By Marvin O. Ellis, CLU–Branch Manager

We have just witnessed some of the most turbulent financial times that any of us will probably ever see again in our lifetimes

What is our Current Situation?
March 9, 2009 appears to have been the bottom of our most recent financial downturn.  The S&P 500 declined from its high of 1,565 on October 9, 2007 to 677 on March 9, 2009, a 57% decline.  By September 30, 2009 the index had climbed to 1,057, a 56% increase (1).  However, because negative numbers in absolute terms are bigger than positive numbers, it will take another 48% increase in the market to get us back to the market high of 1,565. 

The S&P 500 for the decade ending 9/30/2009 lost 0.15% compounded (2).  Most other markets were also flat due to the two recessions we had during this time.  The first recession was the protracted down turn caused by the technology bubble that burst in early 2000.   The last time we had two recessions in the same decade was during the depression decade of the 1930’s.  But combined the declines in the market caused by the two recessions have produced a flat performance decade.

How did we get here?
The 10/2007-3/2009 decline in the financial markets was largely caused by the bubble bursting in the housing market.  The bubble started in late 1999 when the House Financial Services Committee put pressure on Freddie Mac and Fannie Mae to make sub prime loans more accessible.  This helped to spurre the housing boom.  Too many people speculated that homes would rise faster than was reasonable.  The housing bubble began to burst as prices stabilized in 2006 and then began to fall.  Many who had financed these purchases with sub prime loans could not meet their obligations.  Others who in normal markets would not have qualified to purchase a home also defaulted on their sub prime loans (3).   

Many leading financial institutions such as AIG and Lehman Brothers helped to package these sub prime loans into investment vehicles.  They were collateralized with promises of insurance which made these packaged products appear safer than they were.  They were sold to pension plans, endowments, trusts, insurance companies and many other institutions all over the world.  Towards the last half of 2007 it started to become apparent that there might be a problem.  At first the problem was like a small leak in a dam, not very threatening.  But then as housing prices fell further and sub prime loans became harder to get and more and more sub prime loans went into default the leak escalated as a vicious round of lower home prices and defaulting sup prime loans fed each other. 

By the second quarter of 2008 mark-to-market accounting rules which had been designed to create transparency, required financial instructions to price their portfolios at prices other financial institutions would pay for them.  Confidence and prices eroded as everyone became suspect of the quality of any investments that contained sub prime loans.  As prices fell the capital of many of our most prestigious institutions shrank.  The leak now was a gushing river.

To raise capital, institutions began to sell their best investments.  This drove higher quality bonds and stocks down in price.  By October the credit markets had almost come to a standstill and we saw one of the fastest declines in the US and world financial markets. 

Does History provide any prospective?
Yes.  This recession, as of the 3^rd quarter of this year, has just passed all other recessions in the last 90 years as the worst recession since the Great Depression and has been referred to as the Great Recession.  But it has only gained that reputation by a small degree. 

Our Gross Domestic Product has only fallen by 3.8% while during the depression it fell over 26%.  We have had other recessions that were close to this recession in length and depth.  Our unemployment rate may hit 10% while the Depression rate was 24%.  Top tax rates most likely will go up in spite of what President Obama stated during his campaign but even if they do they will not go up from 25% to 63% as they did during the Depression.  And, although many banks have failed and more will fail, we have not had close to one third of our banks fail as they did during the depression.  We also have FDIC insurance, Social Security and unemployment compensation which didn’t exist then (4). 

Have there been any efforts to repair our economy?
Again the answer is yes.   The Bush administration encouraged Congress to pass the $700 Billion Troubled Asset Relief Program (TARP) in the middle of the confidence meltdown last fall.  Most other major nations passed similar legislation.  The Federal Reserve (Fed) lowered short term federal interest rates substantially to 0 to 0.25% last fall and foreign countries have followed suit.   The Obama administration got Congress to pass the $787 Billion American Recovery and Reinvestment Act which is estimated to put $280 Billion into our economy this year.  “Cash for Clunkers,” First Time Home Buyer Credits, both at the national and state levels, and extension of unemployment benefits have also provided stimulus to keep our economy from stalling.   And the Fed has increased the money supply which has provided further stimulus rather than decreasing it as was done during the Depression.    

