Archive for February, 2008


February 29, 2008

This week on WealthTrack, it’s back to school with three experienced investment mentors- Random Down Wall Street’s Burton Malkiel, Harvard behavioral economist David Laibson, and energy market veteran Tom Petrie. They all have pointers for tough market tests ahead on Consuelo Mack WealthTrack.

CONSUELO MACK: Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. There are volumes of research proving the futility and destructiveness of investors trying to time the market. Most of the time, we get it exactly wrong, and only the savviest of pros get it right. As Warren Buffet famously said, “We want to do business in times of trouble.” Well, times of trouble are here. Mr. Buffet has been putting Berkshire Hathaway’s prodigious billions to work, while individual investors are selling stocks in droves and fleeing into short-term cash instruments like bank CDs and short-term treasury securities. According to Charles Biderman, publisher of TrimTabs, which tracks daily money flows in mutual funds and ETFs, “it’s as if investors made a New Year’s resolution to get out of the U.S. stock market.” Since the beginning of the year, selling of U.S. stock mutual funds of all sorts has been accelerating. The selling has spread to international stock markets as well, especially emerging markets, which, as you know, have been stellar performers for the last several years.

Meanwhile, long-term institutional investors have been putting money to work in the most downtrodden sectors of the market. Recently on WealthTrack, third-generation value investor Chris Davis of the Davis Funds explained why his firm invested $1.2 billion in Merrill Lynch stock. After following the company for ten years, he now believes it offers good value. In recent months, Warren Buffet has purchased a distressed re- insurance company, started a municipal bond insurance firm, and purchased a 60% stake in Marmon Holdings, a manufacturing and service business conglomerate. Buffet called the $4.5 billion purchase of Marmon a “very large bet on America over a long period of time.” Sovereign wealth funds, investment funds controlled by foreign governments, are also making large long-term bets on American companies. Singapore’s Temasek holdings was another big investor in Merrill Lynch. Citigroup has tapped not only Singapore, but sovereign wealth funds of Abu Dhabi and Kuwait. And China has invested in Morgan Stanley. Is this any time for you to be making some new investments? We’ll ask Burton Malkiel, David Laibson, and Tom Petrie next on Consuelo Mack WealthTrack.

How efficient are the markets right now? Where do China and energy fit into your portfolio? And how can you prevent yourself from making harmful investment mistakes? Our first guest almost needs no introduction. His classic, A Random Walk Down Wall Street, now in its ninth edition, has sold over one million copies and introduced the concept of index investing to millions more. He’s Burton Malkiel, professor of economics at Princeton University, and now the author of a new book, From Wall Street to the Great Wall, about the opportunities he sees in China. China looms large in the energy market, and one of the savviest experts in the business is our next guest. He is Tom Petrie, whose longtime research and investment banking firm was bought by Merrill Lynch in late 2006. Now, he’s a Merrill Lynch vice chairman, where he focuses on investment banking in the hyperactive energy field. Our third guest is a PhD economist and professor of economics at Harvard University who works at the intersection of economics and psychology, a field called behavioral economics, among others. He’s David Laibson, named one of the ten people to watch by Fortune magazine in 2005. One of his many interests is the puzzling behavior of individual investors. And puzzling it is indeed, especially seeing what’s happened since the beginning of the year. It’s great to have you all here. Professor Malkiel, let me ask you, the ninth edition of Random Walk Down Wall Street, does the efficient market theory still hold up? Has anything changed?

BURTON MALKIEL: One of the things I do when I do new editions, I keep asking myself, is the advice in the first edition that you are probably better off just buying a low cost index fund, does that still hold up, and, in fact, it holds up beautifully. Index funds continue to beat about two-thirds of the actively managed funds, and the one-third that may win in one year aren’t usually the same ones that win the next year.

CONSUELO MACK: Let me ask you about that. Because we did some research in down markets and it turns out that the median actively managed funds outperforms the index funds. In down markets, is that really the case?

BURTON MALKIEL: There is a slight —


BURTON MALKIEL: But I emphasize slight tendency for index funds not to do as well in down markets for one obvious reason. That actively managed funds typically will have 5 to 10% holdings in cash. The index is 100% invested, and therefore there is a tendency for it to not do as well in a down market. Having said that, though, you’re never going to know exactly when the down and up markets are over the long haul, indexing is still the place to be.

CONSUELO MACK: Tom Petrie, you have spent most of your difficult life trying to disprove Burton Malkiel.

TOM PETRIE: The first half of my adult life, anyway.

CONSUELO MACK: You research companies and try to find the best companies for your clients. How efficient is the energy market, is the oil market for instance?

TOM PETRIE: I think it does vary over time. There is a good chunk of time in the ’80s when oil was not very much in favor. I think there was an inefficiency at that time. But over longer periods of time, I would not argue that there is a real effort — the competitiveness in the sector has resulted in a high degree of efficiency. And the professor’s findings are ones I’m aware of, and I would not take great issue with them.

CONSUELO MACK: What about the oil market now? I’m specifically referring to oil.

