Twenty four months ago the Dow Jones Industrial Average closed at 9,033 – down 232 points for the day. The following day the index fell another 500+ points. The financial crisis was upon us. Bear Stearns had been saved by the government, but Lehman Brothers was not. In spite of the heretofore unimaginable nationalization of Fannie Mae and Freddie Mac, the collapse of Lehman was the final straw. A massive rescue of AIG would soon follow. Market volatility ratcheted morbidly higher until the DJIA reached 6,547 on March 9, 2009. Several money market mutual funds put a 7-14 day hold on customer funds. The entire banking system was inches from collapsing. For all that central bankers and Treasury officials may have missed, there is no doubt they performed heroic service.
In my new book, The Arrogance Cycle – Heads I Win, Tails I Don’t Lose (just submitted to my publisher, Globe Pequot), I interviewed two psychiatrists. They explained that parameters for socially acceptable behavior may vanish during life threatening situations. If you can imagine being terrified in a dark alley, your only thoughts are of getting out of the alley and out of mortal danger. Gone are thoughts of your dinner menu, car repairs, and morning appointment. Danger brings intense focus on the immediate.
Investors tumbled and bruised by the markets’ crashing waves have moved as a herd into the seemingly safer, more stable realm of bonds. Treasury Bill yields for maturities less than a year range from 0.13% to 0.2%. The 2-year treasury yields 0.35%, and the 10-year Note is yielding 2.5%. Moreover, investors must pay tax on interest earned. The clear interpretation is that investors remain scared, not interested in longer-focused strategy but on immediately getting out of the dark turbulent alley by any means necessary.
Optimistic people may argue that the DJIA may rise to 15,000 or 20,000. Whether or not you agree, one must grant that such things are possible. Buyers of 2.5% 10-year Treasury Notes cannot enjoy such imaginings. There is a finite upside to owning a 2.5% Treasury and arguably a significant downside. We’ve shared the math in recent letters and won’t belabor the point.
Talks with audiences at some of my recent speaking engagements and with Fidelity representatives are about clients who are waiting and immobilized. Clients with significant amounts of cash are keeping it and remaining on the sidelines. They suggest that they want to wait to see election results, the actions of a lame duck congress, the tax code revisions after the first of the year, an increase in employment, and the list goes on. They struggle to draw conclusions from these concerns. They can’t quite say what they should do about their investments when these various pieces do or do not fall into place.
Warren Buffet says that he attempts “to be fearful when others are greedy and greedy when others are fearful.” I’m writing to ask you to step back from your fear and think about what will benefit you and your family most for the years and not the months to come. Since World War II there have been several harrowing periods of American history: both for the country and the economy. Consider the Bay of Pigs, Kennedy’s Assassination, Nixon’s resignation, the 16% interest rates and energy crisis of the 1970’s, and 9/11. As desperate and horrible as each has been, markets have moved higher, and corporate America has grown.
While there have been several forecasts of Armageddon, each has managed to fall a bit short. Unless we are at the end of the American experiment, I suggest that this period will pass and that days of growth will emerge at some point in the future. So rather than ask what you should do to prepare your portfolio for the world’s collapse, think about what you should be doing should the world survive and flourish. Like our friend Larry Kudlow, we are bullish on America.
This is not to sound any sort of “all clear” or that difficult times have passed. There is still ample danger and peril in the economy and financial markets, but the time for short-term, get-out-of-the-dark-alley, survivalist tactics has passed. We continue to favor a defensive portfolio. We are not concerned about losing out on hot opportunities but are very concerned with losing principal. Consumer Staples, Technology, and Healthcare are sectors that appear attractive. Multinational companies with strong balance sheets, low debt, high returns on equity, low price-to-earnings multiples, and attractive dividends continue to represent significant value.
Hang in there,