There is a time to be buying and a time to be selling. Simply put, in bull markets, you want to buy the dips. In a bear market you want to sell the rallies.
This may seem obvious, but investors constantly get it backwards, they panic and sell out when investments in a bull market decline and they get duped into buying investments that are rallying in a long term bear market.
The chart to the right shows the long term history of General Electric. We chose GE out of literally hundreds of similar charts we could have used.
You can see that from 1982 to 2000, GE was in a bull market. This bull included the Crash in 1987 and the mini-bear of 1990. Even with such scary events, they ended up being buying opportunities in a longer term bull market.
Conversely, since 2000, GE (and the rest of the US Stock market) has been in a long term bear market. Here the dips were warnings of further declines, not to be bought.
The fundamentals of GE and the economy had changed and they were no longer favourable to GE’s long term performance. In this phase of GE’s chart, rallies during the bear market needed to be sold, since lows kept going lower and fundamentals were deteriorating.
This is exactly what the average investor does not want to do. It separates the men from the boys, if you will. It is hard to step up to the plate and buy an investment that has been declining for the past X weeks/months. But if it is a correction within a bull market, that is exactly what a wise investor will do.
It is even harder not to get sucked in by the siren song of an investment that has been rising for the past X weeks/months, but the wise investor sells investments that are rallying in a bear market. This isn’t easy to do which is why investors hire professional money managers (such as Cornerstone).
Not the extremes – neither total collapse or hyper inflation
As dull as this may sound, Cornerstone’s forecast is for neither Hyper-Inflation (of the Zimbabwe kind) or world ending deflation. That doesn’t mean everything is going to be alright, but investors have a tendency to run to the extremes. They combine the talking heads on the financial channels, mix in some questionable internet research and sprinkle in some blog hyperbole, which creates a recipe for the end of the world.
The odds of a complete collapse of everything to the point that people will need only gold are so low that it isn’t even worth discussing, never mind letting it shape your investment portfolio. But what could really happen could be quite eventful.
Could the US have inflation of 10%, 15% even 20%? Yes, the current Federal Reserve strategy has never been implemented before without inflation being a consequence.
Could the Euro collapse?
Yes, recently UBS put out a report that spelled out a possible end to the Euro. They had a five year time frame and the possibilities ranged from an orderly demise of the Euro to a disorderly collapse due to anything from defaults to out-right civil war in Europe. (the least likely scenario)
Could the US Dollar collapse?
Yes, if you mean decline dramatically in value. No, if you mean disappear, be totally worthless. The Fed’s policies and actions have severely debased the value of the US Dollar. Due to the current focus on Europe, traders are not focused on the US Dollar. But just because traders haven’t turned their wrath on it yet, doesn’t mean we couldn’t wake up one day to see the Dollar having dropped 10% to 20% in overnight trading.
Could the Banks in America Collapse?
Yes, this is another area that is being supported by Fed action. Without the trillions in loans and reserve injections over the past 3 years, many of the top banks in this country would have already failed. Bear Stearns, Lehman Bros and Merrill all failed due to derivatives and toxic mortgages. Nothing has been done over the past 3 years to eliminate or reduce derivative trading at the major banks (now totaling in the hundreds of trillions of Dollars according to the Comptroller of Currency.) At any point in time, we expect to see one of the top banks in America ask the Fed for help in order to avoid bankruptcy.
Are insurance companies safe?
Many insurance company’s products are backed by bonds of various qualities. Some have Treasuries, some have Corporates and some have more dubious portfolios of mortgages and junk bonds. A rise in interest rates could be very bad for many insurance companies.
Could the US have deflation?
Yes, in a way, it already is. This may get a little confusing. The macro trend for this part of the economic cycle is a debt driven deflation. This is what we said in 1999, and what we are saying today. The difference is that the Federal Reserve’s policies are inflationary. Ben Bernanke is viewed as an expert on what caused the Great Depression of the 1930’s and has concluded that the Fed back then did not keep enough liquidity (cash) in the economy. He has concluded that you can fight deflation with heavy bouts of printing money and inflation.
