How to Potentially Survive and Prosper in Recessionary Times
For investors who look to survive and, yes, potentially prosper in these troubling times there can be no sugar coating or denying the facts! The financial crisis and the worsening recession in which we find ourselves will simply not permit it! Investors will aid their own cause when they are able come toterms with the fact that we are not caught up in just any garden variety economic turndown, but rather, as Treasury Secretary Paulson called it, “a once or twice in a 100 years event.” And we believe the lingering effects will be with us for years to come.
The severity and magnitude of losses was attributable not only to common stock but to relatively ‘safe’ vehicles including preferred stocks and tax free municipal bonds; and those losses added up to some of the greatest in history. The mind-numbing losses experienced by even the most prudent of investors hasn’t happened by chance or coincidence but came about as the result of the bursting of two of the biggest bubbles in history, namely those in real-estate and mortgage-backed securities.
No Use Kidding Ourselves
The contagion from the bursting of these bubbles is now spreading to other types of loans, from credit cards and home equity into residential and especially commercial mortgages. As much as we wish to, we should not kid ourselves. We strongly believe there will be no quick fix to all the deep seated problems facing the stock market and economy! We are now in the eighth year of a secular bear market that began in 2000. The three previous secular bear markets of this century lasted 15 to 20 years. Why should this one be shorter when the problems facing today’s economy are measurably greaterthan at any time since the Great Depression? (To learn more about secular bear markets of the past century read our stock market report, Fascinating Stock market Analysis.)
A Recent Market Prediction Comes to Pass
In our last stock market report, written on October 13, 2008, we stated:
While we believe the economy will not bottom until late 2009 to early 2010, we believe the stock market is near a bottom which will be reached next year. Our projected bottom of 6800 to 7500 is not that far from the spike bottom 7882 low reached on Friday, October 10. Our objective would equate to a 57% % to 52% decline from the Dow’s peak of 15,745. This would make the decline more severe than most bear markets, but not as bad as in the Great Depression! However, we believe the market will not go there in a straight line. Like all other bear markets we believe there will be sharp rallies that eventually fail until the bottom is reached.
The prediction came true sooner than anticipated when, on November 20, 2008, the Dow closed at 7552. The next day the Dow rallied 494 points closing over 8000. Have we seen the lows? Have we experienced ‘capitulation’ in the marketplace? We are sorry to say that we do not believe so! Powerful bear market rallies like the one following the Dow’s decline to 7552 are commonplace in bear markets. Bear in mind, some of these rallies may be prolonged and substantial, like in previous secular bear markets, deluding investors into thinking the market has bottomed and a new bull market has begun. However these rallies typically give way to new lows, which we believe will eventually be the case with the current and future rallies for some time to come. Where will this market ultimately come to rest? We have given it some thought and now believe our previously stated low of 6800 in the Dow may be overly optimistic.
A theme we introduced in our June 25, 2007, Stock Market Alert: Have We Seen the Highs, was: The real risk is not what we know about the problems in real estate and mortgage-backed securities, but what we do not know. We are of the opinion this theme will continue to haunt us as the damage and contagion from the bursting of these bubbles will impact us to an extent greater than is the general consensus…as has been the case up to the present!
Once the final low is in place we do not expect a textbook ‘V’ bottom, but rather years of back and forth volatile action, with the market essentially making little progress as in previous secular bear markets.
The Facts
The benchmark S&P 500 index is on track for the worst decade in history; potentially down 32% versus up 1% in the decade (1930-39) of the Great Depression! Consider what has happened this year: The nation’s largest mortgage companies (Fannie Mae and Freddie Mac), the largest insurance company (AIG,) largest auto maker (GM), and some of the largest brokerage companies (Bear Stearns and Lehman Brothers) went bankrupt, are near bankruptcy, or were saved from bankruptcy through government largesse. But the common stock in these companies has become worthless or nearly so. Practically every government report shows vital economic statistics the worst since records were kept or the worst since the Great Depression. You should now better understand why Treasury Secretary Paulson called the current economic crisis, “a once or twice in a 100 years event”, and why we believe the damage is so severe that there will be no quick fix and it will take many years to get back to normal!
