Learning From Past Recessions

Our economy is stated to be in a recession. We will only know this in the future. The question is what can be learned from studying the past recessions? The Dow Jones Industrial Average was studied from 1940 to today.

Three colums are shown below: The time period, number of months from peak to trough, and % decline

Time Period/# of Months/Dow Decline (%)
1948-1949/13 months/16 % decline
1953-1954/9 months/13 % decline
1957-1958/19 months/19 % decline
1960-1961/10 months/17 % decline
1969-1970/18 months/36 % decline
1973-1976/24 months/45 % decline
1978-1980/20 months/16 % decline
1981-1982/17 months/24 % decline
1990-1991/4 months/21 % decline
2000-2001/21 months/30 % decline

The Average values are: 15 months and 26% decline
The Statistical Maximum (95% Confidence): 27 months and 50 % decline

What has happened so far during 2007-2008: Peak to trough has been 13 months and the decline has been 44 %, close to the previous record. The trough occurred on Friday October 10, 2008 at a 44% decline from the previous peak during October 2007. The October 10th trough value has been challenged twice but not broken.

The trough in price was always in the middle of the recession not at the beginning or the end. It appears as if the increase in the stock price predicted the future end of the recession.

We have a decline that is as large as what occurred during the 1973 - 1976 time period in about half the time. In fact it occured in less time than the average. What this suggests is that the magnitude of the decline in stock price was magnified by outside forces not seen before. This new outside force is the creation and proliferation of hedge funds. As hedge funds sold to cover positions the downfall was amplified.

What does this mean:

1. Now is a good time to buy stocks if you have a longer term time horizon.
2. The downturn was magnified by outside forces, such as hedge funds.
3. As hedge funds change into a buy mode the increase should also be faster than normal.
4. A trough in stocks and subsequent rebound predicts the end of a recession.

Bottom Line: Stocks are on sale and now is a good time to buy stocks if you have a longer term time horizon. While it is impossible to predict an absolute bottom, it does not appear likely that the bottom will be much lower than what we have already seen on October 10th.

Investing, Time To Buy Stocks

The recommendation in the last blog was that stocks are on sale now and get ready to buy. After 1 week of investing it looks like now is the time to buy stocks for mone with a time horizon of at least 6 months. Sell money market funds, short term bond funds, CD's, etc... to get money to invest.

The first reason is the Warren Buffet factor who currently has the most influence in the stock market, even more than the Fed Chairman, Treasury Secretary, President, etc... Below is an article that was published yesterday. Enjoy reading it.

Warren Buffett: Buy Stocks! Cash Is Trash! Posted Oct 17, 2008 10:42am EDT by Aaron Task

"I don't like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I'll follow the lead of a restaurant that opened in an empty bank building and then advertised: 'Put your mouth where your money was.' Today my money and my mouth both say equities." Or so declared Warren Buffett Friday in an extraordinary op-ed piece in The New York Times. Buffett's call to stocks amid an ongoing financial crisis could help restore investor confidence, a crucial ingredient so far missing from the government's turnaround effort.

Buffett's optimism is based primarily on the following:

"Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors." Cash is trash. "Today people who hold cash equivalents feel comfortable," he writes. "They shouldn't. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value."A few caveats to Buffett's dramatic call:

By his own admission, Buffett is making a long-term call. "I can't predict the short-term movements of the stock market," he writes. "I haven't the faintest idea as to whether stocks will be higher or lower a month -- or a year -- from now. In the short- to intermediate-term, there's still the issue of reviving the banking sector, and key bank CEOs like JPMorgan's Jamie Dimon have expressed little optimism for the Treasury's program of capital injection. Nobody, not even Warren Buffett, is always right.

The second reason is the low interest rate environment. No long term investor will keep money at an interest rate below the inflation rate very long because they will lose money. When some sort of sanity comes back to the stock market this money will move back to the stock market fueling a rally.

Thirdly, sanity is coming back into the financial sector. Banks are starting to lend again as indicated by the over night, Libor rate, that is the lending rate between banks, has come back to a normal level. Also the Fed has added $600 Billion into the banking system and lowered the Fed funds rate. If the reason for the crash was tight credit then as credit loosens and money begins to flow this should have a positive impact on the stock market.

Lastly, the lower cost of gas and oil will stimulate the economy and increase stock prices. Friday's gas futures price for November delivery was $1.66 per gallon and if you add $0.60 per gallon for taxes and delivery it says that gas will continue to come down to below $2.50 per gallon in most parts of the country by Thanksgiving. This is the financial equivalent of having another $700 Billion infusion into the economy.

