The stock market’s behavior has become rather manic, going back and forth between extreme optimism and pessimism from one month to the next, which is to be expected in a range-bound market. The serious malaise of August was followed by the best September for the market since 1939, as fears of a double dip recession subsided in the wake of more evidence that the economy continues to improve. The recovery may be slow, uneven and halting, but nevertheless it is still growing and trying to climb out of its deep hole. The other growing consensus that helped lift the market was the belief that even if the economy does indeed falter, the Fed will be there to rescue it via even more quantitative easing.
I have problems with both bullish arguments. While the economy may in fact continue to recover for a long time to come, I am struck by the weakness of the recovery and I believe it to be extremely fragile and vulnerable. Any number of scenarios could easily knock it right back down, the most obvious of which is the sovereign debt situation which could lead to another severe global financial crisis. While at the moment investors act is if the problem has been contained, I do not believe that such containment is possible. Similarly, there is a state and municipal debt crisis brewing in the United States that could mirror Europe’s troubles. As for the Fed being able to put a floor on the market, I find investors’ estimation of the Fed’s power to do this to be somewhat exaggerated and even outright faulty.
While I have always advocated an approach to investing that is centered upon careful stock selection, a new theme of growing importance is protection against long-term dollar weakness. A combination of factors including artificially low interest rates, massive federal deficits, and our economy’s heavy reliance on government stimulus have come together to give me great conviction about this ultimate outcome. The biggest lessons that I learned from the credit crisis are that situations that are unsustainable eventually always break down, and that the market always wins in the fight against those trying to manipulate it. It may be advisable to search for investments that are designed specifically to protect Americans from our weakening currency.
Aside from outright hedges against inflation, high quality blue chip stocks also accomplish this to some degree and are priced at lower valuations than historically has been the case. Skilled and experienced investors might also want to add some trading positions as well. The purpose of them can be twofold – to invest in additional quality stocks that one finds attractive, but without running the risk of simply floating up and down with the market in these names, and also to enhance the paltry yield on cash, which might be elevated now due to worries and pessimism about both the economy and the stock market. Investors must be willing to underperform in a bull market to prevent against severe capital impairment in the case of another serious market collapse.
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 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.
Michael can be contacted at firstname.lastname@example.org and at (631) 629-4928.
Financial Fitness & Life Planning