Friday, January 11, 2008

New Year, New Fear?

“Meet the new Boss, same as the old Boss.”
-The Who (“Won’t Get Fooled Again”)

So far, the new year is looking a lot like the old one:

The subprime mortgage debacle continues to unwind through the world financial system, forcing many of the big Wall Street players to seek outside capital to shore up their balance sheets (Merrill Lynch, Citibank et al). Significantly, most of these capital infusions were provided by non-U.S. corporations or governments.

Housing values and sales in the U.S. continue to fall, although “fall” may be too mild – in many areas, “plummet” is probably more accurate. Countrywide Financial – one of the largest mortgage companies in the U.S. - just sold out to Bank of America to avoid bankruptcy.

The U.S. stock markets are now in official “correction” territory (defined as a decline of 10% or more).

The December ’07 retail sales numbers are out and they are not pretty – this is a major indication that the U.S. consumer is cutting spending. (Armageddon hint: consumer spending in the U.S. is 2/3rds of the economy).

Prices for agricultural commodities are hitting all-time highs and oil remains within spitting distance of $100 a barrel. Gold is near its all-time high (in nominal dollars).

The Federal Reserve was forced to state publicly that they will be lowering short-term interest rates this month (January). The Fed is between a rock (lower growth) and a hard place (inflation).

Can you spell r-e-c-e-s-s-i-o-n? Can you spell s-t-a-g-f-l-a-t-i-o-n? Sure you can.

Did we get fooled again? Uh yeah, we did. We fooled ourselves. Again. The securitization of receivables – turning mortgage payments into derivatives – was supposed to reduce risk in the world financial system. Instead risk was increased, exponentially by many accounts. The effect of subprime mortgagees not making their payments has been like the proverbial flick on the last domino in a long row of dominos. And the really good news is that the full extent of the subprime mortgage fallout still isn’t known and probably won’t be for many more months if not years.

If you’ve read this far, you are probably starting to think about where you hid the key to the trigger lock on your 9mm. Don’t just sit there – go look for it! Now.

Just kidding. Take a deep breath. Call your financial advisor for a therapy session.

Short-Term Thinkers
In the coming months, cash will be king. Eliminate debt. Hoard cash. In a taxable (non-retirement) account, buy short-term bank CDs or T-Bills. You could get a little more sophisticated and ride the yield curve by buying long-dated U.S. Treasury Bonds – the coming interest rate cuts should produce some nice capital gains. [Remember: when interest rates go down, bond prices go up.] Reduce your spending. If you are thinking about buying a house, wait – they’ll be cheaper in a year. A painless method of raising cash is to have all mutual fund dividends and capital gains paid in cash as opposed to reinvesting them in the fund. If you are at risk of being laid off, consider reducing your 401k contribution.

Long-Term Thinkers
If you are investing long-term such as in a retirement account (IRA, 401k, etc) review your asset allocation and get more diversified: add commodities (agriculture, energy, metals, currencies, etc), increase non-U.S. stock holdings (decrease U.S. stock holdings), reduce small cap companies in favor of large cap companies, add a long-short fund, add bonds.

Questions? kimm@sweetwaterinv.com

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