Better Safe than Sorry
In light of all that is going on in the world, I thought this would be a very good time to share my investment and economic lookout for the near future.
I am currently more defensive minded than usual and have made sure that my client portfolios reflect that (most portfolios are over-weighted in bonds or have larger than normal money market balances). In this climate, I think protection of principal is more important that trying to time the market and hit a home run if the stock market were to shoot up from here.
I gather information from a number of resources (some are experts from foreign countries) and will quote several of them rather than rewrite what I have heard. These have been ongoing concerns, but I am hopeful that some of them may be resolved in the next 3-9 months.
Why am I concerned?
- The rest of the developed world is either in recession or soon will be.
This chart below is from Prieur du Plessis of Plexus Asset Management in South Africa. Notice that every major region is slipping into contraction except the US (which is a good sign for now).
Many European Countries have borrowed way too much money compared to their GDP. Their countries balance sheets are in horrible shape (Greece, Italy, Spain & Portugal to name a few). The U.S. gave $40 billion (bad idea) to Greece through the IMF and only bought them a little more time at our country’s expense.
The real problem was best summed up this week by Mervyn King, the governor of the Bank of England, speaking at the press conference to launch his Financial Stability Report. “Many European governments are seeing the price of their bonds fall, undermining banks’ balance sheets. In response, banks, especially in the euro area, are selling assets and deleveraging. An erosion of confidence, lower asset prices and tighter credit conditions are further damaging the prospects for economic activity and will affect the ability of companies, households and governments to repay their debts. That, in turn, will weaken banks’ balance sheets further. This spiral is characteristic of a systemic crisis.
The majority of European banks are insolvent. They own too much debt of sovereign countries that are going to have to reduce their debts. There are a growing number of analysts who are realizing that even Italy may have to reduce its debt burden. What this action does is give the European Central Bank (ECB) the dollars it will need to loan to the various national central banks, so they can loan to their insolvent banks. Will they bail them out, or nationalize them? The answer depends on the country and its voters. But absent recapitalizing their banks, there will be a credit crisis that will affect the whole world. The amount of debt that will have to be written off and the loan portfolios reduced, as well as new capital raised, is daunting. As I have noted previously, the need is for around €3 trillion. Writing off so much debt in the midst of a recession, coupled with austerity moves, will be massively deflationary for the eurozone. But Merkel and the German Bundesbankers have made it clear that they will not be part of any “printing press” action that is not coupled with serious commitments for balanced budgets. Even in the face of a recession. From John Maudin
2. Cash Flow Problems at Home
- The U.S. government generally spends more than it brings in . . . and recently, a lot more. For years Congress was willing to serially raise the federal debt ceiling and monetize the deficit. But this past summer, some legislators balked. When the early August deadline for an increase in the ceiling arrived, our elected officials kicked the can down the road, but less far than usual. They created a Congressional super committee with unprecedented power to propose solutions, and they designed automatic spending cuts in case no proposal won approval.
- With the committee working under a November 23 deadline to find ways to reduce the federal deficit by $1 trillion-plus over the next decade, and with a presidential election less than a year away, the subject of taxes is all over the headlines and likely to remain there. Thus I’ve decided to provide a background piece on the issues.
- What form will the deficit-cutting action take? In fact, the possibilities fall into only four categories:
• cut discretionary spending,
• reduce expenditures on entitlements,
• cut waste and fraud, or
• increase tax revenues.
Given the magnitude of the problem, the limited number of potential solutions, and the differences between the parties on the subject, there’s already debate regarding the fourth of those listed above. Democrats generally feel tax increases should be part of any solution, and Republicans often insist that while they’re open to overhauling the tax code, total taxes must not rise. Talk about “the eye of the beholder.” There’s evidence on both sides of this debate:
- The top 1% of U.S. taxpayers pay 38% of all individual federal taxes.
- The top 10% pay 70% of all taxes, the top 25% pay 86%, and the top 50% pay 97% .
- That leaves the bottom 50% of all taxpayers paying only 3% of the total.
- About half of Americans pay no federal income tax, and almost 25% pay no federal taxes at all.
- The average federal income tax rate for the top 1% of Americans is 23% (and for the top half it’s 14%), while the average rate for the bottom half is 3%.
Howard Marks of Oaktree Capital Management
The Debt http://www.usdebtclock.org/ – This is worth clicking on
It is currently $15 Trillion and rising fast. We have a large portion of that tied up in entitlement programs (social security, Medicare, Medicaid and food stamps) as few politicians have the guts to tweak the systems (concerned that if they take any money away today they may lose reelection votes) so that they may be solvent in the long run.
Total Unemployment – If/when this figure heads down, things can get better for the masses.
The Unemployment figure is completely misleading. While the unemployment rate dropped to 8.6%, another $315,000 people quit looking for work last month which means they are not counted as unemployed any more. The total unemployed includes those that quit looking for work (discouraged).
- This hurts the personal balance sheet
- This hurts homeowner’s psyche
- This makes it impossible for most to take advantage of refinancing at historically low mortgage rates
- This makes it difficult to move to a new home if there is no equity to use as a down payment
- Many people in the construction business and all the related home service and goods businesses are barely getting by.
- It’s great for first time home buyers or those with the cash to take advantage of reduced prices and cheap financing.
Well, we are much closer to the cycle bottom than we were in 2008. All of these issues are public information and should already be built into stock and bond prices.
The critical condition of Europe will force them to finally take action and the level of awareness by the average U.S. citizen seems to have reached a level where our representatives may finally take some positive action.
Europe is finally being forced to make some brutally difficult decisions (potentially giving bond holders a fraction of their money back) and I believe that fallout from those will occur is the next few months. After that bottom hits, there should be some terrific buying opportunities.
We have one of the most important national elections in our history next November. The market will anticipate the outcome months ahead of time and depending on who is expected to win the Congress and Presidency the cloud might be lifted and the ship turned around and get headed in a pro-growth manner. Keep your fingers crossed because with a few policy changes Corporate America and the entrepreneurial spirit could take off. This, of course, would mean that the total unemployed figure would drop, tax revenues would increase and housing might finally stabilize. History tells us that our economy has been troubled before and sooner or later the eventual rebound will more than offset the rough times.
In the meantime, staying conservative and having some cash on the sidelines is a prudent way to go. The picture should be a lot clearer early in 2012.
Please let me know if you have any questions or comments.