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Tuesday, 30 November 2010

Investing in Fear Is Big Business

by Brendan Conway

Call it a bull market in fear.

The popularity of the VIX index, which has become a widely watched barometer of investor fear since the financial crisis, is generating a host of spinoffs, copycats and derivatives. It is adding up to big business for VIX's owner, the Chicago Board Options Exchange, as well as partners and competitors that have developed products pegged to, or inspired by, the VIX.

VIX clones have sprung up in Australia, Canada and India. There are now VIX-like measures in the crude-oil and gold markets. Soon, there will be a VIX each for corn and soybeans. The popularity of the index has fueled growth in futures and options just to bet on the VIX itself.

Formally known as the CBOE Market Volatility Index, the VIX tracks the prices investors pay for options to protect themselves against swings in the Standard & Poor's 500-stock index. An increase in those prices suggests an increase in investor anxiety. It is also used as a short-term predictor of investor behavior.

"There's not a bubble in volatility—investors can expect more of that—but there's certainly one in products to trade it," said Michael McCarty, managing partner of Austin, Texas-based Differential Research. Mr. McCarty and others in the industry predict that not all the new offerings will survive. Interest in fear gauges seems likely to wane once markets settle, they say.

The CBOE is the main beneficiary of the boom as it collects licensing and transaction fees on most VIX-related products. The CBOE and its partners are tight-lipped about the terms of the deals, but Ticonderoga Securities analyst Chris Allen estimates the VIX is now worth at least $300 million to the exchange. That is about one-eighth the company's entire market capitalization.

"The VIX is one of the fastest-growing products in the history of the business," CBOE Chairman William Brodsky said in an interview.

The VIX has become such big business that the CBOE expanded the pit that houses trading in VIX products at a time when volume in the industry has been largely flat. The pit was built to be deliberately roomy so it could accommodate an expected explosion in VIX-related trading. The pit has plenty of empty posts, contrasting with the crowded nearby pit for trading S&P 500 options.

Trading volume in VIX options alone rose 42% in the third quarter from a year earlier, according to the CBOE. VIX options worth more than a notional $120 billion have traded on the exchange this year, according to CBOE figures.

Every time one of these options on the VIX trades, the CBOE collects a fee, making it the most promising money maker for the exchange. The fees added up to $6.4 million in the third quarter, which if replicated again, could see the exchange reap at least $25 million this year.

Other firms and exchanges are also seeking to capitalize on the VIX's popularity.

Over at CME Group Inc. (NASDAQ: CME - News), a whole separate group of traders is trading futures on the VIX. Investment banks such as Citigroup Inc. (NYSE: C - News), Barclays PLC (NYSE: BCS - News) and Credit Suisse Group are using the VIX to create complex new exchange-traded notes tied to the index. The Nasdaq OMX Group (NASDAQ: NDAQ - News) recently launched competing "Alpha Indexes."

Some worry that the broad array of products and growth in trading of VIX options and futures could attract investors who don't fully understand the risks. The options can swing wildly in price as sentiment shifts, and investors could easily be caught off guard.

Even having a barometer of fear can make it easier for that fear to spread. That was brought into stark relief during the financial crisis through the ABX indexes, rough measures of mortgage-backed debt prices, and credit-default swaps, which reflect sentiment on individual borrowers. Both have been demonized as products that only compound investor nervousness.

"Derivatives themselves are a good product, but using them without being educated on how they work will eventually lead to big trouble," said Joe Kinahan, TD Ameritrade chief derivatives strategist. For example, he said, VIX options have an inverse relationship to the market, something that has tripped up unsuspecting investors.

For example, investors who had bet against stock-market volatility in April after a strong run in the stock market would have lost money in the May 6 "flash crash," which saw the VIX spike. But less volatile environments can also cause traders to lose money. For instance, investors who bet on a rocky fall for stocks by buying VIX "call" options saw their investments' value mostly bleed away, especially after the midterm elections and the Federal Reserve's quantitative-easing news.

Headaches for the CBOE have also been created by unwelcome copycats.

Last year, California investment firm AlphaShares LLC launched the AlphaShares Chinese Volatility Index, or "CHIX." It tracks gyrations in the Chinese market but isn't licensed by the CBOE.

CHIX has caused a spat between the CBOE and AlphaShares, with CBOE asking AlphaShares to tone down its references to the VIX. CBOE declined to comment. AlphaShares, of Walnut Creek, Calif., describes the China index as a "tribute" to the VIX.

The VIX was born when the CBOE commissioned Robert Whaley, then a professor at Duke University, to design a market-volatility index. He presented the math equation that would become the VIX in a 1993 academic paper. VIX futures became tradable in 2004, followed by VIX options in 2006, enabling investors to bet on the direction of the VIX.

For his part, Prof. Whaley says he wondered what took the market so long to see the benefits of being able to hedge against, or bet on, volatility in the stock market.

"Their current trading volume figures say they now understand," said Prof. Whaley, who is now at Vanderbilt University's Owen Graduate School of Management.

It wasn't until the financial crisis that the VIX broke into the mainstream. The index has a tendency to shoot up dramatically when market sentiment sours, one reason it grabbed so much attention as markets began imploding.

Within a few weeks in late 2008, the VIX shot up from the 20s to a peak of about 96 in October. Its reading is now just above 20, close to the historical average.

—Geoffrey Rogow contributed to this article.
Write to Brendan Conway at

Are We Entering Another Phase of Financial Crisis?

As Spain starts looking rocky, Tyler Cowen writes:

In a nutshell, we're watching the most pitched, highest-stakes, most determined battle between politics and finance which has been staged. I am expecting finance to win.

Arnold Kling follows up with four questions:

1. What is the true state of the large European banks? In particular, if, they had to write down the principal on the debt of the PIGS by, say, 15 percent, which banks would still be solvent?

2. What does the option for inflating away European debt look like? How would the cost of that inflation be distributed? Can the inflation take place within the context of the euro, or does it require that some countries leave the euro?

3. Does a crisis create an opportunity for governments to make radical changes to the welfare state, or is that still not possible?

4. Suppose that governments have to choose between preserving their banks and preserving high levels of spending on public employees and retirees. Which choice is better for the economy? For political survival?

I don't know the answer to any of them, but of the four, I think the last is the most interesting; Europe cannot let its banks fail, but it also can't divert public pensions to line the pockets of bankers. Yet it may well have to do one or the other. I am also expecting finance to win. Forget whether Germany has the political will to bail out the PIIGS: does either the EU, or the ECB, actually have the means to bail out all five? If Spain topples, that is what it will come to.
This is starting to throw off more echoes of the Great Depression, where you have a sequence of crises, each touched off by the ones that came before, like dominos falling into some diabolic design. Europe and America thought they'd seen the worst of things by the end of 1930, only to be knocked back down even harder by the contagion of the Creditanstalt crisis. In the US, the crisis ultimately triggered a string of bank failures worse than those sparked by the initial stock market crash, and the worst two years of the Great Depression were 1932-3.

I don't want to lean too hard on this, as economic commentators (maybe including me) have started seeing Creditanstalt everywhere--in Dubai, in Greece, now in Ireland and maybe Spain. It's entirely possible that we'll eventually muddle through without a second major event. But it's worth remembering that these things take a long time to unfold, and that we are often most vulnerable just when we think we have time for a breather.

Related thoughts: whatever events unfold, a lot of pundits who insist on treating whatever has happened in the last five minutes as if they were the final events of the crisis, are going to look like idiots. If Spain ends up in the same place as Ireland, the virulent arguments over Irish austerity are going to look rather silly in retrospect; if Europe's banking system is badly compromised, the model of economic crisis that centers around American bank regulation and monetary policy will be severely compromised; and so forth. Pundits and regulators should both be playing the long game.

Monday, 29 November 2010

The real problem: Income inequality

By David Futrelle

(MONEY Magazine) -- Raghuram Rajan wasn't the only economist who warned of the financial crisis before it struck. He was, however, the sole one brave enough to make this prediction in front of Alan Greenspan at a 2005 Jackson Hole Conference devoted to celebrating the legacy of the once-seemingly infallible Fed chief.

Nor is Rajan unique in blaming the panic on the decoupling of risk and reward in the financial sector. But he stands out as one of the few economists who cite income inequality as another root cause.

That's hardly the type of theory you'd expect to hear from an economist at the University of Chicago, a bastion of free-market thinking. But he argues that this income gap inspired politicians on both sides of the aisle to push low-income housing loans as a palliative for the poor, which helped to send the housing sector into overdrive.

The author of Fault Lines tells MONEY contributing writer David Futrelle that unless we come to terms with our economy's structural problems, we may be setting ourselves up for another fall.

The recession is officially over, but it sure doesn't feel like it. Why not?

We haven't had this kind of recession -- created by a financial meltdown and high leverage -- since the Depression. These take longer to recover from.

It used to take eight months from the trough of a recession until jobs came back. In 2001, it took 38 months. It will probably take five to six years this time around.

Why so long?

Much of the growth we created to come out of the last recession was unsustainable. We pumped up the real estate sector, and that created a lot of jobs.

But many of those people, whether they were construction workers or real estate brokers, now have to find jobs elsewhere because that industry is not coming back to the level it was any time soon.

Many blame the financial crisis on housing. But you've suggested the real estate bubble itself was a bungled political attempt to deal with the real root cause: rising income inequality. Can you explain?

In the 1980s we saw a widening of income inequality. Typically the political reaction to that is to redistribute wealth. But in the '80s and '90s there was a sense that we'd had too much redistribution, too much welfare. So you had to find something else, and housing fit the bill for both political parties.

The Democrats thought it was wonderful to support home ownership for the poor, their natural constituents. The Republicans figured property owners would eventually vote Republican.

Congress, of course, can't make loans. But Fannie Mae and Freddie Mac both enjoy this tremendous government subsidy, and politicians used that as a lever. So you had a massive amount of money flow into housing.

