HERE WE GO AGAIN…

We knew that sooner or later, some financial columnists, who also pose as investment advisors, would get back on the Index Fund bandwagon. Well, sure enough, it has happened again, and naturally, immediately following the bear market. Where were these advocates during 2000, 2001, and 2002 when the indexes were “tanking”?

The safety and ease of journalists giving investment advice is based on the fact that they bear no fiduciary or legal responsibility if they make mistakes. If you follow their instructions, and things don’t work out, you don’t have a chance. Basically, they can advise any way they want under the protection of the First Amendment.

In a recent Market Watch column by Paul B. Farrell in the Fort Worth Star Telegram, he starts innocently enough by suggesting people should save 10% of their gross income every year. Fine. A person doing this, starting at a young age will be in great shape down the line. He also suggests that “you swing for singles and forget the homeruns”. In other words, go for consistency rather than a knockout. Good advice.

SO FAR SO GOOD… BUT…

Mr. Farrell goes on to suggest that you should diversify by searching out and buying index funds which he maintains would diversify you in all types of markets.

And be sure to do this on your own. There’s no suggestion that you should seek professional non-journalist advisors. The medical and legal profession suggests that you go for a second opinion.

Following this road is a guarantee that you will never beat the stock market. Since Index Funds charge a fee, they can never outperform the market. New money is immediately invested no matter what the outlook is. These funds are also unmanaged.

As we’ve said so many times before, buying Index Funds is like paying a fee to a computer for buying stocks that no one has researched and that have been chosen by people who simply isolate specific capitalization of companies and put them into a portfolio which fits their size. Can you imagine buying stocks for your retirement based solely on the size of the company and the current demand for that stock in the market place? And don’t forget the S&P 500 included Enron, World Com, et al, at one time in history. Who knows what other time-bombs are lurking inside these indexes, just waiting for the surprise appearance of Eliot Spitzer.

THIS IS NOT THE WORST PART

Buying Index Funds has worked in the accumulation period over longer terms, particularly in bull markets. However, one of the problems people must recognize if they turn over their retirement funds to journalists as investment advisors, is that when it comes time to retire or to use the money that they have accumulated, what do they do then? Do they move it all to an annuity?

Do you wait for the journalist to tell you to move to bonds? Do you start some sort of withdrawal plan and hope that the market will continue to go up? Since the portfolio is not managed, and there are never any capital gains distributions made, if you continue to liquidate shares and are unable to replace them with new shares, what would be the answer? What would be your next step? But the big question is, who do you talk to when the market “tanks”.

"GIVE YOURSELF A HEART BYPASS AND CALL ME IN THE MORNING."

Unfortunately, by the time the Baby Boomers reach retirement age, Mr. Farrell and our old friend Jonathan Clemens at the Wall Street Journal, who also sings the song of Index Funds, will probably be writing the Style section for the Washington Post or the Food section in the New York Times.

Let’s hope they are never assigned the medical section of any newspaper.

"YOU GOT TO LOOK AT THE NUMBERS…"

Here are some kernels of proof. The S&P 500 Stock Index, which was unmanaged and did not charge a management fee, as an Index Fund does, averaged 11.5% per year for the last 10 years ending 12/31/2004. The fund company where we have most of our managed funds, which is the third largest in the country, has ten U.S. Equity Funds. Eight of those equity funds beat the S&P 500 over the last ten years.

Of those ten equity funds, nine beat the S&P 500 over the last five years. (The S&P over the last five years measured -1.77% per year.)

When it comes to the Global and/or International markets, the Global Index (MSCI) averaged 8.45% a year for the past ten years. And of the four Global/International funds represented by the above referenced company: 100% of them outperformed that index.

100% outperformed that same index over the last five years.

All, after expenses.

So, this brings us to the point of what you get with our approach to investing. You get performance, you get service, and when you get ready to retire and spend the money you’ve accumulated, we’ll be right there to give you guidance at no extra charge.

And, incidentally, you don’t have to subscribe to our Newsletter!

SOCIAL SECURITY REVISITED

One of the most realistic philosophies that we have seen advanced in the debate on Social Security and Medicare Trust Funds comes from Rob Arnott of Research Affiliates L.L.C., sub-advisor of PIMCO’s All Asset Strategy Fund.

Mr. Arnott says that pre-funding these systems, “is basically irrelevant.” It matters little whether the system is pre-funded with treasury bonds or privately held stocks. The fact is that both of these financial assets represent a call on future production. If that production could possibly be saved, like squirrels ferreting away nuts for a long winter, then treasury IOU’s or corporate stocks might make some sense, but they can’t.