What is likely to happen?
Of the last eleven recessions, each one was completely different.  However, if you study each recession you will find they each had two things in common:  First, they all ended and second, they were all followed by a large growth in the economy and the markets.  This Great Recession will follow the same pattern.  Many economists have already stated that the recession has ended but it will take 9 to 12 months before that declaration is officially made just as it took 11 months to declare the Great Recession had started. 

Already we are seeing corporate inventories which hit historic lows being rebuilt.  Capital goods orders and light vehicle sales are increasing.  UPS and other shipping companies are reporting increased volumes.  The inventory of unsold new and used homes has fallen closer to average levels and new housing starts have come off their historic lows (5).   Companies will have to rehire to meet demands.  And the fear that this recession would turn into another depression has substantially subsided.

But the recovery will most likely be at a slower pace than in past recessions because of several reasons.  We still have a large number of people out of work.  Those out of work have decreased capacity to spend.  It will take years to put everyone back to work.  We have flipped from spending everything we make to a saving nation again.  When we save there is less money spent on purchases which create jobs.  Federal and state deficits are approaching World War II levels and will hang around for some time.  Taxes, in spite of any promises, will have to be raised to erase these deficits.  Taxes create a drag on incentives which lengthens the time it takes for the economy to recover.  Our higher deficits are causing our dollar to fall which helps exports but causes commodity prices such as oil to increase.  We will all pay higher prices at the pump as oil prices increase which acts like another tax slowing the recovery. 

Inflation could be a worry if the velocity of money (how often it turns over) picks up and the money supply is kept high.  However, money supply has already been lowered and if the economy is slower in recovering the velocity of money may remain low which could keep inflation and interest rates lower.   We don’t see inflation as a worry yet. 

What are our recommendations?
Long term we feel we are in the recovery process.  As of June 30^th and September 30^th there was more money in money market funds than there was in all of the US Stock Market (6).  As perception spreads that the economy is recovering, more and more of this money will find its way into the financial markets and real estate especially as investors tire of earning low rates.  We feel this bodes well for being invested in the financial markets.  In the past, small and mid sized companies tended to do better as we came out of recessions.  With our dollar falling investments with a foreign element could also do better.   

What are the short and long term consequences?
Any time there is a 56% increase in the stock market over the short period we have just experienced, there is always the chance that we will have a pull back or that the market will digest this growth by going sideways for awhile.  Much of this rapid up tick has been a rebound from the over sold condition that was caused from the fear and panic that we would have another depression.  Fundamentals will become more and more important going forward.  Please check with us so that we can determine your risk tolerance and the best approach to investing for you and your circumstances.  

Footnotes:

(1)     JP Morgan 4Q2009 “Guide to the Markets” page 5
(2)     Morningstar Indexes
(3)     Hartford brochure?
(4)     Bureau of Economic Analysis, National Bureau of Economic Research, JP Morgan Asset Management.
(5)     JP Morgan 4Q2009 “Guide to the Markets” pages 18 & 20
(6)     JP Morgan 4Q2009 “Guide to the Markets” page 4

Source: AD# C09-21938
The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Business and Personal Planning Solutions, Inc. and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Investing in the markets mentioned may not be suitable for all investors. The S&P is an unmanaged index of 500 widely held stocks. You cannot invest directly in any index. Individual results will vary. Past performance is not guaranteed.

Written By: Marvin T. Ellis, Jr., Financial Consultant
Written for 2nd Quarter Compass Newsletter 2009

It was brought to our attention that clients wanted to know more about what we think about the markets.  Here is what we are seeing.  

