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Smart Investments, Redlands, Ca.

The Lost Summer

 

July, 2010

 


The Lost Summer

 

Securities markets move up or down based upon the decisions of millions of traders and investors. On balance, if more people are buying, the market will move up. If more are selling, the market will fall off. While this may seem obvious to the casual observer, maybe it makes sense to have a look, not at the decision to buy or sell, but rather examine the reasoning involved in the decision.

 

I think it seems reasonable that investors are more likely to feel comfortable buying securities when they have a sense of well-being. It could be that a sense of well being comes from possessing a certain level of confidence in the surroundings – in this case, the securities markets. It could also be that the feeling of confidence might be stronger or weaker based upon the time period under consideration. For example, an alert trader may feel fairly confident in minute to minute market movements. On the other hand, at the same time, an investor may feel unsettled with the economy or political issues, and the longer term prospects for the market. Therefore, the investor is unwilling to commit additional cash. I believe this is our position today.

 

In that scenario the market will move, sometimes fairly significantly, based on short term trading strategies and current news events, but will have trouble defining a longer term direction. When investors sense political or economic changes ahead they begin to worry, and hesitate to commit capital.

 

A few things investors might be worried about:

 

If capital gain taxes go up – a real possibility if the present Congress prevails – putting capital at risk to earn a capital gain will, by definition, become less attractive. Capital gains taxes have always worked against investors. Making the burden worse will not improve the investment climate, it will worsen it.

 

Congress recently passed a 2314 page bill regulating financial institutions. While there is a great case for additional rules and oversight, it has been estimated that the bill will precipitate hundreds of thousands of pages of new regulations. The legislation is said to have far reaching implication for everyone from bankers to farmers. Lack of understanding is an impediment to a market advance. Investors don’t understand how the Act will affect them or the companies they are invested in. So they sit on cash.

 

Tax law changes may bring an increase in taxes on dividends. This will make dividends relatively less desirable, and hence, the companies that pay them. Taxing investment returns will not increase their attractiveness, it will decrease it. We should be finding ways to make it more profitable, not less. Our goal is to attract capital into investment, not chase it away.

 

The list goes on, and to be fair, there is always a list of things that investors are worried about. It would be nice, though, if our legislators seemed a bit less confrontational to business and investors, and a little bit more accommodating. It is, after all, investors and savers that provide the capital to help build businesses, finance ideas and new products, all of which puts people to work and bread on the table. Investors need to trust the system. Our public officials need to find a way to help business by providing stable regulation, and keeping negative publicity to a minimum.  It sometimes seems like we have forgotten that.

 

In the end, a good amount of investing is based upon faith in the system. It seems easy to understand why people are questioning their faith at this point, and that is, without question, affecting the markets performance. In the meantime, institutions are feeling the same as investors – wary of committing funds to business projects.

 

With all of that as a backdrop, what’s an investor to do? Sitting on large cash balances doesn’t provide much return with interest rates at historic lows. But that’s what people and institutional investors are doing.

 

Here’s what we think:

 

Bold is inadvisable at this point. The markets have improved a bit, but there is plenty of reason to be cautious. The market tends to be positive at this stage in the cycle. The market ended positive in year two in 16 of the last 17 market lows since 1933. As such, we believe that it is reasonable to hold some stock investments, albeit at a lower percentage of your portfolio. The questions surrounding taxation of dividends notwithstanding, we favor holding large cap dividend paying companies. They currently are one of the few investments that provide a reasonable rate of cash flow. Also, stable dividends help reduce stock price volatility at a difficult time.

 

Fixed income investments should be confined to short to intermediate maturities for one simple reason: Interest rates are at historic lows. It seems counterintuitive, but from the perspective of the bond markets, the lower the interest rates, the higher the bond price. Buying long bonds at current rates, we think, means buying at the high. If rates go up in the future, and they will, an investment in a long bond could be a losing proposition. So be careful to keep investments on the short side of 5 years. You will earn less interest for now, but you might be able to invest at new higher rates when your bond matures.

 

A look into 2011

 

Interest rates will have already begun their ascent by summer 2011. The labor market will have improved, but probably won’t be all the way back. Equities will be a bit higher than they are now, likely a function of our current large un-invested cash balances. Through 2010, companies have been reducing debt and adding to productivity, which should lead to improved earnings performance.

 

It somehow seems that there are more questions than usual for the upcoming 12 months. The mid-term elections are weighing heavily on the economy and the market. Unfortunately, political fortunes can turn on very short term events, so caution is the order of the day.

 

Americans are an incredibly resilient bunch. Lay out the rules, and we will find a way to do business. Keep the rules a secret, and tough times will persist. Hopefully, the next few months will bring a bit more transparency to our markets.

 

Barrick Smart



Disclaimer: All investment entails inherent risk. Smart Investments Advisory Inc. seeks to assist investors in determining when to buy and when to sell certain investments in an attempt to maximize profits or minimize losses. All final investment decisions are yours and as a result you could make or lose money. The statements made herein include information obtained from sources believed to be reliable, but no independent verification has been made. We are unable to guarantee its accuracy or completeness. The statements made herein contain general information and do not constitute an offer to buy or sell any security.