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The Independent Investor: R2D2 and the Stock Market

By Bill SchmickiBerkshires Columnist

Tuesday's "flash crash" precipitated by a fake tweet attributed to a major news organization is old news by now. No long-term investors got hurt in the debacle and by the end of the week it was business as usual in the nation's exchanges. That doesn't mean it won't happen again and again.

In just four minutes, $136 billion was erased from the S&P 500 Index, the main benchmark average of the stock market. The Dow lost 145 points at the same time. Both averages regained those losses over the next two minutes causing some traders to check whether the elevator ride was real or a computer glitch. It was neither.

Having a front-row seat to the now-notorious tweet from the hacked Associated Press account claiming that the White House had been bombed and the president injured, my first reaction was to check its authenticity. I guess human nature is a lot more cynical than computers because in the time required to determine the tweet had been a hoax, billions in securities had changed hands.

Although no one is completely sure exactly what happened, we do know that the brunt of the decline was caused once again by algorithmic trading programs, which are these proprietary software trading systems that are lightning fast and take advantage of minute disparities among stock prices. The newest wrinkle in these high-frequency platforms involves computer scanning for key words among various news agencies.

Computers are now programmed to search out words that may impact stock price movements. In this case, words such as White House, explosions, bombs and injuries could and did trigger a sell program among Wall Street's R2-D2s and C-3POs this week. Once the ball started rolling downhill, armies of computers began spewing out sell orders instantaneously. Once the truth was discovered, these same computers stampeded in the opposite direction. This is what most observers believed happened this week.

It wasn't the first time. In May 2010, the now famous "flash crash" occurred. It erased $862 billion from the market's value in less than 20 minutes. Last year, the same kind of computer glitch wiped $440 million off the books of one trading firm and sent it to the brink of bankruptcy.

Regulators have been working to safe guard the public from these on-going speed traps. Under what is called the "limit/up-limit/down system," trades in stock prices will gradually be limited to a certain percentage range above and below the average price of a stock over the last five minutes. It will act as a speed bump. It won't be perfect but could at least slow down the declines we have experienced from seconds and minutes to hours or more.

That may just be wishful thinking on my part. More and more of the trading in the stock market is done by these "algos," as they are now called. It has changed the nature of the stock market and has precipitated the demise of many day traders that are simply outgunned by these R2-D2s. What worries me most is that some day in the future these systems may accidentally short circuit in a big way and suddenly we are all looking down the barrel of a financial death star.

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.

     

The Independent Investor: Insider Trading Alive & Kicking on Capitol Hill

By Bill SchmickiBerkshires Columnist

It happened while most of us were focused on paying our taxes. By unanimous consent, both the House and the Senate repealed a portion of the Stop Trading on Congressional Knowledge Act (The STOCK Act) in just 30 seconds with no debate or discussion. President Obama signed it into law on April 14 — shame on them.

I should have known it was too good to be true. Readers may recall my December 2011 column where I celebrated the passage of the STOCK Act, which made it illegal for congressmen and their staffs to profit from insider information just like the rest of us. It was one of the few actions of a do-nothing Congress (their approval rating at the time was just 9 percent) that I applauded as overdue and a step in the right direction.

It wasn't the first time I had written about the insider profits both senators and Congressmen had been making over the years. In my May 2011 column "Gordon Gekko Should Run for Congress" I explained:

"On average, the lower house members beat the market by about 6 percent a year while those of the higher chamber wrack up a 10 percent level of outperformance annually. Now, if you believe that's purely coincidental, well, I have a bridge I can sell you cheap."

Shortly before my second column on the subject, a "60 Minutes" report brought national attention to this scandal, highlighting profits made by political figures such as Democratic Senate Majority Leader Harry Reid. The public outrage was such that the STOCK Act passed both houses of congress quickly.

I complained at the time that the act was loaded with loopholes. For example, the rules apply to only information obtained by "pending legislation," however, tons of other kinds of insider information obtained from governmental sources such as a regulatory briefing would be allowed. Unlike existing public insider trading laws, which are deliberately broad and vague, the politicians' guidelines are quite specific and narrow.

The original law required extensive disclosure of financial holdings by congressional staffers and 28,000 senior executive branch employees. Our elected officials, including the president, are already required to disclose their financial activities. The disclosures were to be posted in an online database open to the public. This database was an important part of the law since it would allow public watchdogs to quickly identify profitable trading activity by thousands of staffers.

Prior to the STOCK Act, the financial positions of staffers was part of the public record but were not readily available, making scrutiny deliberately difficult. Information had to be requested on a name by name basis from individual agencies. The process was so time consuming and onerous that it effectively blocked the public from obtaining information buried in these records.

In the name of "national security," this new change within the law removes the requirement to create a searchable index of financial trading activity and ownership in an online database. As a result, it makes it extremely difficult, if not impossible, for researchers to monitor compliance with the law or even obtain records of these public employees. In effect, the law has been gutted.

If you are wondering why this modification was passed by unanimous consent in the middle of the night, a year after it was originally passed, consider this. The elections are over and the politicians figure you will forget all about this by the time 2014 rolls around. In addition, a unanimous vote does not require any specific legislator to be singled out by name in this most blatant act of self-dealing.