Our Current View

Market indicators, such as Gross Domestic Product (GDP), retail sales, new home inventory, etc., are showing reasons why now might potentially be a great opportunity to buy.  Depending on your suitability this may include stocks as well as tax-efficient, corporate and high yield bonds.  The markets have started to turn around and we are beginning to see some strength return in the numbers.  Market indicators are one gauge we are seeing, and the other is the collective emotional change of the consumer, which is almost 70% of our economy.  You have probably seen this change as well if you think about it.   

A few months back, for four to five months straight, the economy was the lead story in newspapers, online and on TV.  Now it is a byline from time to time.  Have you noticed how the retail stores are busier than before?  It seems I wait in line everywhere I go: Costco, Home Depot, Wal-mart, etc.  Retail sales are up and the consumer isn’t as fearful to spend.               

Have you noticed general conversations you have with friends and co-workers?  I’m noticing people are talking more about what they are doing next in life; vacations, the swine flu, who’s on Facebook, who was kicked off American Idol or Dancing with the Stars, and less about how scared they are of the bad economy.   Have you noticed or felt that the doom and gloom is lessoning and life is starting to return to normal?  We feel things are getting better.  The transition from a discouraging bear market to a hopeful bull market will not happen over night.  You can’t turn a world economy on a dime.  It will still take time to continue building strength and stability.  The challenge is no one can gauge the collective emotion of the average investor. 

The key is to be poised now and have your recovery plan in place before the change occurs.

Bear Markets

Last month we held a “How to Handle Bear Markets” workshop.  In this workshop, we examined each decade starting with the depression period (1930).  For example, did you know that after a -78% loss during the depression the market hit bottom on June 1, 1932 and if you did nothing to your account it recovered in 4 years and 4 months?  However, if you invested more money into the market at the bottom, your recovery time was only 3 months.  Of course, this illustration does not guarantee performance but is interesting nonetheless. 

In our “How to Handle Bear Markets” workshop, we focused on 5 key points to help dispel the confusion and myths that surround these markets. 

1.  A broadly diversified portfolio of suitable stocks and bonds can help spread the risk of a portfolio across other asset classes.  Keep in mind though that diversification does not assure a profit nor protect against loss.

2.  It is very easy to get emotional with your money given all the dramatic headlines.  However, dramatic headlines can tend to indicate a buying opportunity for some.

3. In the past, some of the most significant gains tended to arise after the deepest declines. 

4.  If you feel something must be done, please call us to discuss strategies that make sense in your situation.

5.  When the markets are a lemon, make lemonade. (Tax Loss Harvest)

Of the last eleven US recessions, each one we faced was completely different.  However, while past performance is not a guarantee, if you analyze each recession you will find that though they were each different, they all had two things in common.

1. They all ended. 

2. They were all followed eventually by growth in the markets and economy.

This Bear Market is not Normal

This bear market we are in is an abnormality.  Here is some statistical data to show what I mean. 

If you take a 12-month return as of 03-09-09 which is the date of the lowest S&P 500 Index price (676.53) since the correction beginning on 10-09-07, your rate of return was -46.3%.  A probability distribution curve of the returns of the S&P 500 would show that there is only a two percent probability of having a loss of -46.3%.

The April World Economic Outlook has been analyzing global economies.  They are projecting a 1.3% contraction.  They stated we are experiencing the first global economic shrinkage in 60 years.

The 2000 decade has experienced two recessions.  You have to go back clear to the depression period of the 1930s to find another decade that has had a double recession in the same decade.

It is human nature to think in linier lines.  When markets are going down we think and feel they will continue to go down forever.  When they are going up, we also think they will go up forever.  Both are wrong. 

Although the last 18 months have been some of the most difficult investing times we have seen in the last century, we do not expect the downward trend to persist going forward. 

While the past can not guarantee the future, we believe that investors who consider committing new capital at these levels, or rebalance back to their strategic allocations when appropriate, may see significant opportunities for portfolio growth over the coming years.

We believe that in the future we will look back at these times as perhaps one of the greatest buying opportunities of our lifetime.  

