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Economic and Market Update 1/28/09

Posted At : February 11, 2009 1:36 PM

Economic and Market Update:
– Is the Hope rally sustainable or is it a Bear trap?
– Market Strategy
– Portfolio Repair and Recovey Kit

The markets have been fluttering of late, waiting to see if the stimulus is going to rescue the economy. I would expect that the massive fiscal spending (stimulus) will at least generate some optimism and give a lift to stocks. Could the “Hope” rally finally be upon us, and will it be just a Bear-Trap? The durability of this rally will depend on whether we see an increase in buying interest and not just a drop off of selling pressure. I would err on the side of caution.

The news remains bad and seems to be getting worse. That’s not always a bad thing as the market generally starts to rise 4-6 months before the news gets better. However, let’s take a look at where we are. The US likely just experienced a 4th quarter with GDP down over 4%, and maybe even 5%. Estimates for this year are that we are likely going to be down at least 1-2%, which will make this the longest recession since the Great Depression. Unemployment is likely headed to 9%+. Demographics indicate that consumer spending should continue to drop off, as baby boomers pass their peak spending years, (I discuss this in depth in my Economic Tsunami Special Report) and consumers start to find virtue in savings. Housing price stability will have the biggest impact, but are likely to drop another 10-20%, taking homes back to a level where they may be more affordable. Corporate earnings are going to be dismal for at least the first two quarters, with forward estimates being lowered again and again. Commercial property has not seen much of a drop-off yet, which very likely will be the next big shoe to drop.

The problems described above are very large. It is one thing to make credit cheap and yet another to make consumers either want to borrow more, or be able to convince a lender that borrowers can repay their debts. On the one hand, the government is providing capital to banks and hoping they will lend it, and on the other hand the regulators are telling them to reduce lending and increase their capital. Their commercial mortgages on a mark-to-market basis are imploding. Consumer credit risk is high and rising. Banks are stuck!

On a more positive note, oil is relatively cheap, which is more of a stimulus to consumers than anything anticipated by the incoming Obama administration. With short-term rates at zero, adjustable-rate mortgages are actually not the problem anticipated a year ago, and many homeowners refinancing at lower rates. Large banks have even started to actually cut the principle and interest on troubled mortgages, which might lower the number of defaults. Conversely though, the number of defaults is high and rising — throughout the developed world. It is likely to be 2011 before the housing market finds a real bottom and housing construction can begin to rise.

We are in a serious recession, and we have to allow time for both the housing market and the credit markets to heal, likely at least two more years. P/E ratios will likely decline over time to low double digits as they did in the 70’s. The combination of all three bubbles (consumer spending, credit, and housing), which were made possible by increasing leverage and poor lending standards, is by definition deflationary.

Market Strategy:
We are in a long-term secular bear market, and the investor that ignores this fact or simply ignores their statements and “hopes” for a new Bull Market to just reappear will continue to get punished. One of the great sucker plays since the late 90’s has been the “buy and hold” for the long term strategy. Just look at the returns: from 12/31/99 to 12/31/08, if you invested in an S&P 500 index and held for “the long term,” your total return during this time would have been -28.13%, or an annualized rate of -3.6% per year. In inflation-adjusted terms, the stock market is about where it was in 1973! If you reinvested dividends, that gets you to 1991 (inflation-adjusted). Clearly investors must be nimble and willing to desert old fashion buy and hold asset allocation models to be successful.

Hoping that stocks somehow rebound to new highs and that the economy is going to go back to what we saw in 1982-1999 or 2003-2006 is not a strategy. You need to be proactive and take charge of your portfolio. Simply using a traditional 60-40 or 50-50 split of stocks and bonds is not going to get you blissfully to retirement. Ignoring your statements and waiting for a rebound will cause heart aches while trying to time the market will cause heart attacks.

As an investor, there are three steps you can take to improve your ability to handle the current market:

  1. Actively manage your assets  – Tactically – there are many investments that are doing very well
  2. Develop Reasonable Expectations – Hope may win the Whitehouse, but it is not an investment strategy!
  3. Be the expert or hire one – If your portfolio is not performing well, don’t be afraid to get a free 2nd opinion.

The next year and likely two will continue to be challenging to say the least. I would be looking for absolute-return types of investments for the next several years. Quality corporate and municipal bonds are currently VERY attractive, some in the 7-8+% range, as well as high yielding stocks and preferreds, some yielding even higher. Don’t just buy based on ratings or yield. Finding somone that knows these markets is the key.

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