Financial Fitness & Life Planning

 
May is a notoriously poor month in stock market history, and this was the worst May for the Dow Jones Industrial Average in 70 years. The treacherous month was driven largely by the European debt crisis. While the economy continues to show major improvement and corporate earnings have been stellar, the market paid virtually no attention to the good news and has rapidly become gripped by fears of a repeat of the financial crisis resulting in a double dip recession. I believe that this fear is not without merit. In my opinion sovereign debt failures are an even larger threat than that that was posed by large, systemically important financial institutions.
 
After fourteen months of nearly uninterrupted upward progress, the market was due for a correction. 
Now that it has occurred, my outlook is for a choppy, range-bound market. On the one hand the economy is recovering, high quality large cap valuations are reasonable, cash earns nothing, and the serious inflation threat also makes quality stocks a superior alternative to cash. Therefore, a major bear market that erases the gains of the last year appears unlikely. On the other hand the recovery is fragile considering the aforementioned sovereign debt crisis, housing is weak as the foreclosure crisis continues, unemployment remains high, broad market valuation metrics suggest overvaluation, most of the improvements have been brought about by artificial government intervention, future interest rate increases could hurt stock prices, and the stock market’s track record during inflationary periods has been quite weak as valuations shrink reflecting the lower margins that companies earn. Thus, new market highs do not appear likely to occur any time soon either.
 
After the violent so-called flash crash of May 6, in which the Dow experienced its worst intra-day point decline in history, I reevaluated my stance of being largely fully invested. It may now be appropriate to raise some cash and reduce one’s equity weighting, but this should only be done in a careful and opportunistic manner to avoid selling at what could potentially be a near-term bottom. I have come to believe that zero interest rates are almost a ploy to sucker investors into the market regardless of fundamentals and valuations. Earning nothing on cash, however, is superior to making poor investments. With an investor’s cash level raised, he or she becomes more nimble. This posture should serve an investor well in the range-bound market that I expect.
 
Michael H. Berlin, CFA, CPA, is the founder and portfolio manager of MHB Equity Partners, a value-oriented private investment partnership. He previously worked at Lehman Brothers, and before that at Ernst & Young. Mr. Berlin holds an MBA from Columbia and a BBA from Michigan.
 

The information included in this article is not intended to be used as a basis for making investment decisions nor should it be constructed as a recommendation to buy or sell any specific security. Consult your investment professional for additional information and guidance.
 
Michael can be contacted at mberlin@mhbpartners.com and at (631) 629-4928