Until recently, many investors I would come across in California insisted that real estate was the only way to go when it came to investing. “Real estate is something tangible, something I can touch and feel, I can go and kick a building I own, therefore I am comfortable with it. I can’t kick stock” would be the usual reprise. To be sure, you can look at an investment property, you can go slam the door and open/close the toilets, but does this make the investment inherently less risky than owning a basket of equities, or for that matter even a single stock? Let’s look at some real dynamics of real estate ownership:

      Real estate investing is highly leveraged, debt to equity often a 5 or 10 to 1 ratio. It is funny how hedge funds are viewed as highly speculative when they leverage 3 or 4 times, but when someone puts down 10% on their investment property (thus they are leveraged about 10:1) that is viewed as normal if not conservative. To be sure, leverage works for you when prices are rising and income (via rent, etc) supports the cost of leverage (in this case the mortgage), but when, not if, the proverbial ‘price increase music’ stops and/or when there is a hiccup with rents (e.g. your tenant bails for cheaper rent in Texas), then leverage rears its ugly head and works against the investor in dramatic and economically damaging ways.

      Real estate is inherently highly concentrated when it comes to the paying consumer. In the case of a 2^nd home or condo as an investment, you are dependent upon a single customer for your revenue (rent). Imagine a company with the business plan of having exactly one customer. Such a business plan could never be funded given the risks associated with the single customer approach. Compare the reliance on a single renter with the number of customers a company like Coca Cola (KO) has. KO has literally billions of customers in virtually all countries of the world. Its revenue base is highly diversified, the company not being dependent on any single customer but rather hundreds of millions of consumers spread out across the globe. 

       Real estate is inherently local. If the economy surrounding a given investment property goes south, you can’t exactly uproot the business for more robust economic environments elsewhere. In the case of large, multinational companies, they have tremendous geographical diversification such that if a particular region is slow, often other parts of the world are experiencing faster growth and these varied economies can and do offset each other.

At the end of the day, just because an asset is tangible – just because you can kick the side of a building – does not in and of itself make the investment less risky per se. One must look, sans emotions, at the various economic dynamics to determine the risks associated with real estate and equity ownership. When an analysis is done beyond superficial considerations, a conclusion about the lower risks associated with investing money in a broad portfolio of stocks versus a single real estate property becomes evident.

In life, we are generally told not to do this. To hit a man when he’s down is improper etiquette and horrible karma. But what if we’re not talking about a person? Does this PC rule apply when we’re talking about the market? I say “No,” and here is why:

Say the market (DOW) is currently at $13,000. It is expected to reach $26,000 in ten years (7% growth a year is reasonable.) You, as an investor currently have $100,000 in a portfolio invested in the market. Each year, for the next ten years you add $10,000 to the portfolio. What is the most optimal path for the market to follow to maximize your returns? Most answer this question by thinking “Up! I will get the best returns as long as the market keeps moving up!” While this answer is true in part, the thought process is a little premature.

Let’s say there are three ways for the market to get to that $26,000 at the end of the ten year period. It can either jump to $26,000 in year one and stay there for ten years, steadily increase by $1,300 a year, or stay at $13,000 for nine years and jump up to $26,000 in year ten. What will be the best scenario for you as an investor?

Let’s choose the first scenario where the market jumps and stabilizes. If you’re investing $10K a year, you’re only able to buy .38 shares of the DOW each year. At the end of the ten years, you will have 11.54 shares and a portfolio worth $299,940— Pretty good, but you could do better.

Let’s look at the second scenario. The market steadily increases for the next ten years. That means that with each passing year, your 10K will be able to buy fewer and fewer DOW shares. Because the market is increasing, the buying power of each dollar of your $10K into the market decreases. At the end of year ten you’re left with 12.83 shares and $333,694.28. Better than before, but is it the best?

Finally, take a look at the third scenario. The market doesn’t move up until the last year. This means that your $10K is able to buy more shares (.77) of DOW each year than under the previous scenarios. Thus, your portfolio holds more shares. This allows for a greater increase in portfolio value when the market ultimately moves up at the end of the tenth year. Now, you’re looking at a portfolio worth $389,940. You can only imagine how much you stand to gain if the market dropped below $13,000 before making its way back up to the $26,000.

The point is this: If the market tends to move up in the long run (which is the truth), a downward swoop or stabilization of the market in the short run can actually be a GOOD move for long-term investors. When you expect the market to be up in the long run, a low market value before the upswing allows you to purchase more shares at cheaper prices. When those shares then jump in value at a later date your portfolio can provide some hefty returns.

