Fagan Associates Archive for October, 2009

Every once in awhile, several topics arise that merit comment, but are either not sufficient in scope or are merely meant as “food for thought” and do not command a full column.  This is one of those times.  Therefore, what follows is some commentary pertaining to the market or perhaps investing that we believe are very worthy of mention.  We’ll even give our take, where appropriate.

We remember back to early March, when understandably, investors were rattled and indeed, after meeting with them, less than a handful of our clients called to get them out of their investments until “things looked better.”  We candidly informed them that the stock market is an anticipatory mechanism, anticipating economic activity six to nine months down the road and will move prior to receiving confirmation that the economy is recovering.  Indeed, stocks moved during these dark hours and have not looked back, rising more than fifty percent on all of the major averages.

An observation that we have made several times within the body of recent columns in The Record and over various other medium, the final half of the move downward on stocks, from let’s say Dow 10,000 to where it bottomed at 6,547 on March 9^th, 2009 was driven by panic.  The move back up has been a recovery of that panic.  Our take is that now we will have to earn the gains.  The easy money has been made and now stocks will respond to the efficiency and effectiveness of the stimulus package and a pick-up in personal consumption, which represents nearly 70% of the U.S. economy.

A follow up to the preceding paragraph, this is not the popular poker game, Texas Hold’em.  Investors should not go “all in” or for that matter “all out” unless their situation changes.  Everything in moderation.  If you are bearish, then scale back your allocation to the stock market.  If you are bullish, then increase that exposure.  However, make certain that your asset allocation, that is your percentage allotment to stocks, bonds and cash should conform to your long-term objectives.  The further out your objectives are, generally speaking, the higher percentage an investor would allocate to stocks.

Don’t let your politics completely cloud your investment philosophy.  We’re not making a political statement, but with several hundred clients, let us tell you that some disliked George W. Bush with a passion and some dislike President Barack Obama with that same level of disdain.  Please keep in mind that your political bent can cloud your belief in our economy and therefore the stock and bond markets.  Furthermore, should you be conservative in nature, listening to, watching and conversing with those similar in opinion to you, chances are, at this point, you are not very bullish on the stock market.  However, recognize that you were also not very bullish back in March, some fifty percent ago.  Bottom line, invest according to your objectives.  We believe that politicians will come and go, but the spirit of America is lasting and the vibrancy of the economy is cyclical and this combination will outlast politicians, with both sides of the political aisle well-intended, but sometimes misguided.

Invest on a regular basis.  Investors tend to not invest near the bottom of the market cycle, believing that by so doing are throwing good money after bad.  Conversely, now we are getting a continuous stream of calls.  We believe that stocks, bonds or mutual funds that invest in these areas are, for most of us, the best path in which to achieve wealth.  It does not guarantee it, but, if history is any guide, is your best chance.  Therefore, invest regularly, in good times and in bad, according to your objective, time horizon and tolerance to risk.

That’s it.  Some issues, thoughts that we had to get off of our mind.  I hope at least one of these gets you closer to your financial objectives.  The BOTTOM LINE, think for yourself.  Don’t be part of the herd and recognize that, if history is any guide, it is time IN the market and not timing OF the market that will ultimately pay off.

Break out the party hats, this past Wednesday the Dow Jones Industrial Average closed above the psychologically important 10,000 mark for the first time since closing at 10,325 on October 3^rd, 2008, finishing at 10,015.86, buoyed by positive earnings reports from tech-giant Intel and JP Morgan.  Like the proverbially roadrunner, stocks have moved more than fifty percent off their bottoms set in early March 2009, but like that gerbil running frantically along the wheel in a cage (sorry for the analogies), they have gone nowhere for more than a decade.

For others like us who have been in this industry for over a quarter of a century, it is important to put this milestone into context of what has transpired over the past six months, over the past year and indeed over the past decade.  That, and to answer the question, what does this move in the Dow along with the other more important, broader indices mean for investors, and where do we go from here is the intention of this column.

First and foremost, the Dow first closed above 10,000 back on March 29, 1999, closing at 10,006.  Peter Boockvar, equity strategist at Miller Tabak, did some research and discovered that back on this date gasoline was $1.20 per gallon and gold was $280 per ounce as compared to $2.50 per gallon and $1,060 per ounce today.  Furthermore, the total U.S. debt back in March 1999 was $24.6 trillion as compared to the total today of $50.8 trillion while the U.S. population was approximately 272,690,000 back then as compared to 304,000,000 now.

Has it been ten and one-half years of little or no movement in this closely watched index?  Of course not.  If you’ll put on your memory caps, , as the fourth quarter of 1999 came to a close, academicians and computer geeks were all worried about what would happen to computers when the calendar turned to 2000.  This “Y2K” issue was supposed to cause computers to crash and bank accounts to appear empty.  This did not happen.  However, what did happen was an historic doubling in the tech-heavy NASDAQ Composite in less than a year, beginning March 29, 1999 that eventually culminated in a subsequent eighty percent collapse in the index, a collapse now known as the “pricking of the dot-com bubble.”