The primary reason we are invested for inflation, because Ben Bernanke is at the helm of the Fed. If however, the election of 2012 brought a different regime to the White House, we could see a change at the Fed which would force us to re-evaluate our expectation of inflation and possibly shift portfolios to take advantage of deflation. Even then, it would not be the end of the world, although it might feel like it!
Our portfolios at Cornerstone are set up to benefit from most of the things that worry investors – inflation, a drop in the Dollar, higher interest rates, a market crash… They are not going to work 100% of the time in a direct correlation to the day’s problems. For example: Gold is obviously a hedge on currency problems, yet traders sold gold to raise cash because they were concerned about the fate of the Euro. It isn’t logical in the short term, but eventually, the value of gold will shine through.
No Worst Case Scenario
Rarely has the Worst Case Scenario ever played out. That is why it is the Worst Case. Something always happens to negate the ultimate Worst from happening. The Worst Case Scenario usually has a probability of 1 – 2%. The Best Case also has a probability of only 1% – 2%. Yet there are throngs of investors that believe in the pie-in-the-sky best case scenarios, just as there are throngs that believe in the end-of –the –world scenarios.
This leaves about 96% probability that something else is going to happen. That leaves a lot of room for me to create much more likely scenarios based on reality. Parts of the Worst Case Scenarios may actually happen, and we may even anticipate them, (such as bank failures) but part of the Worst Case Scenario happening does not mean all of it will. Worrying about the worst case may be fun (sort of) but we will stay grounded in the fundamentals and how they play out.
What is the safe haven?
If you believe that the worst case scenario could happen, what comes with that is that banks and insurance companies are vulnerable to collapse. Aspects of the Worst Case Scenario that could actually happen include: interest rates could spike up, bonds could crash and holders of long term bonds would lose hundreds of billions of dollars. Some of the biggest holders of bonds in America are banks and insurance companies. Yes, your bank, which may be safe today could become a casualty of the fiscal crisis, even without the worst case scenario happening.
Under a Worst Case and less than worst case scenario, rising interest rates and inflation could be a huge problem for investors. Safer havens from the ravages of inflation are assets that actually benefit from inflation – gold and commodities. Hedges on the bond market might also give an investor benefits from rising interest rates.
Given this circumstance, it would appear a managed portfolio of diversified investments might actually be a better safe haven than the traditional safest havens – banks and insurance companies. This is because a fully flexible managed portfolio of investments can shift the allocation as needed. Banks and insurance companies are pretty much stuck with bonds.
Why not go all cash?
Because many asset classes are just going through corrections in their price, there is no need to go all cash. The fundamentals haven’t changed. The potential is that the bottom could happen at any time and the asset class could start to head up very quickly. We would then be forced into buying back in at potentially a higher price. Not a good strategy. We stay focused on the long term and the fundamentals. This keeps us from getting spooked by short term price declines.
Stay in your seats, It’s all about trust
Just like a pilot is supposed to be a trusted guide or a Doctor is supposed to be a trusted consultant, Financial Advisors are supposed to be trusted counselors, yet many investors don’t trust them. I don’t blame them. The way the financial media hypes the moment by moment events and happenings, I would be scared too and I’m in the business!
I’m sure that if there was a camera in the cockpit of the plane you are on, that showed everything going on behind that closed door, we wouldn’t feel quite so safe. I’m sure there are more close calls and mistakes made than any airline would ever admit. It is the same for Doctors, behind closed doors, in the operating room and labs, “oops” is probably said at an alarmingly high rate. “Oops” does not instill confidence or trust.
The day to day noise of the markets is the “oops” in our business. Sometimes it means something, most of the time it doesn’t. Bottom line is this, you hire an airline to take you from point A to point B because you can’t fly and don’t have a plane. You hire doctors for the same reason. You can’t tell the difference between a pancreas and an appendix, so why in the world would you try to self medicate?
Most investors need to hire a trusted advisor. (Cornerstone is a trusted advisor for hundreds of investors.) The advisor should make sense to you and not “sell” you on a strategy. The strategy should be explained so that you understand the gist of it. By trusting the right advisor, many investors can sit back and enjoy the ride in a way they never have before. Yes, there will be ups and downs, but by trusting the person in the cockpit, they don’t have to worry about the reality of every air pocket along the way to their destination.
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