It may require some patience, but for the long-term value investor, market history suggests that after a 65% drop in stocks and after earnings have been adjusted downward, the stage is set for higher than average annualized rates of return over the next five years.

- Jim Cullen, president of Schafer Cullen

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Work with us:  Manarin Investment Counsel

The economists at First Trust made some encouraging comments in their recent article about the recession.  Here are the highlights I want to share with you:

• The economy and stock market are floating on a sea of liquidity.
• Through Friday, this sea of liquidity had lifted the Dow Jones Industrial Average by 22.5% in less than a month, with the NASDAQ up 27.8% and the S&P 500 up 24.5%.
• If jobs were the catalyst for all economic change, then the economy would never stop expanding if jobs increased; nor would it ever stop contracting when jobs fell … in the past, the unemployment rate has been much higher than it is today and yet the economy recovered and the stock market boomed anyway.  Unemployment is a lagging indicator.
• It takes about six months, but when the Fed injects money into the economy, spending increases.  It always works.  And this time, there is also a rebound in velocity taking place at this time.
• Very soon, the recession will officially end.  This is not a dead cat bounce, and it’s not government spending.  It’s easy money, plain and simple. 

In order to prosper in your financial life and get through this economic environment with the greatest peace of mind, you must rid yourself of any short-sighted thinking that may negatively impact your financial life. 

Every major downturn has its own unique characteristics.  This frightens investors into making the wrong decision at the wrong time.  For example, over the past 18 months I’ve witnessed investors dump their stock market holdings regardless of how well-managed the companies might be.  

A classic short-sighted decision.    

“But Roland,” you say. “Shouldn’t you move more of your money over to cash until you know the market recovery has arrived?  Isn’t that the safe thing to do for now.”

Nope, and here’s why:  For 95 years now the Federal Reserve has destroyed the buying power of our dollars.  With the massive amount of money that’s been created in recent months, I expect inflation to continue being the dominant, long-term trend throughout my lifetime. 

Cash is the LAST place I want my long term savings to be.  For more on this see my previous posts on derivatives. 

Knowledgeable investors I know realize that putting money in the bank today that could buy a loaf of bread will one day be given back those same dollars but this time they will only buy a few crumbs after inflation has taken its share.   

See, there is a difference between money and wealth.  Money is just the tool society uses to measure and trade wealth.  The true wealth: businesses, stocks, land, real estate, and precious metals cannot be created without limit; money can. 

My suggestion is that you recognize the difference between the two and if you have not done so already, start dipping a toe into the market by taking money and buy up the abundance of wealth that so many of your peers are ignoring. 

Here’s one last bit of common sense that explains why now is not the time for cash:

FINAL NOTE: I could be wrong but the chance we saw the market bottom back in the early part of March grows by the day.  Don’t get too excited yet because the windbags in Washington could quickly change that with a speech or a new piece of legislation.  But please stay tuned - the remainder of the year will likely be filled with many twists and turns.  

The below charts are referenced in the video (click for a larger image):

1. The Conference Board’s index of leading economic indicators has risen for two months in a row.
2. Producer prices have increased for two straight months.
3. Consumer prices rose in January – the first monthly gain in six months.
4. The Baltic Dry Index, which measures the cost of shipping key raw materials like copper, steel and iron, has more than doubled from its recent lows.
5. Existing-home sales rose in December, and participants in our weekly survey think that another rise took place in January.
6. Pending home sales went up in December.
7. Builders’ confidence inched up this month.
8. Thanks to lower interest rates, applications for both new mortgages and refinancings of existing mortgages are rising.
9. Real hourly earnings rose 4.5% in December following a 3.3% increase in November.
10. An index of consumer expectations rose in January.
11. Retail sales shot up by 1% in January – the first monthly rise since June.
12. The decline in consumer credit moderated in the latest month.
13. New orders for consumer and nonmilitary capital goods went up in January.
14. The ISM index of manufacturing went up last month.
15. The ISM index of services rose last month for the second month in a row.
16. The money supply is soaring, a sign that there’s plenty of liquidity in the economy.
17. The 3-month London interbank offering rate, a measure of banks’ willingness to lend each other, has dropped to 1.2% from close to 5% a number of weeks ago.
18. Other measures of the state of the financial markets, like the TED spread and the 2-year swap spread are down, as well.
19. Prices of credit default swaps for banks have fallen from their peaks.
20. The corporate-bond markets are thawing out, too; some $127 billion in dollar-denominated debt was issued in January, the most for any month since last May.
21. Some securities on banks’ books are starting to recover in value.

