Whew! Are We Done Yet?

It must have been late July or August of ’07 – back when the "credit crisis" became headline news – when Finance Professor Paul Kutasovic and I were considering the various worst case implications of the mess. As he was arguing some very real points, my response was something like the Federal Reserve and the US Government would do whatever’s necessary to prevent the worst case scenario, perhaps even another Resolution Trust situation akin to the Savings and Loan crisis of the late ‘80s. Of course, neither of us really felt that this was a probability at the time, even when the economic indicators turned increasingly negative near the end of the year.

We can’t say really what could have happened this past week, but clearly the government, however dominated by free-marketeers, realized that reality and purgatory were more important than principals, dodged not a bullet but a bazooka, and did some of what it had to do. What, exactly it has done, or is proposing, is not fully known, and the US Congress and President will surely wrangle through the final details. In an ironic political twist, the democrats will finally be heard crying "not on the backs of the taxpayer" during these deliberations, and this time, perhaps a middle class that has been consistently voting against its best interests may actually get it.

Now is not the time for me to rail about how abysmal has been the oversight of this recent government, nor how the free-market-fanatic politicos who have dominated our policy-making beginning in the mid-80’s have systematically purged so many of the kinds of circuit breakers that could have kept things in check, nor the specific merits and weaknesses of this package. Suffice to say that this is a game changer, and however huge the budget deficits were going to be entering 2009, and how suffocated Obama’s and McCain’s proposed tax changes are already likely to be, whoever takes office in ’09 will be driving the economy with their chins, as both hands will be tied firmly behind their backs.

Simply put, this “bailout” proposal from the Treasury, Federal Reserve, and Securities and Exchange Commission attempts to accomplish four basic things:

• purchase from financial institutions bad loans – mortages, credit cards, lease – from the books of the investment firms and banks thereby freeing them of these obligations,
• provide some degree of guarantees for money markets funds,
• prevent short-sellers from easily ganging up on certain financial institutions and driving their stock prices quickly to the ground,
• create the Church of the Treasury Secretary by turning it into the financial equivalent of the Vatican.

Where the American citizen and taxpayer stand at the end of the day depends upon any number of factors, not the least of which is the backbone of both the liberal and conservative representatives in Congress to limit the size of the windfall for the mis-doers and pain for the innocent. Certainly something drastic had to be done. Let’s just hope that unlike our recent energy policy, the foxes aren’t making all the decisions for the chickens.

Now that the markets have showed us the value of Pepto-Bismol, it’s a good time to take stock of how we react to these events. There are learning experiences for each of us in these circumstances. But periods of intense emotions are usually poor times to hazard investment decisions, especially for the lay investor. From our perspective, we saw the dangers (and still see some others) of a downward spiral on equities, and we reacted accordingly, even though it meant altering the asset allocations of all portfolios. But it’s instructive to see that at the end of the day the equity markets ended flat last week, despite the interim misery. Of course, it didn’t have to end up that way, and it’s not over yet.

Back to Basics. Frankly, economic fundamentals haven’t materially changed in all this recent craziness, despite hopefully stabilizing some key institutions. Unemployment continues to ramp up in response to overall weakness, housing prices continue to slide, credit for businesses remains tight, economic weakness remains a global challenge, and consumer sentiment and spending are weak. Corporate earnings expectations are lower.>

But there’s also a flip slide, a brighter side. Corporate balance sheets have held up remarkably well, exports remain strong despite dollar strengthening, China will shortly be looking to stimulate their economy, commodity prices are much lower than a few short months ago reducing input costs to businesses and lowering inflation pressures. Equity prices are starting to look cheap in places as the markets have already built in a slowdown in prices. Cash is abundant and bond yields are so low that investors see little benefit in that sector. The US, in particular, as the first into this global slowdown, stands to be the first out of it.

So where do we go from here from an investment perspective assuming we can make some headway in terms of the “bailout” effort? Right now, we’re looking at a number of different time frames. From the longer term perspective, we see continued credit tightening throughout the banking sector, reduced risk tolerance, and a global economic weakening. There will probably be something of a paradigm shift as we collectively move from a place of easy credit and spending to a more responsible approach as a nation (what a concept!), as we set aside our immediate goals of purchasing the new Porsche or super wide screen plasma set on credit.

In the shorter term, we may see a market “relief” bounce continue this week or perhaps a return to a melancholic over the issues that remain unsettled and the expected Congressional bickering. The short term crystal ball is foggier than usual – more like sludge, actually. But any euphoria is likely to lessen as the weaker economic fundamentals return to center stage.

So while we’ve taken off the "red alert"” status, we’re going to remain cautious here. Yes, we’ll start moving back slowly into certain opportunities and defensive equity positions, and slowly work our way to more normal asset allocations, but only as we see appropriate. We expect the dollar to be pressured in the short term, and expect a related bump in certain commodities, although the longer term outlook for the dollar remains strong.

Portfolio Actions.  

We’ll be looking to reduce hedging positions but maintain strong cash positions. We will continue to identify and tip-toe into opportunities for certain investors. Simply put, we remain cautious.

 

Please feel free to call with any questions or thoughts.

Peace,
Ron Stein

Good Harvest Financial Group
631.423.6501