So go ahead. Take a swing at the market while he’s down. He’ll eventually get back up, and when he does, you can take his money and run. How’s that for good karma?

You may have heard about before, various conflicts of interest arising between individual investors and their advisory or discretionary brokers—where the broker makes or advises a deal just so he can get commission or increase company sales. With due diligence laws and the threat of securities fraud, many believe the days of these conflicts are long gone. However, it only takes a glance at the NY Times Sunday edition to shut that belief down. Sales of auction-rate securities are the new culprit, and the reason so many investors are scraping for cash.

Auction-rate securities (bonds whose interest rates are determined via auctions), have been held by corporations and individual investors since the 80’s. For the past 20 years, these securities were sold to individual investors as risk-less cash equivalents, better than money-market funds because of their higher return. Recently however, investors were made aware of the risk involved in these securities when underwriters began marking down the value of these securities with investors suddenly unable to liquidate. The question then becomes, why were so many of these investors unaware of the risks involved with these securities?

At the end of 2006, corporations held 80% of auction-rate security market, a hefty percentage. Later, in mid-2007, corporations seemed to have sensed the problems that lie ahead and began bailing out of the market, selling off these securities until corporations only held 30% of the market by the end of 2007. With big corporations selling, they needed buyers. That’s where this conflict arises. It seems that corporations began looking to individual investors to buy these securities and take them off their hands. Individuals were sold these securities with faulty promises of liquidity from brokers. The brokers simply needed to find someone to buy these securities and recommended them to clients, regardless of the client’s best interest.

Beside the fact that investors have no access to their money, there is very low incentive for institutions to help this market as firms continue to receive auction fees despite the faulty auction. Just goes to show that trust, the truth and integrity in today’s world are still hard to come by.

It’s so easy to get caught up in a fad. In fact, that’s exactly what so many investors do and precisely why they do it- because it’s easy. But the question is whether or not this kind of behavior is smart. When the market is hooked on a price increasing fad, be it for macroeconomic or sector related reasons, that’s the time many people look to buy, and precisely the time they shouldn’t. They see a stock hitting high and they want in. The more people behave this way, the more the price increases in so on. Pretty soon everyone is buying simply because other people are buying, thinking “they must know something I don’t.” But the reality is that you can, and should, know everything about a company before you buy its stock. Don’t trust your neighbors’ judgment. See for yourself.

This is not revolutionary thinking. I can bet that you did not buy your car without looking at it. You would not make this kind of purchase simply because someone else thought it was a good deal. No, to the contrary, we make big investment decisions based on our own judgment. We want to see how the car handles, what color it is, and determine the MPG before we buy it. We should utilize this same way of thinking when it comes to buying a company. No, we can’t take it for a test run, but we can look at its history, its CEO and its balance sheets and make these kinds of judgments for ourselves.

Under the same logic, it is just as easy to get caught up in a panic as it is a fad. When the market is down in a certain sector, causing a certain company to be down as a result, people panic and sell, at arguably the worst time to sell. If people keep playing according to these rules, everyone would end up buying high and selling low.

They way to make good money is not to follow the market mark for mark, but to invest in good companies. The market gives us an opportunity to buy good companies at good prices. It does not determine the credibility or the strength of a company—that’s what the balance sheet is for. There are so many outside influences that can affect the share price a company that really have no influence on the core of the company whatsoever. So rather than looking at an increasing share price to decide to jump in, or a decreasing share price to jump out, look for a strong company. Do you’re homework, because the best way to invest is to buy stock in a good company that is undervalued by the market.

I was riding a stationary bike last night and a financial show I watch from time to time was on the TV in front of the bike.  The show has 4 or 5 regular guests – the Traders – who give sound bites about particular stocks they like, dislike, etc.  I have noticed that from time to time the moderator of the show will ask the panel if they own the stocks – this is probably both for interest as well as compliance/disclosure purposes.  A typical exchange is as follows: Moderator: “Ok, I am going to ask each of our panelists what they think of AAPL – good stock, bad stock…give us your thoughts.” 

It was recently reported that a major brokerage firm reduced its recommendation on Bear Stearns (BSC) to SELL from HOLD, but at the same time RAISED its price target to $10…even though the stock was trading above $10 at the time of the revised recommendation.  Go figure.  Another example of large brokerage firms giving recommendations to buy or sell after a given stock has already made a significant move (in this case, BSC went from the 80’s to the 50’s to about $2 and then a little over $10 in a matter of weeks). 

“Pain Is Pleasure.”         

