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Avoid the Herd Mentality

Avoid the Herd Mentality

September 9, 2010 by Lesjak Planning

The U.S. economy remains almost comatose. …The current slump already ranks as the longest period of sustained weakness since the Great Depression. …Once-in-a-lifetime dislocations… will take years to work out. Among them: the job drought, the debt hangover, the defense-industry contraction, the banking collapse, the real estate depression, the health-care cost explosion and the runaway federal deficit.

That’s how Time magazine described the dismal state of the U.S. economy – in September of 1992.

On the eve of the signing of the Revenue Act of 1951, which lifted the top marginal rate to 91% from 84.4%, George B. Haynes of Evanston, Ill., wrote a letter to the editor of Barron’s excoriating the Truman administration. ‘I am a bear on America for at least the next 10 years,’ Haynes declared. ‘The financial ignorance on recklessness of Congress and the administration, the willingness to sacrifice the country to continue the Party in power, the enormous Federal debt, the high taxes, the readiness to give billions of taxpayers’ money to foreign countries can have, in my opinion, but one result, i.e., the worst collapse this country has ever experienced, though I do not know when’.

We revisit these past descriptions of the state of the U.S. economy because investors’ outlook today is just as pessimistic…which may be too extreme. The quotes above have a consistent theme with today’s environment where the country is going down the tubes. The demise has been averted in the past, will this be the time?

There is no doubt the economy is growing much slower than expected and job growth is well below what we would like it to be. But the fact is we are still seeing growth.

The last time interest rates were this low on Treasury bonds was 1955. If we think interest rates will rise over the next decade, the possibility of substantial capital losses on bonds is quite real. For example, if 10 year interest rates rise from the current 2.8% to 4%, which they did last spring, bondholders will suffer a capital loss of more than three times the current yield.

Long term investors need to be careful to not deviate from their plans and run with the herd to alleged safe havens. Many of those moving to bonds after the decline in 2008 missed the record setting rebound in equities in 2009. There have been numerous times in the past that called for patience in investing. As frustrating as it can be at times, sticking to a diversified plan gets results.

Other fixed income vehicles that offer “guarantees” against loss have substantial sales gains after market declines. Some bank CD’s offer higher rates to lock in longer periods. Annuities have their best sales years after declines by offering fixed rates with an additional “bonus” of 5%-10%. There is no free lunch and these are no exception. We have high quality no-load annuities available to us and rarely use them. See the attached annuity descriptions for greater detail and comments.

We have endured considerable tough times the past few years and the economy is limping along with a cloudy outlook by some, and the political environment is hostile to say the least. But we have been here before as the beginning quotes in this article attest. We are growing as an economy and substantial cash on the sidelines offers us future spending to come.

Throughout our history, time and again the general opinion and the movement of the masses prove to be wrong. We think that being too pessimistic at this time may just be a mistake.

 

In fact, corporate America seems to be quite strong and looking to bust out into a new growth phase.

Earnings continue to be good – this past quarter we have seen nearly 80% of companies meet or exceed their expectations. Corporate cash holdings are at a staggering $2.8 trillion dollars and growing. Productivity has actually increased for the first time ever in a recession. So why aren’t they hiring full time employees and investing all that cash into capital improvements?

Research we have done suggests that business is unwilling to commit resources for the long term while so much uncertainty looms in the near future. Reports show that hiring by the private sector is growing each month, and hiring of part time and temporary workers is quite strong. But to hire full time and commit to all the benefits, clarity needs to be brought to issues such as: let the Bush era tax cuts expire at year end or extend them; leave capital gains tax rates where they are or raise them; make permanent the current estate tax exemptions or let them revert back to 2000 rates ($1 million); will there be a climate tax; clarify health care reform’s effect on business. These are just a few of the issues that business’ need to know before they can plan their budgets and strategies for the future. From what we hear, the purse strings will stay pretty tight until some decisions are made.

The pessimistic outlook of investors has generated a spectacular move of assets in search of alleged safety. According to the Investment Company Institute, from January 2008 through June 2010, outflows from equity funds totaled $232 billion while bond funds have seen a massive inflow of $559 billion. And, this is continuing as corporate bond sales are expected to raise $125 billion this month as finance and utility companies look to take advantage of low borrowing costs. The last two times such a flight out of equities occurred was in 1979-1981 and 1972-1974. The Dow Jones Industrial Index was at 777 and 577 respectively. Today the index is over 10,000. We believe what is happening today is the flip side of what happened in 2000. Just as investors were too enthusiastic then about the growth prospects of the economy, investors today may be far too pessimistic.

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