The Dow, comprised of a cross-section of U.S. Industry fared much better during this collapse, but could not overcome one of the darkest days in our nation’s history, September 11, 2001.  The Dow closed at 10,033 on September 5, 2001 and three days later at 9,606 on Friday, September 7.  The attacks occurred and miraculously the New York Stock Exchange was shut down for just five trading days before reopening on September 17^th.  The attacks as well as the fact that American economy was mired in a recession, was too much for stocks to overcome.  This combination, along with illegalities surrounding Worldcom and Enron pushed the Dow down to a then low of 7,286 one year later.

Despite the wars in Iraq and Afghanistan, the Dow began to push its way higher, closing back above the 10,000 mark on December 11, 2003, its first time above this benchmark in over 1½ years.  From that point on, the Dow climbed higher, peaking ultimately at a record 14,164.53 on October 9, 2007.  However, the economy once again entered a recession and this time, it was brutal.  As a result of shoddy verification procedures as well as complicated mortgage-backed securities, Housing Prices collapsed and foreclosures mounted.  Too add insult to injury, unemployment which once stood at under five percent within the past three years, is now approaching ten percent.

Since that top back in early October 2007, the Dow fell 53.78% to 6,547.05 on March 9, 2009.  However, from then it has vaulted nearly fifty-three percent to where it closed Wednesday, 10,015.  We noted above, that the last time the Dow closed above 10,000 was back on October 3, 2008.  It is important to note that one day later, the Dow closed at 9,955 some 3.6% lower than the previous day.  The downward spiral had intensified and fear of a collapse in our financial system reigned.  Finally, investor panicked and then buyers stepped in.

THE BOTTOM LINE – Investors are convinced that despite the fact that we experienced a deep recession, it is indeed coming to an end and we a depression was averted.  This cross back over 10,000 feels good because it is on the way up and not the way down.  The economy, at least for the next two to three quarters should be experiencing an upturn and that bodes well for stocks.  We believe that given this scenario, we would add to positions in your mutual funds or individual holdings on pullbacks.

There is an old saying on Wall Street that “stocks climb a wall of worry.”  Undoubtedly, we live during a period of worry.  Worry that outsourcing to other countries is killing American industry; worry that Social Security will not be there when we need it; worry that the budget deficit will result in spiraling interest rates; worry that terrorists will strike again.  With this in mind, and despite the recent run-up, investors are scared to death of stocks and would love to be out of the stock market so then they would have cash to invest!

The moral of this humorous statement is that most individuals realize that now is a good time to invest, but are too afraid to do so.  This accounts for the billions of dollars of cash still on the sidelines and in risk-free investments such as Certificates of Deposit or Money Market accounts.  Prior to making a decision, Benjamin Franklin, utilized the “T” method, writing the positives on the left of the “T” and the negatives aspects of the decision on the right.  The result was a clearer picture of the factors impacting the decision and whether or not the positives outweigh the negatives or vice-versa.  With this in mind, let us utilize this method, first concentrating on the right side of the “T,” the negatives.

The negatives include headline risk, or the risk that the company you decide to invest in announces news that negatively impacts the share price of the stock.  This risk is evident in a press release by Research In Motion this past week, in essence stating that it’s revenue and earnings growth would not be up to what Wall Street expected.  Headline risk may also pertains to acts of terrorism abroad that tend to move the markets and therefore your stocks.

Another negative includes the risk of future terrorism in the United States.  President Obama as well as the majority of the officials in his Administration refer to the potential for terrorism in the United States as not an “if” but a “when.”  We believe that this realization by investors continues to weigh down stock prices.  Only time will mitigate this concern.

Corporate governance issues also weigh on the minds of investors.  We often field the question, “do we own any potential Bear Stearns or Lehman Brothers.”  We respond that there is very little that an investor (or a regulator for that matter) can do to completely eradicate fraud.  What we can do is invest in quality companies with strong balance sheets and diversify your holdings so that one “blow-up” will not severely comproimise your portfolio.

Fundamental valuations also pose a risk to stock prices.  At the conclusion of most bear markets, valuations are approximately one-half of what they are today.  That said, we believe that what most of the bears are overlooking are the facts that stock valuations respond inversely to interest rates and that earnings are low due to the current state of the economy.

The above represents the right side of the “T” or the bear side of the argument.  Now for the left or bullish side.  First and foremost, the recovery is beginning to take hold despite the fact that approximately only one-third of the stimulus money has filtered through to the economy.  Included in this conclusion are the facts that business inventories are low, the housing market is stabilizing, interest rates are low, inflation is tame and consumer sentiment is on the rise.

Another reason for the bullish side is that there exists a record amount of cash on the sidelines, both in absolute terms and relative to total stock market capitalization thereby providing potential fuel for equity prices once investors feel they can safely re-enter.

A final reason for the bullish side is old-fashioned greed.  The only emotion greater than greed is fear because with fear comes self-preservation.  Until recently, the bears have fed on this sense of fear.  However, we now believe that the fear selling is over and we are in the midst of transitioning from fear-driven selling to greed-driven buying.

That is it.  Come up with some further issues for the market to contend with.  Then determine when it is appropriate for you to re-enter.  As far as we are concerned, and despite the potential for a pause, one that we believe would be one to refresh, now is a very good time to put money to work.  We believe that five years from now, when you look back, you will be happy that you took the plunge.