News & Insights
Recovery in 2009?
In 2008 the S&P 500 including dividends was down by 37%, one of the worst years on record. Last January when we announced a defensive investment posture, we believed we were in for a tough year but the breadth and scale of the decline exceeded our moderately bearish posture. The fragile nature of our debt-burdened financial system caused it to buckle, and what began as a spark in the mortgage backed securities market turned to an inferno consuming venerable financial institutions like Lehman, AIG, Wachovia and Merrill Lynch. The year 2008 represents a change, when past experience seems less useful as an exemplar of the future, than at other market bottoms. Assumptions concerning the resilience of the American consumer, the ability to carry large government and personal debt, the persistence of U.S. market and political leadership and the smooth working of free markets have been seriously undermined. A deep recession in economic activity has commenced. The road back to prosperity seems harder to find than in bear markets past.
The environment for investors is much like it has been at other recent market inflections, only more so. By that we mean the cycle of boom & bust followed by an “easy money” policy response and recovery still dominates, however, the current cycle continues the pattern of the past few in that it takes an ever increasing policy response to correct an ever weaker recovery. Eventually, there may be a cycle when the Fed and the Congress will bring all their firepower to the scene and it will fail. We are substantially closer to that time now than in the past and this must be taken into account when selecting investments.
We have become accustomed to quick non-inflationary recoveries from recessions and certainly that is one possibility. However, the extraordinary amount of policy stimulus in the form of easy money and big government spending, if successful at floating the economy, may induce an unhealthy level of inflation which would cause us to consider those assets which thrive in an inflationary environment. The reason for the current easy policy stance is fear of deflation, which has afflicted the Japanese economy over the past 13 years or so. If an unprecedented bout of deflation takes hold in our economy then investors would benefit from a high cash position and investments in government securities.
We think the primary case is that the policy makers will be successful at reflating the economy in 2009 or 2010, and upon achieving that success, will move quickly to drain the market of excess money in an effort to head off incipient inflation. As this process unfolds, investors will deal with more uncertainty than in the average recovery.
Stocks, Bonds and Cash
With the stock market at very attractive levels, we are compelled to move from an underweight towards an overweight position in stocks. However, as the year 2008 ends, we do not believe such a move has to be done precipitously. Among stocks, the highest quality U.S. shares and international opportunities in emerging markets are the most compelling.
Within the bond markets, investment grade corporates remain attractive for new money. Additionally, Treasury Inflation Protected Securities are priced attractively and should hold up well if either inflation or deflation is in our future. In taxable accounts, municipal bonds offer attractive yields.
The Altavista Investment Team-Winter 2009