Homebuyers were told there was no risk of loss -- that ever since the Depression we've never had an across-the-board housing price fall. They were also told homes are a great way to build equity, and you can borrow against that equity.

The brilliance of the home-equity loan, which was a substantial feeder of consumption growth, was that people could borrow without guilt because the rise in home values offset that additional borrowing. What people didn't realize was that some of this asset value was illusory.

The easy credit you describe has gone away, but the inequality remains.

Yes. And societies that have extremely high levels of inequality eventually break down. The politics get ugly, and then the economics get ugly.

It used to be that many Americans felt they had a good chance of becoming really wealthy. But the route to getting there is a good education, and too many Americans can't afford that. A significant part of society doesn't believe it can get access to wealth.

What can government do to reduce inequality?

In the long run, redistribution doesn't work. Focusing on improving the quality of the workforce -- through education and skill building -- is probably the only answer.

While unemployment benefits have been extended this year, you've argued that our limited safety net may be exacerbating the political desire for quick fixes.

When you have a very thin safety net, losing your job means you lose health care and your unemployment benefits run out quickly. There are benefits to a thin safety net. Those who lose their jobs have a strong incentive to look for one.

The question is, is it better to focus on strengthening the safety net? If you do, you could actually have less pressure on policymakers to pull rabbits out of the hat by trying to create jobs where there are none.

The tolerance for unemployment in the United States is far lower than in Europe. Spain has 20% unemployment. I think we'd have a revolution in the U.S. if we had 20% unemployment. That puts pressure on Congress to pass big stimulus bills, and on the Fed to keep interest rates low.

The standard Keynesian economic response to stimulate the economy is with government spending and low rates, right?

This is where I depart from economists like [New York Times columnist] Paul Krugman, who has been emphasizing the need to pump up demand, whether it be through monetary policy or through fiscal policy.

My view is that it's not all about demand. In the jargon of economists, we don't just have a cyclical problem, we have a structural problem. There's a fundamental mismatch between the skills of the labor force and the kind of jobs that the economy is creating.

Pumping up demand again may create an illusion of growth, but until we fix the underlying problems we will not have sustainable growth. The Fed can keep rates low for a very long time, and pump up asset prices and create new lending booms, but if the underlying dynamics aren't sustainable, we'll end up creating an eventual bust.

But wouldn't raising short-term rates now potentially send the economy into a deflationary spiral?

I'm not saying raise rates tomorrow to 5%. We are still in an environment of great uncertainty. I'm saying we should exit panic mode as soon as we're confident that we are out of the panic.

And my sense is that as confidence about Europe's financial system -- a potential source of the next panic -- increases, we should start to raise rates, and bring real rates at least to zero. They're still negative after you factor in inflation, and that's worrisome.

What's the harm in keeping rates low?

Japan has had extremely low rates for almost 10 years, with little effect in revitalizing its economy.

People here are saying there are no bubbles around, so why worry? My point is we don't recognize bubbles until it's too late.

By the time you're staring inflation in the face, it's too late. So we can't look at what's going on and say, "We have plenty of room, let's keep things going the way they are."

We cannot keep rates low until the jobs come back. And we can't keep spending indefinitely. If the U.S. government's financial situation were to be questioned by the markets, it would be a calamity beyond any we've seen.

When you argue for raising rates, you sound like a conservative. But when you talk about inequality you sound like a liberal. Which is it?

I would call myself pragmatic. I believe that in general markets work. Growing up in India, I saw what can happen when markets are weighed down by too much government intervention driven by vested interests. But markets don't work independently of regulatory support. We need to find a balance that works.

For now, foreigners don't seem to mind our structural problems since they keep bailing us out with investments.

The immediate effect of this crisis has been to push more money into the U.S., because Japan and Europe look even worse. However, as industrial countries stabilize, and if emerging markets start to look more creditworthy, people will ask more questions of the U.S.

If a divided Congress can't cut spending, but also can't raise taxes, investors are going to question the size of the U.S. deficits and the unfunded liabilities of Social Security and Medicare. And they're going to say this looks like a government that doesn't have the will to bring its liabilities under control. At that point they will question our debt, the dollar, and our monetary policy.

Could the U.S. lose its economic superpower status?

Nothing can be ruled out. One reason that a country like the United States has remained successful for so long is that its institutions have by and large worked. When problems became big enough, we've been able to come together and forget our differences.

But high levels of income inequality hurt that consensus. We need to worry about inequality not just because it upsets our sense of fairness but because it creates dangerous political dynamics.

Thursday, 25 November 2010

The Goldman Sachs guide to interview success

Sarah Butcher

For anyone not already aware of this, Goldman Sachs has produced a presentation on how to kill it in an interview.

Their advice is aimed at the student market, but some of it could apply equally to the experienced, lateral hire. For the sake of the latter, we have distilled the most pertinent points below. If you are the former, we suggest you watch the whole thing.

The quick version:


• Make a long list of your qualifications and strengths and weaknesses. Think about how past experiences demonstrate your skills.

• Familiarise yourself heavily with your CV.

• Make sure you know your ‘key selling points’ and practice talking about them in a ‘confident and conversational’ fashion.

• Create a coherent story based around your CV, which makes you seem like an ideal candidate.

• Be prepared to talk about things which demonstrate leadership, teamwork, professional accomplishments, interpersonal skills and your ability to overcome obstacles.

• Leave 20-30m before the interview for final preparations. Memorise names, especially those of your interviewers.

Interview types

• There are three main species of interview: historical interviews, behavioural interviews and case study interviews.

• Goldman likes behavioural interviews.

• Behavioural interviews (known also as competency interviews) are all about how past behaviour influences future performance. You’ll need some stories to demonstrate this. Goldman likes behaviours showing thinking and problem solving, team orientation and leadership potential.

• In historical interviews you’ll have to talk a lot about your CV and highlight information on it that suggests your suitability.

• In case study interviews, you may be asked technical/weird questions. Eg. Why are manhole covers round? The trick, in this case, is to articulate the rationale behind your answer. The answer need not be right.

Questions you may wish to ask at the end of the interview

• Focus on the industry and trends, eg. ask for the interviewer’s perspective on what’s happening in the market and what the job involves.

• DON’T ask about pay and benefits.

• DON’T ask questions which will make the interviewer feel defensive.

Post-interview pleasantries

• It’s not obligatory, but can be nice, if you send a thank you email.

• Don’t phone.

• Don’t even think about sending a written letter.

Why getting a 50 per cent pay rise isn’t always so awesome

Rio Goh

In an emerging and growing market like China, job opportunities are plentiful, while candidates are scarce and are understandably looking to benefit from this growth.

I often speak to front-office candidates who expect base salary increments of more than 50 per cent when they change roles. Some banks are actually willing to provide these raises to sales people, provided they bring in and increase revenue by 50 per cent within a short time frame.

The best case scenario if this happens is that the relationship manager is able to deliver on this revenue promise and it becomes a win-win situation for both parties.

However, the most likely scenario is that the candidate over-promises and high expectations are created. When the candidate then under-delivers and fails to meet revenue targets, both parties are disappointed.

Managing your salary expectations is therefore crucial to managing your career. The ultimate career entails a combination of learning, development, growth, promotions and being rewarded accordingly. Think of where you would like to be three to five years down the road and think of the steps needed to get there.

Would a one-time 50 per cent increment bring you more satisfaction, or a year-to-year increase of 10 to 15 per cent based on good performance and meeting your employer’s expectations?

Would your manager give you more time to perform if you join on reasonable and fair terms, or would you prefer your manager to get as much out of you within a year before disposing of you?

The answers to the above questions should be very obvious. It is all about trying to find that balance between what the market is willing to pay and how you perceive what your actual market value is or could be.

So you’ve accepted a job offer…

You have found a new position and are preparing to resign. A very well known phenomenon nowadays is the counter offer. A counter is a nightmare for all parties involved. It’s an action of despair from an employer’s point of view because it’s a reactive, last-minute decision.

From your perspective as a candidate, a counter can be a very emotional gesture, especially after many years of service and commitment. You need to consider all your options before deciding whether to accept one. Ask whether it was really necessary to resign in order to get a promotion and/or a salary increase? What if the counter offer is really attractive?

Based on previous scenarios and experience, trust is normally gone between the manager and the employee. Career development and growth over the next two to three years will be limited. Could you imagine your manager providing another counter offer next time? Most importantly, there was a reason why you wanted another job in the first place.

Ideally, before you even begin looking at other opportunities, ask yourself this: can I speak to my superior in order to improve my current situation? If the answer is no, then start your searching. If the answer is yes, then you should certainly talk to your manager.

In all scenarios, prevent yourself from burning any bridges. Resigning and moving on is nothing personal – it is a professional decision and you should try to ensure a smooth transition/notice period by being cooperative and helpful. What matters is closing off a career chapter and starting a new and exciting one.

Rio Goh, manager, Michael Page Financial Services

Saturday, 20 November 2010

Special report: A far from random walk from Wall Street

By Leah Schnurr and Edward Krudy

NEW YORK (Reuters) - Leanne Chase took her money out of stocks in early June 2008 before the collapse of Lehman Brothers sparked a near-panic. She said she and her husband had the same feeling they had during the dot-com bubble: The market had become just "weird."

Though the couple had been in and out of the market before, Chase, a 42-year-old part-time consultant and self-described conservative investor, said she has no intention of getting back in again.

"It makes me nuts when I get out early and there's more money to be made, or I get out late when I could have made more if I'd gotten out early," she said. "The stock market's not an investment, it's gambling."

The faith -- and money -- individual investors once held in the stock market has severely eroded. Two painful major stock market crashes over the last decade combined with the advent of arcane, complicated trading practices has created widespread suspicion of Wall Street, which many people now regard as no better than a roulette table.

