This could be one of the most important updates I have written in my 24 years as an investment advisor.

The reason is that I sense that most, if not all of you, are so sick and tired of reading and hearing negative economic news, and seeing your Schwab accounts going down in value month after month after month. And, who could blame you? The media paints a picture of hopelessness and the stock and housing markets just seem to keep confirming that picture.

But I am going to give you reasons for optimism and demonstrate conclusively why now, of all times, you should not give up on your investment strategy.

First, take a look at the graph below, which describes the emotional cycle of investing.

Screen Shot 2014-12-16 at 2.48.20 PM

Do these emotions match the ones you have been experiencing? Where would you say we are on the emotional cycle today? I think we are somewhere between capitulation and despondency. And closer to despondency.

The interesting point, and the one I hope you will easily grasp, is that this is very near the point of maximum financial opportunity. The point just before things start improving.

This cycle is so common in investing that the Internet is full of different versions of the same chart. How can we benefit from this knowledge? First, get in the habit of always checking your emotions. Use them as a gauge to help your rational mind know what decisions you should make. Just like a fever tells us that we are sick, feeling despondent and hopeless about the financial markets should tell us that now is the time to be bold and fearless. Similarly, when your emotions are running high about your investments, tell your rational mind that now is the time to be cautious and careful. The ability to master this process is critical to investment success.

There is a story I like to tell about financier and philanthropist J.P. Morgan, who by the 1930s had retired to England. During the depths of the Great Depression, a reporter caught up with him there and breathlessly asked Morgan what he thought of the severe stock bear market the world was going through at the time. Morgan sniffed snootily and responded, “This is the time that stocks revert to their rightful owners.” His meaning, of course was that while het little guys were panicking and selling at fire sale prices, the fat cats were busy picking up the bargains of a lifetime. And, in his opinion, stocks, and their outsized returns, rightfully belong to the rich.

And so it has been for hundreds of years, because it always turned out that the little guy just couldn’t seem to handle it. The wealthy could, of course, because their families had always had them, they understood how the markets behaved, including the screwy times, and accepted it. Not only did they accept it, they learned to look forward to the difficult times as an opportunity to grow even wealthier by buying up everything they could while others were panicking.

And so I want to ask you- are you going to perpetuate this age-old pattern or learn from it? Do you want to let somebody else profit from the very same assets you currently own but are thinking of dumping near the point of maximum financial opportunity?

Early Signs of Recovery?

Lost in all the loud media shrieks of 1929 and the Great Depression II are some early signs of a potential recovery that may be taking root. Among these are:

  1. Real GDP (Gross Domestic Product) for the 4th Quarter was expected to come in at -5.5%, but came in at -3.8%, indicating that the economy wasn’t quite as sick as the economists thought. Keep in mind that in 1982, the economy shrunk in excess of 10% both in a single quarter and for an entire year.
  2. Leading Economic Indicators for December came in at +0.3%, compared to the consensus which expected a decline of 0.3%. This is a composite index of ten economic indicators that should lead overall economic activity, giving us a clue of what might be coming our way several months down the road.
  3. Existing home sales in December unexpectedly came in 6.5% higher in December. The consensus forecast was that they would be down slightly. This indicates that housing prices might be low enough to attract investors, and providing some early evidence that a bottom could be forming in the housing market.
  4. The Institute of Supply Management’s (ISM) survey of 300 manufacturing firms showed manufacturing unexpectedly increased in January to a level of 35.6 vs. a consensus estimate of 32.5. Interestingly, the new orders index shot up by 10 points. Any number below 50 indicates contraction, so the January report indicates that manufacturing is slowing down with less velocity than before.
  5. Today, a report showed that same-store sales at major retail chains unexpectedly increased by 1.6% last week.
    Also today, another report confirmed improvement in the housing market. Pending home sales in December came in +6.3% from the prior month. So now we know that both actual (closed) sales and pending sales improved at the end of the year.

For each of these positive reports there are a bunch of critics quick to say, “Yeah, but….” However, I expect to see the frequency of these reports increase until the naysayers can no longer explain them away. Another positive sign is the number of positive corporate profit surprises there have been for the 4th Quarter. The markets have been bracing for Armageddon but so far, with about 60% of companies reporting their quarterly profit, the figures are down about 25% from a year ago. If we took out the financial companies which are the locus of the current economic problems, profits wouldn’t look nearly as bad.

Despite the press reports we’ve all read about “the worst January in history,” for stocks, the markets so far have refused to go down below 8000, and have yet to drop below the November 20th bear market low near 7500. Maybe they will yet, and maybe they won’t. But the fact that 8000 seems to be a floor that has been sticking is a hopeful sign.

I must in fairness point out that for every positive economic report we get there are four or five negative ones, including, recently car sales, which are off 30-50%, and unemployment, which in recent weeks has been increasing at an alarming rate. Keep in mind though that unemployment is a lagging indicator, reflecting where the economy has been, as opposed to where it is going.

Employers unfortunately seem to rely more on the rear-view mirror than they do the front windshield when it comes to hiring and firing staff. Also, keep in mind when you read these reports of companies laying off 70,000 employees, those layoffs are usually spread out over the next 18 months. If the economy picks back up, many of those layoffs never actually occur.

So, there are hopeful signs pointing toward increased economic activity in the future. Also, keep in mind that economic growth is like fault lines. We know that the major faults move slowly at a certain rate of speed. Sometimes, however, that movement gets arrested for a period of time, but the momentum of movement continues unabated. Eventually, the pressure builds up enough to break free, and the result is an earthquake. The longer the pressure builds up, the greater the magnitude of the earthquake.

Similarly, the economy has a long-term capacity to grow at a 3% annual rate. 1% of that is from population growth and the other 2% is from expansion of the economy. When that growth gets arrested by something like a recession, the longer and deeper that recession is, the greater the snapback in economic growth is afterward—just like an earthquake.

The chart below graphically displays the bull and bear stock markets in the United States since 1927, including the current one. As you can see, past bear markets always end in a new bull market. Ignoring what your emotions tell you, what does your rational mind tell you will eventually come?

Screen Shot 2014-12-16 at 2.50.16 PM

As we can see, past bear markets have always ended in a new bull market. And, if you can ignore what your emotions are telling you about the current state of affairs, what does your rational mind tell you is most likely to happen next? And what should you be doing now to be in the best position to benefit?

I hope I have made a compelling argument for you to have a clear understanding of what the greatest dangers and opportunities are for you right now. To me, the greatest danger is that you would get out of the stocks you own and miss out on the returns the next bull market will deliver to those who are invested when it begins.

Stay the course. Continue to be patient, and know that this course is the one most likely to create the kind of financial security you want for yourself and your family.

 

 

“One-size-fits-all” won’t fit you here! The Del Monte Group team understands that everyone’s financial goals are unique. That’s why we always provide customized advice. No matter where you are in life, you can depend on our proven expertise to provide financial planning support for long-term success. Ready to get started? Schedule a meeting with Richard or Angela in our Alamo, CA based office today or we can meet via Zoom! >> You can select a date and time that works for you via our calendar, call us at 925.736.6410, or send an email to Info@APlaceOfPossibility.com. We can’t wait to help you!

 

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