The Plunge Continues - China

The rest of the world markets yawn as Chinese speculative bubble continues its plunge. Most global markets opened either flat or slightly down....

Chinese Stocks Take Big Fall
Chinese Stocks Tumble 8.3 Percent, Biggest Daily Drop Since February Plunge

BEIJING (AP) -- Chinese stocks plunged Monday following government efforts to cool a market boom, recording their biggest one-day fall since a February drop that triggered a global sell-off.

The benchmark Shanghai Composite Index tumbled 8.3 percent to 3,670.40, falling for the third time in four sessions since the government raised a tax on trading last week. The index had dropped 2.7 percent Friday. The Shenzhen Composite Index for China's smaller second market fell 7.9 percent to 1,039.90.

http://biz.yahoo.com/ap/070604/china_markets.html?.v=6

"There is the risk that this snowballs into a crash. Sentiment is so fevered that a bubble could burst," said Claire Innes, an economist in London with the consulting firm Global Insight.

Chinese Market Plunges - barely causes a ripple outside of China

The recent correction of the Chinese markets today barely caused a ripple in stock markets outside of China. The main Shanghai Composite Index tumbled 6.5 percent to 4,071.27 Wednesday. The Shenzhen Composite Index for China's smaller second market fell even more, closing down 7.2 percent at 1,199.45. Most of the other world indexes closed up by more then 0.7% on average in response; largely ignoring the Chinese market plunge. This is another sign that the stock market bubble in China is irrelevant to the rest of the world. The stock market in China represents only a small fraction of the overall worldwide markets and the overall capitalization is minuscule on a comparative basis.

From a big picture perspective, the combined capitalization of the Chinese stock markets was US$786b at the end of 2006. The total for all the global equity markets is over $33Trillion; the NYSE alone is at over $23T (Sept 2006). The US represents over 1/2 of the global equity markets capitalization.

The Chinese government holds over $1.2T foreign reserves, and are increasing these reserves at over $12B per month. The Chinese product exports (not overall trade) are now at over $1.2T per year. While the Chinese national gross GDP was at about $2.6T; compared to the US at about $13.2T (notice that the US stock market capitalization is 2x bigger then the national GDP).

The size of the Chinese stock market is a small percentage (2.3% at best) of the overall world-wide equity markets (ignoring the size of the futures, commodities, options, bond, debt, and other markets), and just a fraction of the Chinese foreign reserves or export trade size. The overall stock market capitalization places the country in a distant sixth place slot for overall national equity market size. The stock market capitalization in China represents a mere 60% of their GDP.

From the math, the stock market is an insignificant (and non-critical) component of the overall Chinese economy. This minimizes the risk that a meltdown in the Chinese stock market would have any international impact.

From a broader economic perspective, most analysts expect the sizzling economic growth in China to slow a bit because the government is deliberately tapping the brakes. Most do not expect the slowdown to be very significant despite these efforts. There is still a huge demand in China for building materials, energy, raw materials, etc.... and the economy is still growing at greater then 9% per year. The economy in China remains strong.

The stock market situation in China however is another story. The local equity markets are in a speculative bubble that is doomed to burst; the question is when rather then if. The good news is that the size and capitalization of these stock markets are insignificant from a global perspective. The bad news is that the bubble pop will take a lot of unknowledgeable individual investors located in China down with it.

One recent article also looked at the Chinese market situation:
Greenspan's China-Stock `Contraction' May Not Spread
http://www.bloomberg.com/apps/news?pid=20601087&sid=aQ281g_cfnWI&refer=home

Some quotes:

"That's the conclusion of a number of international economists and former government officials around the globe. They say China's economy shows little correlation with its stock market, foreigners are mostly excluded from owning shares and Chinese participation is limited to less than 10 percent of the population, reducing the effect of a bursting bubble."

``This is a relatively small casino,'' said Edwin Truman, a former director of the Federal Reserve's international finance division and now a senior fellow at the Peterson Institute for International Economics in Washington. ``Even the implications for the Chinese economy should be minor.''

