A “Sign of the Apocalypse” to me is that last week Gene Simmons was being interviewed on a CNBC show called “Closing Bell” on the state of the markets. For all of you who know who Gene Simmons is, go ahead and use the napkin to wipe up what water or coffee you just spilled. For those who don’t, Gene Simmons is none other than the famous “devil-y” bass guitar player from the makeup and costume rock group of the 70’s, KISS. Remember KISS? In the last decade he has become a celebrity television staple.

The financial news industry has a single and sole purpose – to sell advertising. The more viewers, the more money they make. How much money can they make if they come on each day and say, “We are in the trough part of the business cycle and will eventually start the growth phase in the future.” That is boring and no one would tune in, and therefore, they would not make any money. Though our current issues are broader than a typical slowdown, their objective doesn’t change.

Some people try to figure out how each news item will affect financial markets during the day. That’s like looking over the edge of the boat to determine how each wave will move your course. You get sick and the boat veers back and forth. I do keep a close eye on the financial news, but if I tried to move the rudder of your portfolio every time with every headline, there would be no long-term gain; indeed, the obverse.

What to look for

In August I wrote a paper, Taking Measure, identifying five keys to consider for a turnaround in the market and economy. They were a stronger dollar, lower oil prices, housing finding a bottom, loosening of credit, and improved corporate earnings. I noted that until we had improvements in all five we would be in for a decline in the economy and financial markets—but having housing values reach a bottom was the most critical.

The Troubled Asset Relief Program was an attempt by the Federal Government to address the credit markets. This one is in the beginning stages and being tweaked as we speak. Not necessarily to the favor of investors or citizens. How long it takes get all five “righted” depends importantly on the actions of the new administration and Congress.

The New Administration

After studying past government intervention during economic declines, I think we can watch for the following actions to shorten or lengthen the time until recovery. If the President and Congress…

…focus a stimulus package on giving dollars to individuals, it will take longer. A stimulus focused on infrastructure development (roads, bridges, etc.) would be a preferable, though not perfect, solution.

…try to “help” people who cannot afford the house they are in, it will take longer. Banks should make this determination because they can get a better sense of whether the homeowner is worth the help (or a house “flipper” caught in the storm).

…force cheap dollars upon solvent companies, it will take longer. This just adds to the deficit and creates a new problem for the future.

…raise marginal tax rates, capital gains rates, and corporate tax rates, it will take longer. Taking money out of the hands of job creators and consumers historically has not worked.

You can see I have not said when I believe we will see an upturn in the economy. I cannot predict that. I have noted some of the markers that will give us an indication. Every piece of news does not carry the same weight. Every new headline does not have the same impact on the markets. Financial news purveyors want you to believe you need to tune in for the next headline. “It may be the big one.”

But that is not how the financial markets and the economy work. The stock market is a leading indicator of the economy. It acts 6–9 months ahead of the economy. Anyway, if we make the wrong policy moves, recovery could be a while. A long while.

Why the current volatility?

Three factors have contributed significantly to the stock-market declines of the last few weeks.

First, investors are taking the new administration at its word. Those with capital gains want to get rid of them at a current 15% tax rate instead of waiting until next year for a 25% tax rate. A 66% increase in taxes is no fun. Investors will pay the lower tax rate for this year and then go back into the market next year at a new cost basis.

Second, large investors (think pensions, hedge funds, mutual funds) are being forced to sell due to policy mandates, bad debt, or withdrawals by jittery investors. For example, a pension plan may have mandate that it cannot own any stock with a value of less than $5 in value. When a holding like Citigroup falls below $5—as it did recently—the pension plan is forced to sell all its shares—which can number in the hundreds of thousands for a single pension fund. These forced sales create a downward price spiral because it dumps the security on a market with no demand. High supply combined with low demand means declining prices. A hedge fund may hold stocks bought on margin—that is, bought with funds borrowed against the value of other securities. If the value of the underlying security drops below a certain level, the investor must add cash to the account–in response to a “margin call” from the broker/lender. If the hedge fund has insufficient cash, it is forced to sell assets it would not otherwise want to sell. Again, this dumps securities into a market without demand for them. Again, high supply plus low demand equals lower prices. Now, if you also hold this investment, the value of your security is down, too, even if you don’t intend to sell.

Finally, psychology is playing a big part. The market reached a high in October 2007. We are now more than a year into a decline. Add to that a presidential election, geopolitical tensions, a lengthened news day stirring us up, and the Steelers’ absence from the Super Bowl last February, and you can see this is weighing on all of us. (That last one was for my father-in-law.) I would anticipate this activity through January.

By the way, all bonds other than Treasuries have been hit for the very same reasons. If you remember back to the decline of 2000 – 2002, bonds help up pretty well. But the forced selling of everything to get cash and run to Treasuries included many different types of bonds.

Why didn’t you put me in cash?

So what does this all mean to you now that your hard-earned assets have lost so much value in so short a period of time? I have spent a great deal of time in the last year talking to, and listening to money managers and market analysts on where we are, how we got here, and where we are headed. I have tried to strike a balance between the people with whom I’ve entrusted your assets and objective third parties without a dog in the fight. The calmest are those who have been doing what they do since the early 1970s. They have seen nearly every type of financial crisis since then, and their knowledge and experience deserve attention.

They suggest that though this crisis is different from any in the past (no two crises are identical), it is not unique in being derived from a credit bubble. So to them this crisis resembles others, and they see a similar aftermath—namely a financial-market recovery. That is good.

Therefore, we have done the following:

For expenditures in the next 12 – 24 months we have cash.

For anticipated needs 3 – 5 years from now we have fixed income.

And if you will not use the money for at least 5+ years we have it in various equities in order to benefit by the long term nature of the market.

Notably, I differentiate equities from stocks because your holdings have various real assets and commodities also.

This isn’t “buy and hold and take the pain” because in the meantime, the money managers you use are taking action within their portfolios. They raise and lower their cash levels and buy stocks and bonds during periods of revulsion for amateur investors. For the great ones, of which I think we use a few, when others are forced to sell or panic, they are on the buying end getting things on sale. For those of you who have cash, you know we have been buying at different intervals in the last several months to take advantage of the same. Additionally, many bonds are paying high single digit and some double digit yields. Healthy companies maintain or increase their dividends during these times.

In closing, I appreciate the inquiries as to my own personal sanity this year. I assure you it is intact!

Author: David Jeter, CFP®, Allegheny Financial Group, November 2008

Securities offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.
The above comments are provided for discussion purposes only and are not meant to be an offer of any specific investment.