Investment Outlook
By Akber Zaidi
Yorba Linda , CA
The first quarter of 2009 continued the negative trend of last year with all market indexes ending in the red by about 10%. Even the bond market turned negative this period. In any other quarter, we would be upset by these numbers. But after the disaster in the second half of 2008, almost anything looks good in comparison.
Many investors were taught that buy and hold is the best investing strategy. With the Dow Jones Industrial Average recently at lows not seen since 1997, it has been very tough for the buy and hold crowd. The proponents of buy and hold, mainly the investment and academic community, taught investors to expect 8-10 percent returns on their money in the long run. The returns generated over the last 10 years buying and holding stocks have been negative.
We are in a different environment now than we were in the last twenty years as the bull market that began in the early 1980s turned into a bear market in 2000. A buy and hold approach does not work well in bear markets and investors will need to make prudent decisions to survive this bear market. A more balanced strategy might now be required. Investors will need to balance between long-term investing and timing intermediate term trades. They will need to take profits after significant rallies and move portions of their portfolio to other asset classes or even cash. We believe that the current bear market may last into the first half of the next decade and have substantial rallies and crashes from now until then.
We are currently experiencing a market rally as the stock market indexes have rebounded off their lows. We have had multiple large one-day gains which are typical in the middle of bear markets, not during bull markets. This current bear market rally could last for a few months and could take us up to the January highs or beyond. We recommend holding equities till the rally has run its course and using stops to protect the downside risk.
As the stock market bubble has been deflating worldwide over the last year we have also been witnessing the bursting of three other bubbles simultaneously: the h ousing bubble, the debt bubble, and the consumer spending bubble. Bubbles have existed throughout time. Never in the history of the world has a bubble burst only halfway. Bubbles always collapse to their starting point or below. Famous examples of bubbles that fully deflated include the tulip bubble in Holland in the 1600’s, the South Sea bubble in England in the 1700’s, and the Nikkei bubble in Japan in the 1980’s.
The bubble in home prices started in 2000 as interest rates were dropped to 1% and Americans took out adjustable rate mortgages in increasing numbers to buy homes. The average price of residential real estate has now fallen almost 30% from its peak as tracked by the 20 city S&P Case-Shiller housing index. The housing bubble is still deflating and will not end until home values are back to 2000 levels, a fall of about another 20%. We suggest staying away from residential housing until the bubble has fully deflated.
The bubble in debt is unraveling even faster than it expanded. The deleveraging of debt is showing up in the delinquency rates of mortgages and credit cards. Residential real estate delinquency rates have continued to rise with sub-prime delinquency rates at over 30% and even prime delinquency rates now over 10%. Credit card delinquency rates are also spiking and show no signs of peaking as consumer balance sheets deteriorate amidst dramatic job losses. Total debt currently amounts to 340% of GDP. To fully deflate the bubble, debt would need to go back to 200% of GDP. This would require $20 trillion of debt to be paid off or written off. The longer the process takes the more deflationary the outcome.
The bubble in consumer spending is deflating due to massive job losses and higher unemployment. As consumer spending slows down so does GDP growth as consumer spending makes up two-thirds of it. GDP growth from 2000-2007 averaged 3% a year of which 1% was underlying GDP growth and 2% a year came from mortgage equity withdrawals. If we continue to project 1% GDP growth going forward but with home equity spending acting as a drag of 1% on the economy then we should expect zero per cent average annual growth rate for the next few years.
Governments around the world will not tolerate zero or negative growth and in their attempts to get their economies going again have dramatically reduced interest rates and flooded their banking systems with liquidity. Interest rates for all G7 countries are at historic lows, near an average of 1.25% while money supply is up sharply.
The US has gone one step further and made the decision to adopt “quantitative easing” or money printing. History shows that printing your way out of a problem creates inflation. A surge in money growth has its peak effect on economic activity about 9 to 18 months later. Against this backdrop of higher future inflation, the fundamentals for commodities and specifically oil are very bullish. We suggest buying hard assets at their recent lows as a future hedge on inflation.
An inflexible method of investing that ignores new trends and places trust in sure things like “buy and hold for the long run” always risks ruin. There are times in history when things change. This is one of those times. (The writer is President of Alpha Asset Management LLC, Yorba Linda, CA)
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