"ENTER BILL GROSS…"

Our old friend Bill Gross, Co-founder and manager of PIMCO, points out that future health care for seniors can only be provided by today’s teenagers, 20-something’s, and even the yet-to-be-born. Too bad we can’t store their energy today for some future rainy day, nor can we save food, transportation, or entertainment for anything more than a few years forward. Each must be provided by the existing generation of workers for those who have retired and are presumably incapable of working.

Mr. Gross, continues to point out that the ratio of retirees to workers (the dependency ratio) soars from 0.2 retirees for every worker to 0.35 over the next 20 years. “There’s your problem,” Gross adds. Neither privatization or any goodly number of Government bonds deposited in the Social Security “Trust Fund” can solve it. While these paper assets may pay for goods and services, their value will be market adjusted in future years to exactly match the quantity of things we buy, and that quantity will be substantially a function of the available work force and the price they command for their services.

What appears is that the value of treasury bonds and even stocks will be valued down in price as they are sold to pay for future goods and services, and that the price of these goods and services will be marked up by inflation, of course, to justify their reduced supply.

Mr. Arnot concludes: “Production of these required essentials can only come from employed workers and so the basic solution is to produce more workers either through immigration or postpone retirement for the existing workforce. Productivity gains are often advanced as a solution, but employed workers cannot be expected to handle the future advances to retirees. Having more babies will also turn the trick, but at the moment, according to Mr. Arnot, “making fewer seems to be the going trend”.

From this writer’s viewpoint, we should attempt to reduce our budget deficit now, especially that portion of the deficit owed to foreign governments. In this case, we would be able to keep more of our domestic production within our borders and therefore available to senior citizens.

Finally, Mr. Arnot and Mr. Gross believe that the Social Security and Medicare imbalances are based on demographics and not financial funding. Again, to quote Mr. Gross: “Keeping the size of our future IOU’s low and out of foreign hands would minimize inflationary pressures and the transfer of goods and services overseas in future decades.”

To sum it up, we need more young people producing goods in the future to support not only the Social Security income of our retired people, but also to produce the goods and services required during the future years.

The boys at PIMCO have some excellent ideas. This is what is needed: a give and take debate that is not clouded by partisan politics. The administration has opened this can of worms, so now let’s get some sensible answers.

ITEMS FOUND WHILE LOOKING FOR OTHER THINGS THAT MAY OR MAY NOT BE AS IMPORTANT…

China National Offshore Oil Corporation – China’s leading oil and gas group – is considering making a 13 billion dollar bid for U.S. rival Unocal. This is one way of trading paper assets, dollars, for real assets, oil production and services…. In another trade.. Russian steel maker OAO Severstal, spent 140 million dollars to rebuild the cooking ovens at a Wheeling Pittsburg Steel Corp. site. Severstal will get half ownership of a real asset and share the coke. Other moves show acquisitions by U.S. companies of real assets trading with “paper assets”.

"IT’S A TOUGH WORLD, BIFF, BUT IF IT WERE EASY EVERYBODY COULD DO IT."

There’s no denying that increased trade between the West and the new market in China and India has had two dominant impacts on the global economy. First, it has increased competition for natural resources. This has driven commodity prices up and been a boom for investors. Second, it has exerted enormous deflationary pressures on wages in the western world, especially in the U.S. However, some economists say that Hedge Fund investments in futures are responsible for the run-up in oil prices, and that there is really no shortage of oil. One thing for sure, the demand for these “real assets” is skyrocketing.

The competition is tough. Textiles have been bludgeoned and other industries are certain to face consolidation in the West in order to survive. Dan Denning at Strategic Investment believes that 10 years from now, there will be only 3 or 4 major global auto makers and that one of them will be Chinese, perhaps owning the assets of the bankrupt Ford or GM (which spend much of the time running finance companies at a profit and selling cars at a loss).

OUR OPINION

As the 21st century gets underway, we’ve learned the difference between production and consumption. The laws of economics have not been repealed. The weight in national and personal wealth is through production, and not consumption. Nations that produce more than they consume, tend to get wealthier. Making things takes capital, and capital itself takes many forms: it can be land, it can be labor, it can be money, or it can be capital goods (goods that create new value, new revenue, or new machines).

What we see in the market right now is a dispute between the “asset economy” and a “real economy”. In an asset economy, you are encouraged to believe you can get rich by borrowing money to buy stocks and bonds and homes, which go up in value and pay for your retirement. In a real economy, economic growth and prosperity come from production, savings, and capital investment. Wise investors are not concerned about markets. They pay attention to individual companies which make up a market. These companies, in order to be successful, must compete globally. This takes leadership as well as capital.

The same truth applies to individuals. Our people must return to the job of reducing debt. When that happens, our savings will increase, and in this new era of an ownership society, we should come to a new time of prosperity.

Years of “easy, low-cost money” has not helped. But the pendulum has begun to swing. Let’s hope we have the courage to return to fiscal sanity both as a nation and on an individual basis.

That’s our take. Yours is welcome