Too Extreme?

By Bob Wood, MMNS

This article is a follow-up to one published in this space last September, regarding investing with an eye to what is happening with the U.S. economy. Since more has become clearer now, we can safely remove some of the conjecture from my premise to make better decisions about what lies ahead for our economy and stock market.

Investors are finding themselves with some mighty difficult tasks these days. The job for each of us is to weigh mountains of information that argue either for and against what we should be doing with our capital. Simply put, there are always reasons to do — but also reasons not to do — whatever we are considering at any given point in time.

Do we buy shares in Microsoft — or not? Do we buy large cap stocks — or small caps? Do we load up on domestic stocks — or international options? For each decision, we can find plenty of reasons to go either way — and both bullish and bearish opinions to consider.

And when we look at the overall economy and its effects on the stock and bond markets, the quandary grows. But our important decisions certainly should be affected heavily by the outlook for the economy as a whole. As usual, the Bulls and Bears fight it out over this topic daily.

Some prefer to think of Bulls as the optimists and Bears as pessimists. I think this is a great time to put that distinction to rest. While I have long been bearish on the domestic economy and stock market, I remain very optimistic about international economies and stock markets.

For most investors, the domestic markets are of prime importance. Many of you are most likely invested according to what is commonly accepted as ‘’conventional wisdom,’’ meaning you favor our home market over all others. However, the most important decision you can make is whether to be defensive or aggressive with your investments. In my way of thinking, this is where the Bears have it!

And I think they have it right now – and have generally had it right all along, or at least since the late 1990s. Remember the last days of that wonderful secular bull market when all we had to do is buy almost any stock mutual fund and sit back and watch our holdings grow in value?

The Bears tried warning us then that the free ride had gone too far and would end badly. Of course, the financial media had no trouble finding one promoter after another to expound on how everything was just fine and that stocks would go ever higher over time. We now know how well that worked out! The S&P 500 lost almost 50% of its value from the peak in early 2000, and the tech-heavy Nasdaq lost 80% before the carnage ended.

A couple years ago the housing market was booming, and again the Bears tried to warn us that that, too, would end. Again, the bullish promoters assured that all would be well, that the worst we could expect was a ‘’soft landing’’ and that home prices wouldn’t fall, but, rather, just rise more slowly than they had previously. Even former Fed Chairman Alan Greenspan was a calming influence, assuring us that an adjustable rate mortgage was a good deal — an opportunity to take advantage of some of the wonderful financial innovations brought to us by our benefactors on Wall Street.

As the housing market began to slow and we learned about esoteric mortgage instruments and their various derivatives, concern began to climb among investors. But again, we were assured that losses, if they were coming, would be small.

Yet bearish analysts warned that those losses could be substantial. One estimate saw those losses reaching the half billion dollar mark and was, again, scoffed at by those who are more bullish. It has always been too easy for the bullish side to simply wave away any legitimate concerns, offering nothing more substantial than bromides like ‘’stocks climb a wall of worry’’, ‘’don’t fight the Fed’’ and assorted other meaningless maxims.

This past week, a front page story in the Financial Times newspaper featured a leading financial authority showing how costs for these mortgage related losses could spike to over $1 trillion. By the way, the source of that discomforting news was none other than — the International Monetary Fund!

So again and again, the Bears have steered us in the right direction — or at least out of the path of the next train wreck. And now, even Greenspan himself says that our economy has entered a recession. And that comes from the guy who helped put us in this most unfortunate position!

So now, in the fullness of time, what should we expect to see in the coming months and years for our economy and the stock markets? Since, as we are fast learning, the Bears have been much more accurate in their assessments of where we’re headed, let’s look at what one of them is telling anyone who will listen, or at least anyone subscribing to his excellent service at

I am, of course, referring to economist John Williams, who has done great work in alerting us to the true state of our economy. He regularly provides actual statistics to show how the government manages and manipulates official statistics like the rate of inflation, the unemployment rate and growth in the supply of money.

Williams’ latest monthly report begins with this lively sentence. How’s this for an opening?

“The U.S. economy is in an intensifying inflationary recession that eventually will evolve into a hyperinflationary great depression’’.

How are you doing so far?

He forecasts that ‘’ hyperinflation could be experienced as early as 2010, if not before, and likely no more than a decade down the road.’’

And the next paragraph begins with a doozy, as well.

‘’The U.S. has no way of avoiding a financial Armageddon.’’

What follows are 22 more pages explaining why he thinks this way while too many in the financial media propose that we will skirt a recession and, at worst, see a one-quarter recession followed by a nice comeback in the second half of 2008.

Remember, the Bulls are the same people who assured us in 1999 that ‘’the only risk with tech stocks was not owning any of them.’’ More recently, they have assured us that housing prices never go down and, since the sub-prime mortgage market was a very small portion of the overall mortgage market, no lasting damage would come from its difficulties. Now we see that damage being felt around the world!

So what’s the final analysis about the back-and-forth predictions of what is to come? Let’s say the Bulls break from their recent record and are proven right this time: the economy rebounds in the second half of this year. What would you lose by being defensive for the balance of 2008 — just in case?

At worst, you would lose some opportunity to profit, but you will survive to fight another day. Now, what if the Bears like Williams (and me) are calling this right, and the economy is headed off a cliff? If it happens, and you sided with the Bulls, the damage could be enough to take you out of the game for good.

Are the Bears too extreme in their warnings? If we’re going to make a mistake, let it be on the side of caution, knowing that staying solvent is paramount to all other concerns. If the Bears are right, all is not lost. Bearish investors in hard assets like precious metals and other asset classes like foreign stocks and bonds should still do well. And don’t forget an allocation in bear market mutual funds. These would certainly be winners in a bear market. Let’s hope caution puts us among the winners!

Have a great week.

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


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