but sell others, perhaps even energy stocks, into rallies. Raise cash for opportunities which will arise later.

Has The Housing Market Turned Around? Recent data show that it hasn't with nationwide prices dropping more than 3% during the past 12 months. These data also show how strongly regional factors affect the marketplace. In Tibodaux, Louisiana home prices increased 11%, the highest in the nation. You will probably be shocked to find out that number two was Grand Junction, Colorado with an increase in excess of 9%. No major city in Colorado reported a decrease. Is it time to venture into residential real estate investments? Some think it is; however, don't expect price increases to accelerate rapidly. It could be years before we see strong appreciation again. Still, those who want to diversify will probably find the returns from residential real estate investments will exceed those available from the stock and bond markets, particularly with the potential for renewed inflation.

Why Is Colorado Housing Doing Better Than The Rest of The Country? Part of the answer is the energy business. Colorado has always been sort of a hub for oil and natural gas exploration and production. I get numerous e-mails about the potential of "The Bakken Fields which are located in the Williston Basin of Montana and the Dakotas. The area is reported to contain 500 billion barrels of light sweet crude which has only become available due to improved drilling technology. Of course, much of this is probably hype but drilling activity has picked up considerably. Certainly, there are other areas in the Rocky Mountains and Denver will probably regain some of its reputation as an energy hub. These are high paying jobs and will probably insulate us from some of the ill effects of the slow down in other sectors.

Headed To Colorado For a Month. As I said before, I am driving towards Denver day after tomorrow. I will be available for client meetings so any of you who need to schedule a meeting can call our office and leave your contact information. Of course, you can also send an e-mail; however, I am not as tied to the computer while on the road as I am at other times. You can also leave some contact information in the event that I run out of money and can't afford the gas to get all the way home. Your help would be appreciated.

IN TROUBLE WITH YOUR MORTGAGE?

A Lot of People Over-Extended Themselves. I could lecture those who got themselves in trouble by taking out mortgages they really couldn't afford. Certainly there is plenty of blame to go around. If you are one of those in a position to lose your home because of a bad mortgage decision, what you really need is a strategy to deal with the problem today not a critique of what you did in the past. Here are some strategies that may help some of you.

1. Take Responsibility. There is a lot of talk about predatory lenders but, in most cases the bulk of the responsibility lies with the borrower. Borrowers who blame others for their problem tend to expect others to solve them. In some cases this may work but, in most cases, you will have to take charge of your own situation.

2. Look For Someone To Negotiate With. Your lender will not benefit by taking your home but there is no benefit in letting you live there free either. Your problem is one of finding someone within the lender's organization who is empowered to negotiate on the lenders' behalf. Often the lender that you make your payments to has sold your loan and is only a servicing agent with little motivation to negotiate a solution. Patience and persistence will be necessary in order to find someone to discuss the matter with.

3. Find an Advocate. There are real estate agents who specialize in liquidating properties for lenders. These often have contacts within the lenders' organization. If you have decided to sell your property to get out from under a bad situation keep interviewing agents until you find one who knows his or her way around the system. One potential strategy is to negotiate a short sale, that is one where the lender accepts less than the full mortgage balance in order to facilitate the sale of the property.

4. Beware of Simple Solutions. Once news of a potential foreclosure gets out, you are likely to be inundated by those who claim to have a solution to your problem. Many of these are attempting to buy your property at a below-market price. While it may be in your best interest to leave a considerable amount of money on the table in order to break free of a bad situation, you need to do all you can to preserve as much of your equity as possible.

5. Know Your Property Value. You can use the internet to get a handle on the value of your property. Public records are now readily available in most areas and sites like Zillow.com can help you find out what similar properties in your area are going for. If your home is worth considerably more than the mortgage amount, you should be able to find a solution to your situation.

6. Start Early. Many of those I try to help come to me after it is to late to solve the problem. If you have two or three weeks to work something out, your options will limited to those strategies that can be executed in a relatively short period of time. Start early, be persistent and patient and your odds of success will be greatly improved.

Its been a Busy Two Weeks Since My Last Post. I have been to Denver and back to Texas since my last post. Much of my effort has been directed towards closing out a long-term real estate investment and putting the finishing touches in settling a family estate. I'm sorry that my communication with many of you has been limited. I hope to get back to Denver at the end of the month, at which time I will be able to devote more interest to my clients. In the meantime, I would like to assure all of you that I remain in tune with the real estate and financial markets. The recent rebound in the stock market has been a surprise. We aren't totally convinced that these improvements will last. High food and energy prices and the credit crunch are still a problem and may mean further trouble for the markets down the road.

WATCHING REAL ESTATE CYCLES.

Why is Real Estate Cyclical? Just about everyone knows that real estate prices cycle from high to lows depending on market conditions. As markets improve more and more investors, builders, and flippers want to get into the market. Rising prices and higher profits result in higher demand until prices strain affordability to the breaking point. When that happens prices level out or drop until speculators decide that opportunities are limited. Prices then level out or even drop. We watch several statistics to get an idea of the risk level in a given market. One very important factor is the number of building permits being issued. In one of our previous posts we showed that the number of single-family building permits decreased by 34% from 2006 to 2007. Condo/townhome permits decreased by 8.3% over this same period.

Is This Trend Continuing? Looking at January 2008 compared to January 2007 certainly leads to that conclusion. Last January there were 344 single-family permits issued compared to 548 the previous year. Looking at condo/townhomes, we saw only 88 new permits this year compared to 614 last year. This represents a decrease of 85.7%. Of the 88 permits issued 58 or 66% came from Denver and Jefferson County. Arvada, Aurora, and Arapahoe County reported no new permits.