Bottom Line: The business cycle of what happens in an economy is acting normally. What has not been normal has been the credit crisis that crushed stock prices. As the credit crisis ends stock prices should recover with time. The rate of recovery is fueled by lowered interest rates and lower energy cost. This means that stocks are on sale now and with money that is not needed for at least 6 months it is time to shop.

Investing, Time to Get Ready to Buy Stocks

The guidance from the last blog last week was to hold your investment positions for a number of reasons. The guidance now is to get ready to buy stocks and let the market tell you when to buy as stocks are ON SALE NOW.

This past week, we had the worst performance on record even worse than during the depression. Let's recap:

• Virtually all investments crashed: stocks, bonds, and commodites except for gold.
• Stocks dropped the largest point total and percentage amount ever.
• Investors pulled money out of the market and put it into cash in large chunks.
• On Friday, we had a 1000+ point swing and got within about 5% of the low during the last correction.
• On Friday, we had about 10 times the normal volume on the NYSE, 11.5 billion shares.
• As you check any US or international mutual fund it seems that it has lost about half of the value.
• If you want to see what a financial shock looks like as yourself did you really want to look at your account balance or your mutual fund performance???

If we got within 5% of the previous correction this means that we probably know where the bottom will occur, Notice investors bought stocks to achieve a 1,000 point swing. THIS MEANS THAT THE STOCK MARKET IS NOW ON SALE, TIME TO BUY!!!!!

When do you know when it is a bottom? When bad news comes in and the stock market goes up anyway.

When you see this happen you can buy literally any US or international mutual fund as virtually all of them were punished. You want to avoid gold as it will fall and act like the other commodities as the crisis ends. You want to avoid bonds as interest rates will rise and price will fall as the crisis ends.

US Stocks Market Index, Buy Sell or Hold

The highly touted bailout bill passed last week and the stocks reacted by falling. The most recent 3rd quarter was brutal for even the most seasoned investor. During the last year, from October 1, 2007 to October 1, 2008, the US stock indexes are down about 30%. WOW, the average investor lost about 1/3rd of their money during the last year.

The news on TV and in the newspaper is fear and panic. Non-financial experts are talking about how bad things are things can get worse. When these experts talk about how bad things are and a feeling of panic is in the news it typically means that we are about at a market bottom.

At a market peak the news will be how wonderful things are and people will have a normal reaction of buying. At a market bottom the news will be how bad things are and people will have a normal reaction of selling. If the object is to buy low and sell high, then this strategy is exactly wrong.

What is best choice now between buy, sell, or hold US stocks? The answer is hold and if you have some cash that is not needed within the next year do some buying. Do not sell just for the sake of selling. While it impossible to know the absolute bottom, going down much further would be rather unprecedented.

What is the reasoning behind holding:

1. A 30% drop historically represents the low end of the distribution for the US Stock market.
2. The average length of a bear market is about 14 months and we are at 12 months.
3. The current financial data does not support the US Stock market going down further. A warning is that when the market runs on emotion it is very difficult to know the bottom.

It makes sense to sell to obtain a tax break in certain accounts. This is best done by buying a similar asset and holding it for 31 days or more before repurchasing the asset. It may also make sense if you need cash in the near future.

When fear and panic exist keep your wits about you. You want a diversified portfolio of excellent mutual funds that can weather a financial storm.

If you need assistance with building such a portfolio, contact an investment professional.

Importance of Stewardship

The past few weeks has been brutal for an investor. Last Monday's 777 point loss and the tumultous rest of the week was enough to make even the most veteran investor a little nervous.

What these events do show is the importance of applying christian stewardship principles in finances. What is meant by christian stewardship? This means taking the principles in the Bible and applying them to everyday life. If you follow these principles you never need to worry about a credit crisis. Here are 2 of my favorites.

Credit Card: Never have a balance that you carry forward into the next month!!!!! Paying 20% interest is always a bad strategy. If you can not pay it off each month, cut it up. Do not let a credit card company control your actions.

Personal Auto Loan: A depreciating object such as a car is a liability not an asset. The loan balance will be worth more than car which means that if you turn in the car during the loan period you will also be paying to get out of the loan. You pay interest and fees to get the loan and then pay more money to get out of the loan. The better solution is to save for the vehicle to avoid getting a loan and buy a car that is 2 years old or older to avoid the steepest part of the depreciation curve.

If you live with minimal need for credit you will sleep better at night. In the past, I was guilty of these 2 mistakes. A little upfront effort can avoid sleepless nights.