Financial Markets - August 4, 2009

Here we go again making another comparison to The Great Depression. Only this time, it’s a positive comparison.

For the five months ending last Friday, the S&P 500 had its best performance streak since The Great Depression year of 1938, according to Reuters. During these five months, the S&P 500 index rallied 34%. Yet, despite this tremendous rise, losses between January and early March of this year limited the S&P’s year-to-date gain to 9.3%, according to data from Yahoo! Finance.

Several factors helped propel this rally including a normal bounce back from a deep correction, better than expected quarterly earnings, and “less bad” economic news. Rallies like this also tend to feed on themselves as trend followers jump on board and help push prices higher.
Interestingly, corporate insiders have been big sellers during this rally.

According to Vickers Weekly Insider Report as reported by MarketWatch, the ratio of insider selling to insider buying over the past few weeks was at its highest level since the fall of 2007 - right before the bear market began. Although not foolproof, this suggests corporate insiders are less sanguine about the future of this rally.

Corporate insiders notwithstanding, this has been a powerful rally. Only time will tell if it continues into the fall or rolls over into a new leg down. Either way, we’re doing our best to help you preserve capital and generate profits as appropriate.

ARE WE HEADING TOWARD INFLATION OR DEFLATION over the next few years? The answer to this question may have significant portfolio implications.

With the economy having just completed four consecutive quarters of negative GDP growth, it’s hard to imagine that inflation could be a potential problem - but it is. Thanks to the government’s massive monetary and fiscal stimulus, all this money sloshing through our economy has the potential to juice it so much that we end up with double-digit inflation and a weak dollar.

Deflation, on the other hand, is possible, too. With unemployment near double-digits, consumer spending subdued, banks being tightfisted, and our industrial complex operating way below capacity, we could end up in a vicious circle of declining prices that overwhelms the government’s stimulus efforts.

From a portfolio standpoint, here’s the rub. Investments that have historically performed well in an inflationary environment may not necessarily do well in a deflationary environment and vice versa.

So, what’s an investor to do?
Ben Bernanke, Chairman of the Federal Reserve, is on the record as saying the government, “…would take whatever means necessary to prevent significant deflation in the United States.” From a political standpoint, some inflation is preferable because it allows the government to pay back its debts with cheaper dollars. Given the government’s comments and the political benefit to inflation, it’s reasonable to conclude that if the government errors, they are more likely to error on the side of inflation rather than deflation.

However, from an investment standpoint, putting all your eggs in an inflation-based portfolio would be risky. A more prudent strategy may be to include some asset classes that could benefit from inflation and some that could benefit from deflation and then monitor those assets closely to see which scenario unfolds.
Successful investing is never easy and it is issues like the inflation/deflation question that are especially vexing. While you may find this issue boring, it excites us and is an example of what you have hired us to help you navigate. Please be assured that we are doing all we can to find the smoothest route possible through this potential white water issue.

Weekly Focus - Think About It

“And now let’s go hand in hand, not one before another.”

– William Shakespeare, The Comedy of Errors