Its Not Yet a "No Brainer." Markets may drop even further and there is no guarantee of success; however, each month has brought us some new encouragement. Stay tuned for the next chapter.

Cash flow Is Improving. Vacancy rates in rental units is dropping slowly and rental rates are starting to rise. One investor I know who has 40 years experience in the business is beginning to acquire units to rent out and hold for up to three years, at which time he believes the market will rebound and he can sell those units at a profit. Not a bad strategy for patient investors. Generally, the best buyer for these investments will be nearing peak earning years with ample income from other sources.

LOOKING FOR NEW ENERGY SOURCES

Why Don't We Just............. You fill in the blank. This statement is usually followed up by suggesting some alternative energy source like bio diesel, ethanol, hydrogen, solar, oil shale, etc. I don't want to burst any one's bubble when I tell you that it ain't gonna happen folks. At least, not in a hurry. So-called experts used to tell us that alternative energy sources would be practical when oil was 60 dollars a barrel or higher. With oil at almost $110 a barrel, you would think companies would be scrambling to bring new sources to the market. You can always bring the old paranoia back and say that the oil companies are protecting their vast wealth by destroying any attempts by entrepreneurs to develop alternative energy sources. Let me assure you that these companies are just as eager as you are to develop alternative energy. If they don't, their future is limited by a finite pool of fossil fuels waiting to be found. Many of these companies are using their profits to buy back their shares rather than search for new reserves because of the high cost of finding and developing those reserves. Here is the most important point you need to remember about alternative energy sources: It Takes Energy To Make Energy. What does that statement mean? Using ethanol from corn as an example, you have to use fossil fuels to cultivate the soil, fertilize, water, and harvest the crop. Then you have to convert the corn to ethanol and distill the ethanol to the desired purity. At the end of this process you have a fuel that you can use for energy; however, you get very little more energy out than you used to manufacture the ethanol. This example holds true for a number of alternative sources. Using current technology, by the time you consume the fossil fuel it takes to produce these alternative sources, you might as well have burned the fossil fuel for energy in the first place.

Are We Doomed? I don't want to imply that we can never have alternative energy sources, only that we have to use fossil fuels until we develop the technology to make these sources economically feasible. Of course we can conserve by limiting our consumption which means driving less, lowering thermostats in the winter, buying more fuel efficient cars, etc. This can help a lot in the short run but it only buys time. We need to obtain more domestic fossil fuels to use in the transition period between now and the availability of alternative sources. We need to utilize more of one alternative source that is currently available and that is nuclear energy.

I Am An Environmentalist. I love this planet and I believe we need to limit those things that do harm to it. I differ from the majority of those who call themselves environmentalists in that I realize we have to be practical. It is insufficient to just call our attention to the problems, we have to find solutions. Don't just tell me that the planet is growing warmer, tell me a practical, economically feasible way to prevent it. Don't tell me that we can't develop known fossil fuel reserves in the US, tell me how to find the energy we need without enriching the treasuries of those countries dedicated to bringing us down.

On a More Positive Note. I don't know how many of my fellow Colorado residents have heard about the purchase of the Louisville Storage Tech site by Conoco-Phillips. They propose to develop a huge research facility dedicated to energy research. They will be looking for alternative energy sources and more efficient ways to utilize fossil fuels in the interim. This could be very positive for the Colorado as well as the national economy. These are the kinds of steps we need to take.

How Important is All This? A recent poll shows that more people want to solve these energy problems than want a cure for cancer. While this may sound appalling to those of us who have lost loved ones to cancer, it shows how important this issue is to Americans. I will strive to discuss this issue more in the future and relate it the management of our current finances.

SOME INVESTMENT PRINCIPLES

What Principles Govern My Investment Policies? I've never claimed to be a guru when it comes to investments and I have often said that there is no one approach that works all the time for everyone. Still, I have several principles which strongly influence the decisions I make. Here are some of them.

1. Cash Is Not King. Never has been. The real king can be seen in the title to this blog: Cash flow. I'm sure none of my regular readers will be surprised to hear this. You can generate cash flow from a stock portfolio in several ways but the main two are dividends and capital gains. Of the two, dividends are the most reliable; however, it depends on your station in life. If you need the cash flow to sustain your lifestyle, dividends are definitely preferred; however, if you are younger, with ample income to support your needs and a long time frame before you need the cash flow, you can depend more on capital gains. A friend of mine once said, "You can't eat growth."

2. You Can't Time the Market. Over the years, I've met advisors who use several different methods to get you in the market or out at appropriate times. Few, if any, are still around today. While there may be some who are successful at this, I have never met anyone who can deliver consistent results. Anyone who left the market last September and stayed out until the present is sitting on a bunch of cash they can use to re-invest. If you will look at my posts from last summer, you can see that I had some fears about the stability of the market. Still, I didn't have enough confidence to go totally out of the market.

3. You Cannot Not Forecast. I am reminded of Thomas Dewey who once forecast that he would be voted president of the United States. Before he went to bed on the night of the election he told his wife, "Tomorrow night you'll be sleeping with the president of the United States". The next morning, he and his wife heard the news and his wife asked, "Tom, will I be going to Washington or will Mr. Truman be coming here." (I must give credit to my friend Steve Goodier of lifesupport.com for that story). Even if you have no intrinsic forecast in mind, every financial decision you make involves a forecast. For example, if you choose a lower interest rate adjustable mortgage over a 30 year fixed rate, you have forecast that interest rates are unlikely to go though the roof and the current lower payment will be less than with a fixed rate for some time. I would encourage everyone who doesn't have a set of assumptions about what you think will happen in the future, to write some down. These should have an influence over your current decisions and you should always ask yourself if a decision you are making is consistent with your assumptions. You might be surprised at how often they are not.