"Total stock holdings in China account for just 25 percent of domestic wealth, and in Asia only Indonesia has a smaller market capitalization than China's 60 percent of GDP."

So in summary, the Chinese stock market melting down (which is likely to happen) is a non-issue from an international perspective; the Chinese economy having issues would be another story.

More Dark Pools: The Secret Stock Market

Story from MarketWatch...

The secret stock market
'Dark pools' and other new-age exchanges rewrite the rules, under the radar

NEW YORK (MarketWatch) -- Fourteen floors above Seventh Avenue, in an office more than a mile from the trading floor of the New York Stock Exchange, a trumpet sounds reveille over a loudspeaker.

Liquidnet Holdings Inc., an alternative trading system used by institutions, has just executed a block trade of a million shares or more.

Unlike the bulk of trading in stocks, this trade was made anonymously and was executed outside of the market where retail investors and institutions meet. And unlike a trade on the floor of the New York Stock Exchange, no one will ever know who put a million shares up for sale and who just bought them.

Liquidnet is one of dozens of new private trading networks that -- in just two years' time -- have ushered in a sea change that challenges Wall Street's top institutions while posing vexing questions for regulators and investors alike. [more at below url]

http://www.marketwatch.com/news/story/secret-stock-market-upstart-systems/story.aspx?guid=%7B11EB6EC9%2D6D71%2D43C9%2DADD2%2D59C6B9E3C5D1%7D

Everyone is jumping into Dark Pools

Just a quick update on dark pools...

"The number of dark liquidity pools has doubled to more than 40 since the start of last year. The big names are jumping in. Goldman Sachs, Merrill Lynch and Credit Suisse are among those who have started more dark pool services. Goldman's Sigma X is a good example. The proliferation of dark venues has come as institutions have found it particularly vexing to execute small- to mid-cap stock trades." - from FierceFinance

Dark liquidity pools make a splash with US traders
http://www.financialnews-us.com/?page=ushome&contentid=2347636817

What’s coming up !

I would like to thank folks for their feedback asking when some more posts are coming. I have been buried under between soccer and delivering programs at work recently. However there is some good information coming soon! Here is a list of some of the posts I am in middle of putting together:

1) Investing for Global Warning
Global warming has been a topic that is increasingly in media reports recently. There is significant debate if man-kind generated global warming exists and what it’s impact will be. One of the truths however is that politicalization of “global warming” will drive government mandates that require investment. Which sectors and companies will be hot in the coming years as the business sector contends with this situation. Should you be investing in alternative energy companies, water firms, uranium firms, or power-related semi-conductor tech firms?

2) Portfolio Design for your 401K – Part 2
What are all the questions and details of designing a portfolio. Why does modern portfolio design lead to more questions then answers. Delve into the depths of the problems an investor will encounter when attempting to look at the details of creating the optimum fund mix.

3) Real Estate Update
The summer selling season is almost here. Will poor sales this summer finally break the back of the real estate market in most localities and result in a climate with more “fear”? What are the possible outcomes? Does risk exist beyond the subprime and Alt-A meltdown?

4) Screening for Winning Stocks
At times investors seem to be divided into two camps; fundamental and technical. An approach to selecting stocks involving both fundamental information and technical indicators appears to get the best results for investors. Most investors should have both methods in your arsenal. Does it not make sense to use all the tools at your disposal to get as large as an edge on the market as possible? This summary will discuss some of the criteria, both fundamental and technical, which I use when screening for stocks.

Interesting Take on Entrepreneurship

This article is interesting because it reflects the changes in perspective regarding Entrepreneurship. It draws some interesting comparisons regarding the old and new ways of thinking when it comes to starting your own business.

