Stocks, by at least one historical yardstick, appear cheap. Specifically, the stocks that comprise the Standard & Poor’s 500 Index are trading at 13.7 times profits; that is a terrific number when compared to the historical average of 16.4 (from 1954 to the present). Importantly, stocks have remained below that average for more than a year. According to an article at Bloomberg.com, you would have to go back to the Nixon administration to find a time when valuations were this low for such an extended period.

What’s causing this unusual situation? It appears that after the stock market turmoil of the past few years, millions of investors are gun shy. As the article says, “Battered by the 14 percent decline in the S&P 500 since 2000, the worst financial crisis since the Great Depression and the so-called flash crash 21 months ago, investors are staying away from stocks, even after record profits, 10 quarters of U.S. economic growth and promises by the Federal Reserve to keep interest rates near zero through 2014.”

From my perspective as an Investment Advisor, I also see far too much fear about the short term, without an appreciation for the long term prospects.

This period of stocks selling at what might be called “sale” prices won’t last forever. A low valuation certainly does not guarantee instant profits, but speaking for myself, I surely would rather buy when everyone else is selling. Or, at least, scared to buy.

My optimism stems from a fascinating chart I came across in a financial industry publication (Nick Murray’s Interactive, Jan. 2010). Based on statistics compiled by Intrinsic Research, the chart looks at the stocks that make up the S&P 500 – but with all financial stocks removed. (Those would be banks, insurance companies and REITs.)

The chart shows three lines over a ten year period: revenue-per-share, earnings-per-share, and stock prices. In general, revenue-per-share and earnings-per-share are key drivers of stock prices.

As of Dec. 8, 2011, for those stocks as a group, revenue-per-share and earnings-per-share were soaring to all-time highs. But their stock prices were still languishing well-below their high points. That is a strong positive for stocks.

And not shown on that particular chart is that profit margins are at 20-year highs and corporate debt levels stand at multi-decade lows. Those are two additional strongly positive indicators for future gains in stocks and stock mutual funds.

No prediction for stocks is ever more than an educated guess, and a myriad of things could screw things up. But I want you to go into the New Year sharing the cautiously optimistic feeling I have, i.e., that the case for higher stock prices in the coming year appears strong.

And more importantly, can it happen to your brokerage account?

The $1.2 billion figure is the amount that somehow went missing from MF Global, the once little-known firm helmed by former senator, former NJ governor, former Goldman Sachs chief, Jon Corzine. He says he is as shocked as everyone else at this immensely disturbing turn of events.

Regardless of who knew what when, thousands of MF Global investors are walking on eggshells right now as they await the results of various investigations. If nothing turns up, many of those innocent investors may suffer substantial losses.

The whole episode is immensely troubling – and puzzling. All client accounts at brokerage firms are supposed to be segregated from everything else the firm does. There are supposed to be strict controls to make sure that the wall is never breached; the idea is that while your account will fluctuate with the markets, the money itself should be untouchable. Or so I assumed until I read this article in the NY Times. It turns out that in rare cases it is possible for that wall to be breached.

But getting back to the title question – how safe are your brokerage accounts, and specifically, how safe are your investments in Fidelity mutual funds?  As president of a firm that interacts with Fidelity Investments daily, I am sometimes frustrated by their layers of legal requirements. In the long run, however, those procedural hurdles are in the best interests of you, our clients. To put it bluntly – I believe what happened with MF Global could never happen at Fidelity Investments. MF Global was a completely different animal; they focused on high risk trading, while Fidelity does not.  Nor, by the way, do the other major firms such as Schwab or Vanguard.

Most importantly, even if every safeguard at Fidelity failed and client money somehow vanished, your account is insured against fraud, up to $500,000, by the Securities and Investor Protection Corporation. And beyond the half-million dollar SIPC limit, Fidelity has insurance on your account with Lloyd’s of London for an additional $1.9 million per account. (MF Global investors have the same SIPC protection on cash and securities, but not on futures contracts.)

You can read about how Fidelity protects your assets here, on the Fidelity web site.

Yes, the markets will gyrate, and so will the value of your account. But I am convinced that your account at Fidelity is held safely behind a rock-solid wall.

“Any set of mechanical rules cannot take account of the diversity of derivatives and the multiplicity of ways they may be used by portfolio managers,” BlackRock managing directors Joanne Medero and Ira Shapiro said in a Nov. 4 letter to the SEC. “Used appropriately, derivatives can be effective tools in seeking to achieve returns and control risks in funds.”

Here’s a case where we back the SEC and think the industry leaders are wrong.

Mutual funds should be what they originally were – baskets of stocks or bonds watched over by professionals. Period. There is no clear need to muddy the waters with other instruments like derivatives.