The last crash wiped out all of the gains made during the 2000s after the dot-com wipeout. The worry now is that a Lost Decade will create a Lost Generation of investors who avoid the market in a way not seen since the Great Depression.

If that happens, smaller investors could end up safe -- and sorry. Experts fear people will be unprepared for retirement as a result of their exit from equities. By shunning stocks they may also be helping to create precisely the kind of stock market that ordinary investors rightly detest: one driven by day traders with low volume and prone to sudden reversals in direction.

What's clear is that whatever love affair many Americans may have had with stocks is over, at least for the moment.

By the end of 2008, $234 billion fled equity mutual funds as the stock market spiraled, according to data from the Investment Company Institute (ICI). The last quarter of 2008 was characterized by late-day market drops as a run of client redemptions forced mutual funds to sell their holdings in order to raise cash.

Last year, investors continued to leave even as the market stabilized. At the time, the worst seemed over, with just $9 billion coming out of equities overall and money starting to flow back into international stock funds again.

But losses intensified again in 2010. ICI estimates $19 billion has left mutual funds for the year so far as of the end of August. In September, equity funds recorded their fifth consecutive month of outflows. That sort of thing tends to happen only after a major event: there was a seven-month run of outflows in 2008, smack in the middle of the financial crisis, and an eight-month streak starting October 1987 after Black Monday. This time around, the flash crash may be to blame.

For the most part, investors are eschewing stocks for the perceived safety of bonds and other fixed income assets, trading the possibility of high returns for stability. Bond funds took in an unprecedented $376 billion in 2009 and another estimated $216 billion in 2010 as of the end of August.


Although 90 percent of the stock market is owned by 20 percent of the top income earners, according to Citigroup, the perception of public capital markets as the place where capitalism became a democracy has been a cornerstone of America's promise.

Now, as in the wake of the Great Depression, a generation of investors may have become alienated from the stock market.

Sol Malkiel, a costume jewelry wholesaler from Boston, lost what little money he had in the crash of 1929, an experience that was to instill in him a life-long aversion to stocks. Nearly half a century later his son, an economist at Princeton, would publish a book that would rank him as one of the great 20th-century proponents of stock market investing and make him an intellectual light to a generation of America's small investors.

If every bull market has its intellectual doyens, Burton Malkiel -- author of the 1973 book, "A Random Walk Down Wall Street" -- was certainly one of them during the stock market's dizzying run over nearly two decades starting in 1982. The book, due for its 10th edition later this year, has sold over 1.5 million copies, according to its publisher.

An ironic and sometimes caustic look at the often weird and occasionally wonderful world of Wall Street, "A Random Walk" held that an individual investor could beat the pros over the long run by simply picking a broad-based stock market index.

Malkiel, sitting in his office in Princeton, is convinced that abandoning the market in times of uncertainty is exactly the opposite of what investors should do. He is worried by the possibility that a swath of people will never buy stocks again, much like his father after the crash of 1929.

"My father didn't have much money, but he lost whatever he had in the crash and never wanted to be in the stock market again. It was a terrible mistake and anyone who bought any stocks in the 1930s and 1940s did extremely well," said Malkiel. "We might very well have created another generation of people who don't want to touch it. It was wrong in the '30s and I think it's wrong today."

Others point to the aging of America's largest population cohort as the chief culprit.

Brian Reid, chief economist at ICI, started noticing the shift toward more conservative investments in 2006 as a generation of baby boomers began to leave the workforce. After two decades of buying stocks to save for retirement, boomers have been shifting their holdings toward fixed-income assets to ensure a steady stream of money they can live off.

The shift was also part of the fallout from the first crash of the decade, the bursting of the Internet bubble. The recent housing and financial crisis spooked investors even more, and they have been walking away from mutual funds ever since.

It is all a far cry from the 1990s, when investors piled money into mutual funds month after month for an entire decade. "Certainly there was an attitude in the '90s that the stock market could never go down, just like there was an attitude in this decade that housing prices could never go down," said Reid. "We've learned those two perceptions were incorrect."


Financial advisers and portfolio managers frequently speak of a "paralyzed" investor: one that wants to invest money, but is terrified of making the wrong decision. Whereas in the 1990s, investors were convinced they couldn't do wrong, the last decade has made the retail investor much more cautious.

"They've been burned for 11 years and they are just done," said Steve Stahler, financial planner and president of The Stahler Group Inc in Baton Rouge, Louisiana.

Advisers also note the deep distrust many feel toward Wall Street, manifested in the deep backlash against the government bailouts of financial institutions in 2008. A changing market landscape, including a move toward high frequency trading and this year's abrupt "flash crash" -- when the Dow Jones industrial average dropped some 700 points in a matter of minutes -- has added to the complexity the average investor faces.

Whatever the cause, nervous investors are sitting on cash that is making next to nothing from historically low interest rates. And all that dead money may result in too-small nest eggs for many Americans.

Investment advisor Bob Mecca, of Robert A. Mecca & Associates in Chicago, says that the overwhelming concern of people who have about five years until retirement is protecting their initial investment. This partly explains why investors are content to park their money in bonds rather than seek out aggressive gains in stocks.

"The days are gone when older people are searching for the last dime," said Mecca. "They're looking for return of principal rather than return on principal."

Advisers fret that for those with a longer time horizon until retirement, conservative investing may not be the best decision. Lower savings and investments that are returning less than in the past may prove to be the wrong combination.

This is exactly the scenario people like Malkiel worry about. "Many investors have thrown up their hands and said, 'I'm not going to touch the stock market,' and I think they're hurting themselves by doing so," said Malkiel. "I'm more worried that people haven't saved enough and they haven't taken enough risk."


The trillion dollar question for the market is: Does the flight of retail investors matter?

As stocks began to stabilize in 2009, analysts predicted that the floods of retail money returning to the market would fuel a rally. That didn't happen, but the market rose anyway. As measured by the broad S&P 500, stocks are up about 77 percent from the crisis low hit in early 2008. But the index remains down about 23 percent from October 2007's record high close.

Whether less retail money hinders the actual performance of the market rather than just sentiment is debatable. In theory, an influx of investors looking to hold stocks for the long run should drive up prices and smooth out volatility.

Analysts say the absconding retail investor is also helping to shape the type of market we are seeing: one that is less driven by fundamentals than by traders looking to profit by getting in and out relatively quickly. The end result is a market with low volume and high underlying uncertainty that is easily shaken by news and rumors.

There is a self-fulfilling component to all this. "With retail investors less and less in the game it does come down to a series of more esoteric trading strategies for most of the market," said Nicholas Colas, chief market strategist at the ConvergEx Group in New York, pointing to the upswing in high frequency trading as an example.

Price to earnings ratios, a measure of a stock's value, remain depressed today. S&P 500 companies are now trading at about 12.3 times estimated 2011 earnings, according to Thomson Reuters data. Since 1960 the price to earnings ratio has been about 16.4, according to Bespoke Investment Group, which suggests that stocks today are a relative steal.

"We have had two essentially 50 percent declines in the equity market over the last decade and that has profound impacts on psychology and how people think about equities," said David Giroux, portfolio manager at T. Rowe Price. "And over time that probably puts some downward pressure on equity multiples."


For retired Colonel Roger Potyk, the flash crash was the last straw. In 2008, Potyk and his wife lost $75,000 on the Lehman Brothers bond they held when the bank collapsed. Even so, the couple held onto their other investments, including stock mutual funds. With the market bounce in 2009 and Potyk returning to work part-time, they were able to recover some of their losses.

But after seeing the Dow sputter in May's unprecedented flash crash, the Potyks pulled their money out of stocks and put it into fixed-income assets.

"It was just a little much for us after being sensitive about the other loss," said Potyk. "We said we'll take whatever we can and be happy, and know when we get up in the morning, it won't have gone up 10 percent, but it hasn't gone down 10 percent, either."

The Potyks were not the only ones shaken by the crash. Weekly data from ICI estimates money came out of mutual funds for 22 consecutive weeks following the flash crash, ending only in mid-October.

Experts say the flash crash is likely just another reason for investors getting out of stocks rather than the only factor. Advisers say clients don't bring up the crash very often, but the data suggests it hasn't been unnoticed.

"I really do think it's primarily driven on sentiment and consumer confidence," said Colas. "I don't think the flash crash was the only driver, but it's hard to ignore that correlation and it begins to look like causation."

Investors who do want to hold stocks have been flocking to stable, blue chip companies that pay dividends and increasingly popular electronically traded funds (ETFs).

Hesitant retail investors are likely to inflict pain on parts of the brokerage industry. Online brokerages like Charles Schwabb are relatively insulated by a core of active traders. But brokers that deal exclusively with buy-side institutions such as mutual funds are having a tough time as retail investors eschew stocks.

Analysts say retail investors will come back once the uncertainty surrounding the economy begins to clear, but even the optimists among them fear that they will not return with the same vigor they once had.

An improvement in the labor market may be the most important catalyst. As long as investors are worried about losing their jobs, saving money and paying down debt will be the priority before saving for retirement.

Dario Caloss, who got out of his mutual funds in 2007, is waiting for the uncertainty to pass before he returns to the market. He had initially planned to get back into the market when the Dow recovered to 8,000, which happened sustainably in May 2009. He admits he's been sitting on the sidelines longer than he planned as he waits for the economy to stabilize.

"This downturn was really about people we were in a position to trust that didn't really do their due diligence. That's kind of shocking," said Caloss. "It's hard to get back in with a lot of faith."

(Additional reporting by Jonathan Spicer; Editing by Jim Impoco and Claudia Parsons)

6 Easy Ways to Increase Retirement Savings

by Kimberly Palmer

Here's a pop quiz: Do you know much money you need for retirement? If you're like most people, you probably don't. According to the Transamerica Center for Retirement Studies, most of us just guess how much money we'll need once we stop working. Only 1 in 10 people does any sort of calculation at all.

