Client Update Blog
I wanted to give you an update on current economic and market trends as a result of a conference I attended in San Francisco in late May which I think you will find interesting as well as my thoughts on some investment strategies we will probably be implementing soon. Finally we will conclude with 12 core happiness strategies that are beneficial for all of us.
The first speaker from the conference was Roger Gibson who is a Certified Financial Planner who has written several books on asset allocation who is very highly regarded in our field. He seemed confident that investors with diversified portfolios that include stocks will experience strong returns over the next ten years but doesn't mean the roller coaster will move up immediately. He currently is showing clients another chart showing the possibility that the market could get worse before it get’s better. He feels there is a possibility of another sharp drop before the market rebounds strongly and he's warning clients if they want to experience the high returns over the next ten years, the trip could include another freefall experience. He's not saying that's what's going to happen. He saying it's a possibility. In addition he said if clients don't believe that free enterprise will survive then their portfolio should consist of a cabin in the woods, canned food, krugerrands in the floorboards, and guns and bullets. That doesn’t sound like a great portfolio strategy to me.
The other speaker was David Kelly, the chief economist at JP Morgan. He is originally from Ireland and was quite interesting. He acknowledged the world is experiencing a crisis of unprecedented scope and magnitude and he confessed that he has little faith that the actions taken by the central governments of the developing nations[ including the US] are going to be very effective. Nevertheless he was upbeat about the prospects for recovery as early as this year. First he gave us some statistics that were very interesting. He said that the average daily market movement for the S and P 500 has been .81 percent in either direction over the last 50 years. In the final quarter of 2008 that figure rose to 3.7 percent, an unprecedented number which Kelly described as a 100‑year flood of volatility. We are not out of it yet because in the first five months of the year the average price movement came to 1.6 percent a day.
He then started turning serious and said we will never know how much of the market downturn was caused by the credit crunch and how much of it was due to panic. He noted also that until the fourth quarter of last year the economy was in a very mild recession and then the bottom fell out; a 6.3 percent drop in GDP in the final quarter plus a 6.1 percent drop in the first quarter of this year. This he said is comparable to the 1982 and 1975 recessions but not nearly the same magnitude as what the US experienced in the 30s. In addition new housing starts fell to 500,000 units, well below the 2.3 million people who are entering the home-buying marketplace every year which could precipitate a run on housing at some point in the future. He pointed out that auto sales fell to 5,000,000 cars while an average of 30,000,000 vehicles are being scrapped each year. These things have to bounce back simply based on supply and demand.
Mr. Kelly also stated that on average unemployment peaks five months after the recession is over predicting that the US rate will hit 10 percent before 2009 is over. From there the unemployment figures should drop at 1 percentage point or more a year until it's down to about 5 percent by the year 2015 which is considered full employment. This could be regarded as a positive sign if you add historical gains and productivity. He figures that lowering unemployment could fuel five or six good growth years after the end of 2009. Some of the audience found his inflation forecast to be a bit optimistic. He said that until the unemployment rate has been lowered to an equilibrium point, wage inflation won't be an issue and declared the fed probably won't have to start fighting inflation until the middle of next decade. We'll see what happens. Interestingly he is also not afraid of the budget deficits that the US government will be running in the next few years. The deficit will run around 11 percent of GDP in 2009 and 2010 compared with 30 percent in 1943 during World War II and 119 percent in 1944. He is more worried about the possibility that consumers will become too thrifty or stifle growth and he anticipates more oil shocks in the future.
We would now like to talk about some probable changes in investment strategy. Most of our clients now have 45 percent to 55 percent or more in conservative bond funds now to cushion any future market declines. As we have stated before we are considering some other options that might use hedging strategies that would protect the downside much more in the event of any other serious stock market declines. The only issue with this is sometimes these hedging strategies don't give you quite as much upside but protect you a lot more on the downside. We're considering allocating 10 to 15 percent of the portfolio into funds that could include market neutral funds, collar investing, and arbitrage. We are also considering an asset class notice known as publicly listed private equity. All of these are in mutual funds which are transparent, not like hedge funds which we don't trust at all because they don't have the public disclosure requirements and a lot of blowups have happened with hedge funds. Some of these funds do use hedging strategies and they've worked very well in certain cases. One of the market neutral funds we’re considering only lost a little over one half of 1 percent in 2008 which is pretty phenomenal considering the stock market averages were much worse than that in 2008. Market neutral funds use hedging strategies going long and short to hedge out most of the risk of a downside market. By doing that though, usually they will not get as robust returns on the upside.
Collar investing is another interesting strategy we're looking at where options are used to protect the downside so that your worst-case downside exposure might be 10 percent and your best case upside might be 15 to 20 percent. There is a mutual fund that's going to be coming out by the end of June [in which we know the manager] who has been running separately managed accounts since 2005. They've done pretty well with this strategy. There are also funds known as arbitrage funds that allow the manager to invest in mergers and acquisitions. Traditional arbitragers such as this fund try to enter in deals quickly after they are announced capturing as much of the spread between a market price and acquisition price as possible. This is an interesting play where we've seen one fund in particular that's done pretty well and only lost six tenths of a point in 2008.
Finally there is an area known as publicly listed private equity. That's an area where normally only the very rich have been able to get involved. There's now a mutual fund where you can invest in companies that are public companies that do private equity deals. Companies that are well known in the private equity field such as Blackstone [which is pretty well known nationally] is an example of some of the firms that might be in this mutual fund. This may not be appropriate for all of our clients but we're at least looking at this as a strategy as well.
In either event some of these strategies we may be implementing in the very near future and we will notify you immediately upon implementing any of these changes. We wanted to remind you that we are not trying to predict the market and still believe very strongly in modern portfolio theory and broad asset class diversification but we also feel there's a possibility that we could have what's known as a W stock market event which means first the stock market declines, then has an up tick or bounce back like we've had recently, then it has another decline before it is has a strong rebound again. Nobody knows for sure if this will happen but as noted earlier from Roger Gibson’s discussion it's a possibility and of course we don't know for sure what will happen. Nobody does but we're looking at trying to utilize hedging strategies that are more conservative and safer as a result of utilizing mutual funds rather than hedge funds.
To close I'd like to leave you with 12 core happiness strategies I think would be good for all of us: Remember to have gratitude and count your blessings, cultivate realistic optimism about your circumstances, avoid over thinking and social comparisons, commit acts of compassion, nurture key relationships, do engaging activities and experience the flow of them, savor life's joys, commit to your top key goals giving you a sense of purpose, focus and commitment, develop your own coping strategies, cultivate forgiveness, release resentment and anger that holds us back, practice religion and spirituality, and take good care of your body. I think these are excellent core strategies for happiness for all of us and I'd like to wish all of you a very happy and productive year with us and with your families. Thank you very much for the opportunity to serve you.
Sincerely,
William T. Morrissey, CFP®
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Sound Financial Planning, Inc.
www.SoundFinancialPlanning.net
Primary Office
321 West Washington St., Suite 329
Mount Vernon, WA 98273
Phone: (360) 336-6527
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(360) 378-3022
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