4, Price is What You Pay, Value is What You Get. The Motley Fool website gets credit for that little slogan. What it really means is that the market may "misunderestimate" the value of a stock. A stock may drop for a number of reasons, not all of which are indicative of the fundamental value of the underlying business. An example in recent times is the large drop in the price of all oil service sector stocks right after Slumberger reported disappointing earnings. Stocks in a given sector often advance or decline based on some event that influences the price of an industry leader. While this isn't always irrelevant, it often is.

5. Watch The Business Not The Stock. I have mentioned before that you are buying into a business any time you buy a stock. Instead of becoming enthralled with the fluctuations in the market price of the stock, watch the business fundamentals and management action. Base your buy/sell decisions on these rather than price changes.

6. Patience Is Genius. It's OK to bail out of a stock if you change your mind about the prospects of an investment but if the company you buy is still fundamentally sound, have patience even if the price drops. I have been advised by a close friend to use "stop losses." which are automatic sell orders if a stock drops to a certain price. Granted, these can be invaluable when a stock drops before the news about the fundamentals come out but I have found it preferable to base my decisions on fundamentals not price. In the late 90's I bought real estate investment trusts, even though the rest of the market thought they were less valuable than the high tech stocks that were all the rage. I chose to stay with them and buy more, a strategy which allows me to work on my own schedule now rather than being chained to my office every day.

These Are Trying Times. High home foreclosures, volatile stock prices, falling home values, and inflation worries are rampant. I know astute investors who have made the decision to get out of the market entirely. My approach is as it has always been. Stay informed and act accordingly.

EXCESS CONSUMPTION

I Try To Stay Away From Sugar. That's because I have diabetes. Fortunately, they make everything from Hershey's chocolate to Jello Pudding without sugar. Sometimes they use a substance called "sugar alcohols" which are chemically altered sugars that have a sweetening effect without causing an increase in blood sugar. If you read the label carefully, you will see a warning that says: "Excess Consumption may have a laxative effect. As one who has experienced excess consumption of sugar alcohols, I am here to tell you not to ignore that warning.

We Can Extend That Warning To The Economy. A natural consequence of excess consumption causes considerable discomfort in our economy. That's why the Fed and JP Morgan had to bail out Bear Stearns. The Bear got in trouble because they were stuck in the sub-prime mire. The sub-prime fiasco was started to allow borrowers with no down payment and marginal income to buy houses they couldn't really afford (excess consumption). During the past five years, virtually anyone who could fog a mirror could buy a house. Lenders who originally made sub-prime mortgages cashed in big time. Because few lenders offered these loans, they had little competition and could charge high enough interest rates to offset the projected higher delinquency rates. Because of property appreciation and a high demand for housing, the projected high delinquency rate didn't happen. Because of the high profit margins, more and more lenders got into the business and competition forced lenders to lower their rates and relax their qualification standards. The Fed didn't help when they lowered the fed funds rate to 1%. The yield on savings accounts went through the floor and investors had to utilize a more speculative approach to get higher investment returns. We are now experiencing the "laxative effect" that the labels on sugar free foods warn us of.

So Now What Do We Do? The Fed is trying. They even took time yesterday (Sunday) to lower the fed funds rate by a quarter per cent. Another cut is expected on Tuesday. This is the same practice that caused the present fiasco, only now some other unintended consequences are taking place. The dollar has lost much of its value. In Europe, oil prices are up over 100% as opposed to 200% in the US. This is because of the weak dollar. I may sound like the people I complain about, those who love to point out problems but have few solutions to offer. Here are some of the more obvious measures you can take.

1. Raise cash. I don't mean to imply that you should sell everything and go to cash; however, instead of re-investing your interest and dividend payments, leave them in cash. This will allow you to withdraw money for emergencies without having to sell assets into the current soft market.

2. Avoid excess consumption. Don't use credit cards if you can't pay the balance monthly. Don't borrow on your home to buy depreciating assets (cars, furniture, etc). Before making a major purchase ask yourself if you really need it and make sure you can afford it. If you aren't willing to pay cash or write a check, you probably are better off foregoing the purchase.

3. Diversify. Don't put all your money into any asset class. While I recommend emphasizing certain market sectors to fit what you want to accomplish, don't overdo it, especially in this volatile market.

4. Don't quit your day job. Unless you are absolutely certain you will have adequate cash flow to replace your employment income, don't quit working just yet. If you've already retired, look for new employment, at least part time. This income can help you weather some tough times and may even be better for your mental health than a life of leisure.

Reflections on Turning 70. I guess I am now one of the "elderly" but I am not retired. I still have clients and I still manage money and consult for my former company, "Westmont." Frankly, I am as retired as I want to be. I am reminded of the 103 year old skycap at the Beaumont airport who considered himself extremely fortunate to have such a fine job at his age. He called in sick on a Friday and passed away the following Monday. A much better fate than being "warehoused" in a nursing home waiting for death to set you free.