That might help explain why, on average, Americans are on track to replace less than 60 percent of their income during retirement. Financial experts generally recommend that retirees replace at least 80 percent, given the rising costs of healthcare.

The best way to unveil the big mystery is to punch some numbers. Luckily, online tools make it easy. Banks and brokerage firms increasingly offer calculators that can automatically incorporate your personalized information; Fidelity, T.D. Ameritrade, Transamerica, and T. Rowe Price are among those that do. If you prefer to do your own research, consider plugging your details into one of's retirement calculators. Be sure to experiment with different rates of returns, inflation rates, tax rates, and lifetime expectancy, since no one can predict those factors with any accuracy.

Meanwhile, consider these six strategies for getting your 2011 retirement savings on track to provide fully funded golden years.

Save a higher percentage of your income all year long. The Employee Benefit Research Institute reports that on average, employees contribute just 7.5 percent of their income into their retirement accounts. But most people need to save at least 15 percent to be on track, according to Vanguard founder John Bogle. Instead of worrying, just save more, he urges. January is a good time to review your contribute rate and consider raising it for the year.

Use the end of the year to bulk up your contributions. You can contribute up to $16,500 into your 401(k) in 2010; for those 50 or older, the limit is $22,000. If you're nowhere close to that amount, you can ramp up your contributions to take advantage of tax-advantaged accounts. The same goes for Roth IRAs and traditional IRAs. If you want to max out your retirement savings, now is the time to start putting more money away. (You can contribute up to the 2010 limit until April 15, 2011.)

Consider opening an after-tax savings account, too. If you find yourself hitting up against the savings limits on your tax-shielded retirement account, then consider opening an additional after-tax account that's dedicated to your retirement. Just because the law prohibits you from putting more than $16,500 into your 401(k) doesn't mean that's all you should be saving, it's just all you'll be saving out of pre-tax money.

Use special savings accounts during work breaks. Just because you're not earning a steady paycheck doesn't mean it's a good time to put retirement savings on hold. Spousal IRAs for non-working spouses and Roth IRAs can make this easy. Roth IRAs are particularly useful for freelancers, students, and other people with unpredictable income streams, because you contribute money into the account after paying taxes on it, which means you can decide how much to contribute after considering your other expenses. If you think your tax rate is lower now than it will be when you take the money out, you'll benefit.

Don't forget about taxes. According to the Michigan Retirement Research Center, married college graduates — people who are otherwise among the most prepared for retirement — often forget to consider just how much of their retirement income will be going towards Uncle Sam. Only three in four people in this group are prepared for retirement after taxes are taken into account; otherwise, 92 percent report being ready. Many online calculators allow users to consider taxes in their calculations.

Lower your fees. Expenses can take a big chunk out of your investment return. But fees vary widely, typically from 0.1 to 2 percent of your total investment on an annual basis. Think tank RAND calculates that even just 1 percentage point difference in annual fees adds up to $3,380 after 10 years on a $20,000 account balance. But RAND found that when people were presented with various fund options, including one that clearly came with the lowest fees, only half selected that lowest-fee fund. One in 3 people inexplicably selected the fund with the highest fees. (All of the funds exhibited equivalent returns.) Index funds often offer lower fees, which means investors can keep more of their money.
Copyrighted, U.S.News & World Report, L.P. All rights reserved.

Friday, 19 November 2010

The 17 Things Worrying Investors Right Now

Lloyd Khaner

Ever since Benjamin Graham created the concept of "Mr. Market", investors have noticed that when the market gets worried, stocks tend to get cheaper. With that in mind, I've been keeping a running tally of all the issues, events and future concerns affecting market behavior at any given moment. Here's a look at what's happening this week in "Lloyd's Wall of Worry." Also, click here to see the interactive Wall of Worry on Minyanville.


CHINA: Kickin' it purely "my way or the highway." Especially treacherous on the rest of us as they are still building their highways.

THE PIIGS: Portugal, Ireland, Italy, Greece and Spain. FYI: News of their demise has been greatly…delayed.

CALIFORNIA AND THE OTHER 49 STATES: Automakers – done. Banks – done. Next on line at the bailout window: Muni Bonds. "Please step up to the white line."

QE II: In the popularity ratings still more dear than a root canal but not by much.

U.S. ECONOMY: This aging heavyweight looks to be making a comeback but don't expect any championship belts.

UNEMPLOYMENT: The good news is we added 151,000 new jobs. The bad news is that's about 100,000 less than needed to keep us from sinking deeper into the jobless quicksand pit.

TAXES: Extend and Pretend-- it ain't just for loans anymore.

HEALTHCARE REFORM: "If I were a cheese what kind of cheese would I be? Umm…that would be Swiss." Give it a year or so.

OBAMA ADMINISTRATION PART II: "Heavy lies the crown."

XMAS 2010: Praying the Repo Man doesn't tow away Santa's sleigh until after he brings some good cheer. Stack of $20s for me, KK!

CURRENCIES: No longer a race to the bottom. More like a slow bumpy roll down into death valley.

HOUSING CRISIS: The reset button doesn't seem to be working here. Might I suggest bulldozers and bonfires?

INFLATION/DEFLATION: The Fed's inflation wish will come true. And then, like old luggage and my gut, it will be with us for a long time.

G20 MEETING: Granted I wasn't expecting any Gold Medals for the U.S., I wasn't expecting a disqualification smack down either.

TERRORISM: I knew there was a reason I always hated changing the toner cartridge.

COMMODITIES: Trying to wrestle them down with higher margin requirements. You mean some people actually pay for these things?

HFT: High Frequency Trading -- a festering boil on our stock market but nothing a penny transaction tax wouldn't clear up. Dr. SEC, we're waiting…?

What is the Wall of Worry?
Since the 1930's, when Benjamin Graham created the concept of Mr. Market, investors have been trying to figure out what's worrying the stock market at any given moment. Oddly, no one has ever kept a list of the concerns -- except for me. I've been managing money for the last 20 years and keeping a running tally of all the things that are bothering investors. It's an important part of my value investment discipline, because when Mr. Market gets nervous, stocks tend to get cheaper.

As Warren Buffett says: "Be fearful when others are greedy and be greedy when others are fearful."

The Wall of Worry will be updated regularly, so keep coming back.

5 Ways to Save Money in Retirement

by Amy E. Buttell

In retirement, it's time to spend wisely.

With retirement, you're dealing with a phase of your financial life where you have a limited amount of money and no concrete idea of how long it must last. With finite resources, you must be mindful of your spending so you won't outlive your money and so you'll have the funds for the things most important to you.

"By the time people are ready to retire, or have already retired, they should have a very current picture of what their spending is," says Tim Kober, a certified financial planner with Cedar Financial Advisors in Portland, Ore. "There's the problem of spending going up in the initial part of retirement when people do all the deferred things that they've been wanting to, and it's important that they don't overdraw their nest egg to make all those nice things happen."

Retirement has many stages, and not every stage is one where you'll want to splurge. But it's important to realize that you may spend more initially, and budget accordingly. As you get things like the travel bug out of your system, spending may go down. But other expenses, like health care, may increase.

Time to Face Realty

A potentially emotional decision about retirement expenses is a possible need to downsize your housing, says Kober. Although adult children may be emotionally attached to the old homestead, "you may need to have the brutal, honest conversation with your family and say, 'This isn't a long-run sustainable housing situation.' You can reduce your housing costs and spend more time and money on leisure activities."

Gordon J. Bernhardt, CPA, a financial planner with Bernhardt Wealth Management in McLean, Va., agrees. Many consumers bought too much house or spent too much money on rental properties during the real estate boom and now may face a cash flow problem in retirement. "Is the individual overextended? Did he or she buy too much real estate and is facing the consequences of negative cash flows? In the cases we have seen, that individual is still above water, but selling the property will help their cash flow."

But remember there are a number of costs involved in moving, including real estate commissions and potentially higher property taxes. Also, according to Bankrate's 2010 Closing Costs Survey, average closing costs on a $200,000 home were $3,741.

Do Expense Accounting

Experts say one golden rule of retirement should be "Plan what you spend, spend what you plan." "Too many people don't have a budget," says Michael Kay, a certified financial planner who's president of Financial Focus in Livingston, N.J. "You need to know which costs are fixed costs, and which costs are discretionary. It's the discretionary costs that you choose, that you can trim."

Before you can cut your discretionary spending, you have to know how much it is. So keep track on what you're ppending for frills like entertainment, travel or impulse purchases.

Dining out is one place to put your budget on a diet, says Bernhardt. "Our clients have shared that they did not realize how much money they spent on eating out until they changed their habits and ate at home more often," he says. "And they did not feel like they were making a significant sacrifice."

Be Present-Minded

Grandparents and parents, naturally, want to lend a financial hand to their descendants. But it's not a good idea if it imperils your ability to stay financially solvent in retirement. Take a hard look at any outright cash gifts that you are giving, or expenses like private school tuition or summer camps that you're covering.

"Some of our older clients have reduced their annual gifting to reduce the withdrawal rate from their portfolios," says Bernhardt. "It's nice to be able to help out the grandkids, but you don't want to risk running out of money."

Go to the Goals

Whether you're already retired, or about to be, you need to periodically re-evaluate your personal spending goals. "You start with your core beliefs, what's important to you, and then you take a look at your financial reality," says Kay. "Then you may have to say, 'OK, do I need to make changes in my discretionary spending or do I need to make structural changes, like in where I'm living?'

"Some people might say, 'It's really important for me to live near my grandchild, and I'm willing to give up some discretionary spending to do that,'" Kay says. Others might conclude that some cuts in structural expenses are worth it in order to send a grandchild to summer camp.

The bottom line, Kay says, is that you must have a game plan to achieve your goals.

