In This Issue:
The Long-Awaited Bear Rally May Be Starting
Although Weak, Some Hopeful Economic Signs Are Emerging Credit Is Slowly Opening Up Again If Fear Subsides, The Outlook Will Improve Immediately A Recovery Will Bring Unwelcome Inflation The Bottom Line This Week
As we reported in our previous issue, the sharp stock market advance over the Thanksgiving holiday came to a crashing end on December 1. However, prices have been stronger since then. Although the gains weren't enough to fully erase the earlier plunge, the Dow and the Nasdaq managed to end last week down just 2.2% and 1.7% respectively. From Monday to Wednesday of the current week, the market managed to make some additional gains.
It's significant that the price increases occurred while more bad economic news was breaking. A manufacturing decline, an auto sales plunge, and more job losses should have pushed stocks down several more notches. The fact that investors largely ignored the negatives may indicate that the bear market is close to a bottom.
The Long-Awaited Bear Rally May Be Starting
Many analysts believe that the market's apparent strength indicates that investors may be looking beyond the current situation and are seeing signs that a recovery is on the way.
Our response is that severe bear markets always have strong rebounds that usually become traps for the unwary. In 1933, for example, there was a big rally that investors believed was the recovery they expected after the 1929 disaster. Unfortunately, the rally collapsed within a few months and created another round of big losses for investors.
Although Weak, Some Hopeful Economic Signs Are Emerging
That is not to say that there isn't any light appearing at the end of the dark tunnel. But as the old joke goes, the light may be on a locomotive that's speeding our way.
In this case, the "locomotive" to worry about is declining corporate earnings as job losses and slow economic growth begin to take a greater toll on business activity. Most optimists acknowledge the weak outlook, but they believe it is fully discounted in today's low stock prices.
Another major worry is the prospect of further job losses. However, many analysts are quick to point out that a 6.7% unemployment rate isn't out of line for a recession where a 10% rate is often seen. Again, the optimists say, the market has more than discounted the outlook.
As for overtly positive news, as we reported last week Black Friday sales were much better than expected. Nobody is expecting a consumer spending turnaround anytime soon. But stocks appear to be priced for a much lower spending rate than we may actually see.
Many analysts are also encouraged that productivity (the amount of value produced per hour by workers) is on the rise. Clearly, workers who are keeping their jobs are working more hours, or are working more efficiently. When productivity grows, output can increase even when employment declines. We may finish the year with a higher GDP than in 2007 even though employment is lower.
Credit Is Slowly Opening Up Again
The brightest ray of economic sunshine to break through the clouds is on the credit front. Banks are starting to loan money again, albeit cautiously. As you may have noticed, many lenders are now running ads for mortgages, refinancing, auto loans, and the like. It's not a flood, but the tide does appear to be turning around.
Of course, the heady days of easy money are probably gone forever. But, that's as it should be. All we need for the economy to get going again is for banks to return to the lending standards they had before the credit madness began in the late 1990's.
If Fear Subsides, The Outlook Will Improve Immediately
From all the headlines about collapsing home values, rising unemployment, excess consumer debt, and the like, it would be easy to think that most Americans are in financial trouble. But that's simply not the case. Fear, not true hardship, is the biggest reason consumer spending has plunged.
Some of us at The AIA Advocate are old enough to remember the role that a climate of fear had in the severe recession of 1980-81. Even people with secure government jobs wouldn't spend more money than was absolutely necessary. As a result, auto dealers, real estate agents, homebuilders, and so on often went bankrupt in towns that were awash in wealth.
The bright side of the fear picture is it can end as quickly as it began. Americans are predisposed to be optimistic, not down in the dumps all the time. When good news begins to replace the frightening headlines we are seeing now, the economy will start to recover.
A Recovery Will Bring Unwelcome Inflation
However, there is a downside to a recovery that you should know about. So much money has been pumped into our economic system in an attempt to restore credit and prevent bankruptcies that inflation will almost certainly accompany a rebound. Some analysts think inflation is likely to be such a powerful force that investors should play that event rather than an earnings recovery.
Although we believe an earnings rebound will be the biggest money-maker for most investors, taking inflation into account is also a good idea. That's especially true since today's strong dollar will buy a lot of inflation investments at very low prices.
Gold looks especially attractive now. At its current $771 price, the yellow metal is off 23.3% from the $1006 high it reached in March of this year. There is every reason to think that gold will move back up as the value of the dollar declines due to inflation.
A shortage of U.S. gold coins continues, but premiums will come down as the Mint catches up with demand. Meanwhile, premiums for Canadian Maple Leafs and South African Krugerrands remain reasonable.
Alternately, you can buy the
SPDR Gold Trust (GLD), a popular exchange traded fund. http://finance.yahoo.com/q/pr?s=GLD We continue to think the ETF is the best way for most investors to buy gold.
Silver is down 52.3% from its $20.92 high set in March. However, silver is largely an industrial metal that is priced to a great extent by the level of economic activity. Since growth is likely to be slow when inflation first begins to be a problem, gold should be a better performer.
Swiss francs continue to look very good longer term. Besides being a good hedge against the dollar, the Swiss currency has a positive effect on overall investment performance. In the latest issue of Review & Focus, Chuck Butler of EverBank World Markets, had this to say about foreign currencies: Everbank.com
Had an investor invested $100,000 in stocks during [the past year], they would have experienced a 39% loss, or a final dollar value of $60,577.29. But if they had added a 20% allocation of gold, and a 20% allocation of currencies (a combo of Swiss, euro, and Japan), their overall portfolio performance would have been a final dollar value of $74,450.82. While the portfolio was still at a loss, the overall value ends up almost $14,000 higher, a 14% improvement vs. the S&P alone.
Treasury Inflation Protection Securities (or TIPS) are also looking very attractive again. These special government bonds have their principal adjusted twice a year to compensate for the rate of inflation.
With TIPS, if you purchase a $1,000 bond and the inflation rate turns out to be 8.0% for the year, its value will be adjusted to $1,080. Consequently, your purchasing power will remain the same as it was when you bought the bond. You are also protected in the unlikely event of continued deflation because your final payment cannot be less than the original par value of the bond.
If inflation rises, not only will your principal be adjusted upwards, your twice-yearly interest payments will also go up. So, if inflation occurs throughout the life of your bond, every interest payment will be higher than the previous payment. If deflation occurs, your interest payments will decline.
Investors can buy TIPS directly from the U.S. Treasury Department's Bureau of the Public Debt. The bonds are available in 5-year, 10-year, and 20-year maturities. Uncle Sam will hold your TIPS in a Treasury Direct Account set up in your name. You can get the necessary information and forms using the link:
If you don't wish to lock up your money for fixed periods of time, you should consider a TIPS fund. We particularly like the
Vanguard Inflation-Protected Securities Fund Investor Shares (VIPSX). http://finance.yahoo.com/q/bc?s=VIPSX&t=2y As with most Vanguard products, the TIPS fund carries no load and has a very low 0.20% expense ratio, vs .86% average for its competitors.
The Bottom Line This Week
The financial turmoil that has been hammering the economy and the stock market is likely to continue well into 2009. However, there are some tentative indications that a gradual rebound may begin before the year ends.
Because of the unprecedented amount of money the Fed is pumping into the economy to fight the downturn, a recovery will almost certainly be accompanied by higher inflation. Gold and hard foreign currencies such as the Swiss franc should be good hedges against the declining value of the dollar. TIPS should also prove to be very effective protection against inflation.
Copyright 2010 The Association for Investor Awareness, Inc. All Rights Reserved
All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions.
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12-11-2008 11:35 AM
Research & Editorial Staff