During the last week, the stock market as continued to move surprisingly higher, despite the absence of good economic news. Each day that the market moves higher, further away from its base of support, we grow increasingly confident that a correction will occur in the near future. After all, markets cannot remain overbought or oversold forever.
Recent market activity as highlighted the growing division of investors that we have found since the precipitous decline of last year. In the post-panic investment world, individuals tend to fall into one of two distinct categories.
1. Those that are sure that the market is on its way back to pre-crisis levels, and perhaps even on to old highs. These investors wouldn’t think of selling today. Instead, most have set artificial numbers in their own heads as some kind of vague strategy. For example: “When the Dow gets back to 12,000, then I’ll get out or look at other alternatives. But until then I’m just going to sit tight.”
2. Those investors that, after being ravaged by the market last year (as we all were), have decided that they have had enough. They simply want to “cash out” to avoid any further losses. After the emotional toll taken last year, they sometimes have trouble sleeping, knowing that their money is still at risk. Typically these investors are a little closer to retirement, or perhaps already retired and living off their investment accounts. And while their concerns are legitimate, as I will demonstrate, there are some real problems with their solution.
Unfortunately for the people in these categories, which include the vast majority of individual investors today, they are both wrong, and both stand to pay a high price for their opinions.
First, for those stubborn investors in the frame of mind reminiscent of Cold War bomb shelters – just hang tight and wait it out. It pains me to say this, but the stock market will take years to get back to old highs. Investors with this mentality need to understand that they may have to wait for a very long time.
Consider the following example: In January of 1973 the Dow peaked and promptly crashed. By the fall of 1976 it was back near its new highs, but then traded sideways, more or less, until the fall of 1982. It took until October of 1982 for the stock market to finally break through its 1972 highs. On this timeline, that would mean that the Dow won’t set new highs until nearly 2014.
Is it really reasonable to wait another five years for investors to get their heads above water? While that may be a reasonable strategy for investors in their thirties, that may not be so for people closer to retirement. Secondly, remember inflation, which had huge effects on purchasing power through the ‘70s.
As for the second group, those wanting to cash out: In today’s market, and the way political and economic forces are playing out, it simply is not in anyone’s best financial interest to completely abandon equity investments. This is due to the inflation that is coming through the pipeline, and is set to sweep through the US economy like an economic twister, laying waste to any portfolios that aren’t properly prepared.
When it comes to investments, most people consider the absolute safest options to be either cash or bonds, particularly Treasury bonds. In an inflationary spike, both of these investments can prove toxic. When investors sit in cash, they earn little or no interest on their savings, even while their cost of living rises with prices (the main symptom of inflation).
Furthermore, once the government decides to halt inflation in its tracks, the usual course of action is to raise interest rates. This is bad for a couple reasons. First, investors holding bonds are receiving a lower coupon than new bonds being issued are paying. Second, if they try to sell their bonds in order to buy bonds paying higher coupons, they’ll find that the bonds they’re holding are worth much less in the market. It’s a lose-lose situation.
Since they first came about in 1997, Treasury Inflation-Protected Securities, or TIPS for short, have been an alternative used by many investors to help protect their portfolios, or at least a portion, from the threat of inflation. However, our advice to investors is simple: Forget TIPS, they’re utterly useless, for one simple reason.
TIPS increase their coupon rates as the inflation rate, based on Consumer Price Index (CPI), increases. But remember, CPI is a statistic that is released and even massaged by the US government. It has been proven in countless reports that this number simply can’t be trusted. So why do investors continue to stake money on an artificial number?
With all this in mind, investors need to find investments that will survive or even prosper in the coming inflation. These are mostly real assets, including precious metals, oil, and real estate, as well as the stocks tied to them, like those engaged in mining or drilling operations.
Let me leave you with some thoughts on Cash for Clunkers. Through this underfunded program, the federal government is giving away up to $4500 for old cars. While these cars are supposed to be in less favorable condition, they are, or were, assets for Americans, whether they run or not.
Through Cash for Clunkers, the government is taking those assets, perfectly good cars in some cases, and taking them off the road. In their place the government is helping to put a liability, a new “fuel-efficient” car that, more likely than not, isn’t paid off. In other words, by giving away $4,500 for old cars, the government is convincing (or fooling, depending on your perspective) hard-working Americans to borrow money for new cars that they may not even need.
The government is urging on this new debt under the auspices of both helping the environment by replacing gas-guzzlers with more fuel-efficient vehicles as well as saving the American auto industry. While the environmental impact may be true, it seems hard to argue the economic impact when four of the top five most popular cars sold through this rebate program are foreign-built Hondas and Toyotas.
What seems strange is the federal government’s approach to manufacturing in this country. In one hand there’s the olive branch, and a dagger in the other. While Congress publicly boasts their supposed saving of the US auto industry (which is hardly the case), the simultaneously work on legislation to ban energy derived from coal and natural gas, which are the only options that produce energy cheap enough as to make manufacturing economically feasible. Or is the government going to take that over, too?
This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.