WEEKLY ECONOMIC ANALYSIS: March 6th, 2009

Provided by TEAM Financial Services

“Depression is merely anger without enthusiasm.”
- Steven Wright

Items for Discussion

Given the market decline in the past two months and our lack of success in navigating it on an absolute basis, we thought it was an important time to try and place the current bear market in historical perspective. The bad news is that we are truly in un-chartered territory during the current bear market, as no other decline since 1900 has failed so miserably to even retrace a decent percentage of the initial crash. Prior to the current market environment, the post 1929 period was the only market decline of more than -40% that did not recover 100% of the crash within a couple of years. Even the crash of 1929 was retraced by over 50% prior to the descent into the low in 1932 – which was about 85% below the 1929 peak. 

When TEAM analyzed our entire body of research and looked at probable outcomes, we expected the market to retrace the crash of last fall at least into the 40%-50% area. Indeed, we placed the probability of such an occurrence as being quite high. However, as we often state, ours is a business of probability and not assurances and it is obvious at this point that our forecast was flat out wrong – the chicken bull ran into the slaughterhouse. 

To place the recent decline in historical perspective, we will list all of the major declines in the Dow Jones Industrial Average since 1900:

1901-1903 -46%
1906-1907 -48%
1916-1917 -40%
1919-1921 -46%
1929-1929 -49%
1937-1938 -50%
1973-1974 -46%
1987-1987 -41%
2000-2002 -40%
2007-2009 -54%

So as one can see, the current decline is the largest uninterrupted decline since 1900. The Dow did end up collapsing much further following the 50%+ rebound following the 1929 crash, and at this point we can not rule out a similar catastrophic move lower in the market during the current cycle. The break below the November low caused us to become more proactive in looking for ways to reduce client portfolio risks in the near term, and we already began that process this past week. Although we continue to like the long term prospects of our portfolio holdings, discipline and risk management have driven us to begin making some portfolio adjustments to reduce risk. 

Given this backdrop, the good news for TEAM clients is that portfolios remain relatively resilient despite our being wrong about the likelihood of the current melt down emerging without a major move higher preceding it first. Those clients who have been with TEAM for the duration of the bear market, since October 2007, remain close to break even over that period. Our long stated goal of maintaining client portfolios between plus/minus 5% of their bull market peak value (i.e. value at the end of October 2007) was intended for a major bear market. At present, we continue to deliver on that goal despite the current bear market being the worst on record in the US, according to most metrics we monitor.

Our inability to preserve the hard earned gains for 2008 at this time is certainly a disappointment. However, we remain focused on meeting our clients’ long term investment and financial planning objectives, which are typically measured in decades rather than weeks or months. As we look ahead now into un-chartered waters, global stock markets have once again become like extremely stretched rubber bands. 

Similar to October and November of last year, the level of fear and selling intensity has reached levels that have always exhausted eventually and resulted in the rubber band snapping back – even if it is to be temporary. Both selling exhaustions in October and November of last year were followed by market moves higher of 20%+. At this point, we expect any further panic driven market declines to be recouped very quickly once the selling exhausts – again even if the move higher is very short term and temporary in nature.

Market/Economic Climate

Investing in financial assets is counter intuitive to human nature and emotion – that is what makes it so hard and is likely why so many fail at the endeavor. The reality is that the likely future return on a quality investment GOES UP as its price comes down. The problem we all share is trying to determine when something is cheap enough to we worth stomaching the agony of watching it go from very cheap to extremely cheap prior to the eventual recovery. 

To use an extreme example, the Dow bottomed out in 1932 at about 41 after peaking around 380 in 1929. If one were to have bought the Dow when it was at 80 in early 1932, that would likely have felt like a pretty stupid move later in the year when it hit 41. However, a longer time horizon was more enjoyable, as less than 5 years later the Dow reached over 190 and it has not revisited the 80 level again. The 80 price level surely reflected excellent long term value in early 1932, but it took quite some time and agony to receive the benefits of being an investor.

After being very bearish for what seems like forever, TEAM is finally beginning to assume a more sanguine long term outlook. The key phrase here is “long term”. There is no question that the problems facing our country and economy are profound and perhaps even worse than those faced post 1929 – something we argued as far back as 2004. While we believe the US and much of Europe is probably facing many years of economic hardship, much more than ½ the world’s population has not been binging on credit card and mortgage debt over the past 20 years and we expect the growth in much of these “emerging markets” to provide widespread opportunities for investors. 

The same forecasting methods that allowed us to predict the very poor US stock market returns over the past 7-10 years is now forecasting that the potential returns to investors in emerging market could be approaching 15%-20% per year over the 7-10 years. While the past 2 years have reinforced that anything can happen, TEAM believes that the time to be ultra conservative was when the Dow was at 14,000 – not 6,000. As asset prices continue their decline, TEAM’s goal is to begin accumulating what we believe are extremely high quality assets at distressed prices that are highly likely to provide significant long term returns to our clients. We are not oblivious to the short or intermediate term and continue to do our best to minimize downside risks when we can. At this point, we are looking to shift closer to a neutral investment posture until we see tangible signs of market stabilization.

Weekly Economic Analysis newsletters are provided by TEAM Financial, and are written by TEAM's Chief Investment Officer, James L. Dailey. Visit TEAM's website if you want to receive weekly economic updates right in your inbox - Click here.