Let us Build you a Recovery Plan

To help our clients recover, we recommend they have a recovery plan.  To launch this process, we are holding another workshop, titled “Moving from Defense to Offense:  Portfolio Strategies for Today’s Market.”  If you are looking to possibly shorten your recovery time or to better position yourself to take advantage of perhaps one of the greatest buying opportunities of our lifetime, we strongly recommend that you attend this workshop.  You do not need to have attended the previous bear market workshop to benefit from this one.  It will be offered on Thursday, May 28^th, 2009.  Please go to www.marvinellis.com for times, location and other information.  

Did you know that as of March 2009, there is more money sitting in money market/cash alternatives than there is in the entire stock market?  As some of this money moves into the markets and investor confidence improves the markets should move higher.  Difficulty lies in guessing the collective emotion of investors in the world when they will move that money back into the market.  If you wait till you see the movement, much of the gains may have already been realized by someone else.

Who do you know that…

In the last six months there have been more brokerage dealer buyouts, changing the landscape of financial advisors, than we have ever seen in our industry.  This means friends and relatives who you care about; investing with a different financial advisor at another firm, may have had a broker dealer change on their account.  Let me show you what I mean by changing landscape in the last six months:

• Merrill Lynch was bought out by Bank of America. 
• SmithBarney was sold to Morgan Stanley
• AG Edwards was sold to Wachovia.
• Wachovia was sold to Wells Fargo. 
• UBS asked Wells Fargo to buy them out, but Wells Fargo rejected the offer.
• Now it appears that Wells Fargo is going to sell Wachovia to UBS. 

Have you heard Raymond James in the news media?  In these current markets the fact that you haven’t is a good thing.  In July, Raymond James ranked “Highest in Investor Satisfaction with Full Service Brokerage Firms” in the J.D. Power and Associates 2008 Full Service Investor Satisfaction Study^SM.   The results are a demonstration of the very high level of service we strive to achieve.¹

With all of the above brokerage dealer changes, who do you know that …

• Is at one of the above listed firms?
• Is selling, or about to sell, a business?
• Has recently switched jobs, been laid off, or may need help with a 401(k) rollover?
• Is getting ready for retirement, and may need help with the transition?
• Would like a second opinion on their investments?

We would be honored to work with your family and friends who may benefit from our services.

¹Raymond James received the highest numerical score among full service brokerage firms in the proprietary J.D. Power and Associates 2008 Full Service Investor Satisfaction Study^SM. Study based on responses from 4,528 investors measuring 19 investment firms and measures opinions of investors who used full-service investment institutions. Proprietary study results are based on experiences and perceptions of consumers surveyed in April-May 2008. Your experiences may vary. Visit jdpower.com.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any options are those of Business and Personal Planning Solutions, Inc. and not necessarily those of RJFS or Raymond James.  Expressions of opinion are as of this date and are subject to change without notice.  Investments mentioned may not be suitable for all investors.  Past performance may not be indicative of future results.  This information is not intended as a solicitation or an offer to buy or sell any security referred to herein.  There are no guarantees that the recommendations or the strategies mentioned will ultimately become successful or profitable nor protect against loss.  Bond prices and yields will fluctuate with market conditions and may be worth more or less upon redemption.  High yield bonds are not appropriate for everyone and when appropriate should only represent a modest portion of a portfolio. You should discuss any tax or legal matters with the appropriate professional.

2008 was one of the most extraordinary years in U.S. financial history and the worst performance year we and our clients have experienced in our investment careers. Although this doesn’t make anyone feel better, analyzing the statistics, this really is a 50 to 150 year event.

History of This Last Year Markets

In December 2007 Barron’s published an article which was titled “A Bullish Call-Wall Street’s Seers Forecast more gains for stocks next year” (Barron’s Online, December 17, 2007).  In the article, 12 well known economists gave their forecasts for where they thought the S&P 500 would end by December 31, 2008. Their estimates ranged from 1525 to 1750. The S&P 500 was at 1468 at the end of 2007. None of the strategists predicted a recession and one believed that stocks were “screaming cheap relative to bonds.” As you know the markets went the other direction. The S&P 500 ended down 37% at 903, in 2008. The Dow retreated from 13,265 at the end of 2007 to 8,776 on December 31, 2008, a loss of 33.8 and its worst loss since 1931. This goes to show the direction everyone was thinking at the end of 2007 and that this current bear market and recession has been such a surprise to everyone including the experts.

