The Freddie & Fannie Meltdown

Investors turned their backs on home finance goliaths Fannie Mae and Freddie Mac after Freddie, on November 20, posted a surprising third-quarter loss of $2 billion, and said it might have to cut its dividend.

That news cast doubt on the reliability of Fannie's November 9 earnings release, which showed a $1.4 billion loss, and shook the shares of both companies. Fannie dropped by nearly 25%; Freddie tumbled by almost 29% by the end of the day.

Meanwhile, the Commerce Department reported on November 20, that while housing starts overall rose 3% in October, an apparently cheery number, single-family starts fell by 7.4%, and building permits sank 6.6% to the lowest level since July, 1993.

* * * * *

Is Your Money Market Fund Really Safe?

Last week, something very significant happened when a $5 billion money market fund run by the General Electric Company (The GEAM Cash Trust Enhanced Trust) offered a new price of 96 cents on the dollar - to its non-GE investors - and also encouraged them to cash out.

Now with this news, any astute investor should be asking him/herself this question: If a top money market fund can no longer be relied upon for complete protection of your invested principal, is there anything that's still safe anymore?

Money market funds originally came into existence in the early 1970s, and were meant to serve as an alternative to bank savings accounts. And as interest rates soared during the terrible Carter-stagflation of the 1970s, investors came to think that money market funds were the best game in town and so the money market business soared with some funds paying returns of more than 10% per annum.

Unlike bank deposits, money market funds are not guaranteed by the Federal Deposit Insurance Corporation (FDIC), thus fund managers knew they needed to offer investors as much security of principal as possible. But this began to change in 2001 as short-term interest rates dropped down to the 1% level, and returns on money market funds(after expenses) were only slighly above zero.

Wall Street responded to this by offering investors more risk by putting the money funds into asset-backed commercial paper which offered a higher return - which was the wrong move to take - because while these riskier funds paid better returns, the average investor had been lulled into believing that the fund manager would never allow their price to fall below $1.00.

And thus, the perception of decent returns and security of principal by having your money invested in a money market fund has now been shattered. GE is one of the biggest names in money market funds so if you can't rely on a fund backed by GE, then no fund management group can really be trusted to keep your fund share price at $1.00.

There are several possible ways to solve this problem, however, and we will talk about this at our next meeting on Thursday, December 6, 2007.

* * * * *

A Thought in Passing

"Nothing ages people like not thinking."

- Christopher Morley


* * * * *

Puny Muni Costs

Two municipal bond exchange-traded funds (ETFs) were launched in September and 10 more are on the way. Each muni ETF will track a municipal bond index and pay tax-exempt income to investors.

These ETFs address the most notorious shortcomings of muni bonds: pricing. In the muni market, there can be a huge gap between the prices that dealers pay sellers and charge buyers. The spread for ETFs usually is around $1 to $1.50 per $1,000.

The first two muni ETFs, Lehman Municipal Bond and iShares National Municipal Bond, have yields in the 4%-4.6% range and annual expense ratios of 0.20% and 0.25% respectively.

* * * * *

Inching Closer To $100 Oil

It's getting to be an everyday thing: The futures markets hit a new high-oil mark as crude surges toward an apparently inevitable $100 per barrel.

On Nov. 7, oil touched an intraday high north of $98 before slipping back on a report that U.S. inventories hadn't shrunk as much as expected. On the same day, the dollar sank 361 points. Meanwhile, the dollar, in an inverse spiral, reached new lows against the euro.

The $100-a-barrel question is whether the economy will slip on oil prices and fall on its face. The answer is that it probably won't, because America isn't as oil-dependent as it used to be. But oil plus the credit crunch could deal a nasty blow.

* * * * *

Thoughts on the Business of Life

"Pleasure is a shadow, wealth is vanity, and power a pageant; but knowledge is ecstatic in enjoyment, perennial in frame, unlimited in space and indefinite in duration"

-De Witt Clinton

* * * * *

China's Asset Gold Rush

Foreign asset managers are flocking to where the money is: China.

Growth in that market has averaged more than 60% over the past three years and will run above 20% for the next decade, according to an industry report.

So it's no surprise that more than 27 companies have set up shop in the past five years. But low fees and the tendency of Chinese customers to churn accounts make it tough for anyone to turn a profit.

* * * * *

An Open and Shut Case

Income-oriented investors can expect good performance from closed-end funds, many of which took a drubbing in the summer markdown.

Closed-end funds are like mutual funds, but they trade on the stock exchange. If you want to buy or sell them, you do so like any other stock.

They have a limited audience of buyers because, unlike mutual funds, they lack management companies actively marketing new shares.

Many closed-end funds have good yields now and their prices are at a wide discount to the net asset value of their holdings.

Good Web sites with information on closed-end funds include www.quantumonline.com and www.etfconnect.com.

* * * * *

Staying Power

You'd have made 7.4% a year in the average stock fund over the past 10 years, with a buy-and-hold strategy. However, investors actually earned only 5.9%: 20% less. That shortfall occurred in part because many investors kept popping in and out of the market, trying to anticipate swings. The moral here is to stay calm and stay put.

NOTE: Those are the figures for stock funds, but the message is the same for individual stocks, where steady investors do much better than those who try to time the market.

* * * * *

What $850 Gold Should Be Telling You

With the rapid run-up in the price of gold recently, there are several messages the market is sending to anyone who is paying attention:

1. The official inflation statistics are a lie. Reality: CPI X 2-3.

2. The Fed will sacrifice the dollar in order to fight recession.

3. Gold, having tripled since 2001, may be poised to triple once again.

4. Gold is fast becoming a mainstream investment worldwide.

* * * * *

Letting Intel Be Intel

While the chip maker may be in hot water in both Europe and Asia for alleged anticompetitive behavior, U.S. regulators appear to be shrugging their shoulders.

Japan, South Korea, and the European Commission have accused Intel of coercing PC makers to lock archrival AMD out. But the Federal Trade Commission has declined to elevate its own inquiry into a more formal investigation, The New York Times said on October 21. Intel still faces a civil lawsuit by AMD.

* * * * *

Going Against The Grain

In general, investors look for low correlation as a safety blanket whenever the market is moving down. For example, from the beginning of 1979 through the first quarter of 2007, real estate investment trusts (REITs) had low correlations to stocks in up markets but much higher correlations in down markets.

Investors looking for diversification benefits as well as cash flow might do better with high-yield bonds, which have been more correlated in up markets and less correlated in down markets.

Judging from the results of the past 30 years, government and corporate bonds are appealing for their lack of correlation in down markets - so they may produce positive returns when stocks sink.

* * * * *

Apple's Outstanding Results

To say that it's "all systems going magnificently" doesn't do justice to what Apple is pulling off these days.

On October 22nd, the company obliterated Wall Street projections with yet another blowaway quarter. It wasn't just that revenues hit $6 billion, up 28% from the previous year, or that profits jumped 67%, to $901 million. It's that there's so much room for growth.

Mac sales climbed by a torrid 94% in the quarter, even though many shoppers may be waiting for the new Leopard operating system. Apple shares rose 9% by the next day.

* * * * *