Oh, and by the way, guess who sponsored the legislative change — your friend and mine, Sen. Harry Reid. Enough said.

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.

     

The Independent Investor: Japan: The Rising Sun, Part II

By Bill SchmickiBerkshires Columnist

The Japanese stock market is the single best performing market so far this year. That's saying something, since we all know that our own markets are hitting record highs on a daily basis. I'm betting this is just the dawn of a new age for this island nation.

Frankly, there is still a lot of skepticism that the Japanese have finally turned the corner. There have been so many false starts since their markets peaked in the late 1980s that the last three-plus decades have bred an enormous amount of cynicism from both the Japanese themselves as well as international investors.

On Wall Street there are only a handful of us left who remember the glory days of Japan. I first visited Japan in 1977 as a Fulbright Fellow. In those days the Japanese export miracle was in full throttle. Fueled by an invincible stranglehold on the world's exports markets, the country had transformed itself into the second largest nation in terms of Gross Domestic Product. There was even talk that at some point Japan would overtake the U.S. for the No. 1 spot in GDP.

It all came crashing down as a result of excess speculation, missteps in government and monetary policy followed by the rise of truly cost effective competition in the form of emerging markets. Japan's decline has been long and depressing. The country's troubles and the private and public sector's attempts to fix them have been held up as a textbook case of what not to do in economic policy. Fed Chairman Ben Bernanke actually did his doctorate thesis on that very subject.

We old Japan hands thought the country's woes could get no worse and then two years ago an earthquake and tsunami devastated the eastern part of Japan. The resulting meltdown of the Fukushima nuclear plant was the final blow. Credit agencies downgraded the country’s sovereign debt to negative, the market sank (the Nikkei was trading at 9,815) and the hit to the economy convinced most investors that Japan’s sun was setting, not rising.

I begged to differ. In June 2011 in my column "Japan: Is the Sun Beginning to Rise?" I argued:

To my way of thinking, here is an economy that is on the eve of a massive stimulus program, a declining currency (good for increasing exports), a corporate sector hell bent on increasing capacity and re-gaining global market share (think autos) and a population that is willing to finance the effort regardless of Moody's outlook on their bonds. In the eastern region, new housing (unlike the U.S.) is in great demand. And unlike our own financial institutions that refuse to lend despite low interest rates, Japan's banks will lend and lend to corporations and individuals in order to help the recovery effort.

What this indicates to me is that a V-shaped economic recovery in Japan is a strong possibility. If I'm right, the stock market is a screaming buy."

Granted it took some time for the country to reorganize, find its footing and develop an alternative direction. In November of last year, new Prime Minister Shinzo Abe was elected, promising a radical new approach (for Japan) to eradicate two decades of stagnation. This year the Japanese government, along with the central bank, has embarked on a huge stimulus program. Although comparable to the type of quantitative easing our own country has employed to lift us from recession, Japan's program is far greater given the size of their economy.

They are deliberately attempting to combat years of deflation by reigniting its opposite. A daunting task since it is far easier to manipulate inflation than deflation within a country. The process has begun. The value of the yen has plummeted, bond yields are rising and the stock market is taking off. Yes, the stock market is up some 13 percent so far this year, but we have to put that gain in perspective. The peak level for their market index, the Nikkei, occurred on December 29, 1989, at 38,957. Today the Nikkei is trading at 13,549.

In hindsight, it took the U.S. market four years to reach its present state of record highs from the bottom of the financial crisis. I attribute that gain to the efforts of our central bank's stimulus programs. In Japan, after 30 years of bottoming, the stock market is just beginning to respond to their central bank's quantitative easing. We still have a long, long way to go before the Nikkei approaches even the halfway mark when comparing record highs.

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.

     

The Independent Investor: Gambling Could Be Your Next Download Application

By Bill SchmickiBerkshires Columnist

Last month, the New Jersey legislature passed a bill allowing regulated online gambling within their state. Nevada already has such a network in place as do several other states. Many state capitals across the nation are also debating the same type of legislation. There is a real possibility that someday soon you may be able to play the roulette wheel from your living room couch.

Depending on how quickly the right to gamble via the Internet occurs, people will be able to bet on casino games from their mobile phones, laptops and other Internet hardware. That has created some concern among those who believe gambling is an addiction. However, state legislatures appear to be ignoring those issues as they forge ahead with plans to legalize this form of gambling. And given the numbers it involves, it is easy to understand why.

Globally, online gambling is worth $30 billion and is expanding at a 2-3 percent rate annually. It is estimated that 51 percent of the world's population partakes in some form of gambling.  At the same time, by the end of 2013, 39 percent of the world's population will have access to the internet. That represents 2.7 billion people.

Both vendors and state tax officials are eyeing Europe as a model for potential U.S. expansion. Europe experienced a 45 percent increase in a total online gambling yield last year largely because Europe has the highest penetration of internet access (75 percent of the population) in the world. More and more officials realize that when you combine the public's desire to gamble along with the growth and penetration of the internet the numbers become staggering.