Maybe I’m old fashioned. When I started delving deeply into the world of mutual funds in the 1970’s, mutual funds were uncomplicated affairs. Each fund had a clearly described mandate, and they ought to stay that way.

Derivatives have the potential to cause unexpected turbulence. As SEC Chairman Mary Schapiro says, “A relatively small investment in a derivative instrument can expose a fund to a potentially substantial gain or loss––or outsized exposure to an individual counterparty.”

The fund companies (and so far, it doesn’t appear that Fidelity mutual funds are part of this movement) say they need derivatives to help them control risk. To which I say, “No.”  If I want a fund that is fully invested in the stock market, don’t play games. And if I want to control risk for myself or my clients, I can easily do it by either investing in a bond fund or a money market fund. In other words, the funds should do what they are paid to do.

The same concepts, of course, would apply to funds whose objective is lower risk – they can “control risks” without resorting to derivatives. Let’s never forget that the financial crisis of 2008 clearly taught us all that derivatives are not nearly as simple as their inventors wanted us to believe.

And finally, I couldn’t believe it when I read this…

“Provided ETFs offer sufficient transparency, their investment in derivatives should not raise any additional concerns,” said Phillip S. Gillespie, executive vice president and general counsel of Boston-based State Street’s investment-management arm.

Derivatives “should not raise any additional concerns”?! Haven’t we heard that line before? Amazingly to me, they still want us to believe it.

So when it comes to traditional no-load mutual funds “needing” derivatives – I just don’t buy it.

Matthew Hutcheson is, or perhaps I should say – was – a man I respected greatly.  He has been a highly visible leader in the fight to protect employees from retirement plan rip-offs. While I personally tried hard over a number of years to bring publicity to the problems of hidden fees in 401(k) plans (I even had a meeting in the offices of then-Attorney-General of New York, Elliot Spitzer, about the problem), Matthew managed to appear before Congress, telling them in clear and ringing terms that the system was rife with problems. His White Paper on the subject became our go-to resource for understanding some of the more arcane wrinkles in the complicated world of corporate retirement plans.

Now he is suspected of serious wrong-doing, including breaching his fiduciary responsibilities – the very cause he championed. I fully recognize that the allegations made in the article are not convictions. However the story, sadly, does seem to strongly delineate a pattern of fiduciary sloppiness – at best.

My heart goes out to the people who are now fighting to get their hands on their retirement money. 

What could, or should, the employers have done differently?

First and foremost, we have always urged employers to place corporate retirement money with nationally-known mutual fund custodians such as Fidelity, Schwab or Vanguard or at least with a major insurance company (although I am not a fan of their generally higher fee structures). That simple step, instead of placing the money with Hutcheson’s proprietary firm, almost certainly would have precluded the problems now faced by these innocent workers.

If the charges against Matthew Hutcheson prove true, it will be an astonishing fall from grace for a man who, more than almost anyone else in America, should have known better.

Which leads me to a discussion of “relative” vs. “absolute” performance. Some years the markets go up, some years they go down. The important question that needs to be asked is how did you (or your advisor) do in comparison to an appropriate benchmark?

If the S&P 500 Index goes down 10% but your stock accounts go down only 8%, you can reasonably say you did 20% better than the market. Conversely, if the S&P gained 26.5% (as it did in 2009) but your account gained 37.4% (as our Diversified Growth portfolio did that year, after all fees) then you can say you did better than the market. (Past performance does not guarantee future results. This example is not indicative of Weber Asset Management’s long term performance and is used for illustrative purposes only.)

Sometimes you will hear about “absolute” performance. This way of looking at investments is concerned only with the raw numbers, up or down, i.e. “What did I end up with?”

Some advisors say they care only about absolute performance and indeed, their arguments are compelling. After all, if the market stumbles badly, the fact that you lost less might be small comfort.

The problems come in the execution of that quest. To achieve good long-term absolute returns you or your advisor must be willing, in our view, to sacrifice good long-term performance. “No pain, no gain” works for both body building and investments. In other words, to say “I don’t want to risk losing money,” means “I won’t move out on the risk spectrum.” Almost always, over many years, investors who stay conservative reap less than those who accept a higher level of risk. That’s why stocks and stock mutual funds, over the long term, have returned more than bonds and bond mutual funds.

Here at Weber Asset Management we continue to advocate for superior relative returns based on each investor’s appropriate risk level.

That seems to make the choice a no-brainer. But prudence, as always, is necessary.

For one well-publicized example, Chrysler Stable Value Fund B, which was only available to white-collar workers at the number three U.S. auto manufacturer, fell 11% at one point in 2009.  In other words, despite the name of the fund, those employees received only 89 cents on the dollar when the fund had to close down.