TOM PETRIE: Oil has a degree of complexity, and arguably inefficiency in it because of the variety of grades of oil and locational advantages and disadvantages, and the different markets that they serve. All of that can introduce pretty good opportunities for arbitrage and for capturing some errors in valuation. In the property market, where I spend a lot of my time, there is an inefficiency in that market. Although I will say, it is much more competitive today, and it is becoming a lot more efficient. What we’re working on in terms of differences in valuation today are much less than they were five, ten, 15 years ago.

CONSUELO MACK: That’s interesting. David Laibson, perhaps the most relevant part of this discussion is how individual investors react to whatever advice Burton Malkiel is giving or Tom Petrie. How efficient are individual investors in taking advantage of investment opportunities?

DAVID LAIBSON: I love that question. I think the problem is the individual investor thinks they can take advantage of market inefficiencies, and even if those inefficiencies are there, the individual is actually going to make a mistake, is going to not pursue the strategy that will take advantage of the inefficiency and will instead be the person who is getting exploited, the person who is making a poor investment. So for most individual investors, I would say for almost all individual investors, that index fund looks very, very appealing, even if the market is inefficient in some way.

CONSUELO MACK: Why is that? Can you give us an example when individuals do essentially shoot themselves in the foot?

DAVID LAIBSON: There are a lot of mistakes individual investors make. They’re going to fail to diversify, they’re going to pick high fee funds, they’re going to chase returns, and they’re probably going to be behind the people who know exactly what they’re doing. Think about a diverse environment- there are really some sophisticated investors, and they’re going to be ahead of the market. There are a huge group of unsophisticated investors, and they’ll be on the other sides of the trades. Do we think that Warren Buffett is going to make a mistake? No. Who is he trading with? Everyone on the other side. Those are the small investors. They’ll be the ones chasing the return, in fact, chasing the return in the wrong way. So we basically know that the sophisticated investors take advantage of the unsophisticated investors. The way to avoid that is to stop trying to be an active trader if you’re a small investor; buy the index fund and get a low fee.

BURTON MALKIEL: Can I just add to that?


BURTON MALKIEL: Because I think it is so important. One of the things I added in the ninth edition is a new chapter on behavioral finance. Let me give you a perfect example of the mistakes individuals make. When did people put – individuals– put most money into mutual funds? It was the first quarter of 2000, just when optimism was at its peak. And what funds did they buy? They didn’t buy the value funds which actually did well in the next year? They bought the high-tech funds. When did most people take their money out of the stock market? They actually took most of it out in the third quarter of 2002, which turned out to be the low of the market. As you said, they’re taking it out now. Is this the low? I don’t know. Nobody can time the market perfectly. But when we look back on it, I am sure we will see it is precisely the time when individuals panic, that that’s the time that they shouldn’t, and that they make systematic mistakes.

TOM PETRIE: And what you end up with is, whenever something is really in favor, that’s when it gets mispriced.


TOM PETRIE: We saw energy right at the top there in the late ’70s, and we were expecting $100 oil, and we triggered long-term demand and lo and behold, we find OPEC would spend 15 years in the penalty box as things unwound from the price signals that we sent, and here we are–

CONSUELO MACK: What about now, Tom?

TOM PETRIE: We’re back at finally at a price that’s —

CONSUELO MACK: In the 90s, oil.

TOM PETRIE: $90 oil is flirting with the inflation adjusted old high, and at 100 it is clearly there. There are some issues, and we were talking about this earlier, that would suggest that I think it may take an even higher price to trigger the long-term and demand elasticity. But the cumulative drag that is being introduced in the system, and the price signals, having gone from $25 oil to $100 or close to it, is beginning to create real change. This time around, we don’t have the wild euphoria that we had because we have the lesson from the last time, but we’ll get there. And probably not too far down the road, before the end of the decade.

BURTON MALKIEL: But don’t we have a new factor now? In that we have China.


BURTON MALKIEL: Growing at double-digit rates, and India growing at rates not quite, not so far behind.

TOM PETRIE: And the fallout from those two into the rest of Asia. So you’re right and that’s a very big distinguishing factor, Burton. That’s why we were having a debate. Will it trigger $100 or will we take $120 or $150 oil? I would sense it may well be that we’ll get to that price. We may be triggering something now, but it doesn’t mean we’ve seen the peak.

CONSUELO MACK: To affect the demand in India and China?

TOM PETRIE: And to affect the demand here, too.

CONSUELO MACK: You think it would be that high a price?

BURTON MALKIEL: I wouldn’t be surprised if it took much higher.

DAVID LAIBSON: We have China, but we also have alternative energies that are competitive at these current prices. So it’s very hard to know where the price of energy is going to go. Once again, I would tell the small investor, don’t try to make these predictions, don’t make these big bets, don’t buy a commodity fund right now, don’t short commodities. Hold a diversified portfolio.CONSUELO MACK: Let me ask you about your new book, From Wall Street to the Great Wall and How Investors Can Profit From China’s Booming Economy. Why China — especially when I consider the Chinese stock market because it is still a tiny percent of the world market capitalization.

BURTON MALKIEL: It was a tiny percent, but it is now a much larger percent.

CONSUELO MACK: The economy is.

BURTON MALKIEL: The economy is and the stock market as well, as some of the government enterprises are being privatized. There has never been in history, during the growth phase of any country, that any country has grown the way China has since what I would call the revolution of Deng Xiaoping, who essentially introduced capitalism into China.

