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MAKING CENTS OUT OF THE NEWS
Blog #30
(August 6th, 2009)
SLIGHTLY DOWN IS THE NEW UP FOR NOW
By Tom McAllister, CFP®
"Not yet great, but better than expected" was the diagnosis in the latest government report on our economy, which sank just 1% in the second quarter of 2009. Could it be that the longest recession since World War II is finally winding down? We at McAllister Financial think so, believing it's highly likely the economy will prove to have hit its bottom some time this past May. A more definitive picture may emerge in the months to come. Since the end of a recession is defined by two consecutive quarters of growth in Gross National Product, the earliest an official "bottom" can be recorded is the current quarter.
The stock market, meanwhile, has been anticipating a positive turn in the economy ever since early March. Contrary to my expectations of a slow summer consolidation, the market rose sharply (8.6%) in July. This upward movement was led by the technology-weighted NASDAQ; that indicator finished near 2000 levels.
For the sake of gaining perspective, the NASDAQ topped out at 5,000 in the year 2001, then dropped more than 80% to below 1,000 the following year. After a rally to the 2,000 level in December of 2003, NASDAQ dropped back again almost to the 1,000 level last year. This wild ride is not one that most of my clients would enjoy, and in fact we do very little investing in the NASDAQ.
The answer to the question, "Where do we go from here?" is hardly clear. A case might be made that a large part of the government stimulus program is no longer needed and that it should be cancelled. The high-and-going-higher unemployment numbers ensure that political pressures will make cancellation of stimuli unlikely. We will likely spend the stimulus billions, "pork" and all, risking overheating the economy going into next year.
Support for a healthcare overhaul is weakening in Congress, as Congressional Budget Office projections show enormous cost increases with little or no savings in sight. We simply cannot afford this level of spending at a time when government tax revenues have dropped 23% in the first five months of this year, as compared with 2008 numbers. What the administration would do well to implement immediately are any cost-cutting measures that are possible under the present healthcare system.
The already huge federal budget deficit has doubled this year, with little promise of a decline in 2010. Sooner or later, these budget deficits will lead to inflation. Meanwhile, long term interest rates have crept up to "normal" levels, and should continue to rise as the economy recovers. Shorter term rates, by contrast, remain historically low, with the Federal Reserve determined to keep them there until the economy is clearly out of danger.
The answer to "Where do we go from here?" may not yet be clear, but when it comes to "What do we do right now?" I recommend staying fully invested, adding to stock holdings as you can, trusting that "slightly down" will turn at least slightly up in the coming quarter.
For those already invested in the stock market to their personal limits, another way to fight the coming inflation would be investing in TIPS, Treasury Inflation Protected Securities. These U.S. government bonds pay interest semi-annually, at a current rate of approximately 2%.
The principal value of TIPS adjusts monthly to reflect inflation or deflation (rare as the latter might be). A higher principal value, in turn, raises interest payments. One negative is that these principal adjustments are income taxable in the year they occur. For this reason TIPS are better held in non-taxable accounts such as IRAs and other retirement accounts.
If our expectation of much higher inflation in coming years is realized, these U.S. government obligations offer reasonable returns with little to no principal risk.
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