Mastering the New Entrepreneurship
http://finance.yahoo.com/expert/article/careerist/27680

The Winds of Real Estate Market Change

Profiting on Foreclosures
http://finance.yahoo.com/loans/article/102414/Profiting_on_Foreclosures

It is interesting to note that 18 months ago that all the Real Estate Articles were about how to make a killing flipping homes....... now they are about "Profiting on Foreclosures". This gives a clear message about the real estate market.

The Sub-Prime Meltdown

There has been significant recent financial press coverage of the sub-prime mortgage sector meltdown. Subprime lenders offer mortgages to homebuyers who do not qualify for regular mortgages, usually because of low credit scores. It is time to take a deeper look at this meltdown and its impact on homeowners, mutual funds, banks, and mortgage seekers.

Some Background: Why is the Subprime Market falling apart

Traditionally, banks serviced the loans that they made to homeowners; meaning that your mortgage payments went to the bank that made the homeowner the loan. This also ensured that the bank carefully screened loan applicants because the bank would not want to be stuck holding a non-performing loan. The advent of securitization changed all of this. Most loans were wrapped up into investment packages by mortgage lenders with the help of investment banks and sold to institutions such as hedge funds, pension plans, high income mutual funds, private equity firms, investment banks, and other “qualified investment entities”.

The primary impact of securitization was to take the risk of individual mortgages out of the hands of lending institutions; this was hailed in the market as a great step in financial evolution. The reality is that securitization removed the incentive for banks to carefully qualify loan applicants and caused the banks to focus on maximizing the fees associated with originating loans. Requiring applicants to meet traditional loan standards in terms of income, debt ratio, and down-payment quickly flew out the window.

Traditionally loan applicants were required to have a 28-33% top ratio (meaning your PITI payment cannot be more than 1/3 of your monthly salary) and your bottom ratio to be 33-38% long term debt; meaning your car payment, visa card payment, other loans, plus your PITI cannot exceed 33-38% of your monthly salary. Banks normally required a 10% down payment; in many cases a 20% down payment was required.

These mortgage standards quickly forgotten in the “securitization era” in which banks rushed to maximize the number of loans originated to increase collected fees. The mortgage brokers and executives at mortgage firms rushed out to spend their high bonuses from all the hefty fees.

In recent years, lenders sold off the bulk of their originated loans to Wall Street investment bankers such as Goldman Sachs, which securitized the loans into asset-backed securities (CMOs).

Everything was looking rosy except for one little detail, all the securitization packages had clauses in the fine print stating that the lending firms would have to take the investment packages back and refund the money if more than a small percentage of the homeowners defaulted on loan payments. In financial jargon, the securitization units would be returned for a full refund if tranches failed to adequately perform within the guidelines of the covenants.

As homeowner defaults increase nationally, lenders such as New Century (the second largest sub-prime lender) are being forced to take back bad loans from the investors and investment banks. If the mortgage lender does not have adequate reserves to cover the returned loans then they are forced to file for bankruptcy.

Major banks are putting aside large reserves to deal with their subprime exposure. For example, HSBC put aside more then $10B. Other subprime lending firms do not have this much collateral, and their credit facilities have been cut-off from outside institutions who are seeking to limit their exposure.

Over 25 subprime lenders have gone out of business in the last four months. More are likely to follow. A complete list can be found here:
http://www.ml-implode.com/

Information on CMOs
http://en.wikipedia.org/wiki/Collateralized_mortgage_obligation


What is the impact to Subprime Loan Holders

Over 15% of the outstanding mortgages at the end of 2006 in the US are subprime and given to homeowners with low credit scores. An additional 24% of the outstanding loans in the US are deemed risky and are outside traditional lending standards.

Currently 12% of subprime borrowers are delinquent in payments. The sub-prime default rate is now up at 10.7% up from 6.1% in early 2006. Also sub-prime loans now represent 24% of the newly originated loans in 2005 and 2006 compared to 10 years ago where they accounted for only 3% of the mortgage market.

Recent press indicates that as adjustable mortgage rates increase over 2.2 million Americans are expected to lose their homes during the next two years. Every month, this number keeps increasing as new surveys are released.