POLITICS AND YOUR PORTFOLIO

Your Check Will Soon Be In the Mail. Hey! Let's send everyone six hundred dollars. That will solve our economic problems. It's doubtful that many investors believe that. If the stimulus package is an example of how the government is going to solve our problems, I prefer the problems. In my last post, I was critical of those who believe the declining value of our homes and our 401k plans is more important than international conflicts. One of my readers reminded me that a lot of folks are in "survival mode" and are so worried about their financial situation, they have little energy left to worry about anything else. I can understand that. I've been there. In reality, it is difficult to separate what's going on in the political arena from what's taking place in the financial markets. The government has little power to control the markets and their attempts to try have consequences that are often different from those intended.

We've Been On A Binge. In an attempt to encourage home ownership and full employment, as well as mitigate the economic consequences of 9/11, the FED lowered interest rates to unrealistic levels. Investors seeking high yields bought sub-prime mortgages. This allowed borrowers, who could barely afford to pay rent, to buy homes they couldn't possibly afford long-term. Buyers who needed a 1500 square foot home bought 3000 square feet with adjustable mortgages and low initial interest rates. The party is over but no one wants to go home. How can we prolong the party? Sending everyone 600 dollars that we borrow from China will only add a few hours and we will still have to go home and sober up. Allowing congress to change the terms of existing mortgages might save a few homeowners from the horror of foreclosure but it will also discourage lenders from making new loans without higher profits. The bottom line is that we will have to solve our own problems and not depend on the government for solutions. Betty and I will donate our $1,200 to Wounded Warriors and pledge to make sure we live within our means. We will continue to practice prudent investment strategies that emphasize cash flow over capital appreciation. We will keep an eye on the markets and government policies in an effort to preserve capital and obtain a reasonable rate of return.

It's A Cold, Clear Day In East Texas. Looking out my window I see Azaleas blooming, green grass, and Magnolia trees with glossy green leaves. I am indeed fortunate to have survived 70 years on this beautiful planet. I know I can't predict what tomorrow will bring but I am extremely thankful for this day.

MAKE LOVE NOT WAR.

Hell No...We Won't Go. War is not healthy for children and other living things. What would happen if they gave a war and nobody came? Remember those statements? I sure do. They were part of a fierce anti-war campaign brought forth during the Viet Nam era, almost 40 years ago. These protests were certainly a major factor in our decision to abandon the war effort. Almost 10 years of effort, 50,000 American lives wasted, and hundreds of thousands of Asians were down the drain after we left. We didn't lose the war because of our military, we lost it because the folks at home lost the will to fight. Should we have been in that war? Two democratic and one republican president thought it was worth trying to win. They had huge brain trusts of military and diplomatic advisors who thought so. Looking back, I can't imagine why so many thought they knew more than the commanders in chief and their legions of advisors.

How Does This Relate To The Current Conflict? One similarity stands out. We have more than a hundred thousand of our young people with their lives on the line while the rest of us go about our daily business. In the Viet Nam era, the "sex, drugs, and rock and roll" crowd marched the streets, attended events like Woodstock, and smoked dope on the streets of San Francisco while our troops were sleeping in the mud and rain if they were lucky enough to survive the day. What are we doing while our soldiers are being killed and maimed? The vast majority of us are more more worried about the value of our homes and our 401k accounts than we are about our kids. Don't take my word for this. Look at all the polls taken during this primary season. They show that the economy is by far the main concern of the voters.

Should We Have Gone To War In The First Place? My position is that I don't consider myself qualified to out-guess those who began this venture. They had access to far more information than I. Most everyone blames President Bush. How can we possibly believe he made this decision by himself? Prior to the invasion, I heard politicians from both parties proclaiming the danger from weapons of mass destruction that were proven to be present in Iraq at one time. Most of those politicians conveniently forgot these statements and place all the blame on Bush.

What Should We Do Now? It's too late to dwell on the question of whether or not we should be in Iraq. The real question is whether or not we should beat a hasty retreat. I tend to think that would be the worst strategy. We can ill afford to leave that area to those who who want destroy us. I'm tired of those who complain about what is going on without offering a solution. Want to close down Gitmo? What do we do with those who are detained? Don't tell me we shouldn't have established the facility in the first place. It's too late to change what has occurred. I could support any solution that made sense.

One Serious Question Is Whether Or Not You Will Read This. I have tried to stay away from politics on this blog and I am tempted to erase this entire post before anyone gets a chance to see it. I know much of what I have said sounds partisan but the main point is that we need to make this conflict our main concern and we need to work together to find an honorable solution.

MANAGING YOUR RISK

What Can We Do To Lower Our Risk? Just when you think your portfolio is coming back, we have a day like yesterday when the Dow Jones average lost more than 300 points. Retail stocks, financial stocks, and even energy stocks were hit hard. The sub-prime mortgage debacle and lousy housing markets are spilling over into a number of other sectors. Oil at $100 a barrel has resulted in consumers spending much of their discretionary money on gasoline to get to work and the grocery store. None of this adds up to a favorable economic environment. As I have said before, much of this correction is a healthy payback for the excesses of the previous 5 years when people bought bigger houses than they need and borrowed on their home equity to finance purchases they didn't really have to make. Stocks and real estate have dropped because they were driven to unrealistic levels by easy money. Everything became over-priced and now a correction is necessary. All this is an attempt to explain that which really can't be explained. The real question is in the first sentence of this paragraph. What is an investor to do? Here are some suggestions.