Not all stable-value products are the same, but all explicitly seek to preserve principal. In general, the portfolios consist of various types of bonds.  To smooth out the inevitable fluctuations in the underlying investments, they buy insurance “wrappers” which are supposed to kick in when bond prices fall. Some stable-value investments can also be insurance contracts such as annuities issued directly to a company’s 401(k) plan.

Problems tend to occur, however, when everyone rushes for the exit at the same time, and, let’s face it, Chrysler in 2009 didn’t seem rock solid. The lesson is that if it can happen once, it can happen again. Basically, anytime an employer runs into trouble or undergoes a major restructuring, or if bond prices plummet, stable value funds may experience turbulence.

There are other potential problems with stable value funds. As Businessweek magazine recently pointed out (9/29/11), you may face unexpected restrictions on how or when you can transfer or withdraw your money…

“People who use one of the stable-value annuities issued by TIAA-CREF may only withdraw or transfer funds according to a set schedule of 10 payments over nine years.”

That’s pretty restrictive. So while I can recommend stable-value funds under certain circumstances, please be sure you realize that they are not a true substitute for plain vanilla money market mutual funds.

What causes these nerve-rattling moves? Pundits differ in their explanations, but I believe a primary factor is the new widespread reliance on computers to make trades.  These unthinking machines are basically trend-followers, placing huge bets in nano-seconds. They buy and sell based on stock price movements. They are unconcerned with the traditional drivers of stock markets: price-to-book ratios, new products in the pipeline, quality of corporate leadership, etc. 

As a result of these trend-following robots, each trend becomes magnified, for better or worse.

Another factor is the significant increase in the use of Exchange Traded Funds. ETFs, unlike traditional mutual funds, can be traded throughout the day. While this feature is touted as a benefit, we think otherwise. Investors seem willing and able to jump in and out more quickly, often to their financial detriment. Mutual funds, on the other hand, can only be traded at the end of each business day, and in my opinion that helped, in the past, mitigate market fluctuations.

Whatever the cause, the message is clear – you cannot allow the frequent and wild price swings to deter you from sticking to your long-term investment plans. Over a period of months, the markets will filter out the short-term noise and revert to economic fundamentals.

Yes, sad but true – when the economy is weak, hucksters flourish. It makes sense that during periods of economic malaise people seem most willing to let their guard down. “Something,” folks figure, “has to be better than what I’m doing.”

Con artists never disappear, of course. But over the past few months we have seen an unusual flurry of arrests and indictments against financial fraudsters.

Last week the North American Securities Administrators Association (NASAA) released its annual list of fraudulent financial products and practices. While the individual cases are new, the basic themes are all too familiar, with every sales pitch based on greed or fear.

NASAA’s Enforcement Section identified the top ten financial products and practices (five of each) that threaten to trap unwary investors:

Products: distressed real estate schemes, energy investments, gold and precious metal investments, promissory notes, and securitized life settlement contracts.

Practices: affinity fraud, bogus or exaggerated credentials, mirror trading, private placements, and securities and investment advice offered by unlicensed agents.

Each of these is a topic unto itself, loaded with hidden dangers. Let me just give you one sadly funny example from the NASAA, from under the heading Exaggerated Credentials:

• Securities regulators in Utah came across a broker who listed “C.H.S.G.” after his name on his business card. When asked, the broker told regulators the initials stood for “Certified High School Graduate.”

As always, it’s buyer beware. If the pitch sounds too good to be true, it is.

Is this smart? Well, it may be if a) it lets you sleep at night, or b) you will need to start living off some of your managed money within the next five years.

For me personally, I try to add to my stock market positions when markets falter. That strategy seems to have worked well for the second wealthiest man in America.

“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

- Warren Buffett

Right now stock market investors are nervous. Many are, to use Buffett’s term, fearful. But if your investment time horizon is at least five years into the future (and I don’t mean that you will retire in five years, but that you will need to start withdrawing money to live on in less than five years), I believe you should consider bear markets to be buying opportunities. Stocks (and stock mutual funds) are on sale.

Yes, they could very well become much cheaper, but the future is unknowable, and you have the certainty of knowing that right now you can buy into the stock market for substantially less than what the world considered a fair price just weeks ago. Those opportunities don’t roll around too often.

I recognize that it takes some serious internal fortitude to jump in when others are bailing out – and yes, it takes some spare cash, which not everyone has right now – but it does appear that Mr. Buffett has done OK by buying when others are selling.

This is, after all, America, and we have always dug ourselves out of holes. We will again, and those who can buy now, or at least stay in the market, will likely be amply rewarded in the years ahead.