CONSUELO MACK: And I have to tell our viewers, one of the neat things about your book is that you do give a history, in the beginning of the first chapters of the book, about China, which is really fascinating.

BURTON MALKIEL: China was basically falling apart during the Cultural Revolution, and Deng Xiaoping came in and said socialism doesn’t mean we have to have shared poverty. He actually said to be rich is glorious. He said it doesn’t matter whether the cat is black or white, only that it catches mice. And you had a practical nature of the Chinese government, and what was unleashed was the entrepreneurial power of the Chinese people. China has always revered education, since the time of Confucius, and the genius of Deng Xiaoping was to unleash the risk taking, and the entrepreneurial spirit. And China has been a tremendous growth story, and in my view, it is going to continue. After the Olympics, Shanghai is going to have a world’s fair to end all world’s fairs in 2010, and I think that growth is going to continue for decades to come.

DAVID LAIBSON: 10% growth?

BURTON MALKIEL: No, it can’t possibly continue at 10%, but in high single digits, yes.

TOM PETRIE: Much higher than we would see.

CONSUELO MACK: The developed world, at any rate, because China certainly is coming into its own as a developed country very quickly as well. Tom, how big of an impact is China having on the oil market?

TOM PETRIE: It is very big. I was in China in 1983, and saw the early stages of this, and I agree with what’s been said. It took a while for China to come to grips with it because they were — their natural resource was coal. And they’ve been using that. But as this has developed, they come to realize they really need to reach out and secure reliable supplies of liquid fuels, and that’s caused an outreach into the rest of Asia, and into Africa and so on. They’ve gone from being an exporter — when I was there, they were still an exporter. They were producing two million barrels a day, and consuming one. Today they’re consuming seven, producing 3.5, and importing 3.5, and on their way to 10 and arguably 15, and at some point, we’ll be competing with them as to whether we’re a larger importer than they are.

CONSUELO MACK: David Laibson, listening to this conversation, pro-China and pro-energy, it sounds like oil prices are going to go up. There is tremendous demand and there is still supply constraint. Thinking about how we should all have diversified portfolios, don’t you feel like we should be overweighting China and overweighting energy? Are there decisions you think can work for individuals like that?

DAVID LAIBSON: If an asset has great prospects and the market knows it has great prospects, if an economy has great prospects, that gets priced in. So it doesn’t mean that Chinese stocks are a good buy. In fact, if anything right now, most pundits are saying that Chinese stocks are in a bubble. So period of spectacular growth often can actually produce a mispricing, not an opportunity. I think right now I wouldn’t be overweight in China. I would argue at best, diversify, and maybe worry about the bubble that so many people are describing.

BURTON MALKIEL: Can I make two points about what David said?

CONSUELO MACK: Yes. I kind of had a feeling you would.

BURTON MALKIEL: First of all, when you talk about Chinese stocks, it is very complicated. There are A shares for locals, and there are H shares that Chinese companies trade in Hong Kong, and there are N shares that are Chinese companies traded in New York.

TOM PETRIE: You never know their real ownership.

BURTON MALKIEL: And the problem is that the same companies — a few of them trade in all three markets, and the prices in Hong Kong and New York are the same, but in Shanghai, they are 50 to 100% higher. When David talks about a bubble, and I think he has a point here, we’re talking about the A shares, not the H and the N shares. Secondly, I agree with him 100%, diversification, I’ve been on the diversification bandwagon —

CONSUELO MACK: That’s been your mantra —

BURTON MALKIEL: Forever. But I would argue that most investors are actually underweighted in China. And I just want them to be diversified and would like them to have at least a market weight in China, India, and some of the other developing countries.

DAVID LAIBSON: How do we do that?


DAVID LAIBSON: They’re underweighted internationally, in general. So the way you fix that is by holding international mutual funds, not necessarily holding the India fund or the China fund. You want to hold a diversified bundle of foreign stocks. The best way to do that isn’t to focus on a single country here or there. You buy the portfolio.

BURTON MALKIEL: I certainly agree that someone ought to have a broadly diversified international portfolio, a broadly diversified emerging market portfolio, but most of those indices are as of now underweighted in China. I think to be diversified, you’re going to have to have at least a piece of it that is China.

TOM PETRIE: Interestingly, in energy, people, in my view, many people are also underweighted there because there is a sense that this future cycle is going to be a replay of the cycle we saw after 1980, ’81, when oil prices peaked and that drove prices — the price of oil way down and put us in effectively about a 10-year depression in the sector. A lot of the outperformance of certain money managers who were active was a function of their having no representation in energy. There are some who think that history will repeat itself. They miss this role that China is going to play, and that’s going to cause some who are now betting on being underweighted in energy to find some other—

DAVID LAIBSON: But there is enormous exposure of energy through emerging stocks, through domestic stocks, that which now have high market capitalization.

CONSUELO MACK: Certainly the energy sector of the last four years has. What should our energy strategy be, Tom?

TOM PETRIE: I think one needs to have representation that’s about market weighted, I’m not arguing–

CONSUELO MACK: And market weight now is —

TOM PETRIE: Market weight in the U.S. would be about 10% or 11%, not including utilities, just the main energy producers, primary energy producers. But on the international side, most of the energy stocks there are intermediaries, the refining companies and so on. Most of the producers of primary energy today, three-quarters or more, are in the hands of national oil companies that aren’t publicly owned.