They key problem for most homeowners with subprime loans originated in 2005 and 2006 are that their rates are shortly due to increase. Most received loans with low teaser rates and minimal down-payments. These teaser rates are due to reset, and at this point as lending standards are being tightened no bank will offer them a new loan. Many of these home owners will see their monthly payments double or triple.

As rates soar, 2.2 million Americans risk losing homes this year
http://news.yahoo.com/s/afp/20070314/ts_alt_afp/useconomyproperty_070314133106

Valley may be insulated from mortgage morass
http://www.mercurynews.com/ci_5432047


Outlook for Subprime Lenders seen as Bleak

With over 25 firms going under within the past 4 months, the outlook for the subprime lenders is generally bleak. The majority of these firms will either declare bankruptcy, stop operations, or be sold over the upcoming months in the opinion of most industry analysts. Many of these mortgage firms had oversized ambitions coupled with their ignorance of risk and drive for revenue from fees. For example this quote from an article from Economist is very telling:

“Last March, ResMAE, a mortgage lender catering to risky borrowers, cut the ribbon on its new headquarters in Brea, California. The sprawling, 135,000-square-foot building dwarfed the company's 458 local employees. But it fitted the firm's outsized ambitions. Less than a year later the company, rather than its ribbon, was facing the chop. This week it said it had filed for bankruptcy and was selling its assets for a diminutive $19m.”

America’s riskiest mortgages are set to pop. Where will the shrapnel land?
http://economist.com/finance/displaystory.cfm?story_id=8706627

Mortgage Crisis Spirals, and Casualties Mount
http://www.nytimes.com/2007/03/05/business/05lender.html?_r=1&oref=slogin

Outlook For Subprime Lenders Seen As Tough
http://www.forbes.com/2007/02/13/subprime-update-lender-markets-equity-cx_jl_0213markets32.html?partner=yahootix

Another subprime lender, ResMAE, files for bankruptcy
http://biz.yahoo.com/cbsm/070213/5d76d8ddb54449beafcbb50fc56d311d.html

Subprime: The Risk to Wall Street
As subprime woes widen, the money machines at Morgan Stanley, Goldman and other banks may sputter.
http://money.cnn.com/2007/03/12/news/companies/subprime_brokerages/index.htm


Contagion

There is significant fear that the subprime mortgage meltdown will spread upward in the market. There are a significant number of outstanding loans from the past few years to non-subprime credit homeowners with adjustable rates who do not meet normal lending standards. The default rate on these loans has also been increasing in the past few months as the rates have been resetting. The adjustable interest rates for a large number of these loans are due to reset over the next two years leading to increased payments for these homeowners. As mortgage credit standards start to tighten due to subprime meltdown, it will be more difficult for these homeowners to refinance into new loans.

Mortgage Defaults Start to Spread
http://finance.yahoo.com/loans/article/102536/mortgage_defaults_start_to_spread


Credit Standards – Time to Tighten

One immediate impact of the subprime meltdown was the tightening of credit standards. This will make it more difficult for homeowners to get a loan. Banks will expect applicants to have solid credit scores, normal debt ratios, verifiable income, and proper down-payments. This will hurt many homeowners with risky ARM loans attempted to re-finance into fixed rate. It will also impact homeowners who are trying to use the equity built up in their homes to get a loan to spend on consumer items (cars, boats, etc.). People using their homes as ATM machines is likely to come to a grinding halt shortly.

In my opinion, the tightening of credit standards for home loans is long overdue. Or should I say returning to traditional standards. Over 25% of the mortgage loans made in the past 3 years in the U.S. would have never been originated if proper standards were enforced. The loose credit standards also helped fuel the wild speculation that led to over-sized real estate price increases in many U.S. local markets, placing these markets in a significantly overvalued state and ripe for a tumble.

