April 2009

A Forward Looking Game Plan

Today we spend the day looking forward at what is likely to be our reality in the next decade. While it is understandable that most of us are almost always preoccupied with the here and now in our daily lives, from time to time, it is vitally important to look ahead. Today is one of those days.

As is always the case when I write these letters, I write an outline of what I'd like to say, write the letter, then come back and put together a little introduction. What I discovered in reading this letter surprised me a bit because I feel very at ease saying what I am saying, even though it is not in line with the financial industry. In other words, my level of confidence in this piece is very high. With that, let's begin

America the Beautifall

Four years ago, I wrote that there were a host of problems with the economy:

  • Net job losses
  • Lower median incomes
  • Energy price increases
  • Hard asset/materials price increases
  • Increasing environmental damage costs
  • Healthcare cost increases
  • Reduced access to affordable education
  • Record Trade Deficits
  • An expanding National Debt
  • A bear market in U.S. Stocks
  • A weaker dollar

Today some of these problems still persist, and of course we have new issues facing us. At the moment however, we are feeling the effects of a strong dollar. It is a welcome reprieve that the U.S. dollar has firmed up and is supporting lower energy, food and hard asset prices in virtually all households. At a time when jobs are uncertain and corporations are cutting compensation, lower food and energy prices are saving many families while they tighten their collective belts.

The future of the dollar is not likely to be pretty however. In printing money and running massive deficits to keep from falling into a depression, I believe we have all but assured that the dollar will fall in value over the next several years. This will ultimately create inflation at home, especially as the emerging world restarts its growth trajectory, even though the main problem over the next few years will be deflationary pressures. We have also likely assured that working through our problems here in American will take much longer than ordinary demand driven recessions.

Please, do not take this observation as a criticism of the current administration. I believe they had two choices to decide between. On one hand, the government could have allowed the economy to fall even further in 2009 and 2010, driving unemployment probably up to at least double the current levels and potentially causing civil unrest, or on the other hand, bail like there is no tomorrow in order to support the economy and deal with inflation later. What the current government inherited from the past several governments and a morally deficient financial system, was so overwhelmingly terrible (we have covered that before), that the choices were between bad and worse. I believe we have chosen bad, which in the end is as good as good can be.

What Is Coming

The uncertainty of job security, stagnant wages and overwhelming debt is going to continue to have a chilling effect on most American households for several years. Our consumer driven economy is for lack of a better word "toast." Don't believe the hype, whoever says it, about a sustainable recovery in the American economy or stock market for the next few five to ten years. Such statements are naiveté, dishonesty, ignorance or some combination thereof. It is a trap to think that because things used to be good, that they will magically become good again soon. Upticks will be met with down ticks for an extended period, especially in the American stock market.

The overwhelming problem of aggregate demand in America will be the aging and impending retirement of the baby boomers. This generation which has driven the economy and markets for decades was going to spend less over time. Now, they have been shocked into spending less. It is unlikely we will ever see the boomers spend as prolifically again as the past twenty years. The boomers being past their peak spending years will cause any economic recovery to face a very strong deflationary headwind until the very young and broke Echo Boom takes hold.

In the short-term, because Americans simply can not and will not be able to consume using debt for a number of years, demand will stay contracted despite the government's and Federal Reserve's best efforts to stimulate. Even when Americans personal balance sheets improve, I believe people will be much more restrained for a long time from over-extending again. The initiatives to stabilize the economy will take several years to take hold. The world economy, though it will grow, will not produce consumers as quickly as expected after this financial debacle. There is going to be a global demand issue for awhile. Eventually however, growth abroad will create growth at home again.

On a not so side note, the post-deflation inflation that is coming will largely solve the coming crisis in Social Security, sort of. Expect cost of living increases on Social Security to fall well below real levels of inflation in the next two decades, which will likely preserve that system. This reality makes it extremely important that you position your retirement assets correctly so that those assets can sustain you. Those who are about to retire or early in retirement need to face and deal with the dual issues of generating income while protecting principal against inflation.

Investing In Reality

Many people I talk to repeat the mantra of "I'm in it for the long run, my broker told me to just hang on." I hear it in the media too. Most "financial advisors" are salespepeople fools, or as Jim Rogers calls people like them, "flunkies." I am sorry, but what credibility does the buy and hold argument really have coming from people who have not made any absolute returns- that is beat inflation- in a decade or more?

Well, if you own the right assets "buy and hold" actually does carry a lot of water, ask Warren Buffett. If you buy and hold second best assets or outright junk, buy and hold will crush you. The major problem many people have is that they have been told to buy and hold the wrong assets, mutual funds in particular, for a long time by people who they trusted to know or care about the difference.

I know I am different from most other financial representatives at the retail level in that I listen to a small universe of great investors (Jim Rogers, Warren Buffett, George Soros, Bill Fleckenstein, Bruce Berkowitz, Mike Avery, Dave Iben...) and generally ignore the industry guidance and product hype, and especially ignore the mass media. I am very comfortable with this approach.

Going forward, as I mentioned in February, I will focus on a number of investment ideas that I believe will sustain my clients going forward.

First, the consumer demand driven economy is in a coma and will remain there for several years, thus:

  • We will be under-weighted in investments that need consumer discretionary spending to sustain profits.

Second, the dollar is going to fall soon, back to at least the levels of a couple years ago, therefore:

  • We will be over-weighted in investments that rise in price due to inflation, such as commodity and/or foreign currency linked instruments. Because a falling U.S. dollar will help American companies get off the mat, we will hold a normal amount of U.S. equities, despite the pessimism. Because of the massive government response with stimulus and an accommodative Federal Reserve, we are buying equities now, despite the overwhelming fear. One thing to keep an eye on is the development of American energy resources. It's too early to tell, but this might be a major catalyst to emerging from the baby bust.

Third, the emerging markets will ultimately drive global growth, thus.

  • We will seek out investments that benefit from the emerging economies reigniting around the world. Eventually we will find investments that normally do well when consumerism starts to rise again, probably in a few years. In the short run the emerging markets are very uncertain so we will be careful there.

Finally due to the eventual end of deflationary pressure and falling interest rates:

  • In a few years we will own very few or no U.S. fixed income because eventually we will get inflation.

While every portfolio is of course a little different based upon when a person invests and their personal circumstances, time horizon and risk tolerance, the above are the broad guidelines we will be following. Only if some huge shift occurs will we deviate much. I will trade to the extent that I am highly confident in the trade, whether it is a defensive or offensive move, however, we will stick to the game plan overall.

Contact me to discuss my rationale, the supporting data and how you can potentially benefit by being positioned well in a rough economy and rough markets.

No pictures in this month's letter, sorry. Make sure you visit next month, I will have some good pictures then.

My plan is to start writing quarterly, so, you will see a new letter in July.


Kirk Spano