Second Half Recovery?

By Bob Wood, MMNS


Market pundits and seers have been watching how stocks would begin the New Year, citing ‘’The January Effect’’ as an early indicator of what’s ahead for domestic markets in 2009. As the first full week of January ends, the S&P 500 is already lower than at the start of business for the year. Does this portend another year of pain for investors? “Not to worry,” we hear. “The economy and markets will recover in the second half of the year.”

Does that sound at all familiar? I seem to remember hearing that tired refrain every year when stocks have failed to find their footing in the early months. Then, when we find ourselves in the year’s second half with no recovery in sight, we are assured that growth and higher share prices are right around the corner. “Surely the good news will come in the first half of the new year, as savers add money to their tax-deferred accounts.”

Yet here we sit, waiting again for the recovery and the start of a new bull market that never seems to come as predicted. This entire decade has been a bust for investors — with the S&P 500 sitting just about where it was in the summer of 1997! Oh, and all those wonderful second-half recoveries have yet to appear!

Investors wait patiently, watching as their savings accounts continue to shrink in nominal terms and weaken in purchasing power. Is there any end to these requests for patience? How long must we continue to “hang in there,” waiting for the next recovery that market promoters promise?

Rather than listening to these false promises, investors would benefit from using a little common sense and their own powers of observation. How many of us knew full well that our economy was sputtering and most likely going into recession well before government officials admitted these possibilities? Now we hear that, indeed, the recession did begin in late 2007. Many of us could have told them at the time, as we saw mounting job losses and home foreclosures on a steady, monthly basis.

Yet many investors who were clinging to the hopes of a “looming recovery” endured another round of pain, with 2008 going into the record books as the worst year for investments since 1931. For many of us, this is the worst year during our entire lifetime.

As I’ve said previously, when investing in the stock market, you’re on your own. Relying on the help of market professionals has produced little, at best, for investors, though the situation hasn’t seemed to hurt those professionals to any great extent! Merrill Lynch is reported to have earned another $1.5 billion last year from its wealth management activities, and that’s with the markets experiencing one of their worst years ever.

How many times have we heard in previous years that “stocks are cheap,” based on forward operating earnings or some other specious metric? I wish I had kept track of the times I’ve heard that comment in prior years when stocks were selling at 14 times forward earnings or a similar, reasonable level.

And here we are at the start of 2009, with the S&P 500 still selling at over 20 times earnings! Is it really possible that the sharpest minds out there can be so steadily wrong in their predictions for the markets? Will virtually none of their predictions come true, year after year, as though they were as clueless as the rest of us? Doesn’t it seem odd that the experts are so often wrong?

Perhaps the argument is that they are not so much continually wrong as they are simply doing their jobs — selling shares and keeping trading activity at high levels. But at what point are any of them held accountable for giving such costly advice? At what point do promoters with miserable track records suffer fines or get banned from offering their views to a mass audience?

But if you’re looking for some sort of investor protection, forget it! The new poster boy for investor fraud, Bernard Madoff, was fingered by a sharp-eyed analyst as far back as 1998. The analyst wrote detailed letters to the SEC about suspicions of wrongdoing, but nothing came of it until Madoff’s scheme blew up, taking investors’ funds with him.

This week, we heard news of another spectacular blow up, already called “India’s Enron”! The founder, chairman and CEO, Byrraju Ramalinga Raju, of the Indian computer software and outsourcing company Satyam Computer Services, has admitted to doctoring the company’s books to the tune of $1.04 billion or 94% of its listed cash and assets.

Those assets weren’t actually held by the company, though its auditors PricewaterhouseCoopers signed off on financial statements, including the balance sheet showing that mountain of cash, without ever actually checking on it! Ironically, Raju won the Ernst & Young “2007 Entrepreneur of the Year Award” and, just three months ago, the company received recognition from the London-based World Council for Corporate Governance for its excellence in corporate governance! And Satyam recently earned a top award, for the fourth consecutive year, as the “Most Admired Knowledge Enterprise for 2008” — for its excellence in knowledge management!

Yes, we investors are truly on our own until some form of real regulation and accountability is enacted. But don’t stay awake at night, waiting for regulations to be enacted!

So what’s an investor to do? Well, if the game is as corrupt as the stock markets appear to be, with no accountability, no real regulation and no trust apparent, who says you need to do anything? No law mandates that you play this game at all.

If we investors lose faith in the markets and see no prospect of investor protections, who says we must stay invested? Wouldn’t it send the right signal if investors simply pulled their money out of stocks and let it sit in cash? Wouldn’t it send a useful signal to the big brokers and other promoters that limits exist on how badly burned the investing public will allow itself to get before pulling the plug on paying fees and commissions for yet another round of losing?

We keep hearing about record amounts of cash ‘’sitting on the sidelines,’’ and how record low yields in Treasury bonds must signal that another bubble will soon burst. Maybe that’s true, or maybe investors are beginning to do exactly what I am suggesting.

All that cash invested in bonds that yield next to nothing must surely signal investor revulsion at a very high level. Why would anyone continue to play a game that appears to be so steadily rigged against them? Where are the customers’ yachts? That question has been hanging around since 1940, and those yachts have yet to appear!

The thought of sitting in cash for the foreseeable future might strike some as a big mistake. Wouldn’t we make that error just as another bull cycle was about to begin, as so often happens? Well, yes, that is a possibility.

But as of right now, stocks could well be selling at some lower multiple of future operating earnings after all the bad stuff has been purged from the income statements of many large companies. But since we are looking at a market that sells at a premium compared to its long-term historic average, I don’t see us missing out on much!

Secular bear markets tend to last about as long as the preceding bull market. That suggests that this bear cycle is only about half over. Given that and the seemingly total lack of investor protections, why bother with stocks at all? Maybe this is the best time ever for investors to stand up and say that they’ll simply not stand for these empty promises any longer!

Have a great week.

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc.,


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