Tuesday, May 12, 2009

Investment Update -- What Now?

It was just nine months ago that George Bush was assuring us that the economy was fundamentally sound and Phil Gramm accused Americans of being a bunch of "whiners" who were going through an imaginary recession. That was, of course, the time when the value of virtually every asset in the world (stocks, bonds, real estate, oil, commodities, businesses) was about to go into a death spiral that slashed at least half the value from the best companies and assets and more from the rest.

At that point investors either chose or were forced to sell pretty much everything they had because many felt the last one out of anything and everything was certain to get zero.

That panic mentality peaked on March 9--the bellweather day when I received five calls and emails from different clients demanding that I sell everything they owned (I talked four of them out of it). As it always has, that panic-fest marked a bottom from which we have seen most markets shoot higher by at least 35 percent over the last two months.

That rally has occurred in the absence of anything that could be called a clear sign of recovery in business conditions. Housing prices continue to fall. The problems in commercial real estate are just beginning to get truly ugly. Most consumers are still deeply in debt. Our economy continues to lose more than 500,000 net jobs a month as almost 9 percent of Americans are unemployed and a larger percentage are significantly underemployed. Any yet, since March the riskiest assets and stocks are the ones that have appreciated the most.

Stocks of home builders have doubled or tripled as have the shares of the most troubled banks and other financial institutions. At a time when mortgage defaults are skyrocketing, the stock of MGIC--the world's largest mortgage insurer--has gone up by 500 percent in just eight weeks. That, of course, is after it dropped from $60 a share to less than a buck. But still...

So here we are. The easiest money has been made. The banks that everyone thought would all be worthless are now way up in price (from the bottom) and actually are selling billions of dollars worth of stock daily to hungry investors--a topic which I was asked about today on National Public Radio's Marketplace.

Has the whole world gone crazy? Is all forgiven? Is this the beginning of the new bull market? Is this a bear trap? Are investors about to get their hearts and 401-k's crushed again? What now?

The answer, of course, is that no one really knows. But the course of action that I've been recommending for months should continue to provide good returns over time as it has recently. That's because during these times of great uncertainty there are some things that we actually know for sure.

We know that our government is determined to stoke the economy with trillions of dollars of stimulus money targeting infrastructure, alternative energy, technology, and creating the jobs of the future. We also know that as an inevitable consequence of the deficits that will accompany that stimulus, interest rates will rise and the cost of tangible assets and many products will go higher--a lot higher.

We also know (with credit to Rod Smyth and Michael Jones of Riverfront Investment Group) that price matters. Historically, people who buy good stuff and good companies at low prices do better over time than people who invest at high prices. By many measures, a lot of good assets and great stocks are cheap right now although prices could pull back some after the recent two-month straight-up run.

So my advice is to buy those things over time and plan to own them for a while.

But there are other things we know. We know that the boom years that just went bust were fueled by unrealistic assumptions about unending growth and by mountains of consumer debt. Most of those bills have not yet been paid and even when they are it is unlikely that lenders or borrowers will get themselves into that big a mess for a while. That will translate into lower consumer spending for some time to come.

We also know that health care costs are killing us (no pun intended). There is going to be pressure on the profit margins of insurers and providers for the foreseeable future.

We also know that our country's demographics do not bode nearly as well for growth as do those of many other countries in the world where there are a lot more young people and a lot fewer old people who will live well into their 80's and 90's. The economies of those emerging, younger markets will probably do better going forward than those loaded down with us fogies who have neither the energy, the appetite for risk, nor the inclination to work as hard as we once did. So an overweight position in selected emerging markets makes sense.

What we don't know is whether the TARP, the bailouts, and the recent spate of stock offerings will put our biggest banks on sound footing again. They are all doing great on an operating basis now taking in deposits at zero percent and loaning the money out at much higher rates. But those pesky balance sheets may still be telling an ugly story that I, for one, don't understand so I'm sort of staying away. If things work out well--and I hope they do--then that's just money someone else will make.

So if I had to make a guess--and I actually do since I do this for a living--I would say that emerging markets, hard assets, technology, commodities and infrastructure companies should be over weighted in portfolios going forward and long term U.S. Treasury bonds should not be owned at all.

Since I first took this strong stand against treasuries, the 30-year U.S. Treasury bond has lost 15 percent of its value as rates have quietly but steadily climbed.

That means that an investor who sold his or her stocks two months ago and invested the proceeds in a "safe" government bond fund has missed out on the 30 percent up move in the market while losing 10 percent of their money in their "safe and guaranteed" investments. Who knew? Actually, I did and I have the blogs to prove it but I've done enough own-horn tooting lately.

Be well and stay in touch.