INVESTMENT STRATEGY PAST, PRESENT AND FUTURE

It has now been six years since the financial crisis and while the causes of the collapse are still in place (inordinate public and private debt and chicanery on the part of the financial industry) the world continues to move on so our investment strategy must continue to evolve.

 

2007 through 2008: Implosion of the Worldwide Financial System

Removing investments from stocks in the Fall of 2007 and buying Treasuries worked well everyone piled into them for safety. The Dow Jones (DJIA) declined from 14,000 to 6900 over a twelve month period; an approximately 50% drop.

 

From 2009 to the Present: The QE Bubble

The Federal Reserve embarked upon a daring and unprecedented strategy of giving CPR to the collapsed patient, the US economy. No one knew, including the Fed itself, how long this effort would continue but every time the Fed backed off the oxygen the patient (and stock market) collapsed. This was known as the QE Bubble that could have burst at any time because there was never complete agreement at the Fed that this was a proper strategy.

During this time I emphasized preservation of principal by investing in high grade corporate bonds. As of October 2014, the Fed has ceased QE for the time being so we no longer have to deal with the daily uncertainty of when and if the Fed will “pull the plug” and the resulting crash.

If you regret not being in the market during this time then you do not understand the magnitude of the risk you would have been taking. Remember without corporate buybacks and QE, the market would still be around 6900.

We have weathered that uncertain time with our principal intact. In addition, we have averaged a 3% annualized return which is in excess of the inflation rate of 1% to 1.5%. All the capital markets were ever designed to do was to keep investors even with inflation. Plus we have slept at night knowing our life savings was secure through the 1000 point down moves and flash crashes.

 

2014 Forward: No Growth, Low Rates, Rising Stock Market

It appears that for the foreseeable future there will be no growth in the economy. If there is no growth there will be no inflation so interest rates will remain low. The Fed wants to keep rates low to encourage borrowing for buying and to prop up the stock market which also encourages consumption. If the Fed sees what it thinks to be growth, it may allow rates to rise modestly to head off inflation.

As I detailed in my last seminar, The NEXT TWENTY YEARS, the business model that has been in place for the last 30 years is broken. Borrowing to pay for the present, past, and future was never sustainable. As we pay off the debt there will be no money for new consumption (demand), hence companies will not post profits.

The profits you read about are a result of cutting costs not increasing revenues. Companies are not investing their trillions of cash in their own businesses by hiring workers because they see no profit potential.

 

What would cause the Fed to raise rates?

If there is real growth in the economy the Fed may raise interest rates to head off any overheating that may lead to inflation. Higher rates slow borrowing and cools the economy down. The Fed has said it will not allow inflation to rise above 2%.

Some believe that the Fed will allow rates to rise modestly over the next year because it sees some indication of growth. Others think this growth is an illusion caused by manipulation of unemployment and profit numbers.

 

What would cause real growth?

Companies would have to spend their cash by creating new jobs and hiring workers or the government would have to institute another stimulus program by hiring workers for government programs (such as rebuilding the infrastructure).

So far, all companies have been willing to do with their cash is to buy back their own stock shares. Less dilution causes the share price to increase which pleases shareholders and hikes executive pay. This is the single greatest cause, other than QE, for the rise in stock market value over the last few years.

 

What about a stimulus? The Republicans have blocked all stimulus attempts on the part of the administration since 2009 and with the newly elected Republican controlled Congress that will not change. We will see further cuts, not new spending programs.

 

Implications for Our Investment Strategy

While bonds will be the backbone of our strategy, low rates and stock buy backs will continue to propel the stock market upward. Without the specter of a breaking QE bubble, it is time for some of us to take a look at stocks.

The stock market is outrageously risky for the small investor.  Every aspect of it is rigged for the benefit of the large banks from Libor (interest rates) to Forex (foreign exchange), but it is the proverbial “only game in town” if you need a higher return than bonds.

Because the stock market really is a game now, you must hire someone who will not exactly “beat them at their own game”, but will protect you from the worst of the volatility. Writing covered call contracts or “hedging” on stocks is an old and conservative way to invest in stocks. In this market it is the only way for the small investor to not be swallowed by the sharks.

I have hired a money manager who specializes in covered call strategies and many of my clients are already participating in this program. My current strategy calls for greater participation where appropriate. I stress that taking more risk never guarantees higher returns.   But for some people not taking risk guarantees going poor slowly.

 

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