Market Volatility and the Economy: Don’t Forget to Breathe
By Laura Alspaugh, CFA | November 26, 2007
In light of recent market conditions and the sometimes doom-and-gloom headlines that seem pervasive, one needs to sift through the news with eyes open, not with blind optimism or fatalistic pessimism. Think about the following:
China – US, not a simple one-way street
It is very easy to become frightened about the US dollar and China’s massive stake in our currency. But even if they wanted to dump our currency, it would not be a plus for them, either. China relies on the US as an enormous outlet for manufactured goods. We need them to make it, and then we consume it. Until the Chinese populace accumulates enough broad-based wealth and habitually consumes more, they will need us to have a healthy economy. Dumping the dollar will not be a good thing for either country. Diversification of your investments to include non-US equities as well as US equities will help to maintain a balance while tension continues.
The consumption problem
The US consumer accounts for much of our GDP. We have been terrific consumers, but we have been doing it by trading future economic security for consumption today through credit cards and home equity lines. We spend more than we make. The US consumer needs a financial makeover. And if we spend less (and save more), this will translate into lower demand for goods imported from China and elsewhere. As this change works its way through the system, the pricing mechanisms will adjust and inflation may continue to be low. S&P 500 consumer discretionary stocks are down over 9% year to date as the markets anticipate weakness from the consumer. As consumers start to rein in their spending, discretionary stocks may continue to be weak and the consumer staples, food and beverage companies, should benefit.
Inflation and energy
Speaking of inflation: Just when oil is hitting $100 per barrel, and just when you think there is no stopping its rise, all of sudden we hear that demand is declining and prices are falling. Is it possible that the exorbitant prices have produced a supply glut? Too much oil at too high a price? Are these economic mechanisms working, after all? While higher energy prices tend to translate into higher prices for goods and services, other factors are keeping prices down: competition from developing countries and cheaper labor costs. Inflation has been contained for some time not only in the US but globally as well. If your portfolio has significant overweight in energy, perhaps it has done quite well. However, bubbles do burst, and a broad exposure to industry sectors is also an important component of your investment program.
Blind competitiveness and lessons learned from the sub prime crisis
Making loans to people who can’t afford them is an ugly business. Wall Street packaged these questionable loans into “low-risk” investments with attractive yields. Hedge funds and other investment managers jumped at the chance to buy them because these yields were especially attractive in a low interest rate environment. Simply looking at the credit rating of the entire bundle appeared to have been considered sufficient. It was a case of so many loans in the packages and so little time to figure out if these were creditworthy investments . Looking back, it seems a bit superficial to have simply relied on the credit rating agencies.
Then there was the consumer who should have known that there is no free lunch. Rates go up and rates go down. They weren’t worried if the value of their homes kept rising; on the contrary, they were betting on the future.
Lastly, the mortgage brokers had the green light to make loans without documentation of income and supporting documents; the borrower just would have to pay a bit more in interest. If the mortgage broker at Countrywide didn’t make that loan, the competitor next door or on the internet would. So now, what? Extra scrutiny and a pendulum swing back towards caution. Lessons are learned over and over again. It won’t be the last time either. US Treasury bonds and equity investments in companies with high-quality balance sheets and excellent cash flow should benefit from a more cautious investment environment. Investors are punishing the major investment banks and consumer finance companies for their inability to manage and measure risk.
An unexciting but optimistic conclusion
Bad economic news and pessimistic predictions sell papers, sell ad space, and draw us to the internet press. Regardless of the current market volatility and tone of the economic news, good minds are finding solutions to improve health and productivity. These ideas will generate capital, which flows back into the economic system. Great products and ideas grow out of difficult times. US innovation, productivity, and access to capital will continue to be hallmarks of our economic system.
In the race for investing towards a financially secure retirement, it’s not how fast you come off the starting block; rather it’s how well you stay on the track. At LTSave, our goals for you are straightforward and simple:
1. Stay on the course towards your retirement goal
2. Don’t sell into weakness or panic when the world or the markets seem uncertain
3. Know where you are and check in with your financial advisor as you would with your doctor for an annual physical
4. Be responsible with your money and save
Topics: Markets, The Economy |