     -        Arnold Schwarzenegger Circa 1982    

This is a concept I have subscribed to since I was a kid, namely the notion that (constructive) pain is an actual source of pleasure as it represents growth, challenges overcome, forward motion….  Lately the stock market has been dishing out its own doses of pain.  To be sure, we have essentially been in a bear market since last summer with major market sectors (certain industries, market caps sizes, etc.) dropping 20% or more.  Typical bear markets are not straight down; rather they tend to grind away with upward spikes along the way.  But nonetheless, during bear markets stocks drop precipitously over time as they have over the last 6 months.  

So what does all of this mean, and more importantly, what should we do about it?  First, some perspective and context.  There have always been and will forever more be cycles.  It is the way life works.  The sun rises, the sun sets.  Oceans ebb and oceans flow.  It rains, then it is sunny.  Fall yields to winter yields to spring yields to summer and so on.  The same holds true for economic cycles.  For over 200 years in the US capitalist-based economy, there have been macro-economic ebbs and flows, real estate booms and busts and stock market peaks and troughs.  Always have been, always will be.  We just don’t know when they will take place, for what reasons or for how long they will last.  

The challenge when it comes to equity investing is that the vast majority of humans have mental character traits that are inherently flawed.  The very same person who would gladly wake up at 5:00 a.m. the day after Thanksgiving, drive 20 miles and battle hardnosed crowds just to save 30% on their favorite appliance or toy on sale, would take a stock which is also temporarily on sale and go straight to the “return” counter (as in sell it after having bought at a higher price earlier).  Simply put, novice investors do the opposite of what they should do – rationally, objectively, mathematically – when it comes to investing.  

Most brokers (which we are not) will only contact clients when the market is up.  I have witnessed this first hand.  Why?  Simple – it is easier to ‘sell’ (as in have you buy) stocks when the market is on an upward tear, even if that is the worst time for you to buy them.  At Coastwise Capital Group, LLC, we offer a different message, a more valuable approach.  When the market is down, like it is now relative to last summer, it is the very best time to add to your portfolio.  Buying low always has been and always will be the optimal time to purchase equities.  For anyone who is a net saver, and thus a net investor (as in anyone who is adding money to one’s portfolio via an IRA, 529 plan, a periodic contribution to an individual account, etc. over time), you should be very glad that the market is down.  Read that sentence again, because you will not hear it often.  Objectively speaking, which is what matters (not your emotional reaction – save your emotions for your family or artwork or some other subjective matter), your returns are enhanced over time when you invest more money in a down market.  It is just basic math.  Even if you are not contributing additional money to your account(s) – which you should be doing – the reinvestment of dividends at lower prices is an important source of enhanced returns and wealth creation over time.  

In summary, it is important to have a paradigm shift when it comes to seemingly endless down days in the market.  Remember, when stock prices decline you have not ‘lost’ money. You have not misplaced it, spent it, burned it, nor has it disappeared.  Rather, the market is currently valuing the shares you hold in a business at a lower price than previously.  You don’t need the money tomorrow – if you did, it should not be invested in equities.  Cycles come and go.  We are likely in a recession as we speak and by the time the government compiles its statistics we will be on our way out of said recession.  We are undoubtedly in a real estate bust which we will also certainly come out of as we have every other real estate down turn since the beginning of real estate.  The stock market – which typically anticipates by 6 months or so major macro-economic trends – will bottom out only to head back north as it has done for the last couple hundred years.  Will this happen tomorrow or next week or next month or this summer?  I do not know – anyone who says he has the answer to this question of market timing is not being truthful.  But for any net saver/investor, the longer the market stays down the better.  Do as I do, which is to put every available excess dollar into quality equities.  The market will be where it will be a year from now, 5 years from now, 10 years from now.  The lower the price you pay for your shares, the higher will be your returns, plain and simple.  Opportunities to buy quality companies at low prices do not come around often.  Once everything is ‘clear’, then it is too late, stocks will have already rebounded, the sun will have already come out, and everyone will realize in hind sight that the storm was not so bad after all….  

A typical recession lasts about 8 months, the average bear market lasts less than that.  Put 6, 12 or even 18 months in perspective.  A parent investing in a five-year-old child’s 529 plan will have more than a decade of investing to do once the next US recession is over.  A 45 year old will have nearly 2 decades – at least – of additional investing for retirement and beyond once the next recession has faded.  A recent retiree will likely have 10 or more years to take advantage of the superior return potential equities offer.  To be sure, a year is a blink of an eye in the life of an investor.  It only seems like a long time because headlines blare dour news minute after minute, hour after hour, day after day….  Do not become beholden to such short-term considerations.  Do not make the mistake of pulling money out of the market at just the wrong time.  Indeed, do the opposite, what the ‘smart money’ does, namely put additional money to work when stocks are on sale.  This is how wealth is created.  You will not call the bottom; you don’t need to.  You simply need to plant as many investing seeds as you possibly can, seeds which will blossom and flourish once the cycle changes, once the sun comes back out, which it invariably will. Today’s stock price pain yields tomorrow’s wealth creation pleasure.    

