What We Don’t Know

By Bob Wood, MMNS

In the coming weeks, as happens every year, we will be privileged to learn what stock market mavens foresee for the coming year. What will be the direction of the markets, and which stocks or sectors will be the best places for investing? One look back at last year’s prognostications should be enough to convince you to ignore this year’s advice!

Let’s face it, aside from a few market analysts referred to as ‘’Bears,’’ few pundits foresaw the market wreckage of 2008. One famed market watcher, Abby Joseph Cohen, told us to expect another big year for stocks in 2008, but, then, she always does.

How many forecasters suggested watching for the implosion of some of the biggest financial firms on Wall Street in 2008? How many warned that financial titans such as AIG, Bear Stearns, Lehman Brothers, Washington Mutual, Fannie and Freddie would all go bust? How many of them called the recession of 2008 or that we would see job losses every month of the year?

Did any of them project that we would experience one of the worst years for stocks since the 1930s? Who prophesied corporate earnings falling sharply, the price of oil dropping back to the $50 level or some of the hottest emerging markets losing more than 60% of their prior peak values?

I haven’t found one of the mutual fund managers profiled in publications such as Barrons or any among those appearing daily on CNBC who warned about the year we’ve had. This year has been so damaging that not one diversified mutual fund has registered a positive return so far in 2008! And that fact, as of today, is likely to remain true.

However, I must meekly confess, looking back at an article written for this column about a year ago, my warning that emerging markets had become too hot and that I was reducing my exposure to those markets. Considering typical “performance-chasing” by the investment crowd, those markets were pushed beyond what their strong fundamentals could support. But I didn’t see the extent of the carnage to follow.

Who could have predicted that so many highly regarded hedge funds would blow up, forcing them to sell good assets at fire sale prices? And who knew they would drag down virtually every sector of mutual funds in the process?

When have we ever seen a year when not one sector of mutual funds remained in positive territory, including bond funds? What a wreck of a year this has been, yet not one of the market seers expected this to happen! I was bearish, but I sure didn’t see it getting this bad.

Instead, who can forget all the exuberant, strained exhortations from people like Larry Kudlow, who touted ‘’The Goldilocks Economy’’ and ‘’The Bush Boom.’’ They couldn’t believe how cheap stocks were and how dumb we were for not loading up on stocks!

Hopefully, by now, wise investors have learned that Wall Street is the most successful sales and marketing endeavor ever created. And the financial media serves as its vocal front line, much like the famous carnival barkers who stand outside the Bearded Lady’s tent, extolling the wonders to be seen just behind the curtain. For only a few dollars, they prodded, you, too, can see for yourself.

And you surely wouldn’t want to miss that, would you? But if you did, then good for you!

Oh, and let’s not forget the value of the academic approach to investing, which is so strenuously advocated by Jeremy Siegel and even Jack Bogle of Vanguard fame. Yes, this is the same Bogle who is generally a friend to investors — an advocate for a better regulated and more honest mutual fund industry. That investors should diversify among several asset classes seems rational, with that plan’s only flaw being that it failed miserably this year. Sure, you could have built a wonderfully balanced portfolio including large cap domestic shares along with a dose of small caps and mid caps, a little dollop of international shares, some bonds and a bit of cash, and you would have had your head handed to you on a plate for your stalwart diversification efforts!

It amazes me again and again that so many highly regarded analysts — or at least those with high media exposure –continue to ignore one of the most potent truths about investing. That is: successful investors must be aligned with the markets’ dominant trends.

The trend is your friend, the only saying goes, and long-term trends are the strongest of all. And there we were, at the start of 2008, with major averages in the domestic markets no higher than they were at the start of this decade. Yet that proof of an existing secular bear market went unheeded — yet again. Instead, the rallying cry was: “Buy stocks; they’re cheap! Don’t miss this big rally!”

During the year, I would tell anyone who would listen about secular bull and bear markets and get reactions ranging from indifference to objection. But that appreciation for long-term trends helped significantly to limit the damage to my managed accounts this past year. This belief mandated that I assume a very different asset allocation set in my model accounts, including what are known as bear market funds and many short positions in what I considered expensively-priced shares. And believing, without any doubt, that we are still mired in a long-term bear market will continue to serve me well.

The big question is: has anything changed for the upcoming year, 2009? Perhaps, to a small degree, it has. With markets around the world hammered beyond what anyone thought likely, stellar opportunities now exist in bargain-priced shares -those shares unloaded by failing hedge funds that took on far too much risk and got caught in dire straits.

Yet none of this opportunity negates the power of the ongoing secular bear market. Sure, we will see rallies during a secular bear market, but I expect most of the domestic rallies to falter before very long. Our economic picture is as bad as many old timers can remember, and, with the S&P 500 still selling at about 18 times trailing earnings, the overall market offers little more than short-term trading opportunities. The strategy in this kind of market is: get in, get out, and keep your losses small.

Overseas markets, however, appear to be much better positioned for gains. And how could the outlook for gold be any better than it is today with our government printing money on a scale not even imagined just a few months ago?

Estimates on the size and scope of money and credit creation by the Fed and Treasury are running as high as over $8 trillion! If I did the math right, that amount equates to about $40,000 for each of the estimated 200 million adults living in America today.

Can you imagine the impact if the government had just mailed each of us a check for that amount? Home foreclosures would dwindle to almost nothing; credit card balances would be paid in full; and people would be lined up to save or spend the rest. The economy would boom all right! But that would also be rather inflationary, wouldn’t it?

Regardless of where all that money really went, and, as of now, no one seems willing to disclose much specific information, other obvious signs of corruption appear to be endemic in our system. This situation will prove highly inflationary at some point, so gold, energy and other commodities should do very well in that environment.

But be forewarned, no one really knows for sure what the coming year will bring! Out of nowhere, we will see developments we couldn’t have possibly predicted. All we can do is invest wisely with the weight of the more evident fundamentals on our side, control risk and losses as best we can and hope that fundamentals will, at some point, matter.

With more to come that we just can’t see or predict, we can observe those secular trends and invest accordingly. Domestic stocks are still in bad shape, and our economy is still mired in one heck of a messy situation. But gold and energy are in the throes of a supply and demand situation that will surely be bullish. Just be cautious — and careful not to load up too much!

Have a great week.
Bob

Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., invest@muslimobserver.com.

10-50, MMNS