Get Out of The Markets. This is what happened in the late 70's and early 80's. (See my last month's post entitled, Turn Around and Run Like Hell). To a certain extent this worked in the 70's and 80's because people were able to get 8-12% on insured bank CD's. The trouble was that they saw these rates drop to 2-3% over the years that followed as inflationary excesses were wrung out of the economy. With rates already down to 3-4%, it is difficult to settle for returns that low. Despite my encouragement to stay with the markets, I have reduced my and many of my clients exposure to the markets by increasing cash reserves. A radical change to 100% cash is nothing I would recommend, so here is another approach.



Stop Worrying. Suppose you bought 1000 shares of 3M in August of 2007 at the high for that month of $91,000. Six months later the "value" of your investment is $78,000. That's a loss of $13,000. Or is it? What you bought was a share of an operating business. The market thought that business was worth $91 per share. A scant six months later, the market thought that business was worth $78 per share. Has the business really changed that much? Not to my way of thinking. Worrying about daily market fluctuations is like planting carrots and pulling them up every day to see if there are carrots forming yet. My philosophy is to buy great businesses like 3M and stay with them unless the fundamentals of the business change. The market is a manic-depressive. Don't let it make you one. There is another criteria I use .


Look For Cash Flow. I bet you knew this was coming. Using 3M as an example, in August of 2007 3M was paying a $480 quarterly dividend. Not a huge yield, but its close to what you would get in a bank. In addition, your tax rate is only 15%, less than half of what a high income investor would pay on a CD. Recently, 3M raised this payout to $500 per quarter. They have raised this dividend each year for several years (in 2003, the payout was $330 per quarter). Statistically, dividend paying stocks have been proven to be less risky than those who don't pay dividends. Using Dow Jones statistics, their are three times as many dividend paying stocks in the below average risk category than non-dividend paying stocks. Even if you earn more than enough money to fund your living expenses, the lower risk category of dividend stocks make them a must for virtually any portfolio.

I Spend Several Hours Each Day Studying The Markets. If you are one of my clients, remember I do it so you don't have to. That doesn't mean I encourage you to stick your head in the sand. If it is as much fun for you as it is for me, by all means do it. If not, spend your time doing things you enjoy. The main thing is not to spend it worrying.

REAL ESTATE SURVIVAL

Its a Tough Market Out There. The Denver market is in better shape than most. The main reason for this is that our market started to slow almost 4 years ago. Other parts of the country didn't slow down until a couple of years ago. As the market approached a more normal state, those who bought when the market was overheated found that they couldn't sell the properties for what they paid for them. Complicating the situation is the fact that people bought with little or no down payment so instead of seeing their equity decrease to a smaller number they found that it decreased to a negative number. In other words, they owed more than the property was worth. If they bought a house that could be rented for the payment amount, they could afford to wait. If not, they were looking at taking money out of pocket each month to do repairs and make payments and there was no end in sight. As if the initial negative cash flow wasn't bad enough, many buyers had sub-prime mortgages that escalated drastically after one or two years. Despite "stimulus packages" and interest rate cuts, foreclosures are still high and many builders have inventory they absolutely have to sell. These make formidable competition for the average home seller. In some subdivisions builders are selling existing inventory for considerably less than current home owners paid for their properties two years ago. This situation exists in the Denver area as well as other parts of the country.

So why is the Denver market is in better shape than most? As I posted two weeks ago, the current inventory of resale properties, especially townhomes, has finally started to decline after several years of increases. This means that the supply is shrinking to be more in line with existing demand. Another factor is that builders are producing fewer new properties. During the first 11 months of 2006, there were 10,478 single-family building permits issued. This dropped to 6917 during the first 11 months of 2007, a decrease of 34%. Over this same period, condo/townhome permits decreased from 4922 to 4510, a decrease of 8%. While the decrease in townhome permits is not as dramatic, bear in mind that the decrease in building permits has been occurring for several years. Last year's level of townhome permits was already 50% lower than in the early 2000's.

So How Do You Sell Your Existing Home in This Market? The first thing that comes to mind is don't. Those who hang on will almost certainly get a better price in the future than they will now. If you plan to sell and move up to a bigger house, it is not as important to get top dollar for your present home since you are buying another home in the same market and what you lose on your old home will be compensated for by a better price on the bigger property. If you are an investor with a rental unit, your first move should probably be to try to maximize your cash flow from that property. This doesn't mean you go to the tenants and tell them you have to have more money because your negative cash flow is too high. They don't care what your cash flow is. On the other hand, if you are renting at a below market rate, you can raise the rent to the market level or slightly below with little danger of losing the tenant. If you do, you should have little trouble getting a new one. Rental rates are a function of supply and demand for rental units, not your need for additional cash flow. You can also look at improving your property to get higher rents. Those properties that are in top condition will always attract more tenants or buyers than marginal units. It never ceases to amaze me how many owners will put their properties on the market in sub-standard condition. Buyers will always pay for quality. Trying to rent properties in sub-standard condition will face an additional risk in that they will get tenants who are willing to accept the situation because they have no pride in where they live. As a result, they will almost always vacate the property in worse shape than at the beginning of the rental period. It has been said that the most important three factors in real estate are, "location, location, location." While this may be true for raw land, I believe the most important factors for rental real estate are, condition, condition, condition.

There is Always Risk in Investments. We are holding more cash in our own portfolios and those of our clients to temper market risk; however, we are well aware that holding cash is not without risk. For example, if you invested $500,000 in cash at 5% a year or so ago, you could receive a $25,000 annual return. Next year when that CD matures, you will only get $15,000, Good luck if you need this money to fund your living expenses. Over the long run, a well-constructed portfolio of real estate and financial assets will almost always outperform cash by a wide margin. Next year will be particularly difficult but there are bargains to be had in the marketplace. It is much better to be a buyer of assets at this time than a seller.

