Returning from a great vacation with my family in El Salvador I am once again reminded of the similarities between financial markets and nature. While on our vacation we encountered a close call that could have been detrimental to the well being of our family. Being surrounded by clear skies, warm weather and tropical drinks we all slipped into a relaxed carefree attitude by the second day of our vacation. My father who is a spry 64 years old decided he would take the next round of playing with my 7 year old daughter and her 2 cousins, ages 7 and 11, in the ocean as they boogie boarded. The waves were big by anyone’s standards (6-8 foot) and being a water family we are well aware of the dangers the ocean harbors and therefore always made sure there was someone watching the little ones. However, in this particular situation one person wasn’t enough as my father became overwhelmed by a changing tide and a fierce rip current that began to threaten all three kids at once. In an effort to prevent my daughter from being swept into what we call the “impact zone” my father grabbed a hold of her letting go of the boogie board and before they knew it they went from being in waist high water to the middle of the impact zone unable to touch the bottom as wave after wave came down on top of them.
In these conditions it is difficult enough to swim by yourself, now try swimming with a screaming 7 year old, a fierce current and a rocky reef. Luckily for my Father and Daughter our oldest daughter Dyanne saw what was happening and she ran to the rest of us for help. Within minutes the water was filled with McFadden’s with my son being the first to arrive taking his sister from Grandpa moments before Grandpa’s eyes began to roll to the back of his head. Within seconds we had Grandpa on the top of a surfboard and paddled to safety. The experience while scary showed the power of anticipation in changing environments and the need to always have backup and support from others as the outcome would have been drastically different had we not kept a close eye on what dangers existed.
Investing in today’s market is no different. We are in a time of tide changes that are drastic and extreme. November was another month of pain for most investors who were not paying attention to the impact zone with the equities markets declining another 15% on top of Octobers 15% decline. In fact the decline from top to bottom in November was as much as 25% as the October lows were breached bringing the total decline from market highs to 50%. With the breaching of those October lows it is most likely that the market will set up a new trading range where the market will trade down to 7500 on the Dow and then back up to 8800. Similar to the last range we experienced in the markets this range will continue until something in the fundamentals change and causes investors to either begin applying more risk by buying stocks or reduce their risk by selling. Learning from the story I shared above, in these times I have found it more important than ever to immerse myself in information in order to anticipate the next change in the environment and the data I am coming across isn’t pretty which leads me to believe that the likelihood of a growing market is slim as there is no doubt that we are in the midst of the worst recession any generation has seen before (with the exception of any depression era individuals that may still be with us).
This month’s news included rising unemployment which is expected to continue, a huge bailout of Citibank, and signs of deflation with fuel and food costs dropping dramatically and continued weakness in every sector of the economy. We anticipate this kind of negative news to continue. While all this sounds terrible it is important to remember that these times never last forever. More importantly it is these times that create great investing opportunities for investors like us which have kept their powder dry. Our intention moving forward is to continue to hold large allocations of cash/money market with an occasional trade in an effort to benefit from the trading ranges noted earlier. Now that the markets have broken their October lows it is most likely we will see the Dow decline back near 7500 (now at 8400) and we wouldn’t be surprised to see the Dow go as low as 6800. We continue to search the bond markets for higher yielding assets and are proceeding with caution as we feel there is no need to rush into anything in this environment.
We were able to avoid the impact zone this month in a few ways. One, we only exposed 10% – 20% of our accounts to the equity markets at fairly low prices after the selloff the markets experienced following the election. This gave us a good entry point as we were also able to move those funds back to money market prior to the market declining below the October lows which we had written about in our last letters. Currently our accounts are 90% – 100% money market**.
We are in an unprecedented time and there is still more pain to come as we will continue to see more layoffs and most likely will begin to hear of banks and credit card companies pulling credit lines from consumers and businesses as they need to continue to deleverage. This will place another pinch on the consumer as well as companies earnings. My suggestion to everyone is to remain in positions of safety and reduce spending or gifting over the next year as this economic condition will most likely continue through 2009. If you know of anyone that does not have their investments in positions of safety please have them contact me, this includes younger people who may have their investments through their 401k. As I have mentioned in my last writing this is not a time to be casual with anyone’s money.
On a brighter note we are beginning to see some fairly impressive rates of over 4.5% from certain insurance companies in an effort to gain new business. These types of accounts may be worth looking into if you are sitting on CD’s or money markets that are re-newing at lower rates. We are also beginning to see mortgage rates decline which can help the housing market if this continues. In addition to lower mortgage rates we have seen a significant decline in oil and gas prices which helps all of our pocket books. Also, it is important to resort to some common logic that with the markets already declining over 40% that we are most likely closer to a bottom than we ever have been. Lastly, it is obvious the government is willing to do anything in its power to get the economy back on track which will most likely include another rate cut of 1/2 percent and a stimulus package from the new administration. While all these noted items will get the markets to jump for a week or two it will still be a little time before we will see the markets fly.
We will update you again near the 15th of December, until then I hope you and your family have a great beginning to the holiday season.
*The opinions expressed are those of Colby McFadden as of 12/1/08 and are subject to change due to market and other conditions
**References to account allocations can vary by account. For allocations specific to your account it is recommended you review your account statements.