Drive a Bargain

After housing, cars are one of a consumer's biggest expenses. "People don't think about operating costs and the total costs of owning a car, including repairs, insurance and maintenance," Kober says.

Kober notes that couples can save money by cutting back to one vehicle. Also, retirees might employ other creative strategies like renting a cheap car for long trips instead of putting more wear and tear on their own set of wheels.
Copyrighted, All rights reserved.

Top 10 myths about job interviews

By Anne Fisher

FORTUNE -- Dear Annie: I graduated from college last spring and, after taking a few months off to take care of some family business, I'm looking for my first "real" job. I've been lucky enough to get several interviews, and they've gone pretty well, but I have to say, I'm kind of mystified. While I was still in school, I read a bunch of books about how to prepare for a job interview, and one thing they all said was that interviewers would be well prepared and ask probing, detailed questions.

Instead, I'm finding that, not only do my interviewers so far seem to have few questions beyond "Tell me about yourself," but they haven't even read my resume (short as it is, at this point). Am I just running into some weird companies, or is this par for the course? --Ivy League

Dear Ivy: In an ideal world, everyone responsible for deciding who gets hired would indeed be well versed on your qualifications and ready to ask thoughtful, incisive questions. In reality, though, many interviewers are managers who are so pressed for time that they just haven't gotten around to thinking about you at all until you're sitting across the desk from them.

And that's not all. Veteran career coach David Couper, who has worked with both interviewers and candidates at Mattel (MAT, Fortune 500), Amgen (AMGN, Fortune 500), Amoco, Allied Signal, and many other big companies, has identified 10 areas where job applicants' expectations are often way out of line with what actually happens.

Here is his list of the top 10 job interview myths, and how to deal with them:

Myth #10: The interviewer is prepared.

"The person you're meeting with is probably overworked and stressed about having to hire someone," Couper says. "So make it easy for him or her. Answer that catchall request, 'Tell me about yourself", by talking about why you're a great fit for this job. If it's obvious they haven't read your resume, recap it briefly, and then tie it to the job you want." Tell them what they really need to know, so they don't have to come up with more questions.

Myth #9: Most interviewers have been trained to conduct thorough job interviews.

While human resources professionals do get extensive training in job interviewing techniques, the average line manager is winging it. "To make up for vague questions, be specific even if they don't ask," Couper suggests. "Be ready with two or three examples of particular skills and experiences that highlight why they should hire you."

Myth #8: It's only polite to accept an interviewer's offer of refreshment.

"They usually try to be courteous and offer you a drink, but they don't really want to bother with it," says Couper. "Unless the beverage in question is right there and won't take more than a second to get, just say, no, thank you."

Couper once interviewed a job candidate who said she would love a cup of tea, which, he recalls, "meant I spent half the allotted interview time looking for a tea bag, heating water, and so on. It was irritating."

Another good reason, Couper says, to decline caffeine is that "if the interview is a lengthy one, you don't want to need a restroom halfway through the conversation."

Myth #7: Interviewers expect you to hand over references' contact information right away.

Hold off until you're specifically asked, Couper advises, and even then, you can delay a bit by offering to send the information in an email in a day or two. There are at least two good reasons for not rushing it, Couper says. First, "you sometimes don't know until the end of the interview who would be the best references for this particular job," he notes. "If you get a sense that the interviewer cares most about, for instance, teamwork, you want to choose someone who can attest to your skills in that area. A reference who can only talk about some other aspect of your work is not going to help."

Second, and no less important, "you want a little time to prep your references, by gently coaching them on what you'd like them to say, before the employer calls them."
0:00 /2:58Business etiquette helps job search

Myth #6: There's a right answer to every question an interviewer asks.

"Sometimes how you approach your answer is far more important than the answer itself," Couper says. If you're presented with a hypothetical problem and asked how you would resolve it, try to think of a comparable situation from the past and tell what you did about it.

Talkback: Has anything surprised you during a job interview? Leave a comment at the bottom of this story.

Myth #5: You should always keep your answers short.

Here's where doing lots of research before an interview really pays off. "The more you've learned about the company and the job beforehand, the better able you are to tell why you are the right hire," Couper says.

Don't be afraid to talk at length about it, partly because it will spare the interviewer having to come up with another question for you (see Myth #1 above) and partly because "in a good interview, you should be talking about two-thirds of the time."

Myth #4: If you've got great qualifications, your appearance doesn't matter.

Reams of research on this topic have proven that physical attractiveness plays a big part in hiring decisions. "Anyone who says otherwise is lying," Couper says. "People care about your looks, so make the absolute most of what you've got." Even if you're not drop-dead gorgeous, it's impossible to overestimate the importance of looking "healthy, energetic, and confident."

Myth #3: When asked where you see yourself in five years, you should show tremendous ambition.

The five-year question is a common one, and it's uncommonly tricky. "Interviewers want you to be a go-getter, but they also worry that you'll get restless if you don't move up fast enough. So you want to say something that covers all bases, like, 'I'd be happy to stay in this job as long as I'm still learning things and making a valuable contribution,'" says Couper.

You might also consider turning the question around and asking, "Where do you see me in five years?" Says Couper, "Sometimes the answer to that -- like, 'Well, we'd expect you to keep doing the same thing we hired you to do' -- is a good way to spot a dead-end job."

Myth #2: If the company invites you to an interview, that means the job is still open.

Alas, no. In fact, the job may never have existed in the first place: "Some companies use 'interviews' to do market research on the cheap. They ask you about your current or recent duties, your pay scale, and so on, to get information for comparison purposes." Another possibility, Couper says, is that "they may already have a strong internal candidate in mind for the job but just want to see if they come across someone better."

If you get an interview through a networking contact, he adds, "an employer may interview you simply as a courtesy to the person who referred you, if that is someone they don't want to disappoint."

Even if the job opening is phony, it's still worth going, he says: "Sometimes they discover you're a good fit for a different opening that really does exist. You never know where an interview might lead."

And the #1 myth about job interviewing: The most qualified person gets the job.

In at least one crucial respect, a job interview is like a date: Chemistry counts.

"A candidate who is less qualified, but has the right personality for the organization and hits it off with the interviewer, will almost always get hired over a candidate who merely looks good on paper," Couper says.

What can you do if you suspect you're not knocking an interviewer's socks off?

"At the end of the discussion, you'll probably be asked if you have any questions," Couper says. "If you sense the person has reservations about your style, ask what the ideal candidate for this job would be like." Then think fast. Can you talk a bit about how you fit that profile? "Addressing any concerns the interviewer might have, beyond your formal qualifications, is your chance to seal the deal," Couper says.

Thursday, 18 November 2010

Here's a job with surging salaries in Asia...

Ananya Mukherjee

Crystal ball gazing suggests good times ahead for the wallets of compliance professionals in Asia Pacific next year.

As a consequence of an existing talent shortage and rising demands for their skills in a changing regulatory environment, base salaries for compliance professionals are predicted to increase in 2011, especially in investment banking and private banking.

Compliance candidates who have Asian, European and American regulatory exposure in monitoring, surveillance, and anti money laundering are the most in demand, says Clem Cull, associate director, banking and financial services, Ambition Singapore.

In particular, firms are looking for mid-level compliance professionals at AVP level, whose salaries in Singapore are typically between S$65k and S$115k, according to Chris Mead, general manager of Hays Singapore.

Singapore-based compliance staff should expect salary rises of approximately 10 to 15 per cent next year. “We should expect further salary pressures in the post-bonus season,” says Ben Batten, head of Kelly Selection, Singapore. Continual regulatory changes in the banking sector will help fuel demand for talent, he adds.

Hong Kong is likely to witness salary hikes of between 8 and 10 per cent, says Stefanie Nitze, consultant, Taylor Root Hong Kong. But when a bank is desperate to retain or recruit, pay could jump by as much as 30 per cent, she adds.

Firms in Hong Kong are increasingly looking for senior compliance professionals who demonstrate strong influencing and interpersonal skills. They must also have the ability to integrate with the business and identify balanced solutions that are in the interests of the client, the organisation and the regulator, says Sarah Poon, consulting manager, Kelly Selection, Hong Kong.

Interestingly, although candidates with knowledge of local regulations are favoured, the talent shortage means that in 2011 firms in Hong Kong and Singapore will increasingly search outside Asia for staff, with the US, UK and Australia being the main hunting grounds.

Wednesday, 17 November 2010

The Beginning of the End?

Dan Caplinger

Investors are used to the stock market playing havoc with their quarterly account statements. What many people may be totally unprepared for, however, is having to blame their Treasury bond holdings for big losses this time around.

The quiet crash in long Treasuries
If you're like most investors, you probably haven't been paying very close attention to the bond market lately. After all, stocks have put in a stellar performance since the beginning of September, and despite some shakiness in the last week or so, they've largely managed to preserve their gains.

Adding to the distractions are big fluctuations in commodities. Precious metals hit new highs last week before dramatically falling in the wake of the midterm elections and the finalization of the latest round of quantitative easing from the Federal Reserve. Similarly, after having hit levels against some currencies that hadn't been seen in decades, the U.S. dollar rebounded sharply in the past 10 days, as European tensions again return to the forefront, this time with Ireland in the hot seat.

But underneath all the noise, there's turmoil in the Treasury markets. Just take a look at what's happened to rates in the past six weeks:

* Yields on the 30-year bond have risen from below 3.7% at the end of September to 4.37% yesterday.
* Similarly, after going below 2.4% in October, 10-year bond rates are threatening the key 3% level, currently yielding 2.91%.

