After getting off to an optimistic start, the stock market ended the first half of 2010 with an ugly finish. The first four months of the year continued the rally which began March 9th of 2009, but the market declined over 7% in May and over 5% in June, completely wiping out the gains of the first four months.
The Bloomberg chart below illustrates just how important it is to NOT take a big loss when investing. This is a chart of the Dow Jones Industrial Average for the previous 5 ½ years. From its peak in October ’07 the DJIA declined 51%. Believe it or not, the ensuing gain of 76% over the following 13 months didn’t repair the damage. You might think “down 50%, up 76%…sounds like a good thing”. It’s not. When you lose 50%, your investments have to double to get back to even. That means you need a 100% gain.
click image for larger view
On the chart, I point out that the 76% gain occurred during and following massive government stimulus. Government stimulus was necessary in the fall of 2008 to keep our country’s economy from coming to a screeching halt. However, the bailout of the automotive companies, the Cash for Clunkers program and tax credits for first time home buyers has turned out to be somewhat like heroin….it makes things seem better than they are for a short period of time and then you need another fix.
Keynesian economists will tell you we need more government stimulus…that additional spending by our government will eventually jump-start our economy. They warn that if our government opts for austerity, we will experience a “double-dip recession” or a depression resembling the 30’s when Hoover chose austerity. I think it is likely we are doomed for a significant amount of economic pain either way. Austerity is immediate pain with less government debt which might be better in the long run. Government stimulus will postpone the pain but adds to our country’s already massive debt…and might actually make things worse in the long run. The Obama Administration and Congress will almost surely attempt to create more economic stimulus since postponing pain is always better than experiencing pain…if you’re trying to get re-elected.
Looking back at stimulus policies of previous recessions may not provide much help. The American consumer is in a “de-leveraging” posture. Consumer spending is down and will continue to stay down. Debt is being reduced and savings rates are increasing. Finding the carrot that will persuade the American consumer to spend might prove to be more elusive than in past recessions. We have never had as much debt as we had entering this recession.
I don’t know if stimulus is the best policy or if austerity will ultimately prove to be the wisest course (even if it is the most painful). As I stated earlier, I think we are in for a large amount of economic pain either way. However, if we are going to choose economic stimulus, I think the government should focus on creating jobs instead of incentivizing consumers to spend which is supposed to indirectly create jobs. If we are going to send unemployment compensation checks to people, why not find work for them and send them “employment” checks?
Cash for Clunkers didn’t create jobs. It just stole auto sales from future quarters. The first time home buyer tax credit didn’t create jobs. It just helped a small number of young people get into existing homes. Future stimuli should be focused directly on creating jobs instead of creating economic activity which may or may not create jobs.
Here we are, two and one half years after this recession began and we still have high unemployment with no sign that a significant number of new jobs are being created. How high is unemployment? Officially it is 9.5% but that is because the government doesn’t count the people who have given up looking for a job. In reality, unemployment is well over 10% and some estimates are in the mid-teens. What is worse is that many of the unemployed are nearing the end of their unemployment compensation benefits which have been extended a couple of times by this Administration. Will the Administration extend these benefits again or will they risk the wrath of citizens who have no job and no income? These people don’t want unemployment compensation. They want EMPLOYMENT!
Meanwhile, once the tax-credit for first-time home buyers expired, housing statistics snapped back to “abysmal” (the deadline for closing was extended to September 30th if the house was under contract by April 30th). New home sales plummeted 33% from April to May. New foreclosures topped 300,000 for the sixteenth consecutive month.
On my bicycle ride, I count real estate signs in the yards of homes…just my own anecdotal study of our local economy. I’ve watched the number of signs climb from seven in the summer of ’07 to as high as twenty-six last summer. After seeing it decline to fourteen in April of this year, it has climbed back to twenty at the end of June. For three consecutive years, it has had an uncanny correlation to the national economy and the stock market.
The past two decades have been an interesting study for the stock market. The decade of the 90’s produced average annual returns in excess of 18%. The following decade lost almost 1% per year. The average return for the entire twenty year period was just over 8% but that is clearly a deceiving statistic. I point this out to illustrate just how difficult investing can be. Just as soon as you think you have it figured out…? Whatever the stock market does in the short run (the next few months), it ultimately has to reflect what is occurring in the global economy. You might think that, surely after an entire decade of negative returns, it has to rebound this next decade. You may be right but you probably don’t want to bet your retirement on it. We feel we are in a “range-bound” market for at least several more years. The elements that would contribute to a long-term cyclical bull market are a long way from being in place.
Because our outlook for the global economy continues to be rather bleak, our allocation to the equity markets continues to be smaller than it would be if our expectations were for a healthy economy. However, because we expect our political system to create some sort of additional fiscal stimulus, we would not be surprised to see occasional short-term rallies.
Fixed income investing is also becoming more challenging in that Treasury bonds have rallied and yields are extremely low. Mortgage rates are at their lowest levels since 1971 so yields on government guaranteed mortgage backed securities are much lower than just a couple of years ago. “Reaching for return” can be dangerous. At Boyer & Corporon Wealth Management, we remain diligent to the notion that you don’t get additional return without taking additional risk. To the extent we take additional risk, we are being very careful and maintain a healthy respect for the markets.
This information is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.