Daily Investment Interpretations

February 11, 2009

2009-2-11 The markets rose modestly today in response to the sealed deal on the stimulus plan. The NASDAQ Composite swelled slightly by 5.77 (0.38%) to 1531, the Dow annexed 50.65 points (0.64%) to end at 7,940 and the S&P 500 rose 43 points (0.8%) to land at 834Oil closed at $35.94, while gold increased to $944.50 The VIX rose to 44.5.  

    O. K., where do we go from here? As I mentioned day before yesterday, the winning economic forecasters for three of the past four months warn that the U.S. economy needs urgent help, but they also forecast that "the economy will contract at a 6% annual pace in the current quarter, followed by a 3.4% annualized decline in the second quarter. Growth should be flat in the third quarter and grow at a 1.7% annualized rate in the fourth quarter. Those figures assume a vigorous response by the Congress and the Fed." In other words, they're predicting that the economy will bottom in the third quarter, and will begin growing again in the fourth quarter. This is consistent with the idea that the stock market hit its cyclical bear market bottom last November 21st. However, Mark Hulbert is reiterating his warning from last Thursday that advisor sentiment is even more bullish after Tuesday's 4%-5% losses than it was last Thursday: What, me worry?  Today, others underscore Mark's warnings: Newsletters & Research: The bullish slope of hope and a silver lining for gold bugs   
    Yesterday brought Michael Ashbaugh's every-Tuesday article: Ashbaugh: Can government save market? In it, he concludes, "The primary trend's firmly lower, and eventually, the November lows likely need to be retested."
    Jason Zweig admonishes, When Predicting the Market, Be Skeptical, Be Very Skeptical (video). And in The future of Wall Street, Todd Harrison mentions that he's more optimistic now than he's been in the past. And here's an upbeat interview with John Sylva, chief economist at Wachovia: Prospects for U.S. recovery (video).
    So where do things stand?
    First, it seems to me that when we get past this current economic chokepoint, our GDP is going to be lower for a few years than it was in 2007, since deficit spending has falsely inflated our GDP numbers for the past decade. Eventually, because of gradual GDP growth, our GDP may be expected to rise past where it was in 2007, but that may take a while. How long? Well, it would seem to me to depend upon the percentage of our 2007 GDP that was debt-fuelled. Then we might divide that percentage by the 1.5-2%-per-year of real GDP growth to arrive at the estimated number of years it will take to replace that debt-driven contribution to real GDP with a savings-and-earnings-driven growth in real GDP. But what the government is trying to do is to spend borrowed money fast enough that we avoid collapsing in a deflationary spiral (liquidity trap)... in other words, to orchestrate more deficit spending ("hair of the dog that bit us"). I'm wondering if, instead of recovering from this recession, the current level of GDP, or even a lower level of GDP becomes the new norm. 
    The latest Issue of Fortune Magazine points out that in the past, people saved during good times in order to draw upon their savings during bad times. This time, it's worked the other way around. This time, the consumer went on a debt-fuelled spending binge during the good years and is now trying to save in the midst of the bad years... something that can be done only if the consumer is still employed. And of course, with consumers all switching from spending to saving at the same time, the economy slows down, generating a vicious circle of layoffs that further slow the economy. This is why I wouldn't see a tax cut helping much. It isn't that consumers have no money, but that they're saving it instead of spending it. Cutting payroll withholding would immediately give the still-employed more jingle to spend, but it would have no effect upon the unemployed, and the still-employed would presumably use their extra cash to pay down their debts or to rebuild their savings.
    In response to consumer spending, companies increased their production capacities, and are now faced with excess capacities.
     Second, given that a fraction of the about-to-be-signed stimulus bill will (allegedly) offer little or no stimulus to the economy, it sounds to me as though the bill will fill only 1/5th or 1/6th of the $2.9 trillion shortfall that the Congressional Budget Office projects over the next three years. Also, although fiscal stimulus plans are said to work, they're said to be slow to work. Typically, only a third of the money allocated is spent within the first two years. and much of the quick money in this stimulus bill... money to shore up state and local government budgets, money to expand unemployment benefits, money to keep public transportation systems running... has been removed from the bill in the Senate. It remains to be seen how much the $789 billion authorized by this bill will do to resuscitate the economy.
    Third, it's been 70 years since we experienced anything like what's going on now.  All of our financial advisors' professional experience has been in an economy that has been experienced continual inflation. Every recession they've ever seen has ended when the Federal Reserve lowered interest rates. Because of this, prior experience with market dynamics might not have the same predictive power it's had since World War II. 
