Hindsight may always be 20/20, but in these market and economic times, the cognoscenti seem to agree that even perfect vision and an understanding of the past may not help us see through the blurry present into the future. In fact, the consensus of the market gurus who contribute to Investment Advisor’s monthly Asset Allocation page is that this environment is not at all similar to other historical financial crises–at least not similar enough to take lessons learned from the past and apply them now.
“All happy families are happy in the same way and all unhappy families are unhappy in their unique way,” notes David Kelly, chief market strategist for JPMorgan Funds, quoting a line from Leo Tolstoy’s Anna Karenina. “That’s kind of how it is with this financial crisis–if it was comparable to another, then we’d know how to get out of this, and then people wouldn’t be so scared about what’s happening in the short run.” Mark Balasa, principal at Balasa Dinverno & Foltz LLC and spokesman for the elite Alpha Group, agrees, “The S&P numbers are comparable to 1973-74 and 2001-02,” he says. “But what’s not comparable is how broad it is outside of that–even bonds are down.”
Faced with rising unemployment, corporate bankruptcies and fire sales, the credit freeze, seemingly unprecedented market volatility, a recession that’s finally been formally acknowledged, and plunging portfolio values, our intrepid panelists were asked to share with us their top worries, offer some sensible solutions, and suggest how to handle portfolios as we begin a very uncertain 2009.
More of the Same?
“The perfect storm of financial market meltdown, credit freeze, and economic contraction are meeting head-on in a period of political transition and regulatory overhaul,” the Securities Industry and Financial Markets Association (SIFMA) said in its latest economic outlook in mid-December. The upside is that some combination of cheaper credit, increased government backing of corporate debt, and an economic stimulus plan (or plans) that President-elect Barack Obama has pledged might lead us out of the recession as early as the third quarter of 2009, as many of our panelists believe. However, uncertainty looms large. “My biggest concern is that it’s not at all clear how big and wide this recession is going to be,” says Lincoln Anderson, chief economist of LPL Financial. “Anyone who says they are on top of it is out of their minds.” So what should advisors and their clients be watching? What should they still be worrying about?
“Very often you can measure the depth of any recession by the level of unemployment that you suffer through,” says Gail Dudack, principal of the Dudack Research Group. “My fear is that the unemployment rate will get higher and fall on top of what was not really a strong employment market–that is behind a lot of the consumer fear that you see.”
My biggest concern is that the continuing stream of the financial crisis will not be contained by Washington’s efforts,” says Gary Shilling, president of A. Gary Shilling & Co. Balasa takes it a step further. “There have been mistakes,” he argues, “and government involvement is one of them.” With the rescue of Bear Stearns, many in the industry assumed that any troubled financial services firm larger than Bear would be considered by the Treasury and the Federal Reserve as too big to fail. “But then within a month or two they allow Lehman Brothers, which is much bigger in size, to go under,” laments Balasa. Like many advisors, Balasa was left wondering what the “rules” are. “They are clearly being made up as we go along, and it’s hard to make decisions–I don’t know how to apply the lessons yet,” he says.
Kelly compares his current worry–deflation–to an insidious disease. “It makes monetary policy pretty powerless and also leads to higher unemployment, but the biggest problem is that it encourages a ‘Wait and see’ mentality; we are in danger of becoming a ‘Wait and see’ economy,” he explains. With high unemployment rates and falling prices, consumers are waiting to buy that new house or car, and corporations may be delaying a decision to hire someone. “When everyone wants to wait and see, what they see is no good–it’s the perils of procrastination,” Kelly says. “You get rewarded for waiting.”
Lack of Trust
Every panelist interviewed mentioned mistrust as a worry. “The credit markets and the lack of trust have bled everywhere,” Balasa points out. “And it’s not only a mistrust of those on Wall Street that created a lot of this carnage, but it has spread into the Big Three [auto makers], and even Congress and how they handled the legislation around TARP.” Anderson says such fear is justified. “Consumers need to be shown a much more transparent and legitimate set of business models with a lot lower leverage and they are likely to get that,” he says. “And secondly, a financial structure and regulatory environment that gives investors confidence and a sense that this is not likely to happen again is needed–I think they are likely to get that, too.”
Dudack believes that once the psychological aspect of mistrust shifts, the recession will be even more likely to end. “The one thing about recessions is that they can feed on themselves, or they can be reversed in terms of consumer psychology, so it’s pretty important,” she says.
Shilling believes excess home inventories are a major problem at this point. “We estimate that there are 1.7 million extra in inventory still out there and they are the mortal enemy of prices. In other words, as long as you have that excess, you have downward pressure on house prices, which puts more people under water, with their mortgages exceeding their house values,” he explains. This, in turn helps to lower consumer confidence and spending. Shilling estimates that house prices that are now down 21% will be down 37% peak to trough, putting U.S. homeowners under water on their mortgages to the tune of $1 trillion. “The point is,” says Shilling, “when people are under water they have tremendous incentive to walk away from their houses and then those houses are resold at huge write-downs, which depresses prices even further.”