If such small rises don't seem like too big a deal, consider the impact they've had on Treasury exchange-traded funds. With a rise of far less than a full percentage point in yields, the iShares Barclays 20+ Year Treasury Bond ETF (NYSE: TLT - News) has dropped more than 10% since the quarter began, while Vanguard Extended Duration Treasury ETF (EDV) has fallen more than 18%. Just about the only investors who are happy with the higher rates are shareholders of the inverse ProShares UltraShort 20+ Year Treasury (NYSE: TBT - News), which have given investors a 22% return in a month and a half.

No panic elsewhere
One reason why no one's talking about a bond crash is that most of the market hasn't seen it. Municipal bond prices have fallen sharply in just the past week, but with just a 5% drop since the end of September for the iShares S&P National AMT-Free Muni ETF (NYSE: MUB - News), the declines aren't anywhere near what Treasuries have seen.

Moreover, prices elsewhere in the bond market have hardly budged. In particular, the corporate bond market has stayed quite healthy, with the iShares iBoxx Investment Grade Corporate ETF (NYSE: LQD - News) down just 3% since September. And among the junk bonds that most people would think of as the riskiest, the SPDR Barclays Capital High Yield Bond ETF (NYSE: JNK - News) has actually risen in price since the quarter began.

What's next
So far, most Treasury traders aren't panicking. Most are simply saying that the move is compensating for the overblown expectations that investors put on the potential impact of QE2 before the Fed announced its actual plan of attack. Mortgage rates remain at record lows, and the market shows no signs of coming to a halt anytime soon. Just yesterday, Procter & Gamble (NYSE: PG - News) joined the growing list of major companies raising cash, while Prudential Financial (NYSE: PRU - News) sold bonds in part to help finance its purchase of a unit from AIG.

But in the long run, the damage from rising rates is extremely unlikely to be limited to the Treasury market. While a healthier economy will support the corporate market generally and especially high-yield issuers, it's important to remember that one of the Fed's most important objectives is to prevent deflation -- even if it causes an inflationary spike later on.

That's likely part of what long Treasuries are catching a whiff of right now, and it's exactly the sort of catalyst that could create unanticipated consequences, either now or down the road.

Tired of getting next to nothing from your bonds? Click here and check out the Fool's free report on dividend stocks, which includes 13 strong candidates to take a closer look at.

Fool contributor Dan Caplinger thinks things are gonna get nasty soon. He doesn't own shares of the stocks or funds mentioned in this article. The Fool owns shares of and has written covered calls on Procter & Gamble, which is a Motley Fool Income Investor pick. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy loves bulls and bears alike.

Is the Rally Over?

by Jane J. Kim

For those investors wondering whether the months-long stock-market rally, after retreating a few steps, has more room left to run, Mark Rylance has some words of advice.

"There's absolutely no way that anyone knows what's going to happen," says the Newport Beach, Calif., financial adviser.

Many investors are wondering whether they should cash out or stay invested. For their part, many financial advisers say they are keeping their clients in diversified portfolios but are making more tactical shifts.

Over the past year, for example, Mr. Rylance has increased the amount of dividend-paying stocks, master limited partnerships and blue-chip stocks to about 25% of clients' total portfolios from about 20% as a way to generate income in an otherwise lackluster yield environment. Now, he's looking at taking some profits given his concerns that the market is "probably overbought."

Many advisers are shifting into alternative assets, such as mutual funds that employ hedge-fund-like strategies to reduce risk and provide steady returns—all with lower correlations to stocks and bonds.

Early in 2009, Jerry Verseput, an adviser in El Dorado, Calif., started putting his clients into managed-futures funds, such as the Equinox Mutual Hedge Fund (MHFAX - News), and energy master limited partnerships, such as the Steel Path MLP Select Fund (EVBLX - News). "Over a five- to 10-year time frame, the equity classes have been correlating more and more," he says of standard-issue stocks and bonds.

For his high-net-worth clients, he has been using "secured income" funds that generate returns by owning income-producing assets, such as privately-held mortgages that are bought at steep discounts. Although investors typically have to lock up their money for at least a year, the funds can generate more-predictable returns.

Other advisers are paring back their clients' stock positions as they hit their investment targets. In recent months, Martha Schilling, an adviser in Drescher, Pa., has been taking profits and investing across other assets such as dividend-paying stocks and exchange-traded funds, closed-end funds, master limited partnerships and real-estate investment trusts.

"They have growth potential, but they also pay you while you wait for the appreciation," says Ms. Schilling, who looks for investments that pay at least 3% to keep up with the historical inflation rate.

Others are outsourcing stock picking to so-called flexible funds, whose managers have the flexibility to move in and out of assets to sidestep market losses. Jody Team, a financial adviser in Abilene, Texas, uses several funds that either employ hedge-fund-like strategies, such as the Hussman Strategic Growth Fund (HSGFX - News), the Hussman Strategic Total Return Fund (HSTRX - News) and the Arbitrage Fund (ARBNX - News), or funds that tend to be more opportunistic, such as the Leuthold Asset Allocation Fund (LAALX - News), as a way to build portfolios that have low correlations to the overall stock market.

Mr. Team is also looking at adding the Pimco Fundamental Advantage Total Return Fund (PFATX - News). About 40% of his clients' portfolios are in such funds, he says, with the rest of their assets evenly split between those that should do well in an inflationary environment, such as gold, energy trusts and Treasury Inflation Protected Securities, or TIPS, and those that should protect clients in a deflationary scenario, such as cash and longer-term Treasurys, such as the Vanguard Extended Duration Treasury Index exchange-traded fund (EDV - News). "Our strategy," says Mr. Team, "is to find true diversification again."

Meanwhile, Femi Shote, an adviser in McLean, Va., has recently been getting out of municipal and government bonds and moving into sectors that are poised to make money, such as the banking sector. "The banking sector has not participated in the recent rally and some may resume paying dividends in the near future," he says. "To take cash out of the market right now is crazy."

Write to Jane J. Kim at

How to Play a Market Rally

by Ben Levisohn and Jane J. Kim

Stocks Have Surged—but Investors Who Want to Lock In Some Profits Now Need to Do It Carefully

Forget "buy and hold." It is time to time the stock market.

For 10 long years, market rallies have ended badly for investors. Now, with stocks up 15.6% in four months, strategists are beginning to suggest that ordinary investors start dialing back on risk.

That doesn't mean dumping shares willy-nilly. With the Federal Reserve committed to flooding markets with liquidity, it still makes sense to be in equities. But "if you've ridden the market up, you might want to do some trimming," says Steven Shueh, managing partner at Roundview Capital.

Some investors may already be starting. The Dow Jones Industrial Average has given up 2.2% from its Nov. 5 high.

The first step is to disabuse yourself of the notion that it's impossible to time the market. It turns out that sometimes you can. When markets are stuck in a trading range for an extended period, selling into strength and buying into weakness can outperform buy-and-hold investing.

If that sounds like sacrilege, it may be because mutual-fund firms have spent decades persuading you to keep your money in their stock funds through thick and thin so they could collect bigger profits.

Consider an investor with a $1 million portfolio on Dec. 24, 1998, the first time the Standard & Poor's 500-stock index was at its current level. But if the investor had merely held on, he would have seen essentially zero appreciation through Nov. 11 of this year. If that same investor instead had sold one-tenth of his portfolio every time the stock market gained 20% and allocated one-fifth of his cash to the market when stocks fell more than 10%, he would have gained about $140,000, according to a Wall Street Journal analysis.

An approach using broad valuation measures performed even better. One metric, the ratio of stock-market capitalization to gross domestic product, tracks the market's value versus that of the underlying economy. An investor with $1 million on Dec. 24, 1998, who sold 10% at the end of each month when the ratio was above 115% and bought stocks with 20% of his cash when the ratio was below 75%, produced a gain of around $365,000. (The average has been about 91%

Of course, investing success depends greatly on when you start. If you had tried the strategy at the market low of October 2002, for example, you would have come out about the same as if you had bought and held.

Throughout this year the market has traded in a band of about 20%—far away from both its 2007 high and its 2009 low. Stocks gained 15% from Feb. 8 to April 23 on hopes that a robust economic recovery in the U.S. would sustain global growth. By July 2, it had dropped 16% to 1022.58, as disappointing economic data fueled fears of a double-dip recession.

Now stocks are up again—but for how long?

Says Tobias Levkovich, head of U.S. equity strategy at Citigroup Inc. (NYSE: C - News): "Investors should be more willing to hedge."

The smartest way to do that now, strategists say, is to switch from riskier holdings to steadier stocks and dividend payers; to embrace "tactical" mutual funds that can jump in and out of asset classes; and to consider bond funds designed to benefit from rising interest rates.

Investors looking for safer stock plays should consider companies that are initiating or boosting dividends, say strategists. Such companies tend to be less volatile than the overall stock market. According to Ned Davis Research, their "beta," a measure of volatility, is just 0.78 versus the broad market, compared with 1.08 for non-dividend payers. (A beta of 1.0 means a stock is as risky as the market.)

Dividend payers may be especially attractive at this stage of the bull market. Whereas non-dividend stocks typically trounce dividend payers during the first leg of a bull run, dividend stocks since 1974 have outperformed by three percentage points during the second leg and seven percentage points during the third, according to Ned Davis Research.

"The biggest headwind for dividend stocks occurs in the very early stages of the bull market, and we're past that in all likelihood," says Ed Clissold, global equity strategist at Ned Davis.

Some dividend boosters in the S&P 500 include Dr Pepper Snapple Group Inc. (NYSE: DPS - News), Time Warner Cable Inc. (NYSE: TWC - News), Starbucks Corp. (NYSE: SBUX - News), International Paper Co. (NYSE: IP - News) and UnitedHealth Group Inc. (NYSE: UNH - News).

Big Tech
The four-month rally has been led by the technology sector: the Nasdaq's 20.4% rise has outpaced the Standard & Poor's 500-stock index's 17.3% jump. Yet the tech sector has a price-earnings ratio of 13.7, only slightly higher than the 13.3 P/E for the market as a whole, according to Thomson Reuters (NYSE: TRI - News) data. Tech also has the fourth-lowest P/E of the 10 major market sectors.