CONSUELO MACK: David, one quick question before we get to the One Investment, and that’s as far as you’ve been talking about diversification, should we be rebalancing, for instance? You’re a big advocate of rebalancing portfolios. Is this the time? What would you rebalance out of China — energy for instance? Sectors that have gone up a lot?

DAVID LAIBSON: I basically wouldn’t be trying to pick individual industries. I would be holding market portfolios. I would be holding international indices, and domestic indices. They automatically weight according to market capitalization. Now where I would rebalance is if international portfolios have done very well, as they have over the past few years, I might be rebalancing away from international into domestic. So those are the rebalancings that I would mostly recommend.

CONSUELO MACK: So I need to switch us to the One Investment. Burton Malkiel, tell us what you’re recommending.

BURTON MALKIEL: Sure. I absolutely agree with David on the international diversification, but as he said himself, most people are underweighted internationally, and therefore I’m not sure I want to take money out of that. I really do think most people are underweighted in China. I would put a Chinese investment in. If I were to pick one right now, I would take a closed-end investment fund, the Templeton Dragon Fund (TDF), it is an active fund run by Mark Mobius–

CONSUELO MACK: Yes, it is.

BURTON MALKIEL: It is an active fund, but the reason I like it is, it is selling at a 15% discount. If you can buy assets at 85 cents on the dollar, generally that is a good deal. China has cooled off the H and the N shares owned in that fund. That’s where I would go.

CONSUELO MACK: David Laibson you have about 20 seconds.

DAVID LAIBSON: I would think international bonds. I agree with you, we need more international exposure to the extent that we’ve heard that message, we’ve moved to stocks, but international bonds are the one big area American investors haven’t touched.

CONSUELO MACK: We’re giving Tom Petrie a pass, because as a vice president of Merrill Lynch, he cannot make specific recommendations. So thank you all so much for being here. We could go on and on with this conversation. Burton Malkiel from Princeton, great to have you here. Tom Petrie, Merrill Lynch, and from Harvard, David Laibson. Thank you for joining us, we really appreciate it.
Every week on WealthTrack, we leave you with one recommendation, one possible action you can take to help you build and protect your wealth. This week’s Action Point, with few exceptions, choose low fee and low turnover mutual funds. Burton Malkiel, Jack Bogle, and David Laibson now have been preaching this gospel for decades for a reason.
There is a body of research that shows that fees are the one sure long-term predictor of mutual fund performance. There is the pure arithmetic aspect- the higher the mutual fund fees, the less you get as an investor, and the more trading in the portfolio, the higher the turnover costs. But there is also research to back up these claims. David Laibson brought what he calls the gold standard of this research to my attention. It’s a paper published in 1997 by Mark Carhart. It is entitled, “On Persistence in Mutual Fund Performance.” We’re going to provide a link to it on our website. It basically concludes that the investment costs of expense ratios, transaction costs and load fees all have a direct negative impact on performance. It does say “the top-decile mutual funds earn back their investment costs”, but “most funds underperform by about the magnitude of their investment expenses.”

So, how much should you pay? In A Random Walk Down Wall Street, Professor Malkiel recommends his 50-50 rule. He suggests that investors buy only actively managed funds with expense ratios below 50 basis points, or one half of 1%, and with portfolio turnover of less than 50% a year. I believe there are exceptions to this rule, especially among our WealthTrack guests. But for the most part, following the low-fee, low-turnover route is the road to more riches.

And with those directions in hand, we will conclude this edition. Join us next week for a discussion on the huge critical but little understood credit markets with two bond market mavens- Jim Grant is the editor of the contrarian journal Grant’s Interest Rate Observer and Paul McCulley is a portfolio manager and Fed strategist at bond powerhouse PIMCO. To view this program again, however, just go to our web site, starting on Monday to view it as a podcast or as streaming video.

Until next time, make the week ahead a profitable and a productive one.


February 29, 2008

This week on WealthTrack, it’s back to school with three experienced investment mentors- Random Down Wall Street’s Burton Malkiel, Harvard behavioral economist David Laibson, and energy market veteran Tom Petrie. They all have pointers for tough market tests ahead on Consuelo Mack WealthTrack.

WEALTHTRACK Episode #335; Originally Broadcast on February 29, 2008

Listen to the audio only version here:
Laibson – Malkiel – Petrie

Explore This Episode

We have compiled additional information and content related to this episode.

[tabcontainer] [tabtext]Guest Info[/tabtext] [tabtext]Newsletter[/tabtext] [tabtext]Action Point[/tabtext] [tabtext]Bookshelf[/tabtext] [tabtext]One Investment[/tabtext] [tabtext]Stock Mentions[/tabtext] [tabtext]Transcript[/tabtext] [tabtext]Video Archive[/tabtext] [tabtext]Web Extra[/tabtext] [/tabcontainer]


Professor of Economics,
Princeton University


Vice Chairman,
Merrill Lynch


Professor of Economics,
Harvard University
Consuelo MackNo Newsletter for this

Mathews  Asia

No Action Point details available for this episode.
No Bookshelf titles available for this episode. No One Investment details available for this episode. No Stock mention details available for this episode. PREMIUM subscribers have access to this transcript here.

