Look Up in the Sky –

 

“The facts, Senator, have changed,” said Treasury Secretary Hank Paulson, in explaining last week to Congress why the government relief program was morphing from its original approach. So the original title of this update was “Leadership, Anyone?” and was all set for release Friday AM when word began to leak out about Obama’s selection of a new Treasury Secretary. The facts, dear reader have also changed, and the update tossed. The pronouncements from the Obama administration that began last Friday have been both breathtaking in scope, and stunning in number, and the equity markets have so far responded with two of the largest up days in years.

 

…It’s A Bird…Rewind to last week – any day but Friday. Go ahead, pick your poison. Maybe you’ll choose really mediocre corporate earnings and expectations. Or unemployment claims rising to the highest levels in years. Or terrible manufacturing numbers. Or tumbling home values and rising foreclosures. Or the unraveling of various hedge funds pummeling stock prices down, and driving to penny-stock range the common stock of what was once America’s proudest bank, Citibank.

 

…It’s A Plane…Perhaps the toxin is a bug-eyed Treasury Secretary Hank Paulson and his TARP government plan that has changed since originally proposed and left many dazed and confused. Or continuation of much of the credit crunch, particularly for college loans, consumer loans, business loans, auto loans, credit cards and pretty much anything that needs to be financed. Or the fact that practically no investment has been immune to assault this past year, short of a mattress. Or the toxic and shameful sideshow of GM, Ford and Chrysler going hat in hand, albeit via private jets to Washington begging for federal funds. Any one of these poisons could reek market havoc, and havoc probably is the appropriate word with the S&P500 index down 20% this past month alone.

 

…It’s Obama

So who, amidst a backdrop of massive market uncertainty, lack of transparency and investor distrust suddenly appears upon the scene, in the nick of time to save us from the deepening economic and emotional distress? Barack Obama, flanked by a team of economic all-stars that resembles an economist’s version of the comic book Legion of Superheroes, armed with a battery of measures and economic weaponry that can stand tall next to FDR’s of the 30’s. Perhaps a bit of tongue-in-cheek here regarding the drama, but in truth, these folks -- Larry Summers, Timothy Geithner, et all – are truly impressive minds, and the economic package Obama presented on Saturday – perhaps well over $500 billion – is an extraordinarily gutsy and ambitious effort, even lacking the specific details.

The essence of that stimulus package – and that’s about all we know thus far – is the creation or saving of 2.5 million jobs through massive investment in infrastructure, green technologies, and education, and pretty much everything Obama campaigned for. Seldom can a president hope to implement such a wish list given the political realities, but the Republicans and Democrats both so far seem to be remarkably accepting of such a broad scale government-led stimulus. This is a rare opportunity, and many progressives sense this, to embark upon the scope of systemic economic change pursued by Reagan and Bush II, and FDR.

 

Taming Fear

We know that the markets (and people in general) hate uncertainty and distrust change – and there has been plenty of both in this economy. As we’ve pointed out many times, the prices of stocks and assets are based upon a perception of the future profitability or credit worthiness of the underlying company – the fundamentals, we call it. This is generally a data-driven concept, meaning the “market” considers input and guidance from the company, evaluates the viability of the company going into the future, looks at prior earnings, the ability of a company to weather difficult times, and so on. Over the long term, equity prices will be in line with this rational information.

Over the short-term, however, all heck can break loose, and for the last few months, it has. Emotions and sentiments are key components of the human condition. If market analysts, hedge fund managers and investors – all imbued with emotions just like the rest of us -- can’t get a reasonably clear sense of conditions going forward, or there are many chaotic conditions in the marketplace, they can panic or at least color their judgments like rest of us, moving the markets to react irrationally. Both of those situations are at play here. We know the economy will be bad this next year, but probably not as bad as many stock prices suggest. Moreover, given all the broader chaos in the financial system as a whole and a new administration about to enter, what impacts will remedies have? And nothing like heading into a storm with the captain asleep in his quarters. All this uncertainty engenders fear that further drives prices down, creating the kinds of negative feedback loops that can drive quality companies, like Citibank, nearly into oblivion.

So, take out some of the uncertainty, and the markets can begin the process of trying to get down to the work of properly fleshing out the fundamentals freed of the sense of doom that turns all news into further reasons to feel hopeless. Hence, the markets’ ebullient response to the announcement of a largely centrist, pragmatic, and experienced economic team. That is why, when markets turn from these extreme corrections, they usually turn big.