Investors concerned that the rally is overstretched might want to shift away from highfliers and toward the 10 largest tech stocks, which Bank of America Merrill Lynch dubs the "tech titans"—Microsoft Corp. (NASDAQ: MSFT - News), International Business Machines Corp. (NASDAQ: IBM - News), Apple Inc. (NASDAQ: AAPL - News), Intel Corp. (NASDAQ: INTC - News), Hewlett-Packard Co (NASDAQ: HPQ - News)., Cisco Systems Inc. (NASDAQ: CSCO - News), Oracle Corp. (NASDAQ: ORCL - News), Google Inc. (NASDAQ: GOOG - News), Qualcomm Inc. (NASDAQ: QCOM - News) and Corning Inc. (NYSE: GLW - News).

Cisco, in particular, may be a better deal now after Thursday's 16% fall.

"When bad news drives these stocks down, it makes them more

compelling," says David Bianco, head of U.S. equity strategy at Bank of America Merrill Lynch. He notes that as a group, big tech has gained just 4.0% this year, versus 6.6% for the entire sector, and carries a P/E of about 12.8, versus about 16.7 for the others.

The key advantage big tech outfits hold, says Mr. Bianco, is their strong balance sheets, which should help them boost earnings even if growth slows. "They will issue bonds, buy back shares and acquire other companies," he says. "Large tech will benefit from that."

Go-Anywhere Funds
Investors who wish to take some profits on stocks and redeploy it elsewhere should consider "tactical allocation" mutual funds that allow managers to jump into and out of asset classes at will.

When the stock market trades in a band, as it has for the past decade, these sorts of funds can perform well. According to data from investment-research firm Morningstar Inc. through October, "world allocation" funds have returned 5.08% annually over the past five years and 5.78% annually over 10 years, compared with the S&P 500's 1.73% annualized gain over five years and an annualized loss of 0.02% over 10 years.

Some tactical funds handily beat traditional equity funds during the financial panic. "There were many investors in 2008 and 2009 who were disappointed by how little their fund managers could do to react to or react ahead of what was developing," says Loren Fox, senior analyst at research firm Strategic Insight.

So far this year, financial-services firms have launched 28 world allocation funds, according to Morningstar.

Steven Roge, a portfolio manager in Andover, Mass., has been moving more of his clients' money from traditional equity funds to flexible funds—such as IVA Worldwide Fund (IVWIX - News), Pimco Global Multi-Asset Fund (PGAIX - News) and FPA Crescent Fund (FPACX - News), among others—because of the managers' ability to make swift asset-allocation decisions and their use of derivatives to reduce risks.

"Asset allocation plays such a big part in the return of the portfolio that we could probably add 2% to 3% more in returns with less downside just from the timeliness of the shifts in asset allocation," says Mr. Roge, who estimates that about 40% of his clients' portfolios are in flexible funds, up from about 12% a few years ago.

The Goldman Sachs Dynamic Allocation Fund (GDAFX - News), launched in January, aims to shift between asset classes based on volatility. If, for example, the volatility of the S&P 500 increases, the fund would pare stock holdings.

"By taking some risk off the table as asset-class risk increases, that potentially sidesteps some of the downward movement in the market," says Theodore Enders, portfolio strategist at Goldman Sachs Asset Management.

Tactical funds can be unpredictable. The $25 billion Ivy Asset Strategy Fund (WASAX - News), for example, held an 80% net equity position at the beginning of 2010, then pared it back to 18% at the end of February, only to ramp it up again a few months later. "If you have a fund that's changing its asset allocation frequently, it can be difficult to know how to position the other funds in your portfolio," says Kevin McDevitt, a Morningstar analyst.

Note, also, that fees for these funds can be high. The Direxion Spectrum Global Perspective Fund (SFGPX - News), for example, has annual expenses of 2.55%.

Rising-Rate Funds
A typical move after a powerful stock rally is to sell shares and buy bonds. But with the Treasury markets surging to record highs recently, putting more money there could be even riskier than leaving it in stocks.

The Fed is buying Treasurys now, but not all maturities. When it said last week it would avoid 30-year bonds, their prices promptly tanked. That could be a hint of what's to come once the Fed stops buying other maturities. Its ultimate goal, after all, is to juice the inflation rate. Rising inflation is usually bad for bonds.

Instead of Treasurys, investors should consider "floating rate" funds, which buy variable-rate corporate loans—and therefore collect more money when rates rise. In 2003, for example, when the Fed started raising rates, floating-rate funds gained 10.4% while short-term bond funds gained 2.5%, according to Morningstar.

There are at least 31 open-end funds and 10 closed-end funds to choose from. Morningstar's picks in this category include the Eaton Vance Floating-Rate Fund (EVBLX - News) and the Fidelity Floating Rate High Income Fund (FFRHX - News), which boast experienced management teams and solid track records.

Warren Ward, a financial adviser in Columbus, Ind., says he is considering the Fidelity Advisor Floating Rate High Income Fund (FFRAX - News) for his clients because of manager Christine McConnell's experience through up and down markets. Another plus: The fund holds a considerable amount of cash, which should allow it to meet any redemptions without having to sell securities, he says.

"If rates rise, floating-rate funds offer investors some protections," says Mr. Ward. "I would like to say go into bonds to get yourself out of stocks, but I think they're more risky right now."

Write to Jane J. Kim at and Ben Levisohn at

Time for Anti-Inflation Planning

by Dave Kansas

The Federal Reserve has unleashed its latest effort to goose the economy, dubbed Quantitative Easing 2, and global stock markets have cheered. When you announce plans to print $600 billion and "throw it at the problem" people can show a tendency toward giddiness.

Now, less than two weeks after the Fed announced QE2, some of the giddiness is giving way to consternation and unease. In the run-up to the G-20 meeting in Seoul this past week, Germans, Chinese, Brazilians and Russians (anyone left?) all made strong complaints about QE2, arguing that the printing of still more dollars could destabilize the global economy. Fed Chairman Ben Bernanke countered that the Fed's job is to focus on the U.S. economy, not everyone else's. Translation: "We'll do what it takes, and the rest of you can pound sand."

The unease emanating from QE2 is the specter of inflation. And while inflation remains a distant concern, it makes sense to start thinking about firming up the inflation defenses in your portfolio.

One reason to tread carefully on this issue is that a number of smart economists argue that inflation isn't a real worry, and won't be any time soon. The main evidence: Japan.

Since the early 1990s, the Japanese have spent huge sums and embarked on several clever QE-style strategies. Today, the country faces deflation concerns, not inflation issues. Similarly, easy money during the past two-plus years hasn't led to inflation problems in the U.S., despite frequent warnings.

And yet, inflation signals continue to bubble to the surface. Gold, considered a store of value in inflationary times, soared to a fresh string of records after QE2 was announced and now trades above $1,400 an ounce. Prices of other commodities, including industrial metals, agricultural products and oil, also have jumped to new highs. The faltering dollar is both helping drive commodity prices higher and raising the possibility of imported inflation.

"At some unknown point, easy money turns into excess leverage, reduced deflation risk becomes inflation fear, fiscal stimulus becomes sovereign credit risk," says the J.P. Morgan Chase asset-allocation group in a recent note. "We can't tell where this turn comes, but history warns us it tends to happen suddenly and violently. As investors, you can't always focus on tail risk, but it makes sense to tilt portfolios toward them."

Even the midterm elections could contribute to inflation expectations. "Higher inflation would help push the unemployment rate down and, most importantly, inflation would help reduce our debt burdens in nominal terms as we pay off our fixed obligations with cheaper dollars," says Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "The jury is out on whether or not [QE2] will ultimately spark inflation. The key thing to remember is that Washington policymakers, divided or not, can all agree on inflation."

So, what to do? Given that inflation isn't at anyone's doorstep, despite howling from some quarters, you should act with prudence and not haste. Most professionals recommend edging your portfolio toward beneficiaries of inflation, which usually include commodities, real estate and stocks. Some also recommend starting or adding to a position in Treasury inflation-protected securities, or TIPS.

TIPS are the most direct way to guard against inflation, and earlier this month an auction of 10-year TIPS had enormous demand, resulting in a record-low yield. That means investors are exceedingly confident that the Fed will succeed in its bid to spark inflation, but it also means TIPS aren't exactly cheap these days.

Advisers recommend that investors hold 5% to 10% of their investment portfolio in commodities, partly as an inflation hedge. This is probably good advice. Food prices are expected to keep rising in 2011, along with oil and metals.

Real estate and equities are tougher calls. The U.S. real-estate market remains moribund and is unlikely to start improving until the jobs situation gets better.

During the inflationary 1970s, however, real estate proved itself as a potent store of value. The J.P. Morgan Chase asset-allocation group believes that QE2 will drive money into real estate and stocks since the Fed is eager to produce some sort of reflationary "wealth effect" that would spur more consumer spending. While it may be tough to go out and buy a house, a REIT fund can provide diversified exposure to the sector.

In terms of stock investing, tilting toward more economically sensitive stocks makes sense if the Fed is to succeed in reflating the economy. Technology, a group which has reasserted leadership in the past two months, is another favored sector among inflation fretters.

Underscoring the complications of investing in a Fed-driven economy is knowing what to do when the Fed's work is done. When will that be?

Not any time soon, it would seem. The Federal Open Market Committee has said for 14 consecutive policy meetings that it will keep short-term interest rates (nearly at zero) low for an "extended period of time."

Meantime, as they teach the young folks on Wall Street, don't fight the Fed.

Write to Dave Kansas at

Thursday, 11 November 2010

Death of the salesmen: Why private bankers should no longer be product pushers

Simon Mortlock

Eliminate sales targets, stop product pushing and don’t hire juniors for client-facing roles – that’s how the private banking sector should knock itself into shape, says Jean Pierre Cuoni, founder and chairman of EFG International.