    By now, a number of financial analysts must have been evicted from their companies, as their companies downsized, merged, or filed for bankruptcy. I'd expect the still-employed financial specialists to be fingering their collars nervously by now, and thinking about how far down they would fall if they lost their ultra-high-paying jobs. Also, finding a new job in the current environment would be next to impossible, especially if they're over 40. Under these circumstances, I'd imagine that they would do whatever they thought might please their employers. Meanwhile, their employers don't make money advising customers and potential customers to sit on their cash, and in fact, they'll go out of business if investment transactions are suspended for very long. So they've got to keep flogging stocks and opportunities. This is something to remember when assessing what financial experts are saying. (I'm directing this admonition to myself more than anyone else because I'm inclined to believe financial experts.) They're hired, fired, and paid by their bosses, and not by us.
    Fourth, it took nearly three years after the Crash of '29 before the stock market hit bottom. Along the way, there were several bear market rallies that lasted for months, during which there were authoritative proclamations that "the worse is behind us" and "prosperity is just around the corner". Bad as was the Crash of 1929, it was the false dawns after the Crash that wiped out what remained of investors' investment capital. The most pernicious was, probably, the first of these: the "Little Bull Market" of December, 1929, and the early part of 1930. The stock market climbed halfway back up on high volume. You know that stock brokers must have been  telling their clients that this was a chance to make a killing, that the stock market was going to go on to new highs in 1930. When the stock market worked its way back down in the spring of 1930, it took a lot of investors with it. 
    I think we've been lucky that, so far, we haven't have many of these bear market rallies that can suck our remaining money away from us.
    I promised several days ago to offer an investment strategy for that time when the markets finally establish an upward trend. So far, with the S&P 500 jumping up and down 40 points a day, and remaining within a trading range between 800 and 900, that hasn't been a burning question, but here a a few thoughts.
    I don't think I'd personally start to put money into equities until the S&P 500 moves above about 905. When I did, I think I'd invest about 10% of my portfolio. Then at, say, 930, I might invest another 10%, and continue to add 10% every time the S&P 500 added another 25 points, until all my money was invested. There would be pullbacks along the way, and if the market pulled back to within a few points of one of my "trigger levels"--for example, if it went to 920 and then fell back to 905, I would automatically--mechanically--sell at 907 or 908 the 10% that I bought when the S&P 500 was at 905. That way, I couldn't lose--right?
    Not quite. In the first place, it means either setting stop-loss limits on my 10% or monitoring the stock market every minute the markets are open. The trouble with stop-loss limits is that stocks can spike down for a moment before going back up, triggering an unwanted stop-loss sale. And in my experience, I'm often somewhere other than in front of the computer screen when the stock market makes a dramatic move. Worse than that, stocks can go up or down in value during after-hours trading, and can open in the morning significantly up or down from the previous day's close. Then, too, the market indices can move so fast when the markets plunge or soar that we can "take a bath" before our trade is made.
    Another approach might be to add and remove money from the marketplace in smaller steps... 5% at a time or 3% at a time. It costs me $8 to make a trade, or $16 for a "round trip", so I have to make sure that the dollar amounts traded are large enough that transaction costs don't eat into my intended profits.
    Another problem that, in my experience, often arises is that I'll buy when I see the market moving up. So it reaches, maybe, 907, and then it falls back to, say, 903. Do I sell at 905 or 903? More often than not, this kind of fluctuation is simply noise, but it doesn't have to be. At what point do I cut my losses? If I sell at 905, when should I buy back? At 907?.
    Also, a lot of bookkeeping can be needed to keep up with what's happened. Computerized trading is a possibility, but you're playing against a huge number of other computerized trading systems.
    I don't have a rollicking good answer to this question yet, which is why I'm looking to the China and Emerging Markets newsletter for timing advice.
    I've mentioned before some of the stocks, exchange-traded funds, and mutual funds that I favor. Without taking time to discuss them here, they include the Proshares Ultra Emerging Markets Fund (UUPIX), the Powershares Wilderhill Clean Energy Technology Fund (PBW), the Vestas Wind Systems Company (VWSYF), the iShares TR FTSE Index Fund (FXI).
    The following article from Minyanville, The Trouble with More Tax Cuts, includes: 
    "What our legislators fail, or refuse, to recognize is that this recession has exposed the profound fundamental weakness in the American economy. We are a debtor nation whose growth for many decades has revolved around cheap credit and consumerism - 70% of our economy is currently based on consumption. (Germany, by comparison, is at 50%.) Our health-care system, schools, infrastructure and energy grid are crumbling. At a time when more people desire public transportation than have in decades, cities are forced to scale back service."

    When I was discussing the side effects of statins day before yesterday, I mentioned that the U. S. health care system is the most expensive in the world while lagging in quality behind other developed nations. What I didn't know when I wrote that was that our U. S. health system ranks 19th among the 19 leading industrialized nations. 
Gold signaling catastrophe?