RIDING ACROSS COUNTRY

Listening to Talk Radio. I've been on the highway a bunch during the past month. How does 4,000 miles sound? When I told a friend about this trip, he said he had driven about 4 miles in the same period. What can I say? I hate the hassle of airports and I like the freedom of being able to come and go as I please and not by the some airline schedule which is often wrong anyway. In this last leg of my trip from Denver to my lake house, I forced myself to listen to financial talk radio. What an experience that was. The underlying theme of most of these shows was an emphasis on what to do if you are losing money in the market. One commentator, Kathy DeWitt devoted two hours to extolling the virtues of their fixed income investment that guaranteed 18.74% return for the first year. "Yes folks, That's Eighteen point seventy four percent guaranteed by the second largest money manager in the world. You can get out of the risky stock market and get Eighteen point seventy four percent. If you'll just call for your appointment today we will stop your stock market losses and guarantee you Eighteen point seventy four percent. Our financial advisors are standing by for your call so you too can get Eighteen point seventy four percent". She said virtually nothing more than that for two hours. Can you believe I stayed with the program for that long. I wanted to find out what kind of investment she was talking about and who the money manager was but she never said. Would you make an appointment to drive to her office and hear the presentation? I can't believe anyone would but surely the company wouldn't be buying two hours of radio time if they didn't anticipate a lot of business from the program. Fear can drive you into some even more dangerous situations than the stock market.

Life Settlements Were Another Popular Pitch. Ever heard of these? My first experience with these came in the early 90's when the AIDS epidemic was nearing full swing. What they did was buy an insurance policy from a terminally ill AIDS patient for some discount below the face value. Then, when the patient dies, you get the face value of the policy. Everybody wins except the insurance company and the heirs. These investments, called viatical settlements, became less popular when the new drug regimen was discovered that prolonged the life of AIDs victims. Now AIDs patients are being replaced by "unhealthy senior citizens 78-80 years of age." Check it out folks. Call your elderly parents or grandparents and see if they have an old policy lying around that they would like to sell. If they don't just call Life Partners of Waco, Texas and we will get you one of these investments. You know what you will get the day you make the investment (the face value of the policy). The only problem is you don't know when. Just hope medical science does not discover a way to prolong the lives of "unhealthy senior citizens" like the way they did AIDs patients. On a more serious note, Life Partners is a company that has been around for a very long time and they perform a valuable service for many terminally ill patients who need money for their care. I have nothing against the company, only the unseemly way their product was marketed to investors who are anxious to stop the bleeding from their stock market and real estate investments.

How About a Variable Annuity? Some of these guarantee a return of your capital if you die. You are also guaranteed a minimal return if you hold it long enough. In addition, they promise some participation in the upside if the market does well during the holding period. These products are very complex and many of those who sell them don't really understand how they work. Just remember the "no free lunch" rule.

Everyone Has A Solution To The Current Market Volatility. Unfortunately, I don't believe any of them. I'll just stick to buying cash flow and believing that as long as I have income, the market will gradually return to historic levels.

SOMETIMES I FEEL LIKE A BROKEN RECORD.

Can Cash Flow Make Up For Falling Prices. Clients often ask me how I can hold on to a stock when the price is dropping. The question they ask is, "What good is a quarterly dividend of $1.00 when the price of the stock drops $10. If you think the stock is going to continue to drop and will never rebound, it is probably best to sell it but that is seldom the case unless the dividend is reduced or discontinued. Using a American Capital Strategies, company I have held since December 2000 as an example, we can see the value of dividends over a long holding period. The stock was paying a $2.08 annual dividend when I bought it for $22 per share. Based on dividends alone, the annual return was 9.5%. I have held it for the past 7+ years, during which time the dividend has increased steadily to the current $4.00 per year. My total dividends collected over the holding period were 19.93, only slightly below my $22 acquisition price. During my holding period, share prices ranged from 17 to 48 per share. In February of 2007, the price was $48 per share. Since that time it has dropped to as low as $26. It is currently at around $34. If I were a genius, I could have sold at 48 and rebought at $26 but I have no way of knowing how share prices of an individual company are going react to market dynamics. There is a whole volume of research that shows share prices don't react to news in a consistent, predictable manner. Another volume of research shows that the majority of investors tend to be worse off when they guess when to get in and out of the market. It has always worked out better for me to monitor a company performance and sell only when I think the fundamentals of a company have changed. I really don't care that the market price of American Capital Strategies has dropped from $48 to $34. I am satisfied with my $4.00 annual dividend.

Some Financial Experts Agree With Me. Wharton Professor Jeremy Siegal has published some calculations that show 97% of the market return over the period from 1872 to 2003 have come from dividends and only 3% come from capital gains. Despite my preference for cash flow, I am surprised that those figures are that high. Kathleen Fuller and Michael Goldstein published an article that show, in a declining market, dividend stocks out perform non-dividend stocks by 1 to 1.5% per month. Even more important, they do it with less risk. In view of these statistics, I am surprised that you don't hear more about dividend stocks.

Will The Market Value of Your Portfolio Decline More? I think it probably will, especially after today's 370 point drop. You can get out if you want. Safe returns are 2-4% and going lower. For me, this is a surefire way to being forced to lower my spending habits. While this isn't all bad, I prefer to change my habits by choice, rather than by necessity. You can take your licks in non-dividend stocks, or you can move into some of the higher dividend stocks. You may have to wait for a rebound in price, but at least you'll be paid to do it.