 

Dark Clouds, Silver Linings

Barack Obama and his economic legion aside, good news has actually been seeping through the cracks. Much of the credit crisis – the inability of institutions to get any access to capital and lend to one another -- has been stemmed, thanks to the original bank relief efforts and the new recent announcements. Huge capital infusions into the banking system have successfully pulled the large banks away from the brink, and Citibank’s rescue – which has its admirers and critics – firms up the government’s commitment to preserving the large “fortress” banks. Dramatically lower costs of commodities, including oil, metals and agricultural goods are now working their way through the manufacturing supply chain and in the near future will show in increased profits. And consumers, with lower gas and heating prices are already beginning to drive more. It might even be argued, that with existing home sales beginning to flatten and no longer plummet, that there may even be a smidgen of light at the end of the housing tunnel. This is in addition to the large additional stimulus – hundreds of billions -- on the way, perhaps in the form of a large middle class tax cut, massive infrastructure spending, additional foreclosure protections, and state funding packages.

Moreover, while Obama presses forward with his “recovery plan for Main Street and Wall Street,” the Treasury and Federal Reserve appear to be moving forward as well. The announcement, early Tuesday of an additional $200 billion to back up consumer loans, college loans and others, indicates, finally, a desire to incorporate Main Street, not just Wall Street in the solution mix.

Let’s be sober, however: this is an enormously difficult lift, and there is a danger in unrealistic expectations. The economic fundamentals we’re looking at remain pretty negative.

 

 

Our Approach  

So with all of this, what about our plan for investors going forward? In a year when anything goes, when many things have gone (Lehman & Bear Stearns), and when many of the things that couldn’t happen did (the equity markets dropping nearly 50%, General Motors on the brink of bankruptcy, and an African-American elected President), it’s clear that some part of the game has changed, at least for now. Unless an investor has an extremely long time frame in mind and an incredibly high threshold, buy and hold and a fixed asset allocation has not been the best strategy to navigate these markets, despite traditional thinking.

The bottom line, in these markets, we choose to continue to be flexible and careful. The economic fundamentals remain very weak, and while we expect a modest rebound and a bit less despair in the markets as the doom and gloom begins to lift a bit with the incoming administration, we are just beginning to enter the tough phases of an economic slowdown. We will pick carefully among the many opportunities, and believe strongly that these markets still will provide advantages in the near future over conventional bank investments.

Let’s consider the various time frames. Even with the modest Obama Team rally, we see the markets potentially nearing a bottom, and see them bouncing along for a while within a trading range. We see the point of the turnaround requiring a sense that at least some of the key economic underpinnings are starting to level off or improve, but see this as being at least several months away, however. Keeping in mind that the deeper the economic decline, generally the stronger the rebound, this suggests that this rebound will probably be very large and swift, indeed. Frankly, there are significant opportunities that we’ve been hankering to pull the trigger on, but we’ve been reluctant and patient as we’ve been watching positions become even more compelling.

As our investors know, we’ve been laying low over the last couple of months performing the necessary but difficult gymnastics of minimizing portfolio loss yet providing upside potential. Yes, some client positions have continued to trend down slightly during this tremendous market sell-off of the past couple of months, in part due to the pounding conservative Berkshire Hathaway has inappropriately experienced, but very modestly relative to the equity markets generally. In the short term, given the somewhat chaotic circumstances we will continue to be defensive over the next couple of weeks. In furthering our defensive posture, we will continue to move out of various mutual fund and other equity positions, and take appropriate gains and losses. We will also continue to hedge some of the equity opportunities that we will hold for dividends and income (i.e. preferred stock positions and bonds), and look to increase those positions. In the short term, we continue to see oil sliding a bit further, the dollar strengthening, and will continue to take advantage of those positions. A modest position will be retained in gold in most portfolios.

The intermediate goal over the next couple of months, however, is to rely on income-generators until situations stabilize while we remain defensive and stay ready to quickly seize on a change in outlook. This will include taking advantage of the outstanding yields of individual equities, ETFs, and various mutual funds. We will dip carefully into these positions and try to hedge them. We will also incorporate bonds and tradable CD’s to round out the mix.

 

Thankful

This is a difficult economic time for many people, and sacrifices seem increasingly to be a part of life. We believe these tough economic conditions will fade, the markets will rebound and portfolios restored and grown. While this has been an opportunity for investors to experience worst-case risk situations and reassess their tolerances, it’s also important to realize that this is, in fact, temporary. The economy will cycle upward as it always has done during its history. It’s a wonderful opportunity to take some pause and consider the many positives we have to look forward to, with a new administration and direction for the nation, and an opportunity to reconsider how we personally spend our resources, reconsider our life goals, and focus on the things that are truly precious to us.

In that spirit, we wish all of you a wonderful Thanksgiving.

Peace,
Ron Stein

Good Harvest Financial Group
631.423.6501