You can also purchase and download this transcript safely and securely with your credit card or PayPal account for

$4.99. You will need the free Adobe Acrobat Reader (Mac/Win) or Preview (Mac) to view and print the transcript.


WealthTrack focuses on the economy, energy and value investing with three guests exclusive to us. ISI Group’s Ed Hyman, Wall Street’s number one ranked economist for 27 years running, star value investor Chris Davis of the Davis Funds, and veteran energy hand Tom Petrie, Vice Chairman of Merrill Lynch.


No WEB EXTRA available for this episode.


February 22, 2008

What are some of the most expensive mistakes that investors can make in the current market? On hand to dispense advice to WealthTrack viewers will be Barron’s Online Editor Randall Forsyth, value investor Whitney Tilson and Consumer Reports Personal Finance Columnist Amanda Walker.

CONSUELO MACK: This week on WealthTrack, where to take risks in a risk averse world, while most investors are seeking shelter, others are heading out to sea searching for new opportunities. We join the quest next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. No matter where you look in the financial markets you can see evidence of investors fleeing perceived risk. According to a recent survey by Merrill Lynch, risk aversion among global fund managers is at the highest level its been in seven years. Risk appetite has plunged to new lows with a net 40% taking a lower level of risk than normal. Fears over the economy and corporate profitability have driven a net 41% of the managers to hold overweight positions in cash, the highest since the 911 terrorist attacks. And 30% say they are hedged against further falls in equities over the next three months. Then there is the bond market. Spreads, the difference between yields on U.S. Treasuries and high yield bonds have widened dramatically. Investors are demanding much higher returns than they have in years to buy higher risk bonds. In some cases they refuse to buy them at all. Are these fears justified? Is this the wrong or the right time to pull back? As Forbes honor roll mutual fund manager Hersh Cohen puts it, referring to the stock market, “the market goes up about 70% of the time. It’s the 30% of the time when it’s flattened down that scares people out of it. And that’s exactly when people ought not to be selling.”

One of the greatest fears among investors right now is that the U.S. economy is not only slowing down but is heading into a recession. Some pros say we are already in one. If history is any guide that could be a positive for investors. If you look at this chart from Legg Mason, showing the historical performance of the S&P 500 before during and after the last nine recessions, on average stocks decline six months before, flatten out about half way through and recover prior losses within a year after the recession ends. So what are we afraid of? Or what should we be afraid of? We’ll ask our distinguished guests next on Consuelo Mack WealthTrack.

Is this the time to be risk averse with your investments or a time to increase your appetite for risk? Our first guest is a value investor in the warren buffet mold. He’s Whitney Tilson, founder and portfolio manager of money management firm T2 partners and two mutual funds, Tilson Focus and Tilson Dividend Fund. Tilson, is also co-editor of the newsletter, Value Investor Insight and writes a regular column for the Financial Times. Our next guest has a familiar and highly respected byline as online editor of Barron’s and a columnist on the credit markets for Barron’s weekly print edition. Randy Forsyth has been keeping his readers abreast of the unfolding turmoil in the financial markets and will update us in a moment. In the latest Consumer Reports magazine there was a thought provoking article entitled “12 Money Mistakes That Could Cost You a Million Dollars” here to explain what some of those mistakes are and how to correct them is Amanda Walker, senior editor of Consumer Union’s Personal Finance Group. So welcome to all of you. It is great to have you all here. I would say these markets are froth with possibilities of making a lot of money mistakes. Whitney, I want to start out with you. You have been increasing the risks, actually, in your portfolios, you’ve trimmed positions in some what you’ve called defensive stocks, one being Berkshire Hathaway, and another being target McDonald’s, even though some would not call them defensive stocks, and you used the cash to buy things like Borders and Sears. Why are you doing that?

WHITNEY TILSON: This period of time reminds us of late ’02 and early ’03 when investors were similarly bearish on anything related to the U.S. consumer. Stocks got very, very cheap in those
sectors, anyway. In 2002, it was pretty broad-based, today it is not so broad-based. But in the consumer sector, retailers, restaurant stocks, that kind of thing, we’ve got quite a bear market here. We’re seeing valuations we haven’t seen in probably five years or so. And the lesson coming out of ’02, early ’03 was, if you owned the blue chip names, you doubled your money. If you owned the sort of lower quality businesses with cheaper valuations, you tripled or quadrupled your money. Berkshire Hathaway and Target are two of our largest stocks, but we trimmed them a little bit. To generate a little cash to buy some of the stocks that have really gotten massacre.

CONSUELO MACK: But you could be early —

WHITNEY TILSON: We’ve been early for about six months, and we could be early for a little while longer. Fortunately we’re patient and have a strong stomach and our investors do, too, and we think we will do well eventually. Hard to predict the bottom here.

CONSUELO MACK: You think there is a big difference between uncertainty, which scares people, and risk.


CONSUELO MACK: What’s the difference?

