Though I briefly addressed the credit crunch in my last newsletter, the financial crisis has escalated beyond what most of us could ever imagine. While credit has not been this restricted since 1929, this is where the similarity to The Great Depression ends.
There is no point in re-hashing the causes of this crisis or to assess blame. There will be plenty of time to discuss and implement essential regulation once the crisis has passed. What is important is where we go from here.
Ben Bernanke, the Federal Reserve chairman, is a student of The Great Depression. In 1929 following the market crash, the Federal Reserve tightened credit markets that resulted in a rapid downward economic spiral.During this current crisis, the Fed and Treasury have responded by flushing the banking system with liquidity to create favorable lending conditions.Actions include the purchase of mortgages from banks, direct investments in bank stock and access to capital from the Federal Reserve by the remaining investment banking firms.In fact, some economists believe that in a few years, the economy could be turbo charged due to the positive effect of excessive liquidity on business borrowing and consumer spending.
While I share the concern of many who are worried that the deficit is out of control, the important barometer of its impact is to measure the debt as a percentage of Gross Domestic Product (GDP). Even with these large additions to the national debt resulting from the passage of the bailout bill, the deficit is only approximately 3% of GDP, a smaller percentage than exists in Japan's economy. And, over time, it is my opinion that we will recover much, if not all, of these funds as real estate and bank stocks rebound.However, this outcome is likely to take many years to unfold.
Of course, the manifestation of this credit crisis has been the 30% plus decline this year in the stock market. Even solid, stable, growing companies such as Procter & Gamble have been caught in the downdraft of collapsing financial companies. Furthermore, international equities have declined more sharply than U.S. stocks despite greater resilience in their underlying economies.
With the most volatile bond markets in memory and decimation in equities, this has been the worst year for investment returns in memory. But there are signs of optimism.First, credit markets are rapidly improving as LIBOR rates decline, the flow of commercial paper increases and global lending rises. The Dow Jones Industrial Average responded with a 1000 point rise on Columbus Day. While it is possible that the market may test its low, many signs point that a bottom may be in sight.
What is an appropriate strategy now? Since, in my estimation, the serious damage is over, investors should review their holdings and make modest changes where superior alternatives may be available. For after tax accounts, no longer do investors need to be concerned with the impact of long term capital gains since imbedded losses should shield these portfolios from taxes for years to come. For investors in financial distress who have large current capital expenditures, it may be prudent to increase their cash position in the event that a new round of market deterioration occurs.
While it may take several years for the market to recover, it is important to note that significant bounces often occur at the most unexpected times. Two years during the 1930's when the economy remained dormant, the stock market rose significantly as under-valued stocks appreciated in an attempt to attain their inherent value. And while GDP growth has moderated for many foreign economies from low double digits to high single digits, their economies are likely to rebound more quickly than the U.S. resulting in a rapid stock market recovery.
This is a difficult time for investors as baby boomers approach retirement and distributions on portfolios for many retirees have increased to untenable rates. I remain confident that we will soon overcome this credit crisis and the entrepreneurial and innovative nature of American business will lead us into recovery. In areas such as biotech and technology where we lead the world and, looking forward into the future, with the prospects of a thriving alternative energy sector, once again the United States can be the driving force in the world for economic growth and prosperity.
As usual, I welcome any comments or questions.
Clifford L. Caplan, CFP®
In the News: Jittery investors are searching for opinions from financial professionals who dispense rational advice based upon experience and a solid track record.As many of you are aware, I was one of three highlighted investment advisors in the October 6th edition of Business Week in an article titled “If you want to Rejigger your Holdings”. I was also interviewed in the October 17thedition of the Boston Business Journal in an article titled “Wild Market Brings Slew of Questions for Advisors”.