The financial crisis has highlighted the potential dangers of a sales-driven private banking model. “Products were ill sold by people who didn’t understand what they were selling, which created disappointment,” said Cuoni, speaking at the recent Private Banker International Wealth Summit in Singapore, organised by VRL.

An aggressive sales culture in a private bank should be stamped out, he addded. “It puts you on the wrong path. You become a salesman. You should be an entrepreneur, a businessman, not a salesman.”

At some larger firms (not EFG, Cuoni hastened to add) private bankers are misused as distribution channels for the investment bank’s products. The Chinese wall that traditionally existed between the two divisions has broken down. “Selling is the name of the game irrespective of whether the client needs it.”

Cuoni continued: “Your bonus, promotion is going to depend on how much investment banking product you sell. This is wrong. It’s not putting the client first and is putting the private banker in a difficult position.”

Instead, bankers need to devote as much time as possible to servicing high net-worth individuals and should “belong to the clients and vice versa,” Cuoni told the conference. The risk of relationship managers jumping ship along with their wealthy customers is worth taking. While EFG lost a few bankers who couldn’t perform during the financial crisis, it has otherwise enjoyed good retention rates.

The firm’s emphasis on relationship building means it is better off recruiting seasoned bankers. “We have no choice but to put experienced, professional people in front of clients…Clients don’t need to deal with clerks who lack authority.”

Bullish Sentiment Creeps Up

Andrew Bond

Since the beginning of September, the bulls have been in charge of the U.S. stock market. The incredible run, fueled by improving economic data, strong earnings reports, and another round of quantitative easing, has sent the S&P 500 soaring by more than 16%, only to be outdone by the Nasdaq's 22% gain as of Monday's close.

The rally has also been broad based as leaders from many different sectors have advanced substantially. Since the end of August, Apple has increased by 31%, ExxonMobil is up 19%, and Goldman Sachs has run up by nearly 24%.

However, bears looking for a ray of light may want to look at the recent American Association of Individual Investors (AAII) sentiment survey. The survey purports to measure the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months.

On Oct. 29, the survey reached a two year high in terms of bullish sentiment, as 51.2% of the respondents said that more upside is to come. The survey had not seen a reading this high since it reached 53.3% in early 2008. In addition, only 21.6% of those surveyed reported that they were bearish. This is the lowest percentage of bears since January 2006. In last week's survey, bullish sentiment was down slightly to 48.2%, but the survey was conducted before the huge market rally last Thursday.

The good news for the bears is this survey tends to be a contrary indicator for market direction. For example, on March 5, 2009, sentiment had reached record extremes of the financial crisis. Bearish sentiment reached 70%, while only 18.9% of investors were bullish. In hindsight, that week marked the bottom, from which the S&P 500 has now advanced more than 80%.

Bullish sentiment highs were reached this year in April, just before the sovereign debt crisis and "Flash Crash" sent the markets into a spiral.

Does this mean the top is in? Not necessarily, but investors should be mindful of extremes of any kind in the market and recognize that no one has ever lost a dime taking profits in stocks that have had a good run. Sure, you may miss some additional alpha, but there are always opportunities to find new winners. So get your powder ready.

Andrew Bond owns no shares in the companies listed. Apple is a Motley Fool Stock Advisor pick. The Fool owns shares of Apple and ExxonMobil. Try any of our Foolish newsletters today, free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

Tuesday, 9 November 2010

On Wall Street Pay is the Problem, Again

Commentary: Risk-taking still gets rewarded

Given a shot at tamping down risk-taking on Wall Street, did Washington miss out on using a silver bullet?

In a blanket approach, the Dodd-Frank Act attempted to safeguard almost every aspect of financial services: consumer protection, limits on hedge-fund and private-equity participation, proprietary trading, a process to deal with too-big-to-fail firms and so on. There are new rules and more rules, more desk jockeys and bureaucrats.

But there is a glaring omission: pay.

For all of the reformist talk of how Dodd-Frank will squeeze Wall Street's ability to take big risks, the plan ignores the impetus behind that risk-taking.

Wall Street's paycheck machine is undaunted in the face of reform. Bonus pay is expected to rise 5% this year, according to the latest survey from Johnson Associates Inc. Overall compensation is edging up, expected be $144 billion this year, and guaranteed pay packages are back in vogue for so-called rain-makers and heavy hitters.

Average bonus: $130,000

Although bonus levels probably won't top the records seen in the bubble years, they are outpacing revenue growth — up just 3% — as well as profits — which are flat to lower — at big firms. Blackstone Group Inc. (NYSE: FHN - News) is setting aside an average of $3.46 million per employee even though Blackstone lost $223 million in the first half of the year. It made a $339 profit in the third quarter. See list of top compensation at Wall Street firms on FINS.

And Wall Street CEOs have dropped their modesty. Bonuses for the C-level suite are expected to rise 50%.

Time will tell if the rise in pay translates into taking bigger risks. Historically, big paydays usually precede big declines. The tech bubble's fallout shredded Wall Street payrolls, and the end of the housing bubble left the economy in tatters.

Even now, there's concern that pay and risk have become intertwined. The Securities and Exchange Commission reportedly is watching with interest as retail brokers are wooed to rival firms with the promise of 300% bonuses above annual commissions and fees. See report on broker incentives.

The fear is that such compensation schemes encourage brokers to promise clients too much, and get them into risky or inappropriate investments — all in the hopes of hitting targets that trigger big payouts.

If that sounds familiar, it's because it is. Yes, pay was reined in temporarily at big financial firms including American International Group Inc. (NYSE: AIG - News) Bank of America Corp. (NYSE: BAC - News) and Citigroup Inc. (NYSE: C - News). But the restrictions were light and will be lifted once the banks pay off their government aid.

Lost opportunity

Efforts to curtail pay on Wall Street failed in Congress as the financial industry successfully lobbied lawmakers with claims that lower pay would drive top talent and business off our shores. Overseas, especially in France and Britain, limits on pay have been tougher. But firms there have argued that if U.S. regulators aren't squeezing, why should they?

It didn't have to be this way, of course. With the fire of the financial crisis still burning, lawmakers considered multiple rules tied to pay. And even some in the industry, including Morgan Stanley's (NYSE: MS - News) John Mack, seemed resigned to changes.

A couple of years ago, Mack predicted that pay would become the biggest issue facing the industry. It didn't, and he exited as the firm's chief executive.

In 2009, the Federal Reserve announced a plan to review compensation and risk practices among member banks. But that plan either hasn't been implemented, or it's having a limited effect. The Fed didn't respond to requests for comment.

As late as this summer, 40 members of Congress called on 17 banks including Citigroup, AIG and Regions Financial Corp. (NYSE: RF - News), to claw back $1.58 billion in bonuses paid out while their institutions had received bailout funds. That request was ignored.

At this stage, it's doubtful that any kind of pay reform would be enacted. Republicans already have promised to roll back many of the provisions of Dodd-Frank. Democrats, including Rep. Barney Frank (D-Mass). and Sen. Chris Dodd (D-Conn.), appeared to be sympathetic to banking interests when the issue was raised.

That's a lost opportunity for the safety of our financial system. Pay restrictions aren't about punishing Wall Street; they're about aligning compensation with risk. Clawbacks and deferred pay would make bankers and brokers more accountable for their short-term positions if those positions turn out to hurt the firms, and the economy, in the long term.

Compensation reform is the coldly efficient silver bullet that remains in the holster.

Congress may be hard-pressed to control Wall Street bankers. Yet when they had a chance to control the one thing that bankers care about — their wallets — lawmakers blinked.

David Weidner covers Wall Street for MarketWatch.

Be nice, begs Wall Street

NEW YORK - The captains of Wall Street yesterday begged regulators to cushion the blow from a sweeping regulatory reform Bill that is expected to squeeze profits from some of their most lucrative franchises.

Two years after a severe credit crisis that was in large part of their own making, top financiers met yesterday at a conference held by their lead lobbying group where they vowed to help "shape" reforms still being hammered out.

Morgan Stanley CEO James Gorman complained at the annual meeting of the Securities Industry and Financial Markets Association (Sifma) about polarising anti-Wall Street "rhetoric".

Sifma represents hundreds of securities firms, banks and asset managers, including Morgan Stanley, JPMorgan Chase, Goldman Sachs and Bank of America.

Just days after an election handed Republicans control of the House of Representatives, Mr Gorman appealed to the public to give markets more time to recover.

"The financial system nearly shut down. It's only two years on. You need a little bit of patience to rebuild, to accumulate the capital you need," he said.

The giants of US finance are still finding their footing after the 2007-2009 crisis that shook the world financial order, tipped the US economy into a deep recession and ushered in a global move toward stricter oversight, he argued.

Another senior banker at the event blamed lax mortgage lending for a housing market crash that he called "avoidable". Said Bank of New York Mellon CEO Robert Kelly: "We need good national standards for mortgage underwriting. The banks should own 50 per cent of the paper, with the other half sold through a privatised securitization process."

US President Barack Obama in July signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, imposing tough new rules for banks and financial firms. These are being put into practice now by regulators under tight deadlines.

Republicans who won control of the House have vowed to try to soften parts of Dodd-Frank, but face an uphill climb against a continued Democratic majority in the Senate.

Sifma president Tim Ryan said his group wants to help flesh out the "Volcker rule" in Dodd-Frank on risky bank trading. The rule curbs "proprietary trading" by banks; limits their involvement with hedge and private equity funds; and caps domestic expansion by the largest banks.

"The important aspect of this set of rulemaking will be how regulators define what activities are deemed 'proprietary' and thus prohibited," he said. "Our focus here is to help Treasury determine what qualifies as proprietary trading." REUTERS

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