WHAT'S GOING ON WITH DENVER REAL ESTATE.

Are Things Looking Up? The demand from real estate investors has certainly slowed down. This means that you won't have as much competition for properties as you had last year at this time. Vacancy rates are down. This means that you will have an easier time finding tenants this year. Interest rates are down. This means that you will be able to finance your acquisitions at a lower interest rate. Of course, financing is harder to get because of the sub-prime debacle. Still, if you have good credit and a respectable down payment there are a slew of lenders eager for your business. In all, now is a much better environment for real estate investments than we've seen for some time.

A Conservative Approach is Best. My real estate investment philosophy is the same as my stock market investing philosophy. Look for cash flow. No one can predict the direction of market prices. Although we want an environment where prices can increase, we never know for sure when that will happen. If we buy when prices are lower, rents, are higher, and financing costs are lower, we have a better chance of achieving a positive cash flow. This allows us to tolerate price dips and choose a time to sell when we can obtain the best return on our investment.

So Is It Time To Buy? One factor I always look at is the inventory or properties for sale. At the beginning of 2007, we had 18109 Single family houses on the market. This year we have 18709. At the current rate of sales, the present supply would be expected to last 5.8 months vs. 5.5 last year. This means that supply/demand factors are a little worse this year than last but not by much. In contrast to other cities, the Denver market isn't getting much worse.

Let's Look at the Condo/Townhouse Market. Currently we have 5894 properties on the market or a 6.43 month supply. Last year at this time we had 6425 properties on the market or a 7 month supply. It appears that the supply/demand balance is improving slightly. These figures would indicate that, while we are not out of the woods yet, this market is improving. Potential investors in this market should look for well-located units with an established home owners association. I have always thought that the demand for single-level units was increasing faster than the supply so this is the area that I would emphasize in my search for strong investments.

We'll Keep Watching. We believe that the real estate investing environment is the best it has been for some time. We will keep watching. In 1991, the signals for a bull market in real estate were clear and aggressive investors made a bundle. We don't intend to miss it this time.

YOUR CHECK IS ON THE WAY.

The Government Rides To The Rescue. The president and congress have agreed to send you a check, that is if you don't make too much money. Somewhere between $600 and $1,200 will be headed your way. What a deal. And they don't want us to do anything productive with it. Just go out and spend it. Wait a minute. The government has no money. How can they send us a check? In fact, the government is in debt. Where will the $150 billion they need come from? They've already thought of that. They will borrow it. Just call China, Japan, etc and tell them to add it to our tab. I'm so glad they thought of that. I was beginning to worry that we might have to stop buying all this junk that complicates our lives. We might not be able to keep building larger and larger houses and taking advances on our credit cards to pay our ever increasing utility bills. We can keep doing what we're doing and leaving our grandchildren to pick up the tab.

I Have An Idea. Let's stop this stuff right now. Instead of spending the money they send. Let's use it to pay down our high interest debt. If we have any left over, let's put it in the bank. Let's cut our expenses and buy less than we can afford. Let's save our cash to take advantage of bargains in the real estate and stock market that will inevitably be available from those who have to sell to meet their living expenses. Lets invest in instruments that pay dividends so we can meet our income needs without having to sell assets.

Still In Scottsdale. We've been in Scottsdale Arizona since Sunday. My brother has his surgery at the Mayo Clinic at 5:30 in the morning. Hopefully, we will be through with this place next week at this time. I should be back in Denver by the first week in February. Hopefully, I will have time to visit with some of you before time to head back to Texas. In the meantime, stay tuned to this spot for more exciting rants about ways to cope with this weird economy.

SOMEBODY HELP US.

Who is Going to Help Us? I just listened to the Fed Chairman discuss with members of congress the possibilities for helping us avoid a recession. I must admit, I don't have much faith in congress or the FED figuring out a way to resolve this problem. Although there is some talk of co-operation between Democrats and Republicans to obtain a solution that both sides support, it doesn't look to me like it can happen. The Republicans want to stimulate business growth to provide opportunity and higher incomes to consumers and the Democrats want to send money directly to consumers. I have a sinking feeling that neither strategy can work. Its kind of like trying to cure a night of binge drinking and overeating by sending the binger to the hospital for a stomach pump and an enema. That sometimes works in drastic situations but the cure is often more traumatic than the disease. Sometimes you just have to change your habits and let the natural mechanisms take over. Let's face it. We've been on a binge fueled by cheap money and foreign capital inflows. We need to slow down and regain our health to regain the confidence of the investment community. Some people will lose their homes. A tragedy, no doubt but they shouldn't have bought big houses they couldn't afford. Some consumers will have to stop spending because their credit cards and home equity loans are at a maximum. This will mean job losses and business failures in a number of sectors, especially retail. Some large banks and investment banking firms will have to scramble to shore up declining balance sheets and several highly paid executives will lose their jobs along with clerical and service workers. Home builders will have to cut their plans to produce more housing inventory in a market with more resale and foreclosure inventory than it can handle. When the smoke clears, we will regain our health and, hopefully, learn to live within our means.

How Do We Handle The Slowdown. I have a retired friend who recently informed me that he has sold most of his stock positions and has 75% of his investment portfolio in a savings account. He says his main problem is trying to support his family on a 4% yield. I have news for him. As the FED continues to cut interest rates, that yield will drop to 2-3%. While we have raised cash in most of the portfolios we manage, we don't recommend moving to that much cash. In a market where you can find 8-12% dividends, moving totally to cash is not a strategy I can afford to follow. If we utilize a portfolio that produces adequate cash flow and we employ more prudent personal spending strategies, it is possible to ride out the market adjustment and have some cash available when the markets recover. I realize this post is short on detail. I'll get more specific on strategies later on.

