August 25, 2009

Is It Time to Join The Party?
A tale of two economies

August has been a strange month of wildly divergent emotions for me. On the one hand I was buoyed by the strong market recovery and gratified to see my clients’  net worths moving back up. On the other hand I was extremely disheartened to hear from a couple of long time clients that they could no longer hold on and were shutting their doors after so many years of business ownership.  These were construction related firms brought down by the screeching halt in both demand and availability of credit. They were too battered, too worn down to hold on just a bit longer, even as the signs of recovery were beginning to emerge.

THE ECONOMIC DICHOTOMY

Stock markets around the globe have rebounded strongly in response to continued harbingers of economic recovery. Indeed, last week, central bankers from around the world, meeting in Wyoming, expressed this very optimism by announcing that the financial crisis had ended and that recovery is underway. Federal Reserve Chairman Ben Bernanke, whose personal stock and esteem seem to be rising as quickly as the Dow Jones average, declared, “The prospects for a return to growth in the near term appear good.” Alan Greenspan, Bernanke’s predecessor as Fed Chief, expressed a bit more caution, stating,  “We’re OK for the next 6 months.”

On the other hand, while stocks have rebounded some 50% from their March lows, unemployment remains high. Many small business owners do not yet see signs of a rebound in their own businesses and continue to struggle. Frustration and anger are still rampant on “Main Street.”                       

WHY THE DISCONNECT?

I can explain the disconnect between the ailing economy and the booming stock market from a couple of angles. Firstly, we can look to the dynamic of our stock market. The stock market, especially in the short-run, is more of an oracle type mechanism; predicting what the future will bring us rather than a reflection of what today looks like. The best example to illustrate this dynamic is the market performance prior to the economic crisis. The Dow Jones average had slipped from its high in the 14,000 range to below 10,000, well before anyone realized that many companies’ profits and balance sheets were cratering. In fact, the drop to 6500 was on the fear that the entire world was on the verge of total economic collapse. And truth be told, while we came awfully close to that doomsday scenario, ultimately, the world’s economic system survived.

The other angle to consider is that in S. Florida and other cities with economies heavily reliant on the real estate market or other profoundly affected sectors; the recession has been much deeper. The devastating effects of this real estate collapse are still being felt by many in related occupations, such as craftsmen, designers, mortgage brokers, engineers, architects, real estate attorneys, etc. While real estate prices have fallen in every state, the glut of condo projects in S. Florida has made our recession especially painful. As a result, the bottoming process and recovery may take longer than in other areas of the country.

THE TWO-TIERED RECOVERY

As I stated previously, the economic system survived and the feared global collapse was averted. The Fed flushed billions of dollars into the system as it also guaranteed and propped up some of our most precariously teetering financial institutions. Many of these institutions are now out of danger and have, in fact, returned to making large profits. Because of this, these companies’ stock prices are rebounding and fueling the stock surge.  The stage is now set  (as the stock markets are predicting) for the recovery to  spread  from Wall Street to Main Street.

One of the multitude of reasons that this will happen is due to a phenomenon called the “Wealth Effect.” As stock prices rise, and consumers see their own net worths rise, whether it is through their 401k values or personal portfolios, they regain confidence. As consumers’ confidence levels rise, they begin to spend more and, thus, the reflating process begins. When consumers spend, more jobs are created, demand for goods and services increases, prices begin to rise and recovery is on the way.

OUTLOOK FOR INVESTORS

In my April newsletter, I recommended that investors wake-up and resume their investment programs. While that may seem like an obvious declaration now, I assure you it wasn’t--- as talk of financial Armageddon was still very much on the table. In fact many prominent, so called “market timers” were directing investors to continue to sell. And we now know, with the benefit of hindsight, that the market was, in fact , at its bottom at that time . Here’s an excerpt from my April letter:

“As I have written to you time and again, there is cyclical nature to our economic system. Eventually problems are solved, as surely as new problems will arise again. In my view, the uptrend has begun and long-term investors can come out of hibernation and assess their opportunities.” (Click here for newsletter “Is it safe to exhale-April 21, 2009”)

While back  in April  I felt confident in making that assessment, knowing that the equity markets  rebound prior to actual economic recovery , I did feel  that my feet were not quite on solid economic footing. Today, some 5 months later, I do feel that the economic ground is much firmer, as the financial landscape begins to green.  Many remain unconvinced,  but I am confident that in the coming months there will be no doubt that the economy is growing again.

I expect that the next 10 years will provide investors with ample opportunity to grow their portfolios and work towards achieving their financial dreams, but, of course, with the usual caveat…. This will likely occur only if they plan properly and carefully. This means following an established, well monitored  ‘financial plan’, as opposed to basing investment decisions on daily events and media hype. As with all things, adhering to a disciplined plan will potentially reap the greatest rewards.

Untill next time,

Austin A. Frye, MBA, JD, CFP®

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Austin A. Frye, MBA, JD, CFP®

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