Homeowners stuck as lenders cinch standards
http://www.usatoday.com/money/economy/housing/2007-03-04-mortgages-1a-usat_N.htm?csp=N008

Freddie Mac toughens subprime standards
http://www.marketwatch.com/news/story/freddie-mac-toughens-subprime-standards/story.aspx?guid=%7B3F839423%2D9407%2D4ED0%2D9351%2D4999979A647C%7D&siteid=yhoo&dist=yhoo

New Standards for Mortgage Lenders?
As more homeowners fall behind on payments, there's talk about whether lenders should be required to ensure loans they issue are suitable for consumers.
http://finance.yahoo.com/real-estate/article/102558/Debating-standards-for-mortgage-lenders

Tighter Lending Rules May Hurt
http://www.newsobserver.com/104/story/553685.html


How will all of this impact a homeowner?

Current homeowners will be impacted by the tighter lending standards and increased foreclosures associated with the subprime meltdown. The impact of tighter lending standards is outlined above. Foreclosures are now reaching 5 year highs in many local markets and are expected to more then double over the next two years. Increasing foreclosures generally hurt the local real estate market and will slow housing appreciation. The foreclosures will act as another factor that will cause downward price pressure in many US markets that have “bubbled-up” over the past few years (e.g. CA, FL, NY, D.C., etc.). The impact of foreclosures on your local market will vary by the percentage of foreclosures in your particular area and how they are handled relative to nominal market pricing.

Also keep in mind that recent real estate statistics show home prices falling at the fast rate in 14 years, and prices are down in half of the metro areas at the end of 2006. Increasing foreclosures will add to this slide.

Foreclosures rip neighborhoods
http://www.rockymountainnews.com/drmn/real_estate/article/0,1299,DRMN_414_5352848,00.html
“Foreclosures in Denver since 2003 will log a fivefold increase by the end of the year, a trend that is tearing apart neighborhoods throughout the city.”

Home prices fall at fastest rate in 14 years
http://biz.yahoo.com/cbsm/070227/341a3f9791f34b15b2618cecc8e0dbef.html?.v=4

Housing Sales Drop in 40 States, Prices Down in Half of Metro Areas
http://www.breitbart.com/news/2007/02/15/D8NACCP00.html

"The National Association of Realtors said the states with the biggest declines in sales from October through December compared with the same period in 2005 were: Nevada, down 36.1 percent; Florida, down 30.8 percent; Arizona, down 26.9 percent; and California, down 21.3 percent."

"In all, median home prices fell in 49 percent of the 149 metropolitan areas surveyed, the largest percentage of areas showing price declines in the 27-year history of the Realtors' price survey. "The price declines were led by an 18 percent decline in the Sarasota- Bradenton-Venice area of Florida."


Are my Mutual Funds safe?

Stocks of subprime lenders have certainly taken a hit, though few stock funds appear to have a concentrated portfolio of subprime lender stocks. In most cases your diversified stock mutual funds are not at risk due to the subprime meltdown. It is a different case in the High Yield Income and REIT mutual fund sector. Some select-type funds have been focused mortgage debt, including a lot of subprime debt to enhance yields. At the Regions Morgan Keegan Select High Income Fund, for example, 13 percent of holdings are unrated mortgage-backed debt. REIT funds that are focused on mortgage debt rather then operating real estate are also at risk.

It is important that you evaluate the holdings of your High Yield Income and REIT funds. It may be time to cycle out of funds that are highly concentrated in risky mortgage debt.

Mutual Funds at Some Risk on Mortgages
http://www.nytimes.com/2007/03/14/business/14debt.html?_r=1&ref=business&oref=slogin

Investors in mortgage-backed securities fail to react to market plunge
http://www.iht.com/articles/2007/02/18/yourmoney/morgenson.php


How are Hedge Funds playing the Subprime Meltdown?

How are the professionals such as hedge funds playing this? Hedge funds that are bearish on housing are spending billions shorting credit default swaps or an index of such swaps. Many hedge funds are shorting the ABX.HE Index, a basket of 20 credit default swaps that reference subprime asset-backed securities. The following article is a good reference for the activity of hedge funds relative to subprime debt.