WHITNEY TILSON: Uncertainty is if we’re buying trading one-third of asset value, or half of what any rational buyer would pay to own the entire company, the fact that the stock might go down a further 20% isn’t risk in the way we define risk, which is permanent loss of capital. As long as you hold on or you’re right about the intrinsic value, you’ll do fine. But who knows when the American consumer is going to pick up. So we’re comfortable with uncertainty, as long as we don’t think we’re taking much risk.

CONSUELO MACK: That’s a very important distinction. Randy, as far as the bond markets are concerned, there seems to a lot of both uncertainty in the bond markets and a tremendous amount of risk in the bond market. So what is your assessment?

RANDALL FORSYTH: The risk is only being now — finally being reflected in the valuations. Only partially. We don’t — there is a lot of uncertainty. Actually, I would say it is almost certain that things are going to get worse. The credit problems that have caused the decline in the economy, that have stopped the stock market from going up, those factors are only, I think, going to get worse and there is nothing but time that will heal that.

CONSUELO MACK: So — and we’re talking about the real risk, which is the possibility of actually losing money — so do you think that there are real risks still in the credit markets?


CONSUELO MACK: And it is not just uncertainty. There is real risks —

RANDALL FORSYTH: Of definitely losing money and principle because the assets backing up a lot of the credit market instruments are still going to decline in price. The main one is housing. And house prices have farther to fall. They are, essentially, the backing for so much of what is in the credit system now. Now, that said, there are other parts of the market where there is some irrational fear and there are opportunities.


RANDALL FORSYTH: I would say municipal bonds would be the number one example.


RANDALL FORSYTH: States and municipalities are not going to go away. Their default experience is vastly better than anything in the corporate bond market. There are a lot of worries about the insurers of the municipal bonds who got mixed up in all of the crazy mortgage stuff, but it doesn’t affect the underlying state and municipal finances.

CONSUELO MACK: You would agree with that?

WHITNEY TILSON: Absolutely. I think it is important for your viewers to understand, there may well be some risk owning muni bond funds because if the bond insurers get downgraded, and it looks quite likely they will, the two largest, then the muni bonds could get downgraded and it could trigger institutions who own these bonds, who have an investment mandate, and if the bonded insurers go away, it could force a selloff. And if you own a fund, the funds could get really marked down. However, if you own individual bonds, if you own the city of Wichita, 20-year bond, Wichita is not going to default on that bond. It doesn’t matter what it is rated. The bond is money good. There is a difference in owning a bond and individual bonds.

CONSUELO MACK: If you’re a long-term investor and you’re owning most of the municipal bonds in the municipal bond funds —

WHITNEY TILSON: That fund may take a markdown, and it may look like a loss, but as long as the fund holds the city of Wichita bonds and so far and it wasn’t speculating in CDOs or other derivatives that are rooted in bonds, and if you have that kind of conviction, you’ll be fine in the bonds as well.

RANDALL FORSYTH: I would add that a lot of the markdowns have already happened. The market is not giving any triple A credit to ensured bonds. And the best bond funds never took the insurance into consideration in the first place. They were only looking at the credits, and the credits as I emphasized, are solid.

CONSUELO MACK: Very interesting. So Amanda, back to — we’re talking about what could be some costly mistakes or not, but consumer reports did an article about it. And one of the most expensive mistakes we can make as individuals is that you can invest too conservatively in your retirement years.


CONSUELO MACK: When looking at the markets now, I can certainly vouch for my parents’ generation, they’re looking at the markets and saying, I just want out. I don’t care —

AMANDA WALKER: Or not even in.

CONSUELO MACK: Exactly right. But you’re saying that could cost you big time. Up from a $500,000 portfolio, it cost you over your retirement, $360 to $750,000. How did you figure that out?

AMANDA WALKER: We looked at different time frames, 25 and 30 year cycles between 1940 and 2006. And there are two different dollar amounts. We assume people would take out about 3% a year, and they’re invested in stocks versus an all bond portfolio.

CONSUELO MACK: That’s absolutely fascinating. Whitney, you in T2 partners, your hedge fund, you can short, and a lot of us wouldn’t dare, but some are going long, actually, some of the things you’re shorting. I mean, financials, for instance, home builders. Why aren’t you joining some of your value peers?

WHITNEY TILSON: Well, that’s what makes markets, of course. It makes me think real hard about going short something if someone I respect is longing it, but we make our own decisions. We are still quite bearish for some of the reasons randy cited. Anything related to home building and financials that have exposure to homebuilders, and to mortgages in particular. I could give an hour long slide presentation and show you the data, but the data is saying very clearly to us is that what we’re seeing now were bad mortgages written in early ’05, that the two-year teaser expired a year ago, and it takes a year for the banks to foreclosure and auction off those homes. We’re seeing the first indications of a title wave of foreclosures and auctions of these homes that are going to crash home prices this year. I don’t mean crash 50%. But nation-wide, I think it is almost certain home prices will decline by double digits nation-wide. Never before happened. Which means that given that half the markets around the country didn’t get overheated, so it means 20% or greater declines in the coastal markets and in the overheated markets, and I think that has a lot of negative implications for financial institutions that own hundreds of billions of dollars of structured finance products that are backed by these mortgages that are all going bad, as well as certainly for home builders. Believe it or not, we are long some retailers, some particular situations. Even though we’re very bearish on the American consumer — that’s right, we’re bearish on the consumer, but we think there are a handful of companies that enough things are going right in the company, even though they’re swimming against the tide for the next 12 months, we’re still comfortable owning the stock because the stock is cheap enough and enough good things are happening internally.