S&P 500 Index at Inflection Points

There have been two causes to this down turn. The first was the bursting of the housing “bubble” and the second was the subsequent credit freeze that has gripped financial institutions. In many ways we are experiencing a recession within a recession. The recession begin December 2007 which had been mild through September and then the credit recession began which has become more serious. Average recession time is usually 14 months, but we feel you should start counting from the beginning of the credit recession as of September 2008, instead of the mild real estate recession in December 2007.

There are many causes and enough blame to go around everywhere. The housing “bubble” got its start when President Clinton encouraged Congress to make it easier for low income families to own their own homes. The way was cleared for banks and financial institutions to make sub prime mortgages. Fannie Mae and Freddie Mac were allowed to package these loans into investment pools and then a number of financial institutions wrapped extra insurance around these pools which raised their credit worthiness in the market place. The “pools” were then sold around the world as higher grade stable investments.

When it became apparent that some of the loans were not performing the institutions who had wrapped the extra insurance around the loans were called upon to make them good. These institutions found the commitments they had made were much larger than they had expected. When the house of cards then fell apart, Lehman Brothers went bankrupt, which started the “Credit Freeze” issues. Other once-strong U.S. financial institutions fell on hard times leading to bankruptcy, failure or acquisition. These included Countrywide, Bear Stearns, WaMu, Freddie Mac & Fannie Mae, Merrill Lynch, IndyMac, and Wachovia. These events probably helped turn the tide for the Presidential race from a McCain win to Obama, as a cry for “change” caught hold in American’s hearts and minds.

The recession which had been mild through September ended. When Lehman Brothers went bankrupt it started a whole new set of dominos to fall. The first 10 days of October. From October 9, 2007, the peak of the market to October 10, 2008, the psychological bottom of the market, the S&P 500 fell 42.5%. Many started to question if we were headed for a depression. If it had not been for the relatively fast actions of the Federal Reserve and Congress, and other banking and government intervention around the world, we could have entered a depression.

Deep Recession but not a Depression

The US has entered a recession which is evidenced by two negative quarters of Gross Domestic Product: 3rd Quarter -0.05% and 4th Quarter -3.8%. (Bureau of Economic Analysis Online, U.S. Department of Commerce)  On December 1st the National Bureau of Economic Research officially declared that the US economy was in a recession and that it had started almost a year prior. (Money.cnn.com, December 1st, 2008, “It’s official: Recession since Dec. ’07″)  A recession is short where a depression usually is much deeper and it lasts a longer time.

By its definition, “Depression” means that prices fall. When prices fall consumers and corporations put off buying because by waiting they can get a better price. This sets up a feed back cycle where by waiting; you can get a lower price. And because purchases are postponed prices drop until buyers are enticed to purchase. We have seen this in the financial and real estate markets.

Looking at the chart below, Ibbotson Stocks, Bonds, Bills and Inflation 1926 – 2007, you will note that in the great depression period, prices fell for more than 10 years. The Fed has been pumping money into our economy to actually create inflation. This helps to prevent deflation. When buyers feel that prices will be higher tomorrow they are incentivized to buy today. This sets up a positive feed back loop where buying today strengths the economy. A stronger economy provides income for others to make additional purchases. Once inflation becomes apparent the Fed will most likely withdraw money from the economy and begin anew the fight to hold down inflation. This inflationary push will most certainly shorten or eliminate any current depression tendency. It will also help to stimulate the economy which in turn will stimulate prices in the financial markets which could be up by year end and real estate could be up by this year or next.