Funds Swap Into Subprime Short Plays
http://www.thestreet.com/newsanalysis/realestate/10343012.html


How Should I Trade Subprime Stocks in the market?

Since the news is out, most of the downside for the stocks in the subprime sector is over. It would not be wise to short these stocks now from potential reward to risk perspective. Most of the upcoming play on these stocks is on the long side. Some of these mortgage lenders will survive and still have credit facilities open to them. All of these lenders have been pounded recently in the market, and are due for a bounce back. In fact the best play on lender stocks right now may be to wait for the bad news to bottom out and then buy stocks of the stronger lenders which are not going bankrupt.

Take a look at the fundamentals of the firms in the sub-prime market before entering a long trade. Evaluate the news regarding credit covenants, etc. Which firms have already put aside cash to cover losses on mortgages (meaning payments to re-purchase secularized loan packages)? HSBC (with subprime exposure) has already done this to the tune of over 10B, how about others such as CFC? Which of the smaller firms relative to this market (NFI, FICC, HMB, ORGN) are toast, and which will survive? Start with the fundamentals in this situation to figure it out. The firms with the financial strength & resources will weather the storm and are possible set-ups for long-side trades. The weak firms will go under when the investors demand repayment for failing secularized loan packages.

Note that I do not urge investors to speculate on these subprime mortgage stocks at this time. The entire sector is very risky at the moment.


Should I feel sorry for the Mortgage Lenders?

The short answer is “No”. Keep in mind that the executives and brokers in these mortgage lending firms were focused on how huge their yearly bonuses were going to be from collecting lots of fees. There was no incentive whatsoever to look out for the long-term prospects of the firm. Seeing the writing on the wall, most of these executives and brokers starting leaving the sub-prime firms in droves starting six months ago, many of them thinking that they hit the lottery. Reading the writing on the wall, many executives in public mortgage firms are still cashing out piles of stock options at an accelerated rate.

Countrywide Chairman Selling Shares like mad....
http://www.secform4.com/insider-trading/1181599.htm

I expect that in the future we will see Congressional hearings where these executives will attempt to explain why they were enriching their own pockets while their firms were sliding towards bankruptcy.


What should an existing home-owner in an overpriced local market do now?

First let me state that I believe a primary home is an excellent long term investment when all the factors are taken into consideration (tax-benefits, no rent, quality of life, etc.)

However if you are homeowner in a market that has appreciated greatly over the past few years then you should take some steps to minimize the impact from the sub-prime meltdown and possible real estate market slide. These steps include:
1) Clean up your financial house (in terms of cash flow, spending, loans, etc.)
2) Get into a fixed rate loan. Rates are still low. No more ARM.
3) If you are considering getting a HELOC for home re-furbishing projects or other purposes, then you should open the line of credit soon before standards tighten up. (Note: I am generally not a HELOC fan, but if you need a HELOC get it now).
4) Take steps to insure that you are living within normal debt ratios relative to your mortgage payments. (e.g. sell that SUV with the $800 per month payment and buy a cheap car).
5) Plan to hold your house through any market dip which may possibly last up to 7 to 10 years (historically).
6) This is not the time to consider upgrading to a new home that is barely affordable for your family or for speculating on a second home. Stick with what you have now and remodel is necessary.
7) Don't get overly concerned about all of this subprime and bubble commentary.... You will ride out any real estate market changes; there is no need to be anxious if your financial life is in order relative to your home. Remember that owning a home is a good long term investment.

Most current homeowners should not panic about the risk of a downturn or its impact. The key thing is to have your financial house in order. This means getting a fixed rate loan, and living within standard debt ratios; coupled with the ability the keep the house long term and ride out any cycles. Keep in mind that a primary home is a good solid long-term investment when all the factors are considered!


What should a Potential New Home Owner Do?