Black Swan
Few would deny we have experienced the dreaded Black Swan event, as described by Nassim Taleb in his 2007 book The Black Swan. Black Swan theory refers to a large-impact, hard-to-predict, once-in-a-lifetime event beyond the realm of normal expectations. Since January, 2008, approximately 16 trillion dollars in losses have been amassed in stocks and real estate in the U.S. alone. And making things worse: For the first time we are experiencing a global recession. There is a massive de-leveraging process occurring world wide leading to mass liquidation and record losses and volatility in practically every investment. Even once-safer preferred stocks and tax free municipal bonds are showing double digit losses. We all have the dubious distinction of living through the worst and most hostile investment environment in our lifetimes. This is the most challenging period for stocks since the Great Depression that we do not think will end anytime soon. We believe that heightened volatility appears to now be a way of life.
…and Now the Good News
Fixating on all the negativity and challenges facing the stock market can do no good. No crisis lasts forever. Stocks and the economy will recover. We believe investors should resign themselves to the probability that it will take a long time! However, as bad as things may appear we suggest there is also positive news: investors do have a choice, one in which they shun denial, embrace reality and react accordingly. Investors, we firmly believe, have the ability to recognize the present economic climate for what it is and attempt to capitalize rather than surrendering to it by adopting a recessionary state of mind !
An attitudinal change can work wonders. In accepting that we are not in the midst of a ‘typical’ economic downturn, one that will be short lived, investors should seek to make the necessary course corrections by diversifying into alternative investments, i.e., those that have the potential to perform well in a recessionary low- or no-growth environment. Make no mistake; few investments meet these parameters. However, our belief is that for suitable investors, commodities, with their potential ability to capitalize on both rising and falling markets, may be suited for these volatile, recessionary times. One way to diversify your portfolio into commodity trading would be to use professional money managers, known as commodity trading advisors (CTAs). Edward Thomas Trading recommends a number of these CTA’s, some of which continued to show positive returns during the market meltdown that occurred in September and October of this year. Investors should be aware, however, that trading futures and options involves substantial risk of loss and is not suitable for everyone. There are no guarantees that these CTA programs will continue to be profitable in future volatile markets. Past performance is not necessarily indicative of future results.
The Value of Professionally Managed Futures
The Chicago Mercantile Exchange’s (CME) brochure, Managed Futures: Portfolio Diversification Opportunities, contains several compelling studies showing the non correlation of commodities to stocks and the value of professionally managed futures. One of the studies (see page 3) states: Including up to 20 percent of total investments in managed futures funds enhances portfolio diversity and therefore promotes greater independence from general market moves.
Just as an investor would diversify a stock portfolio with stocks from different sectors we believe, for maximum potential risk reduction and performance, one should diversify with a basket of CTAs, each of whom trade different markets and employ different trading strategies. Given the comparatively modest minimum account requirements of most of our recommended CTA’s an investor can diversify with as many as three or four money managers at a cost that would normally be attributable to one!
Conclusion
While there are no guarantees or assurances of future performance with any CTA, we believe suitable investors, in the coming years, may stand a better chance for success with a select group of our recommended money managers than they would in equities! Even if our analysis proves off the mark, and a new bull market in stocks ensues, we believe our recommended money managers, given their equally flexible investment approach in both bull and bear markets, can still potentially out perform the stock market! Consult with us here at Edward Thomas Trading for more information on the CTAs we believe can best meet your affordability, suitability and investment goals. Please be aware that you must read and understand each CTA’s disclosure document carefully before investing. Trading futures and options involves substantial risk of loss no matter who is managing your money. Such investments are not suitable for everyone. Past performance is not necessarily indicative of future results.
This piece has been prepared by Vision Financial Markets LLC, a registered Futures Commission Merchant. Futures traders should be aware that daily market volatility might cause loss despite prevailing trends in the stock market. The risks associated with trading futures and options are significantly different than those of stock investing, investors may lose more than their initial investment. While we advocate diversification, be advised that it won’t necessarily provide protection against substantial loss. Past performance is not indicative of future results. There is no guarantee the predictions in this report will come to fruition.