So, what are our real alternatives? How do we weather 10 years or more of greatly depressed economic activity? (not saying that this is what I believe but it is what we are hearing daily)
A Book to Consider Reading
Larry Burkett authored a book entitled "The Coming Economic Earthquake" in 1991 that I read many years ago and decided to dust off the bookshelf and re-read based on everyone's concern (yes, even including myself, that this book’s projections are valid) and that “…there is no historical comparison…not even 1929…” and that “…we may face a world market meltdown..." (media-hype and not my words)
I encourage you to read it, though I must tell you up front that it may confirm your concerns rather than allay them. So why would I offer a book to you that throws more wood on the fire?
Answer: to help you see that I have examined this possibility of an economic collapse (not just from this book alone, of-course) and that I fully feel the pain of this market downturn and understand the feelings, thoughts and emotions of losing a sizeable portion of hard-earned and saved money.
I thought Larry Burkett (now deceased but a very well-respected financial planner and author in my circles during his lifetime) was correct during the 2000-2002 period when the markets declined to a -49.15% by October 9, 2002 – a 30 month decline – but there is something that I believe he had not fully weighed in his analysis.
What?
The Activities of the Federal Reserve and Treasury
After this recovery, we never experienced hyper-inflation (double-digit) although I concede that inflation was beginning to become uncomfortably high until this crisis. Yet there are many mechanisms that can be put into place to calm inflationary fears though they take time and there is pain to be experienced until the results manifest themselves. But the cycles continue – up and down.
Rather than go into the details of the Term Auction Facility (TAF) and loans (still with collateral required) to many parties previously off-limits to the Federal Reserve and, of-course, this new Treasury option to buy up assets and bring liquidity back to the system, you can read what these government entities are doing at http://www.federalreserve.gov/ and other resources. You can choose not to believe their forecasts but it is undeniable that Dr. Ben Bernanke and Treasury Secretary Paulson have “invented” many new and interesting mechanisms to combat this very real economic and financial crisis. I believe it is important to balance what is being thrown at us daily in the media with what really is going on behind the scenes. These activities by the Fed/Treasury are momentous, history-making, extraordinary and very much needed. The government (that is, Congress) has no clue, I agree and as evidenced by their inability to pass the 3-page $700 billion plan presented originally, but the Federal Reserve and the Treasury and the Finance Ministers of other Central Banks around the globe do.
The Government Intervenes in Free-Markets
I am convinced that Larry Burkett understood that past recessions and bear markets recovered by the manipulation of the free-market system through government intervention because he states that in his book. He, however, believed that there would come a time when there would not be enough money available or manipulation/intervention methods possible to stave off the final economic disaster.
That is where you may agree with him and where I disagree – at least at this time in history. I have been amazed at the things thrown at this very serious situation. Even the author of this book describes an economic earthquake – from which recovery is possible - rather than a complete collapse of the entire system.
Irrational Exuberance! / Irrational Fear?
There was irrational exuberance stated by Alan Greenspan in 1996 – 4 years before the market topped – and there is irrational fear now. Markets are tumbling yet the price of oil has gone down from $147/barrel to as low as $73/barrel at one point. (What happened to those who said that supplies were so short that higher prices were inevitable?) The unemployment rate may continue to rise but at 6.1% it is below historical norms. Interest rates are nowhere near the double-digit rates that accompanied the 1973-1974 or the 1980-1982 recessions.
Companies that lower production now and lay off workers will eventually return to productive capacity within a free-market system with government regulation and other external stimuli. What is your company doing? Closing up shop? Never going to make another product or offer another service even when they know they can borrow capital at one rate and return it a higher rate to themselves and their shareholders at a later date?
What Happens Next?
Will the markets go down further? It is possible. Are we at the bottom with the beginnings of a recovery in sight? That is also possible.
What needs to be answered is whether the market has sufficiently discounted for future economic weakness, maybe has over-reacted or maybe the market has much more discounting to go. I do not know. My financial planning methodologies are not based on guessing what the stock market will do tomorrow, but rather to strategize in a reasonable and prudent way based on what we know from history as to what the economic and market cycles have always done. So…history…
A Lesson from 1967
Dis-intermediation (often talked about these days): interesting word. You know why? It was invented in 1967. It actually means: “…the diversion of savings from accounts with low fixed interest rates to direct investment in high-yielding instruments…” (Webster’s Ninth New Collegiate Dictionary). 1967 followed a recession where the market fell from its high on February 9, 1966 to its low on October 7, 1966 – only 8 months later – a drop of -22.18%. The Fed had just raised the discount rate from 4% to 4.5% a few months earlier (the end of 1965 which probably didn’t help) but the Treasury bill rate (3-month, short-term rate that was suppose to follow the Fed’s target) continued to increase from 4.5% to 5.5%. As the market bottomed, the interest rate fell to a low of 3.5% by mid-summer 1967 and, I surmise that the word dis-intermediation was then born. The interest rate on T-bills had been much lower (in fact, it was near 2% prior to the 1961-1962 recession when the markets fell -27.97% (please note that markets falling and recessions do not have to go hand-in-hand though that is the case most of the time). But by 1967, investors wanted other options besides anemic savings accounts and the ability to invest directly in higher yielding instruments. I am stating historically what happened around that time but obviously I do not know the exact reasoning behind the introduction of this word but it is interesting.
