As Fall Arrives

Ah, the changes that come with the start of the school year! My son’s move up to middle school means a different bus schedule…much earlier! But if getting up earlier is the worst we face, things are pretty good.

I wish the changes we face in the economy and the financial markets were no worse.

Short Review: Earlier in the summer I told you we were in the third phase of a recovery. The first phase began with the government stimulus that started in late 2008, the unprecedented spending and borrowing to reflate the economy. The second phase comprised inventory rebuilding. Businesses had slashed inventories aggressively during the downturn and needed to restock. The third phase involves the handoff to the private sector to grow the economy. That handoff, and its success, of course is only possible when businesses have sustained demand, creating the need to bring back employees, add production, and increase spending. This last phase is a dicey proposition. It’s not clear whether the demand, and so the recovery, is real.

There are three possibilities: the recovery is real and economic growth accelerates; the recovery is tepid and we slog along; the recovery is not real and we slide into another recession, the double-dip.

The latter two scenarios would come from an economy losing steam. And indeed, some economic Indicators suggest it is losing steam. At this point in prior recoveries, GDP (economic output) has continued to increase. But we are facing slowing growth and lowered forecasts of earnings for businesses in future quarters.

The economic news has affected the U.S. stock market dramatically. As of September 1st, the S&P 500 Index lost 4.7% in August and is down 5.9% for the year.

It’s not that businesses are in bad shape. On the contrary, many have a lot of cash, lower debt, and are paying dividends. But sentiment is working against the stock market. The confidence of investors and consumers is not growing. You know that; you’ve told me that. Add a slowing economy to weak investor sentiment and market contraction seems inevitable. We may be seeing that right now.

But in a low-growth economy, the market does present opportunity. Dogged by economic uncertainties, the market will go up and go down, seemingly for little reason. These fluctuations are the fits and starts that I’ve mentioned are to be expected.

Clarity will come. Warren Buffet has said that in the short term the stock market is a voting machine. Right now, the votes are still being tallied. But in the long run the stock market is a weighing machine – weighing the value of products and services to enrich our lives and create wealth. And I am optimistic about this long-term prospect.

Two tiny examples illustrate the inevitable growth of demand—and the economy—in the long term.

In India, hundreds of millions of people used to brush their teeth with a wood reed. Now, more and more everyday are using a toothbrush and toothpaste. Regardless of the current state of things, those people are not going back to using a reed. They will increasingly demand toothpaste and toothbrushes—and many companies around the world will provide them.

In China, hundreds of millions of people are getting access to cell phones. They are like laptops or netbooks in the U.S. Many people have two or three. The cell phone is the cheapest way, for example, for the children of farmers, who have moved to the cities for work, to stay in touch— with each other and back home—and for the farmers to check markets and prices for their crops. These people will not give up cell phones, and they and increasing numbers of others will continue to demand accessibility to cell-phone service. That means a lot of technology and infrastructure to build and increasing other demands to be met, and many companies are going to be busy meeting those demands.

Neither in India nor in China will people be willing to go backwards and give up the gains from new ways, new technologies. They have growing wealth and will demand products and services to spend it on.

So, what does the fall bring us besides an earlier wake-up? Yes, some short-term uncertainty or pain, but also opportunity for the future. That means continuing to invest in equities for the long term and continuing to work on getting the right allocation of investments. Depending on your timeframe, it means keeping the right amount in U.S. equities and foreign equities for long-term goals, utilizing fixed-income for short term needs, considering assets that are not correlated directly with the market, and understanding the impact of potential tax law changes.