From the Desk of David Gratke

Although world stock markets have made excellent ground in recovering past years’ losses as reported in the Financial Times article dated August 15, 2009,

S&P surge beats post-war record (click to read article)

I continue to remain cautious regarding the longer term outlook for the US and world financial markets. Since nearly 70% of the US economy is consumer based spending, I don’t think the US consumer has gone far enough to repair his/her balance sheet from the past 20 years of accumulated debt loads and diminished savings, hence I do not see a typical recovery from the consumer. There is plenty to be concerned about; I will not elaborate on those matters in this blog. But rather, reflect on the current buzz phrase, ‘new normal’, as I  have discussed this topic in previous blog postings found here. What will the new normal look like going forward?

I have found the following work of interest:

“Courtesy of dshort.com, here is another chart that makes the case to be cautious. The pattern of the 1929 crash adjusted for inflation is surprisingly similar to what we have seen since 2000.”

“Recognize that you can’t use the chart to predict the future. But what you can do is use the chart to realize the possibility of a prolonged bear market.”

Personally, I am still very cautious. We all have yet to fully understand, and appreciate, the debt loads the US Government is taking on and the full impact on both business and consumer alike. Is this mounting debt load a concern? Of course it is, and for that reason Warren Buffet inked an Op-Ed piece on this matter in the August 18, 2009 New York Times found here:

The Greenback Effect (Click to read article)

Selected text from Buffet’s article

To understand this threat, we need to look at where we stand historically. If we leave aside the war-impacted years of 1942 to 1946, the largest annual deficit the United States has incurred since 1920 was 6 percent of gross domestic product. This fiscal year, though, the deficit will rise to about 13 percent of G.D.P., more than twice the non-wartime record. In dollars, that equates to a staggering $1.8 trillion. Fiscally, we are in uncharted territory.

An increase in federal debt can be financed in three ways: borrowing from foreigners, borrowing from our own citizens or, through a roundabout process, printing money. Let’s look at the prospects for each individually — and in combination.

Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election. To avoid this fate, they can opt for high rates of inflation, which never require a recorded vote and cannot be attributed to a specific action that any elected official takes. In fact, John Maynard Keynes long ago laid out a road map for political survival amid an economic disaster of just this sort: “By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens…. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

What is Buffet saying here? We need to quit our spending spree, but do elected officials have the will to get off the ‘drug of spending?’

By including the chart above, I am not saying that we are going to follow a 1920’s style market decline. First of all, this economic contraction has been much less (so far) than that of the early 20th century. Year-t0-date, this economy has shrunk 3.9% as compared to the 26.7% collapse of the 1920’s. See chart below.

What gives me comfort for my clients within my practice, is that I have asset allocation strategies that have endured much better than the S&P 500 index during the past ten years where the S&P 500 index returned a negative -1.3% annually.

In coming months, I may be recommending client’s shift more of their assets to wealth preservation and absolute return strategies along with continued use of inverse asset classes for such possible ‘range bound’ markets.

As Buffet said in the August 18, 2009 NYT piece,

The United States economy is now out of the emergency room and appears to be on a slow path to recovery. But enormous dosages of monetary medicine continue to be administered and, before long, we will need to deal with their side effects. For now, most of those effects are invisible and could indeed remain latent for a long time. Still, their threat may be as ominous as that posed by the financial crisis itself.

With that quote then, the paddles are standing by, fully charged…..

Thanks for reading.

Sources: Morningstar Advisors, dshort.com, JP Morgan