Saturday, December 27, 2008

News Letter 12/27/2008

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The Economy

2008 was a tumultuous year for the markets. The markets suffered the worst economic crisis since the great depression. Markets indexes went down over 35-45%. click on chart below.


Commodity prices such as oil and gold reached record highs early in the year that later came crashing down. Oil went from a high of $149 per barrel in June (gasoline at $4.25 per gallon) to $36 per barrel (gasoline at $1.60 per gallon) in December. Gold went from $1000 per ounce to $800. Many other commodities such as steel and copper went through similar gyrations.
Retail sales fell, housing values declined, and credit markets stopped functioning in domino effect responses to the underlying credit problem and high energy prices discussed in earlier News Letters.
There were many bank failures and many financial institutions had to be rescued by the Fed to prevent a total collapse of the world financial system. Declining house values, loan defaults, and the credit freeze discussed in earlier News Letters were the reasons for the failure of the financial systems. Lehman Brothers and Bear Stearns filed for bankruptcy protection and were allowed to fail by the Fed. In the aftermath, Freddie Mac, Fannie Mae, and AIG insurance were subsidized by the Fed to prevent a total meltdown in return for a tax payer majority equity stake in the mentioned companies. In late December the Big three auto companies (GM, Chrylser, and Ford) were rescued by the Fed by extending loans with conditions for viability. The auto companies were troubled by a lack of credit availability for auto dealers and consumers. By extending those loans, the Fed acted to prevent a further decline in employment that reached 6.7% in December. The Fed also lowered the federal fund rate in steps to a rate of zero to mitigate the crisis. Congress also approved a $700 Billion Troubled Asset Relief Program (TARP) to allow the Treasury Department to buy distressed assets (homes) from banks and infuse cash into the system.

Future Outlook

Economists have different views on the outlook for 2009. Mohamed El-Erian of Pimco predicts a year of sideways trading with some ups and downs and he is cautious on stocks overall. Mohamed along with Jim Cramer recommend buying selective high dividend yielding stocks to ride out this economic downturn on the way back up. Other economists like Larry Kudlow predict a return to normalcy and advocates planting "mustard seeds" to reap the benefits of this opportunity brought on by this crisis. Larry points out that oil prices are at 5 year lows and the consumers which makes up 2/3 of the economy will have extra cash to spend. Dennis Gartman predicted that consumers will save more than ever for fear of cash depletion. He changed his bearish outlook to a bullish one after the Fed lowered interest rates to zero. He recommends buying stocks of companies that make "things that hurt when they fall on your foot." Other economists argue that the extra cash is not enough to counter the drop in house values and unemployment. It is my view that given the economic incentives in place today with zero interest rates and low commodity prices the economy will reach normally with a new set of rules in place for borrowing and lending. It will be a slow but steady climb up. There is no single investment strategy that fits every investor out there and each person has unique needs. There are no guarantees in stock markets. The only guarantee is that in the long run stock market averages go up at an average of about 10% annually. A diversified portfolio of stocks and bonds is the best strategy for long term investing.

Politics

The Democrats won the majority seats in both the Senate and the House and Barack Obama is elected as the first black President. The President Elect has appointed shrewd economic advisers to help him guide the economy. He has vowed to lower taxes on the middle class and raise them on income earners above $250,000. His press releases late in 2008 were positively received by investors and the markets went higher when Obama spoke and declared his economic stimulus plan. President Elect Obama will invest $800 Billion in rebuilding America's infrastructure to create jobs and get the economy moving again.

Stocks and Bonds

GM is a very risky stock to own given the possibility of bankruptcy and the high debt that has to be restructured in the coming months. Google is cheaper now than it has ever been in terms of forward P/E ratios. Market ETF's are good investments to buy on down days. Dollar cost averaging is the best strategy for buying stocks by buying in increments at different times. Treasury Bond yields are at historic lows but priced high due to high demand for risk free products. I would avoid buying treasury Bonds at current yields. There are better risk free products available for investors.

Mike Katto
CERTIFIED FINANCIAL PLANNER™
Registered Investment Advisor
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