The decade of the sixties is also known as the “Great Economic Expansion” (Ned Davis Research) yet it experienced two recessions with two bear markets to go along with them for:
good measure.
Recent Speech by Federal Reserve Participant: Debt and Credit Markets
Recently, the market seemed to shrug off a coordinated half-percent drop in interest rates. I believe it was because the short-term markets were already trading at less than the Fed discount rate anyway. They were just late to make the reduction that the market had already priced in so the market did not react favorably.
From Federal Reserve Vice Chairman Donald Kohn’s speech on September 11, 2008 here are some excerpts: “…Bear Stearn’s borrowings were largely secured (its lenders held collateral too ensure repayment), …however, the illiquidity of markets was so severe that short-term lenders declined to renew their loans…” The rest is history now. But, “…illiquid markets do not impede the repayment of most loans…” Just because the loan cannot be sold in the marketplace does not mean that everyone stops paying on them. This is important. He further states “…the lack of confidence has created many adverse effects like moving up the demand-for-credit curve … but on the other side, it bolsters profits going forward once the write-downs are complete…” And, finally, “…as intermediaries become deleveraged (a painful process for sure), these lenders will experience greater returns for taking risk than they did two years ago…the transition…as lenders deleverage…involves some over-shooting…and the process of adjustment to a safer, more resilient financial system is going to take awhile.”
Recent Speech by Federal Reserve Participant: Globalization
Finally, from Federal Reserve Governor Randall Kroszner, who disagrees with many people that globalization is bad for the U.S. and with whom I agree on the other hand. But you will not hear this stuff in the media. About the exportation of jobs, the trade deficit and the negative effects of globalization, he writes, “…exports to other countries can provide a direct and powerful stimulus to the domestic economy…”
“First, investments made by U.S. residents abroad and by foreigners in the U.S. are enormous, both in absolute terms and as shares of GDP…but the composition…is quite different…the income return on direct investment by the U.S. in other countries is more than twice as high as the income return foreign investors receive on their direct investment in the U.S….” and, in effect, “…the rest of the world pays the U.S. for the privilege of lending to it…”
It has puzzled economists for some time as to why the U.S. can borrow from foreigners with out increasing its own debt. In other words, we should be showing trillions of dollars more in our annual deficits (yet, last year it was $190 billion; now grant it, that these next couple of years are going to be substantially higher but it is not a result of international trade imbalances). Why? The answer is that the U.S. generates a sizable positive adjustment to the net investment position. This is not available for the public through the media but it is readily available if you desire to find some balance with what you hear and see daily.
Economic Collapse?
What are the real alternatives to us though as investors?
If you think world markets will continue a plunge downward to eventual collapse, then a contemplated money move to bonds, cash or whatever is useless. A greenback under the mattress would be no safer than anything else. All would be worthless.
If there is no recovery of the markets over the next 10-20 years, then moving your money to cash or other fixed income instruments providing rates of returns of 3% or 2% or 1% with accompanying inflation (that may be higher than that) will not be an alternative either. Maybe in the short-term it will feel good that you have saved some of your money but it will not be 5 years from now. Retaining purchasing power for the future is the whole point of what we are doing.
Is it true that there is no historical context for what is happening today? There is some truth to that. There is some falsehood to that. Balance is required.
Another Summary of some Historical Events
800+ banks failed during the S&L crisis of the 1980’s. Thousands failed in the 1930’s. Credit markets have seized up before – that is why in the 1960’s we had interest rates at 1% and in 2002-2003 we had them that low again. We have had double-digit inflationary periods and survived. We have had many problems with the financial markets over the years. Recoveries seem to take less time when the downward spiral is quick. This drop within 12 months is from the historical perspective actually right in line with the median – 12 months – since 1956. I accept that prior to that time there were so many changes that occurred as a result of the 1929 depression that it is less meaningful to look back that far. Of-course, the drops in value may not be over today.
What Alternatives Exist for the Average Investor?
If never again, then your purchasing power will be halved in only 10-12 years. That is a guaranteed loss of 50% by staying out of the market.
There will be many false rallies. In reality, if you had missed only 10 days of the last 2,000 trading days before this severe bear market took place (1998 – 2007) you would have made a zero rate of return. The markets are volatile. They go up, they go down. They certainly don’t go up in a straight line or forever down in a straight line. There is value that companies provide to shareholders by making products and selling services.
If you have a portion of your money in safe liquid CD's, savings/checking, money markets and cash (if already retired, then enough to withdraw from for the next 5-7 years – a prudent and conservative approach – without having to worry about the markets and if still working, enough of an emergency fund to last at least 12 months) then this should, indeed, be a comfort to you. If you had met with me, then you would have this cushion at a minimum.
Fear
But, I do understand how you feel. The raw emotions of fear that grip us daily as we watch our other holdings drop dramatically is not comforting at all. It is very uncomfortable. Very maddening. The alternatives are not good ones in my opinion though and market-timing simply does not work.Sell after this drop in value and you guarantee that your paper loss is a real one and that your recovery time will be twice as long or possibly never (because the rotten rates of return available will not keep pace with inflation and result in a drop in purchasing power). Holding on and being patient is no guarantee either but there is a possibility of recovery that you lose by moving out of your stock positions. This was the reasoning behind the stock/bond allocation in the first place.
Do nothing out of fear. Be reasoned.