Keep in mind that a home is an excellent long term investment. The key words being “long term”.

If you plan to hold the house long-term (10 years+) and can afford the home with a standard fixed-rate loan that is within normal mortgage standards then you should proceed with purchasing a single family home in a good neighborhood.

However if you can only afford the home with an ARM loan and fall outside of normal lending standards in terms of debt ratio, down payment, etc. or you plan to own the home for less then 5 years then you should reconsider your purchase of a home. Especially if you are located in a market that has greatly appreciated over the past few years (CA, FL, NY, etc.).

First time homeowners in areas with significant price run-up over the past few years may want to pay special attention to the local market conditions before considering a purchase during the next couple of years; and attempt to not buy at a local peak. However you should not get hung-up on attempting to time the local market, if the right house comes along and is affordable as a long term investment then you should go for it.


Summary

It is likely that the subprime banking meltdown is just the tip of the iceberg of the overall real estate problems that we will see over the next couple of years. Homeowners should prepare themselves to weather the storm by having their “financial house” in order. Investors should evaluate if their REIT or High Yield Income holdings are at risk.

The key thing for most homeowners is not to panic as more bad news comes out relative to real estate. Owning a home is a great long term investment that adds quality to your life.

Today's Bounce Back - 401K

In these volatile market times, let’s take a look at how a diversified 401K portfolio performed today compared to a single investment in a foreign stock fund. The overall market rebounded slightly today from yesterday’s losses (DOW up 0.43%, NASDAQ up 0.34%, and S&P up 0.56%).

As cited in yesterday’s post, if a 401K investor placed all of their funds into a single sector then they would have taken a significant hit. Today an investor in strictly foreign funds such as FIGRX would be up 0.21% after taking a 4.27% loss yesterday. The owner of the moderate 401K portfolio outlined in my earlier post would be up 0.22% today and took a much less significant loss yesterday

FIGRX up 0.21% (10% of portfolio)
FUSVX up 0.60% (25% of portfolio)
PEXMX up 0.36% (20% of portfolio)
SSMVX up 0.44% (10% of portfolio)
FBNDX down 0.27% (25% of portfolio)
FMPXX up 0.014% (10% of portfolio)

Due to having a properly diversified portfolio, the 401K investor not only took a much smaller loss yesterday, but achieved a gain greater then the single foreign fund portfolio today. Despite all the volatility, this investor with a properly allocated portfolio outperformed over a two day period in a very tough market environment. The same principles hold true for the long term outlook for the 401K account, this investor will achieve solid returns while reducing risk.

The Market Today

The market losses today may be traumatic for many investors (DOW down 3.29%, S&P down 3.47%, NASDAQ down 3.86%).

However they can be used to demonstrate the importance of proper diversification. The 401K investor who placed all of their funds in to a foreign stock fund such as (FIGRX down 4.27%) is looking pretty glum this evening. The losses are even more dramatic for investors who placed all of their funds into emerging stock markets such as China (FXI down 9.87%) or Latin America (ILF down 8.39%).

However if a 41 year old investor followed the diversification strategy outlined in the earlier 401K article from February 6th then they are considerably more chipper tonight (but not quite reaching for the champagne). Using the moderate allocation strategy, this investor would only have incurred a loss of 2.21% in their portfolio today. Most of the indexes were down considerably more then this.

The investor’s portfolio using a moderate allocation consists of the following funds which performed as follows:

FIGRX down 4.27% (10% of portfolio)
FUSVX down 3.48% (25% of portfolio)
PEXMX down 3.34% (20% of portfolio)
SSMVX down 3.52% (10% of portfolio)
FBNDX up 0.41% (25% of portfolio)
FMPXX up 0.014% (10% of portfolio).

By using a proper allocation strategic they endured a single day loss that was significantly less then most indexes suffered in the market today. Over a long period of time, this investor will have risk adjusted returns that outperform the overall market from a portfolio return/beta perspective.