1st Quarter 2008

Market Health Outlook   

1st Quarter 2008 

If you turned on your TV or read a newspaper recently, then you know it has been a tough quarter for both stocks and bonds.   I have felt like a salmon swimming upstream… believing in the goal, the water current pushing you back at times and it can be really tough to keep swimming.

 

Volatility has been high, and it can be scary.  Conversely, trying to be out of the market at just the right time can be just as risky.   Miss one or two big days, and you potentially lose out on 2% of the return for the year.  If 2008 ends up being a positive year (of maybe 5-7% growth), then missing this 2% rally means you end up underperforming.

 

At the end of March, the Market was down 15% from its high last October.  The Market is down 10% in the first quarter of 2008.  Unfortunately most of my client’s accounts are down, but fortunately not nearly as much.  Looking at stock indexes as a guide, the recent setbacks have taken the market clear back to August of 2006.   Once again, my investment selections have done a lot better than this.

 

Temporary dips in the stock market valuations happen from time to time.  You can pretty much count on a negative year every four or five years.  Setbacks are not fun, but this is the price we pay to enjoy the stock market’s long term average return of more than 10%.  The alternative is to try and play it safe.  CD’s are currently paying 3%.  Inflation is running 4%, and you still have to pay income taxes on the 3% interest.  CD’s guarantee that you lose purchasing power, and that’s a formula that puts us all at risk to a fixed income squeeze during retirement.

 

As an attachment to this letter, I am enclosing a chart on the history of recessions.   The typical recession will last 10 months.   The problem with recessions is that we don’t even realize we are in one until we wake up one day and it is upon us.  At this point, the market makes a quick and radical adjustment.  As the chart indicates, by the time the recession is half over the stock market has stabilized and actually begins to increase. 

 

Remember that the stock market is a forward looking machine.  It tries to anticipate the future and, when it gets it right, the market can move upward while everything around you looks dismal.  The average person is viewing all the negative news and is worried, but the smart money has already considered all the known factors, priced them in the supply/demand equation that sets prices, and is looking forward again.  At the point where investors can see that the worst is over, the market begins its inevitable recovery.

 

Remember that the emotional pendulum swings both ways and sometimes too far.  This time, I think the negative news was overstated.   I have enclosed a second chart showing historical stock performance after recessions are over.  The large gains achieved help offset the losses during the recession, so once again the average long term gains of over 10% are achieved.

 

It is my belief that the market hit a low on March 31^st for the year.  At that time, things seemed to be getting worse everyday, but when you see bad news announced and the market actually goes up it is a positive sign that we have hit bottom.  That weekend “Bear Stearns” went virtually bankrupt.  JP Morgan was buying the company at $2 a share, down from $170 a year earlier.  The financial crisis had already been factored into prices and more bad news failed to rattle investors’ nerves.  In contrast, the poor financial report from GE in April sent the market lower because everyone was anticipating a solid report.  When all is said and done, March 31^st was our low and we have seen a nice rally thus far, in April. 

The Federal Reserve’s aggressive actions probably saved us from a larger setback.  Right now I am glad they came to the rescue.  My long term concern is “at what price?  In my opinion, they turned a deep recession into a mild one.  But, will we see higher inflation as a result?  Oil, gas and food costs are all causing inflation to be a threat.  Add on low interest rates and the stage could be set in the next couple of years for higher than average inflation.  Nothing good comes from high inflation, and I will be looking for ways to add a hedge to our portfolios.

 

Every quarter I review the following factors.  There are still significant hurdles for the market to digest.  We should begin the process of stabilization during 2008.

 

Factor	Influences	Current Outlook
Inflation	Interest Rates & Profits	Negative
Fiscal Policy	Interest Rates	Neutral
Monetary Policy	Interest Rates	Bullish - Aggressive
Economic Growth	Profits	Low - Negative
Earnings Growth	Profits	Negative but anticipated.
Stock Valuations	Based on Price/Earnings Ratio.	Neutral
Exogenous (oil, Iran, etc)	Interest Rates	Oil prices are up. Consumer confidence is low.

 

In a few weeks you will have your April reports in the mail.   You may not have made all your money back, but you will see a dramatic improvement.

 

Sincerely,

 

Ron Dickinson, CPA, CFP^®, MPA-tax