As I noted in the June 2007 issue of the “Coastwise Monthly Dividend” Newsletter (http://www.coastwisegroup.com/News/News.php?archive=11), Starbuck’s (SBUX) has had an outlet in the Forbidden City in Beijing for some time. I have seen it on several occasions, and despite the fact that I was SERIOUSLY mocha-deprived when I was there, I did not step foot in the place. To be sure, while I want nothing but financial success for SBUX (and was quite pleased when the stock popped nearly 6% today), I am pleased to announce that Starbucks has decided to close its store in China’s Forbidden City. From a cultural perspective, I think Starbucks made an intelligent decision (if you ever have the opportunity to visit the Forbidden City, do so – it is truly a historical wonder…which is why having a SBUX there was so offensive in my opinion). Further, from a financial perspective, I think the company also made the right move as the negative press and image associated with this one outlet far outweighed the financial benefit – especially as the company pursues its aggressive and important international expansion plans. With over 250 stores operating in China, Starbucks’ future earnings prospects and international expansion, especially in East Asia, look as strong as ever.

GE, one of the oldest and largest companies by market capitalization in the world has seen its stock go from the mid 34’s to a shade under 41, a nearly 20% rise in under 3 months.  That is a couple year’s worth of gains in less than a quarter for this industrial giant.  The stock appreciated after basically going no where for a couple years running.  The important lesson here is that stocks, even the stock price of a very large company, can appreciate a great deal in a short period of time.  You have to be there for the gains.  You have to be patient.  If the company is making good progress, then one day you will wake up, or return from a 3 week vacation, to find that the stock has headed North markedly.  It always seems to happen when you are not looking.  Head to the zoo and stare at the elephant, and he will just sit there barely moving.  When you turn your back, however, he will do a jig that will earn you profits if you were patient enough to hold (this especially holds true for dividend paying stocks that will earn you ever increasing dividends if you reinvest them over time).

New Century Financial (NEW), a company big into the sub prime mortgage industry, ’surprised’ Wall Street by announcing that losses on their risky mortgages would be bigger than expected. These are the same mortgages that writers for the WSJ and other financial periodicals have been saying for months or more were suspect to accelerating default levels as teaser intro rates converted to higher fixed rates - - combined with the cooling off of home prices.

Investment bank analysts are paid to forecast future stock price movements based on company fundamentals. But, more often than not, their recommendations simply reflect what has already happen, and thus, to be blunt, are less than worthless.

In the case of NEW, many prominent investment banks had equivalent of hold (as in keep - it is good) or buy (as in, if you don’t own it already, get some now) recommendations on NEW while it went from the high 40’s to the low 30’s. Then, one fateful day last week, the stock cratered from about 30 to 19, a massive one day drop on top of what had already been huge stock price losses in the previous months.

Only AFTER the stock dropped to 19 from the high 40’s did these investment banks tell you to sell. While the stock was getting clobbered they advised you to buy or hold it, and AFTER shareholders heeding this advice lost over half their money, THEN the analysts said sell (some actually downgraded the stock from buy to hold - meaning, if you take their recommendation at face value, they are telling you to keep your position. Of course, what they REALLY mean is that you should sell - that is what HOLD means - but for some reason they can’t actually be direct and say SELL).

As a related aside, now that most of the damage has been done in the risky mortgage lending industry in terms of providing loans to people who can ill afford them, NOW companies are clamping down on their lending standards. The GREAT companies are disciplined during good times and bad, they don’t wait until the bad times to tighten the screws, in fact, the better the times, the MORE disciplined they become, why, because THAT is when bad times are likely to follow. It is very hard to take this approach as inevitably a company forgoes some profits when maintaining if not heightening scrutiny and standards during the good times, but they weather if not thrive during the inevitable down times due to this ongoing discipline.

So back to the investment bank analysts, THE POINT HERE IS THAT, OVER AND OVER AND OVER, INVESTMENT BANKS CHANGE RECOMMENDATIONS TO BUY AFTER A STOCK HAS RUN UP AND CHANGE RECOMMENDATIONS TO SELL AFTER A GIVEN STOCK HAS ALREADY COLLAPSED. THUS, IF YOU ARE RELYING ON SUCH ANALYST RECOMMENDATIONS, YOU ARE PROBABLY BUYING HIGH AND SELLING LOW.

I can’t put it any more plainly than that.