The Issue of Safety

 Last weekend I wrote a little about what I consider to be the importance of establishing streams of income. I included the statement: "I believe that creation of diverse streams of income can be a critical element in assuring financial comfort." One anonymous blogger apparently mentally added the word "safe" to my statement when he (or she?) wrote: "Safe income streams that should be part of every ones portfolio has now become a myth exactly like the buy and hold strategy. That strategy has really been a myth for as long as I can remember. Not even the safest of all investments, Money Market funds, are immune to loss."

No one, least of all I, suggested that any specific income stream was completely safe. In fact, as far as I can tell, nothing in this world is safe. Breathing can be dangerous depending upon what is in the air we breathe; looking both ways when we cross the street doesn't absolutely insure that we won't get run over; putting helmets on our kids when they are engaging in activities may reduce the likelihood, but it doesn't prevent head injuries. Risk is everywhere and it is certainly present in trading and investing. I wrote "Trade Your Way to Wealth" , in part, at least to show readers where the risk is and ways to reduce or manage risk in their investments.

In my new book, "Smart Investors Money Machine" , I demonstrate a wide variety of ways we can create streams of income, but I also try to discuss risks associated with each strategy. In my view, one of the important ingredients in successful investing is knowledge of and management of risk. If the anonymous blogger was under the impression that I think simple diversification makes for safety, I failed to make myself clear. Diverse streams of income, like the helmet on a child, may reduce risk, but they do not remove it. Nothing removes all risk.

Recently a neighbor asked for some coaching as he was re-entering the investment world. He told me he wanted something safe with a very high income flow. I said I thought that is probably what everyone wants, but the combination is very difficult, if not impossible, to find. As a generality, the higher the potential reward the higher the potential risk and vice versa. Only by gaining knowledge can we make decisions and implement plans that help us manage the risk no matter what we are doing.

More Bank Misery Sinks Stocks

The stock market flirted with its dotcom-era low but trimmed its losses to miss that mark on Friday, capping an otherwise dismal week in which fears of nationalization of major U.S. banks gripped trading floors around the world.

New assurances that nationalization is not in the cards helped the market a bit Friday afternoon. But the matter looms large in the minds of many investors who wonder whether circumstances will eventually dictate a change of plans.

The Dow Jones Industrial Average was off almost 220 points at its intraday trough, which put it slightly below its closing low set in October 2002 after the Internet bubble burst. It ended down 100.28 points, off 1.3%, at 7365.67, less than 80 points above the 2002 low.

On the week, the Dow industrials declined by 6.2%, the worst weekly decline since the week of October 10, 2008, when the Dow fell by a harrowing 18%.

"We don't have investors," said Alan Valdes, a trader with JJB Hilliard, W.I Lyons. "We have flippers and some traders, but no investors."

Bank of America and Citigroup, the two lenders traders fear are most prone to government takeover, fell 3.5% and 22%, respectively. Citi closed at $1.95. A federal takeover of either bank would likely wipe out shareholders, traders fear.

Senate Banking Committee Chairman Christopher Dodd said nationalization of some banks may be needed "at least for a short time," Bloomberg reported. The Obama administration has deflected nationalization talk, saying it wishes to see major banks remain in private hands. The government holds large quantities of best stock in many banks through the Troubled Asset Relief Program.

Bank of America CEO Ken Lewis told Dow Jones Newswires that the bank continues to be profitable. "We see no reason why a company that is profitable with strong levels of capital and liquidity and that continues to lend actively should be considered for nationalization," he said.

"Speculation about nationalization," he said, "is based on a lack of understanding of our bank's financial position as well as a lack of appreciation for the adverse ramifications for our customers and the economy."

Spokesman Robert Gibbs reiterated the White House's stance that the banks should remain in private hands, saying that the administration "continues to strongly believe that the privately held banking system is the correct way to go."

Stephen A. Lieber, chief investment officer at Alpine Woods Investments in Purchase, N.Y., said that his firm is holding on to shares it owns in Bank of America and other financial bellwethers, taking comments like those of Mr. Gibbs at face value.

Associated Press

Dilip Patel, left, and Glenn Carell, both of Bear Wagner Specialists, on the floor of the New York Stock Exchange Friday.

"Everything we've heard points toward the idea that nationalization would be inconsistent with our national goals," said Mr. Lieber. But he addded: "Now, whether an absence of nationalization is consistent with reality is a different matter. We'll have to see."

The banks weren't the only blue chips getting battered. General Electric, the industrial bellwether that also has large financial exposure, slipped under $10, falling roughly 6.7% to $9.38. GE shares have been clobbered along with the banks and are off 42% for the year to date. General Motors fell 12%; its market capitalization slid under $1 billion intraday.

Adding to the frenzy in the markets, traders were scrambling to settle expiring options bets -- a process that often adds volatility. The Chicago Board Options Exchange Volatility Index jumped 4.8%.

Puts, or the right to sell banking top stocks, have ratcheted up for the better part of a month. Moreover, short-interest levels for banking stocks such as Citigroup, Bank of America and even General Electric have moved higher in the past two weeks.

"It's basically impossibly hard to call a bottom for bank stocks. And with the inability of the marketplace to pinpoint any base value for banks, the loss story and capital erosion picture continues to drive shorts," said Craig Peckham, equity trading strategist with Jefferies.

Investors also piled into gold, which settled over $1000, and Treasurys. The yield on the 10-year note was 2.79%.

Other stock yardsticks fell Friday. The S&P 500 Index declined 8.89 points, or 1.1%, to 770.05. The broad gauge's financial sector slipped 1.5%. The Nasdaq Composite Index dipped 1.59 points, or 0.1%, to 1441.23.

Gregg Maloney, right, and Charles Solomon worked on the floor of the New York Stock Exchange Friday.

Markets also sank overseas. Japan's broad Topix index closed at the weakest level in over 20 years Friday. The FTSE 100 fell 3.2%, leaving it off more than 7% this week. The pan-European Dow Jones Stoxx 600 sank 3.5% Friday and lost 7.5% on the week.

Few financial stocks were spared from the selloff. Wells Fargo shares were off by 9.2% and shares of Morgan Stanley were down 2.5%. UBS, which is being pressured by U.S. officials to disclose the identities of thousands of U.S. clients amid a probe of secretive Swiss accounts, saw its U.S. shares fall 8.2%.

Shares in Axa fell 16% after Standard & Poor's downgraded its outlook for the French insurer to negative, predicting a material decline in profitability as the current crisis weighs on Axa's capital position. Other insurers, like Genworth Financial and Hartford Financial Services Group, also slumped on Friday.

Shares of mining giant Anglo American plunged 17% after it reported a 29% fall in profits, halted payouts to investors and said it would slash 19,000 jobs to cope with the global economic slowdown. Home-improvement retailer Lowe's lost 6.6% after it said net slid 60% amid falling sales and margins as economic pressures continued to sap consumer spending.

In economic news, U.S. annual inflation vanished for the first time in over half a century, a government report showed, as the severe recession and sharp drop in energy prices led to a rapid reversal in price pressures. The consumer-price index climbed 0.3% in January from December, when the CPI fell by a revised 0.8%, but was flat when compared to the same time a year earlier.

 

Hot Stocks 2009

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