TURN AROUND AND RUN LIKE HELL

A New Investment Strategy? Turn Around And Run Like Hell is the title of a book I received as a Christmas gift. It is actually, a compilation of war time battle strategies, not a book on how to cope with the recent market distress. You can go back to my post of May 15 entitled, Beware The Receding Tide, as proof that the current market situation is not a huge surprise to us. You can also look at my post of July 15 which makes the point that excess liquidity in the marketplace is causing investors to make some really stupid decisions. So if I anticipated the current correction, why didn't I sell everything and put everyone in cash to preserve capital to invest in anticipation of a turnaround when things change? The answer is that I wasn't positive that a downturn was coming, I didn't know when it would arrive, and I didn't know which sectors would suffer the worst. What we did was raise some cash by accumulating instead of re-investing dividends and selling those stocks that we felt were overvalued. We continue to follow these strategies. If we had known that the correction would begin this fall and that it would involve mostly financial stocks, we would have "turned around and ran like hell." We didn't and now it looks as if totally selling out at this point would result in giving up a lot of upside potential, which appears to us to outweigh the downside risk. For one thing, we continue to collect rich dividends, and for another we believe that a rebound in share prices has more potential than a significant decline. Selling out at market bottoms is exactly this strategy that causes the average investor to miss out on market rebounds.

So What Is Our Prediction For the Future? Short-term it appears that the mortgage and housing industries are a year or so away from a rebound. Financial stocks will remain out of favor and the good will suffer along with the bad. Our current portfolio of high-dividend stocks will languish; however, as more people realize that cash flow and intrinsic value are more important than the market perception of value, we should see a rebound in market prices. My investment strategy will be to keep an eye out for reasons that we might change what we are doing; however, it is highly unlikely that we will be tempted to "Turn Around and Run Like Hell.

BACK IN TEXAS

Back After A Long Trip. After flying to Denver to check on business, I got in my pick-up truck and headed Southwest to Arizona. I had a number of things to take care of such as scattering the cremated remains of my uncle on a mountain in Tucson and visiting my 88 year old father in Mesa. After that, I rode across the desert and back to the woods here in Southeast Texas. I'm glad to be back.

Is An Annuity In Your Future? If you read the financial press, you'll see many negative articles about annuities. Granted, the management/mortality fees are somewhat high and the surrender charges can be excessive if you cash in before the required 5-10 year holding period, Much of these disadvantages are the result of over-zealous sales tactics by some commission-driven sales people. Just like most other financial products, they are useful a number of circumstances and mis-applied in others. For example, I recently ran across a couple with 100% (almost $1 million) of their IRA money in a variable annuity. My opinion is that there are at least two things wrong with this scenario. 1. IRA's are tax advantaged instruments which allow the build up of earnings inside the annuity with no current taxation. Annuities offer the same tax deferred build up. Buying these instruments inside an IRA offers no additional tax advantages and the investor ends up paying excessive fees for services charges inside the annuity. While there might be some reasons for including an annuity in an IRA (I'm being charitable here), you never want to devote 100% of your IRA to an annuity. 2. The other flaw in this scenario is that your investments are limited to those offered within the annuity. While these can be quite broad, they are still a long way from being comprehensive.

What's The Real Benefit Of An Annuity? When I took my financial planning courses, the official definition of an annuity was "systematic liquidation of capital." Sound like a trip to Las Vegas? Translated into English this means that an annuity allows you to draw principal and interest from your investment at a previously agreed upon schedule. Viewed as an insurance, rather than an investment product, the real benefit of an annuity is that it offers a guarantee that you will be able to receive an income stream as long as you live. It insures that you will never outlive your income. For example, consider a 66 year old male with $300,000 in capital. This individual doesn't want to be bothered with managing his investment portfolio and doesn't want to worry about outliving his money. One alternative is to buy an annuity that would pay $2067 a month for life. If he lives until age 90, his total payments would be $570,492. Upon his death, payments cease and there is no money left for heirs. If a spouse is involved, there are other options, one of which is that, in return for a smaller income stream, there is also a guaranteed income for the lifetime of a spouse. In the case of a 63 year old spouse, the income would be $1,773 and the spouse would also be covered for her life. This is an oversimplified approach. I received these numbers from a web site, www.immediateannuity.com. While the site provides a quick estimate of the available benefits, there are other details to consider which are too cumbersome for discussion here.

There Are Obvious Disadvantages To This Approach. If the investor and spouse die in a flu epidemic during the first year, the insurance company gets all the money and the heirs get nothing. In addition, inflation would reduce the purchasing power of this income stream over the years. Theoretically, it is possible to receive this same income from an investment portfolio without forfeiting the principal at death. The main benefit of this approach is stability. You give your money to the insurance company and the game is over. You don't have to worry any more since your income is guaranteed for life. There are also a number of compromises. You could invest part of your money in this instrument and the remainder in other investments. This would enhance the stability of your return while the other investments would allow the possibility of capital appreciation and higher returns. The task is to choose the mixture of higher returns and stability that fits your income needs and risk tolerance.

The Holiday Season Is Upon Us. It is my objective to get one more post in before the holidays. If I don't, I would like to thank you all for your friendship and support over these years. While money is a major part of my life, it means nothing compared to the relationships that have sustained me for almost 70 years.