So as the Internet expands, so do the opportunities to offer several forms of wagering, casino betting and poker. To date, Southeast Asia has been the main driver of growth, followed by Europe. America comes in a poor third, but thanks to the Federal government things are changing here.

The 2011 decision by federal courts that online gambling was not illegal gave new life and impetus to advocates of online betting nationwide. To date, seven states have moved to enact legislation. So far the plans only include casino betting but the real jackpot would be legalized sports betting over the internet.

New Jersey voters approved a ballot initiative for sports betting back in 2009 and Governor Christy signed sports betting into law, but the federal government sued to block it. The case is now being heard before the courts. No matter who wins, the case is expected to go all the way to the Supreme Court before a verdict is final. If the courts decide in favor of sports betting, a boatload of states is expected to push for passage among their own citizenship.

Opponents are afraid the proliferation of sports betting will breed corruption, addiction and tarnish the image of sports figures throughout the sports world. Advocates maintain these arguments are hypocritical at best, pointing to the fact that Americans gamble in casinos, racetracks, off-track betting parlors, and even lotto and other state lotteries but neither crime nor corruption has resulted from these endeavors.

Behind this new development are those old most popular of motivators: fear and greed. A generation ago, Atlantic City, New Jersey, was the only game in town for east coast gamblers. The boardwalk properties generated enormous tax revenues, tourism and profits for the casino owners and the state.

Over the last 20 years, however, there has been an explosion of state-sponsored casinos cutting in on the action. The tax revenues generated by New Jersey and the windfall profits of the Indian Reservations of Connecticut, coupled with inflows of new tourist money was simply too lucrative to resist.

In the case of New Jersey, all this new competition has reduced the "take" on the boardwalk, driving down profitability and state tax receipts as well. Officials fear it will only get worse as new states like Maryland and Massachusetts grant licenses. Internet gambling is a way of turning that situation around.

I suspect it will give a boost to revenues for both the gambling industry and state governments in the short term. However, like the experience of New Jersey casinos, I'm sure internet gambling will reduce both attendance and profits at existing gambling hubs such as racetracks, off-track betting parlors and the like. In the end, we may simply see a shift away from physical betting to internet betting without much of a change in the dollar value of the betting.

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.

     

The Independent Investor: An Educational IRA for Kindergarten and Above

By Bill SchmickiBerkshires Columnist

Most savers are familiar with state-sponsored 529 Plans, a tax-advantaged savings plan to help put your children through college. However, there is another savings plan that could assist you in meeting the bills for school Grades 1 through 12 as well as college. It is called a Coverdell Education Savings Account (ESA).

This plan is ideal for families with multiple children or who want to start saving for their children's educational needs early in their lives. In addition, if you are thinking of sending your child to an independent or private school (or prep school) prior to college then this ESA is meant for you.

You can contribute $2,000 annually to an ESA, although similar to a Roth IRA, contributions are not tax deductible. However, the earnings on contributions and distributions are tax-free as long as they are used for educational purposes. The tax-free money can apply to tuition, room and board, computers, laptops, supplies, tutoring and transportation as long as they are legitimate educational expenses. Attendance at colleges, secondary or elementary schools, as well as vocational schools and other post-secondary educational institutions (whether public, private or religious) are eligible.

Take the example of my grandson, Miles, he is 16 months old, lives in Manhattan and faces horrendous future educational costs. His mother wants to begin saving for his education now. I can't blame her. There are kindergartens in the Big Apple that will set you back $40,000, if you are so inclined. Private grammar and high schools could easily cost $100,000 plus.

Now $2,000 a year in savings doesn't sound like much if you live in Manhattan, but it will certainly help and elsewhere it could be a windfall for many lower-income families. If invested properly, five years of $2,000 contributions could generate a considerable amount of money. Money that would certainly pay for some of the expenses every child will incur through high school and beyond.

So what, you may ask, is the downside to ESAs? The $2,000 contribution per year, per student is negligible compared to the $14,000 a year you can stash away in a 529 Plan. There is also an income limit which kicks in for single taxpayers making over $110,000/year and married couples making over $220,000.

You also have to use the money before the child turns 30 years of age, otherwise the earnings (not the contributions) will be taxed and a 10 percent penalty will also be applied. You could avoid that by simply rolling over the full balance to another ESA for another family member.

The American Taxpayer Relief Act signed into law January 2nd removed any lingering uncertainty concerning the future of ESAs. They are here to stay just like 529 Plans. But unlike their bigger more popular brethren, you can manage your ESA yourself while saving hefty expenses that 529 Plans charge.

Many savers have also been disillusioned with the performance of their 529 Plans thus far. That is an important point since many hoped that the growth of these plan contributions would at least match the rate of increase of educational costs, which are about 6 to 7 percent a year.

If one can afford it, most planners recommend that families contribute to both plans. You still have time to open an ESA account and make a $2,000, 2012 ESA contribution. You can also contribute another $2,000 for 2013 if you are so inclined. The paperwork involved is no more onerous than a standard IRA application that you can obtain from most brokers or your local bank. Do your kid a favor, open an ESA today.

Bill Schmick is registered as an investment adviser representative with Berkshire Money Management. Bill’s forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.

     
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