From Irwin Kellner at MarketWatch.com

Chicago - Any recession is a cruel event, and this one may turn out worse than most.  Many Americans are suffering, and their numbers are sure to rise in the coming months.  But recessions are also an inevitable part of the economy, and they do end up being reversed.  Since 1945, the average length of a downturn is 10 months.  This one will not last forever, and growth may well resume this year. 

Nor is it likely that the current crisis could turn into anything resembling the Great Depression.  The Federal Reserve has acted quickly on a vast scale to prevent the brutal deflation that occurred in the 1930s.  Bank deposits are insured, and people who lose their jobs can count on far more help than was available then, in the form of food stamps, unemployment insurance and welfare. 

In some ways, the downturn may do the economy some long-run good.  Like every recession, it has forced companies to cut costs and operate more efficiently, which will raise productivity.  It has boosted the puny American savings rate.  It has begun a transition away from overinvestment in housing, freeing capital for other sectors.

It has brought down inflated home prices.  It has caused banks to exercise more care in lending, while discouraging Americans from resorting to credit to live beyond their means.  But these changes are a big adjustment, and they won’t happen without pain.

Some critics think it’s dangerous for a president to make dire predictions, lest he spook consumers into hysteria.  That fear is also greatly exaggerated.  When major companies are filing for bankruptcy, the stock market is sliding and home values are falling, Americans feel poorer – because they are poorer – and nothing their leaders say is likely to have a big impact on their mood.

For the time being, the most important asset Americans have is patience, keeping in mind that bad as they are, things will eventually get better.  Bankers and investors will tire of putting all their money in low-yield Treasury securities.  Credit will thaw.  Home prices will stabilize.  Consumers will come out of their shells.  Sales will pick up.  Companies will dare to hire again.

The strangest thing happened on Friday.  It was reported that the U.S. economy lost 600,000 jobs in January and the unemployment rate jumped to 7.6%, but the stock market rallied anyway.  Partly, this was because the stock market is a forward-looking indicator and employment is a backward-looking indicator.  If the economy is near a turning point, the stock market will reflect it well before the employment report.

But there is another explanation — one that is believed by most of the journalistic punditry — and that is that a bad employment report make a stimulus package more likely.  As Christina Romer (Chairwoman of the President’s Council of Economic Advisors) said on Friday, “these numbers…reinforce the need for bold fiscal action.”  What’s interesting about this is that there is absolutely no long-term economic evidence that higher government spending creates jobs.

From Brian Wesbury’s article in The American Spectator

Some excellent points and a position I fully agree with in this excerpt from a recent Longleaf Partners shareholder letter:

Over 33 years we have operated successfully through six bear markets and are now in our seventh.  This one is the most severe, the most painful.  Conversely, it is the one that has created the most compelling opportunity and should produce the highest returns when the fear subsides.  Several observations indicate the extremes affecting the market, and we believe, imply that a bottom was reached in November. 

• The earnings yield of the S&P 500 relative to Treasurys has made equities the most compelling since the mid 1930s.
• The annual 10 year return for large company stocks has turned negative – something that has occurred only two other times, in 1938 and 1939, since tracking began in 1926.
• The VIX, an index measuring expected volatility and therefore fear, hit an all-time high in November.
• Significant margin calls and capital calls from various types of private funds have caused widespread selling of equities.
• Advisor sentiment measuring bulls versus bears has fallen to the lowest level in over two decades. 
• The amount of cash being held on the sidelines by individuals has grown to a sum significantly greater than the total market cap of U.S. stocks.
• Investors have bought Treasurys with no return, an indicator of the fear of other investments.
• Institutional managers have held high cash balances in spite of acknowledging equities’ undervaluation.
• Warren Buffett and Prem Watsa, two of the best fundamental investors, have made significant moves into equities.
• Insider buying at companies has been rampant.

Bottom Line:  In our opinion, buying ownership assets such as stocks, land, real estate, raw materials, or precious metals looks to be the smartest move any long term investor could make today. 

Folks are still asking me about the collapse and what/who caused it.  Here is a video clip sent to me that helps clarify part of the story. 

The stock market has been working its way higher since its late November lows.  A somewhat positive ending to what was a very dismal year.  The Dow was down 33.8% in 2008.  To put this year’s performance in perspective, today’s chart illustrates the 15 worst calendar year performances of the Dow since its inception in 1896.  As today’s chart illustrates, the Dow’s performance in 2008 ranks as the third worst on record.  Only 1931 and 1907 endured greater declines.  It is of interest that major banking crises occurred in 1931, 1907, 2008, and 1930 – the four worst calendar years on record in terms of stock market performance. 

From last week’s Chart of the Day.