October 10. 2008
What seemed like the longest week in history for many investors finally came to a close with slight gains Friday afternoon that did little to offset the week’s historic losses. Like many others I find myself wondering what the heck just happened, what comes next, and even more importantly, what should we do next. I’ll tell you what I know.
First let me say The Sky is NOT Falling! It just feels that way to investors who bought into the idea of buy-and-hold investing without understanding the incredible level of risk that entails. I have had a few calls from managed account clients this week, but for the most part you all have trusted me to do my job and get your money out of harm’s way, and I think I’ve done that for you as you can see in the Account Update section of this newsletter.
So, if the sky is not falling, what is happening?
This past week also marked the one-year anniversary of the current market downturn. The S&P 500 Index2put in its record high of 1565 back on October 9, 2007. Today, it hit 839, — down 46.3% from its one year old peak. Ugh!
To add some perspective, the average bear market produces declines of 38%. We already have had worse than average market action. A lot of us think the economic problems we face are worse than average, and this stock market decline confirms that. But it also points out that the work of the stock market to get back to fair value has largely been accomplished. The economy may continue to soften going forward, but the stock market is saying it is already very close to its bottom, for a little while at least.
Please keep in mind that the stock market and the economy are two different things. The markets will bottom 9-12 months before the economy does, and long before signs of economic recovery become obvious.
The government – and individuals, too – are pumping cash back into the system with fire-hose force. The individual reaction to the increase in FDIC coverage to $250,000 has been nothing short of astonishing. According to The Federal Reserve Economic Data unit, over $100 billion has gone into “checkable deposits” in the past week alone. This – gobs of cash – will do wonders for the wobbly balance sheets of banks and keep many of them from folding. Score one for the government.
This is the first visible result of the $700 billion Troubled Assets Relief Program (TARP) passed by Congress a week ago. It takes a while for TARP provisions to get implemented, but as each part begins to be put into action, the economy will get a little more traction and begin moving forward again. As distasteful as all the “pork barrel spending” provisions built into TARP are, (the bill went from 3 pages to 421 pages before it was passed so you can imagine the amount of pork buried in there) pork will provide many jobs at the local level.
You can see a concise summary of TARP at http://www.thompsonhine.com/publications/publication1543.html
What Should We Be Doing?
Things will be rapidly turning around in the markets. Just like my warnings in 2007 that a recession was brewing and back then was the time to protect portfolios, not when you read about it in the paper, a number of things make me believe that right now is actually a low risk time to be entering the market.
I know, I know. I sound like I’m crazy for making a statement like that.
Investing seems like a crazy business sometimes, and this is one of those times. How I can I say “low risk” less than a day after the low point in a 46% stock market crash? But if you think about it, a year ago was where the high risk was. Few people recognized it then, but the risk was certainly there. Most of the risk everyone worries about right now is really behind us. It has already happened! That means there is less risk in front of us. So we have the makings for some great low-risk investing coming up very soon. Not no-risk, but a lot lower than we have had in long time.
For those of us with our money in money markets and “cash-equivalent” short-term treasuries, this is a great scenario. Most of our capital has been preserved. The real benefit of that is the increased buying power of our cash positions. Right now we can buy for $100,000 the stocks that it would have taken $170,000 to buy a year ago. This shows the real value of my work.
For buy-and-hold investors that have held on this long, the current situation presents a dilemma since it is impossible to know if they would be better off selling following such a steep plunge or holding through whatever remains of this bear market decline hoping that current holdings eventually recover some of their losses.
My experience is that investments that did the best before a major market shift are not the ones that do the best coming out the other side. Market leadership changes as the realities of a new economic environment become clearer.
What this means for buy and hold investors is that holding on until you are “back to even” can be a losing game. And it can take a long, long time. The break-even point from the 2000-2002 decline was not reached for 5 years.
It is often much easier to recoup losses by selling and recording the tax losses now (might as well get some salve for the wounds) and start fresh in investments best suited for the new market realities.
Since we really don’t know what the future holds, if you have been agonizing over investments held through the decline, and are trying to figure out what to do next, consider selling half and moving that money to a money market fund. If the market does go down some more, that portion of your money will be protected. If the market is bottoming as I suspect, the part that is left invested may bounce nicely. But the key is that you will be protected as well as you can be from either eventuality.
Selling everything at this late date, or being fully invested right how are both high-risk propositions. My advice would be to take a more moderate approach and “hedge” your risks in this manner.
The Purpose of Insurance
I received very few calls this week from my managed clients. Most knew they were “out of the market” and did not worry.
Many more calls came in from folks who had, before this past month, thought that buy and hold was working well enough for them. And, on the surface, it looked less expensive. They had never become sufficiently motivated to hire me to watch and actively manage their accounts.
I often say that buy and hold can work very well, but only about half of the time. The other times, when the markets go down, buy and hold can be a disaster. These days it is being called “buy and hope.”
All of a sudden there is a lot more motivation to consider the low-risk profile of my active management strategies. Business is very, very good at Hepburn Capital. Thanks to all of you who have told your friends about my work.
Standard financial planning advice is that you should always carry insurance for something you cannot afford to have happen. My services are a little like auto insurance for your investments. My fees are very small in relation to the size of the recent losses in the market, just like your insurance premium is small compared to the coverage. You should never cancel your insurance just because you have not crashed your car lately. And you need to have insurance in place before the crash to get any benefit.
If you (or someone you know) have taken big losses in the markets and don’t feel you can afford to take any more, please call for an appointment. I would like to show you how you would have benefited under my management compared to your current holdings.
Humor is the Best Medicine
For an investment pitch worth a few laughs check out http://www.nbc.com/Saturday_Night_Live/video/clips/reliable-investments/698621/
A Great Night Out
Last night, Cathleen and I went to the inaugural performance of the Lonesome Valley Playhouse in Prescott Valley and saw an adaptation of “The Odd Couple”. This version was written for women to play the leads rather than men, and is simply hilarious. This play runs Friday and Saturday through October 18th in a converted warehouse at 8859 Valley Road, in Prescott Valley. For a good time, call (928) 420-3321 to reserve your tickets.
The Silver Lining
Every dark cloud has a silver lining. This dark economic cloud is no different.
Consider that if we all end up working forever, we collectively eliminate the Social Security crisis.
And sharply curtailed credit means fewer credit card solicitations. Yeah!
Holding this investment position stemmed losses in both of these strategies. Flexible income1 is showing losses in the -2% range, and Careful growth1 in the -3% range – no change from a few weeks ago. This means we have 97-98% of our capital intact. The “average investor” represented by the stock market averages has only about 58% of their capital remaining.
At my last writing we were using Treasury-only money market funds which, in my opinion are the safest investment there is. Very stable stuff. But as everyone else bought them too, the yields dropped to ridiculously low levels. One tenth of one percent, .1% to be exact. To get a more respectable yield I moved a large portion of our managed account assets into 1-3 year Treasuries.
As I mentioned earlier in the newsletter, I expect a good low-risk buying opportunity to present itself soon, but for now, think boring.