How Stocks, Bonds, Bills and Inflation have done from 1926 - 2007

Deflationary periods cause people to hold off from purchasing because prices are going down and they are going to wait till they get lower before jumping in.  When an inflationary period occurs, people want to buy immediately before prices get too high.  This is how the fed uses inflation and deflation to stimulate the economy.

What We Think Moving Forward

Prices in the financial markets will most likely start steadily moving up by year end and real estate could be up by the end of this year or first of next. However, Obama’s “rescue plan” could send the markets lower because of the fear of additional regulation and uncertainty. One struggle with the Obama’s “rescue plan” is two thirds of the spending will not occur until 2010.

We make money by buying low and selling high. We know this logically but emotionally we want to do just the opposite. It takes courage to buy or hold securities that for a time are out of favor.

Right in the middle of the market downturn, The New York Times Op-Ed on October 16, 2008, quoted Warren Buffett, “Be fearful when others are greedy, and be greedy when others are fearful… Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month-or a year-from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.” He made these statements at the same time he stated he was converting his US Treasure Bonds for stocks.

We agree with Warren Buffett’s statement. We don’t know for sure when the economy and the markets will turn but we know they will turn. Some analyst think the turn around will be as early as the second quarter. Others are more pessimistic and say it will take until 2010 to see the turn around. The market however usually starts going up the proverbial three to six months before the economy turns.

Our view is to take caution and we are feeling that the likelihood of the markets starting to move up will be more like later this year. When the market go down it is like stretching an elastic band. The more you pull back the stronger it will snap forward. We are not recommending moving to cash, but if you are concerned and do not have time on your side then you may want to go more conservative and earn dividends while you wait for the markets to come back.

Many try to time the markets by going to cash and then coming back in at the right time, but to be successful at timing the market you have to be right twice, once for getting out and second to get back in at the right time. This is why we encourage our clients to stay fully invested in suitable securities.

Our Five Steps Financial Journey ^TM Process

To help you during these difficult times, we have recently formalized our processes which can help you through these difficult times. You have hired us for times like this. Please reference our “Financial Journey^TM” by clicking here.

Right now is a good time to review step one “The Chart Your Course Celebration^TM“ and step three “The Personal Navigation Plan^TM“ of our five step process and spend some time reviewing the concepts of a well diversified portfolio (step two) and that we make any necessary changes to your accounts to have the right mix of stocks and bonds based upon your risk tolerance. We also recommend that we review your accounts more often, at least quarterly during these turbulent times of the market.

What You Should Do Right Now

1. Don’t overreact: The temptation to “exit the market” may be nearly overwhelming. Down markets are great teachers. They help us determine how much risk we are comfortable with. If you find you would prefer less risk in your portfolio call us so we can discuss the best techniques for reducing risk rather than exiting the markets.
2. Assess your situation: Let us take you through our “Chart Your course Celebration^TM“ process and evaluate your short-term financial needs and reaffirm your longer-term goals.
3. Think long term: As Buffett – and history – tell us, at some point, the markets will turn. We don’t know when or to what degree, but we KNOW they will go back up. So be wary of selling at the bottom – and missing opportunities as the market recovers. The chart below shows that 40% of the best days occur in a bear market and 34% occur in the first two months of the bull market. This is why getting out can hurt you so much and being more cautious is wise.
   

   Why Market Timing Is So Difficult

4. This is a time to be buying: Instead of selling, consider buying with any extra funds you have. You are buying at a low price and when market prices go up, you will benefit from the great discounts.
5. Let’s make some changes: This is an important time to review your portfolio. With our “Lighthouse System^TM“ (step 5), we can help determine if your portfolio matches your tolerance for risk in the markets, help correctly position your accounts to make a good return when the markets move up or minimize the volatility in your accounts. You can be fully invested aggressively, conservatively or somewhere in between.

As the following chart illustrates, having a well diversified portfolio in both stocks and bonds is the best way to have a more consistently performing portfolio.

Asset Class Returns

Give us a call today to schedule an appointment to go through our five step process. We look forward to seeing you in our office soon.