October 1, 2011

One of the phrases you hear about the market is “Stocks will climb a wall of worry”.  The market took back the gains of the first part of the year and the DOW just closed down 241 points. While we never truly know the cause, I believe it to be Greece and our weakening economy. Here’s my assessment. Greece has had a well-known fiscal problem for two years. Almost half the population works for the government, and they elect whoever promises the most. They have been way over promised. Germany and France have been bailing them out with the understanding that they will raise taxes and cut benefits. In the two years no one has been laid off and virtually no benefits have been cut. The head of their rail system has been quoted as saying it would be “cheaper to put everyone in taxis”. So with money going out and not nearly enough coming in, they are broke. Germany and France will not bail them out forever.  You are most likely asking, why am I’m telling you this, what does this have to do with our markets? Good question. Well, it so happens that a lot of banks, mostly European, hold a lot of the sovereign debt of Greece. The bankers, feeling it’s a country, think it has to be safer than any public company debt and the interest rate is a lot higher than elsewhere. Their investments are large enough that a default would impair the capital of the banks and thus their ability to loan out money. One bank goes and it dominos and presto you have another Lehman Brothers type event. Its contagion flows until it hits Italy which is “too big to fail and too big to bail”. Europe then slows down into a recession or worse. Presto 20% of our exports come to a halt and we go into a double dip. I can assure you it will not happen as I’ve just described but that is what is spooking the market. Our growth is stagnating to a snail’s pace so any “shock” could push us back into a recession.

Great Willis, thanks for the happy news, what should we do? So let’s go thru our options. The first is to go to bonds. Interest rates are at historic lows and the only way to get a capital gain in a bond is if interest rates drops. Even if rates were to drop from the current overnight .25% there is virtually no upside. Inflation just ticked up to 3.8% so you can die of a thousand cuts. Stocks are another option. The valuations on stocks are getting attractive and we may be having a buying opportunity, and we just can’t see it. Also a lot of companies are paying more in dividends than bonds. Stocks lag when inflation hits but they are an excellent long-term hedge against inflation. High dividend stocks are looking cheap. EIA’s  (Equity Indexed Annuities) products can be excellent in a high interest rate environment, but are not now. The most I have looked at have a 2% maximum gain. I would not tie up my money for up to ten years for so little upside return regardless of their perceived safety. With Fixed and Variable annuities you have the same issues as stocks and bonds. I have found one company, Jackson National that has a 4.3% fixed interest for one year and then drops to 2.3% for the next 4 years. It may be an option for some. The high dividend stocks mentioned above may be good values now.  I could go on into commodities and other options. If and when we find something attractive we will be calling. In the meantime sit tight knowing that over the long haul our portfolios are positioned to solve our financial goals.

I would like to thank my friends and associates Bill Patton and Keith Fevurly for their reasoned and sound advice. They have added to the brain pool in ways that are difficult to explain and I am grateful for their input. Lastly, I thank you for the trust you place in us to help you manage your money.

Yours truly,

Willis

Willis Ashby, CFP®

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