Stock & Economic Outlook

In view of the fact that my article on the economic slump, as well as the stock market, were far and away the most popular from last month, I’ve decided to write another.

A point I broached in that article, but did not develop was the posture I found (strike that—“placed”) myself in prior to the collapse of the stock market. I’ll start with that, analyze my mistakes, and then, once again, speak in terms of where I think the market will be going from here. Embedded within this article will be an analysis of where the economic status of the country is at present and where I think it is headed.

#Here was my investment asset allocation, when President Bush publicly announced the dire predicament of the financial industry in mid-September, 2008:

Cash (all money market funds)		60.6%
Equities		24.4%
Bonds*		15.0%

*About 1/3 of the bonds were in mutual funds that invest in U.S. Government mortgage backed securities.

This was, of course, not the conventional wisdom. The “experts,” were consistently saying that a person, depending on age and circumstances, should typically keep about 80-85% of their asset base in equities.

So, why didn’t I?

Because I didn’t trust those who were in control of the financial markets. I didn’t understand the terms and nature of things like “credit default swaps,” or the inner workings of hedge funds. I figured that as a private investor of relatively insignificant means (as compared with the knights of Wall Street) I was not privy to the sorts of opportunities that were the exclusive purview of people like Bernie Madoff and that I would be smarter not to try to keep up with the Jonses, so to speak, and concentrate on what I could understand, and had the means to evaluate.

I understood the 1929 U.S. Stock Market crash and I can still remember the eerie feeling I had pulling into my driveway in October of 1987, the day when the floor fell through the stock market in one day—without notice.

Bond funds, particularly those that are government backed have already recovered for the most part. So, that 15% was well placed.

And, I got skinned, like everyone else on the other 24.4% that was in equities. But, given the overall picture and returns from yesteryear on those equities, we were barely hurt overall.

So, what did I do wrong?

I had all of our cash in money market funds. I used to participate in treasury auctions and buy U.S. Treasury notes on a recurring basis. I had a U.S. Treasury direct account and, if they keep those records on a perpetual basis, probably still do.

I quit to minimize the inherent burden of annual pension tax reporting requirements for those assets.

What were the adverse consequences? I had to hit the panic button, like everyone else, grab our deposits and run to the bank. Yes, I know the federal government moved in fairly short order to insure money market funds, but I tried to move before that. Also, I wasn’t entirely confident of the government money market insurance in terms of what would be required to perfect a claim, how complete the coverage and how long it would take to be made whole.

I did know about FDIC insurance and the quick payment one receives in the event of a bank failure. So, I decided to transfer all of our money market funds into federally insured bank accounts.

That was an eye opener. When I was at Wells Fargo (WFB), since they are our bank by virtue of buying First Interstate Bank (FIB), I learned that in the transition between banks, they had destroyed the FIB account titling records and fabricated new ones. By that I mean funds that I had placed in trust were now in individual names, retirement funds (small amounts, fortunately) were in business accounts, per WFB, even though I had placed them into qualified retirement accounts with FIB and WFB had conjured up partnerships for business interests, wherein I had never had any partners in those businesses. You get the drift.

Since I could withdraw most of our funds by check I went across the street to the Bank of America with the intent of utilizing the new, temporary FDIC limit of $250,000 there for the increased FDIC protection that would have given us (my wife and me). Forty-five minutes later with no assurance that I would ever be waited on that afternoon by the busy bank executives, several of whom had spent most of the time chit-chatting from what I could see, I took our funds back to WFB for a short time.

The reason it was a short time was because they told me that to open a qualified retirement account with them I would have to place them under the supervision of their “investment advisor,” at Blackhawk Plaza in Danville, California and submit to his counsel and guidance each time I made a trade. That was unacceptable. The rank and file employees seemed shocked that I didn’t have to “run my plans by anyone” before making a trade or withdrawing funds from Schwab & Co, even though I and not Mr. Meddlesome Banker was the trustee.

So, I ended up returning the funds to Charles Schwab & Co., Inc. and taking my chances on the FDIC problems. As it turns out, they didn’t materialize.

What did I lose in all this, besides my time? If I had invested in Treasury notes, which was what I did for many years, I would have had some higher rates locked in, along the order of up to 5 – 7% in risk free investments for 5, 7, or 10 year terms, that are now paying 2% at best. Schwab money market funds as of today are paying .42%, not 42%, mind you, but less than one-half of one percent interest. The difference in rates is what I lost in future income.

What did I learn? I learned, reflected in the smile that resides on my face, as I write this, that my mistrust of Wall Street was well founded. And, unlike 80 or 90% of investors and the conventional wisdom, holding most of my retirement funds in cash was one of the wisest decisions I ever made in my life. I was also reminded of the overreaching and obtuse nature of bankers toward that which does not belong to them, namely, the funds which belong to their depositors.

What am I doing now—in terms of investing? I’m dollar cost averaging into the equities market at a feverish pace. Under normal conditions, I adjust my portfolio on an approximately monthly basis, sort of like weeding the garden. Now, because I think we’re at a bargain basement mode that is not likely to recur again in my lifetime, I am doing it weekly.

When I run out of retirement funds to invest, I will probably invest the balance of our cash resources, followed by funds I am considering borrowing, since the rates are so low and the prospect of an upside is so great.

What’s changed? Several things.

Djo investment rule: Things are seldom (you’re better off to read “never”) as good or as bad as they seem. The stock market is built on irrationality in that it does not and never has reflected either the discounted present value of future dividends, or the liquidation values of the underlying companies. Anything else is irrational by definition.

I think we are in fact undergoing “irrational pessimism” at present. Baring something really unusual, such as a nuclear disaster, I think we’re entering a period of improving financial conditions, once the brakes take hold on the downturn.

I think the government policies that are being brought to bear, albeit in a clumsy and somewhat incompetent manner, will in fact reverse the current trends and restore prosperity—at least in the mid- (i.e., 3-5 year) term, once the recession is over. And, the end of that recession is being accelerated by sound government policy.

Yes, I hear the nay sayers and ideologues having a fit, but what I’m seeing is the Keynsian economic principles that I first read about in economics classes at Miami University in the 1960’s put into place. Contrary to the outspoken critics and reactionaries, I’ve never seen them proven false.

Fear not, my fiscally conservative friends, I’m not talking about some of the giveaway programs that are presently being considered in Congress. I have hesitation and concerns there for discussion another day. I’m talking about the stimulus package, the Trouble Asset Relief Program (TARP), the U.S. Federal Reserve Bank’s response and other steps being coordinated by various branches of the U.S. Government to right the ship.

I’ll cover the politics of all this in one of my political commentaries. But for now, I’m addressing only the question of “Will it work?” My firmly held opinion is that it will—at least in the mid-term—and we will in my opinion be experiencing another boom within the next five years, barring unforeseen, non-economic disaster.

Also, I think most of the broad based fraud and ill-advised speculation on Wall Street has, temporarily at least, been laid bare. This is a unique opportunity, I think, to buy securities in an atmosphere of unparalleled transparency--with the usual hype and speculation literally bled out of the market.

So, as far as I'm concerned, "It's time to invest!" (In equities on a diversified basis, using dollar cost averaging.)

Note: I DO NOT sell investments of any type. A limited number of consultations are available in California and Hawaii, incidental to my law practice. (800) 558-4102 For those who live anywhere, including Hawaii and California, you may sign up for a notification, if you are interested in purchasing a copy of my forthcoming book: The Truth About Investing Subtitle: including the basic rules of investing which almost no one ever follows by sending me an email with “inv-book” in the subject line.

“What’s that?” I think I hear the opening bell.