WHITNEY TILSON: Target is our largest, other than Berkshire Hathaway. We think the stock is just above 50. We started buying it in the mid-60s, so we were a little early, but we think it is worth $100 or more a share a couple years out. Eventually, the American consumer will start to look a little better. It might be a year out before we start to see a turn. But they own most of their real estate, and they’ve got a very valuable real estate and credit card portfolio and they’re taking advantage of the declining share price to buyback $10 billion worth of their stock. The fact that they’re able to buyback 25% of their outstanding shares at a depressed price, actually makes the company more valuable a couple of years out, we think. So in the meantime, though, you sort of have to sit and be patient.

CONSUELO MACK: Right. From your point of view, the financials, for instance, you know, would this be a time, if one wanted to take a little bit of risk, would you step into any of the financials? Or do you think they’re great shorts as well.

WHITNEY TILSON: I don’t know if they’re great shorts. So many of them, the stocks have been cut in half. I wanted to sort of — it’s not either or. I want to get a point that Amanda was talking about of not being in the market. I think her comparison was being all in bonds or all in stocks. Overtime but you don’t give up a lot by having a big chunk of fixed income to smooth out the bumps along the way. It’s not either or. I wouldn’t be jumping into financials now, but I wouldn’t be liquidated stocks at these levels.

CONSUELO MACK: That’s our bottom line recommendation. You might want to keep the same diversified portfolio before you retired, after you retired, whether it is 70/30 or 80/20.

CONSUELO MACK: And another one of your points, Amanda is one of the biggest mistakes money- wise you can make is retire too early.

AMANDA WALKER: It is such a sad piece of advice. Someone who gets out at 62, versus someone who stays to 66, which has the average income, 55,000 dollars a year. What they lose in their income each year from their job, plus another 4% increase in their raise each year. What they have to pay for their own healthcare on the market because, of course, they’re not qualifying for Medicare. And it costs them about $200,000 to $300,000.

CONSUELO MACK: Wow. So keep working is the advice —

AMANDA WALKER: That’s the bottom line.


CONSUELO MACK: If you can. Right. Randy, I want to get back to the shorting question. I know that some very experienced money managers have told me they think the best short is U.S. treasury bonds?


CONSUELO MACK: Is that the most overvalued security on earth right now?

RANDALL FORSYTH: I don’t think they’re particularly overvalued or under valued. Given what I think the federal reserve will be reducing interest rates much further, but I think there is much, much better —

CONSUELO MACK: Which helps the bonds.

RANDALL FORSYTH: Which helps the bonds, but I think there are better alternatives that don’t have a lot of risk. There are still a lot of risk in the corporate market. I would say a Ginnie Mae fund — not something in crazy mortgages, but mortgages that are backed by the U.S. government or just agencies, Fannie Mae and Freddie Mac debt, because of the uncertainty, they’re giving a wider spread without a lot more risk. And the main risk, historically is people will refinance. People can’t refinance willie millie anymore.

CONSUELO MACK: Costly mistakes, we’ve been talking about them. What is one of the most costly mistakes you think an investor could make right now in this kind of a market environment?

WHITNEY TILSON: I think looking at big declines and seeing a lot of panic and uncertainty out there in the marketplace, and just sort of wading in and buying beaten down financial stocks.

CONSUELO MACK: Being too aggressive?

WHTINEY TILSON: Yes. Particularly in anything related to housing and mortgages. It reminds me of sort of middle of ’01, 2001, when the Nasdaq had fallen from 5,000, and unprecedented bubble, and it has been cut in half, and everybody was saying it has been cut in half, it can’t go down any further, we reached bottom. And I was writing at the time, saying when you come off one of the world’s great bubbles, it doesn’t come down and hit the trend line. It always slices its way through it. I was warning people it is not safe to go in. Your anchoring on what was a ridiculous high. And if you look at the fundamentals, things are going to get a lot worse. And the Nasdaq went down another 50, 60% from there. I feel similarly about some of the financials and home builders who were drinking the Kool-Aid of the biggest credit bubble and mortgage bubble in history. And they’re all down 50%, but this has not yet played its way out. There is not good disclosure there, and nobody knows where the bonds are hidden. Unless you can very precisely identify who has exposure and who doesn’t, stay away from that.

CONSUELO MACK: Randy, the most costly investment mistake people can make?

RANDALL FORSYTH: To jump out and go 100% into cash. Your returns on cash — one thing I can say with absolute certainty is your returns from cash are going to dwindle. By the end of the year, your money market fund will be paying under 2%, I think, and you need something more than that to survive and stay ahead of inflation. You have to remain invested, but diversified.

CONSUELO MACK: Amanda, quickly, in a housing recession, you’re saying one of the biggest mistakes you can make is to underinsure your home.

AMANDA WALKER: Yes, you should be investing correctly, so you can pay to rebuild your home. About 55% of people have underinsured their home about 28%. If you’ve been in your home ten years or more, it probably has appreciated, and probably about 50% or more. You want to make sure you’re ensured for the proper amount.

