Stock Market Update -- Pigeons Coming Home To Roost

In a market like this, it is easy to feel stupid. Everyone I know has lost money and many people have lost all their money. To one degree or another we have all been impacted by a worldwide economic tsunami that has levelled everything in its path.

Everyone has known for months that serious problems exist. In the past, low stock prices have often signalled great opportunity. I mean we have been told for decades that we should "buy low and sell high." Many technicians and market timers were bearish for much of last year but most decided in October that record levels of investor pessimism and capitulation were signs of a bottom. The U.S. stock market is down more that 40 percent from those levels and making new lows.

Even most of those who remain cautious and say it is still too soon to buy have been saying for months that is is also too late to sell. So while they can technically say they were right on the market, most of their customers have lost big money by hanging on to stocks through this death spiral.

Most of the time, people who lose lots of money are traders or speculators who get caught on the wrong side of risky investments. But this bear market has been very different on two counts.

First, among the stocks that are down dramatically are the largest and most respected companies in the world. Many of the bonds that have lost much of their value were AAA-rated. People who thought they were invested conservatively have lost a fortune.

Second, the smartest people and investment professionals I know have lost the most money during the last year. Normally it's the novice investors who get hurt while the "smart" money typically seems to do better. As we have learned from the Madoff fiasco and other scams, the biggest victims this time have been some of the most accomplished and sophisticated investors in the world.

In addition, legendary investor Warren Buffett has suffered his worst year ever, losing well over 50 percent of his own and shareholders' money during the last six months alone. In addition, dozens of the brightest and most successful asset managers in recent years have suffered similar--and even worse--losses since October.

But it was telling that in Buffett's annual letter to his investors he made it clear that he believes that this is a time of great opportunity. He also shares my view (The Next Investment Bubble Has Started to Pop - Feb, 2009) that U.S. Treasury bonds are not a good place for conservative investors right now.

As Buffett put it:

"When the financial history of this decade is written, it will surely speak of the Internet bubble of the late 1990s and the housing bubble of the early 2000s.

But the U.S. Treasury bond bubble of late 2008 may be regarded as almost equally extraordinary. Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long."

For months now I have been advising clients that it is not time to be bearish or bullish--it is time to be smart.

As a result, we've been invested in exchange traded funds (ETFs) that invest in precious metals and are short U.S. Treasury bonds. Both of those investments are up for the year as are a number of energy and technology companies--solid, well-run businesses with good management, great products, and lots of cash.

On the other hand, the list of investments that are smart in here is getting shorter as it becomes increasingly clear that companies and consumers have started to save more, pay down more debt, and spend much less. In addition, foreign markets which in the past have often been strong when ours are weak are generally in even worse shape than we are.

As you know, we have avoided the financials, the automakers, and other sectors where companies are going to need to raise capital in this very challenging environment. We now have to expand that list to include companies that are most vulnerable to widespread spending cutbacks that will lead to earnings disappointments going forward.

Our accounts are not up for the year, but we are doing better than the market averages. More important, we remain positioned to benefit from the economic developments we expect to play out. People--particularly retirees--should have enough cash set aside to pay their bills for the next couple years plus whatever additional amount they need to sleep at night. The rest should be invested in a smart way.

A whole bunch of past financial policy pigeons are coming home to roost and most of them aren't housebroken. The results have been messy and ugly. This is not about Obama and it is not about the proposed budget or stimulus package. It's about the policies of the past catching up with us.

At the end of the day, I agree with yet another part of Warren Buffett's letter:

"The economy will be in shambles throughout 2009--and, for that matter, probably well beyond. But that conclusion does not tell us whether the stock market will rise or fall.

Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America's best days lie ahead."