Fagan Associates Archive for April, 2012

For all of us, two of our primary concerns in life are maintaining our standard of living, both financially and in regard to lifestyle, and caring for our families.  At different stages in our lives these concerns are defined in varying manners.

Regardless of what stage you are in life, generally the following three factors must be considered prior to making a decision, financial or otherwise.  These factors must be considered because they will impact the two primary concerns noted above.  They are risk, reward and the probability of a particular outcome.

First, identify the potential consequences of an action along with the consequences of inaction.  Then, ask yourself, “what is the potential RISK of this action (or lack of action) relative to the REWARD (return) you are going to receive or what you intend to avoid.  Furthermore, by taking action what is the PROBABILITY of the intended result being realized?”

As these three factors pertain to investing and phrased in a similar manner to the question in parentheses above, but with particulars added, consider the following.

Investors must ask themselves, “What is the risk of subscribing to the belief that the stock market is not the appropriate vehicle for your long-term investment needs due to the fact that over the past decade it has gone nowhere?”  The risk is that you are wrong and that the American Economy and therefore the U.S. Stock Market will eventually recover from this malaise.  However, you will not participate in this growth as your investments will be out of the market.  Furthermore, even if you are correct in your belief, over a long period of time there is not a direct corollary between stock market returns and the performance of the economy where the specific company is domiciled.  For example, the Japanese economy has been mired in a slump for the past two decades and yet, prior to the “unintended acceleration” scare, the stock of Toyota Motor Company performed very well.

Conversely, investors should also ask, “What is the reward of over-allocating assets on a percentage basis to stocks relative to the risk that I am willing to take?”  Given the low interest rate environment in which we are and will most likely be living in over the next year or so, investors into fixed-income instruments like Certificates of Deposit and Bonds are searching for more income and growth.  Some wisely and others unwisely have begun to shoulder portfolio risk by investing into the stock market and as a consequence have reduced the predictability as well as the probability of a specific outcome.

Finally, ask yourself, “what is the cost of being wrong relative to the benefits of being right?”

If history is any guide, the recovery that the United States is currently experiencing has been modest at best.  As a rule of thumb, the deeper and longer a recession, the more robust and lengthier will be the ensuing recovery – and make no mistake about it, the last recession was deep as compared to historical standards as well as quite lengthy.  In fact, during the recovery there are usually several quarters of annualized economic growth in excess of six percent.  However, since the U.S. Economy officially exited the recession after the third quarter of 2009, over the following six quarters growth has not once exceeded six percent.  For that matter, the fastest rate of growth for that time period has been only 3.9% which occurred during Q2-2010.

In our opinion, the prime culprits for the middling economic growth can be attributed to the preceding over build-up of credit between calendar years 1993-2008; weak recoveries in the housing and labor markets and over-regulation of the financial services industry.

Despite the above, there is reason to be somewhat optimistic.  Americans have begun to work down their overhang of credit, specifically credit cards as well as other revolving loans thereby boosting their purchasing power.  In addition, the housing market and labor markets, although not robust by any stretch of the imagination, have at least stabilized.  And finally, corporations have begun to deal with the myriad of this new, onerous regulatory environment.

Regarding those issues negatively impacting the recovery noted above, three individuals, Chairman of the Federal Reserve, Ben Bernanke; Vice-chair of the Federal Reserve, Janet L. Yellen and the President and Chief Executive Office of the Federal Reserve Bank of New York, William C. Dudley, made pertinent speeches.

Describing the current status of the labor market as well her outlook for it, Vice-Chair Yellen noted that “there have been encouraging signs of improvement in recent months.  The unemployment rate had hovered around 9 percent for much of last year but moved down in the fall and averaged 8¼ percent in the first three months of this year, about 1¾ percentage points lower than its peak during the recession.  And even though the latest employment report was somewhat disappointing, private sector payrolls expanded, on average, by about 210,000 per month in the first quarter, up from gains averaging 150,000 per month during most of 2011.  Other labor market conditions have shown similar improvement.”

One day after Vice-Chair Janet Yellen made somewhat positive comments concerning the direction of the labor market, President Dudley outlined the case for a relatively buoyant consumer, stating that “the incoming data on the U.S. economy generally has been a bit more upbeat over the past few months, suggesting that the recovery may be finally establishing a somewhat firmer footing.  Real GDP expanded at a 3.0 percent annual rate in the fourth quarter of 2011, the fastest growth since the first half of 2010.  The average monthly job gain was 212,000 in the first quarter of 2012, up from 164,000 in the fourth quarter.  Sales of light-weight motor vehicles were about 14½ million at an annual rate in the first quarter, the best quarter in sour years.”

THE BOTTOM LINE – Although we may be hitting somewhat of an economic soft patch resulting in some profit-taking in the stock market.  At this time, we believe it will be limited to less than eight percent which will in hindsight have provided an attractive entry point for long-term investors.