CONSUELO MACK: Let’s talk about the one investment for a long-term diversified portfolio. Whitney?

WHTINEY TILSON: Berkshire Hathaway (BRK.B) has been my favorite for years. It is the only stock we’ve owned more than nine years. It has ranged from a 3% position to a 30% position.

CONSUELO MACK: What is it now?

WHITNEY TILSON: We owned it through options, and we have custom written five-year options on it, as well as some stock. Looking through options, it is north of a 20% position for us, even after we trimmed it down a little bit. The reason is in this environment, we’re looking first and foremost for safety. Berkshire Hathaway has probably the strongest balance sheet of any company in the world. 50 billion of cash run by the most conservative capital allocator and investor, Warren Buffett, in history, probably. But — and we think the stock is probably 20% undervalued without giving any Warren Buffett premium, just the current business. And lastly, this is the kind of environment where other investors are panicking, where Warren Buffett can put that capital to work. Because in the land of the blind, the one-eyed man is king, and Buffett has two eyes and the land of the blind.

CONSUELO MACK: And he is doing it all right. Putting some of that capital to work.

WHITNEY TILSON: He is certainly making offers, like the offer he made to the bond insurers. It gives you the idea the kind of thing he can quickly put 5 billion or 10 billion to work where nobody else can.

CONSUELO MACK: Randy, misunderstood munis, you mentioned them before, you think we should all own a municipal bond fund.

RANDALL FORSYTH: If you pay taxes, which covers everybody. And once more, I predict in 2009, it is fairly certain all of us will be paying more taxes. That makes the taxes income from municipal bonds even more valuable. You have a very unusual situation now. Where top quality municipal bonds pay the same interests virtually as taxable treasury bonds. I think the best way for most people to invest in it, who don’t have the ability to buy their own bonds and hold them, is in very conservative, well- regarded mutual fund.

CONSUELO MACK: And we have two Morningstar recommendations, because as a journalist you can’t recommend them yourself. There are two we have up on the screen. I have to move to Amanda. You think there is a bargain of a lifetime out there for…

AMANDA WALKER: Term insurance. One of our money mistakes concerned term insurance. We recommend it for a long time, versus something like a whole life policy. It is cheaper, versus thousands of dollars a year. You can have more to spend to invest with smart money managers, instead of investing through an insurance policy and having that extra layer.

CONSUELO MACK: Great advice one and all. Whitney Tilson, great to have you here. Randy Forsyth from Barron’s online, thank you so much. And Amanda Walker from Consumer Reports. Great to have all of you back on WealthTrack for another visit.

Every week on WealthTrack we leave you with one piece of advice to help you build and protect your wealth. This week’s action point picks up on Mandy Walker’s recommendation: don’t be too conservative when investing during retirement. It might feel counterintuitive in today’s volatile markets but investing too conservatively can cost you a lot of money over time.

While the worry of losing hard- earned savings during down markets is a real one, the biggest risk you run over the long run is that your nest egg doesn’t keep up with inflation. If you keep your retirement savings mainly in bonds, money market accounts or CDs, even though it looks like you are getting a safe and decent return on paper, in real life you are not. Even benign inflation takes a substantial toll on the purchasing power of a fixed income portfolio and if inflation heats up it can be devastating. The easiest way to stay ahead of inflation is by owning more stocks. Over the past eight decades stocks as measured by the S&P 500 had a compound annual rate of return of over 10%. Super safe 30-day treasury bills over the same period only returned about three and a half percent. According to the research of Consumer Reports and Ibbotson Associates, an all-stock portfolio of $500,000 during the period 1940 to 2006 would have outperformed an all-bond portfolio by as much 750,000 dollars.

And that is definitely worth some angst of owning stock. Thanks for joining us. Next week we’ll talk about how efficient the markets really are, with the expert in the field, Princeton economist and Random Walk Down Wall Street author Burton Malkiel. We’ll also discuss investor behavior with noted Harvard professor David Laibson and delve into energy investments with veteran oil analyst Tom Petrie. And don’t forget, to see this program again, go to our website Starting on Monday you can view it as a podcast or as streaming video. Until next time, make the week ahead a profitable and a productive one.


February 1, 2008

Yale Professor Robert Shiller, the man who predicted both the tech and housing bubbles will return to WealthTrack. We’ll ask him what to expect next. He’ll be joined by legendary investment strategy consultant Charles Ellis who will talk about protecting your portfolio from market risk, plus dynamic fund manager Susan Byrne.

WEALTHTRACK Episode #0331; Originally Broadcast on February 1, 2008

Listen to the audio only version here:

Explore This Episode

We have compiled additional information and content related to this episode.


Professor of Economics, Yale University Chief Economist and Co-Founder, MacroMarkets, LLC


Chairman, Chief Investment Officer Westwood Holdings Group, Inc.


Founder, Greenwich Associates Author, Winning the Loser’s Game

Consuelo MackNewsletter available soon.
Mathews Asia

Action Point available soon.
Bookshelf titles available soon One Investment available soon. Stock mentions available soon. This transcript will be available soon. More information regarding WEALTHTRACK transcripts can be found here

Back to Top