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MAKING CENTS OUT OF THE NEWS
Blog #03
(January 21st, 2010)
MANAGING EXPECTATIONS AND HERDING CATS
By Tom McAllister, CFP®
Expectations (reminiscent of those old saying about the difficulty of herding cats) tend to be difficult to manage. Nowhere is the challenge of expectation management more evident than in the investment arena. As we move deeper into 2010, a year in which the economy is expected to improve slowly, unemployment is expected to fall, corporate earnings expected to advance greatly, with stocks expected to move higher as a result, I believe this would be a good time to more closely examine all these expectations!
In fact, I expect the U.S. economy to grow this year, but at a rate of 3-4%, which is half the growth rate typical when emerging from recession. And, yes, my expectation is for corporate earnings to be up sharply in contrast to 2009, with the result that stocks will follow this upward movement. In anticipation of higher inflation in 2011 and beyond, investors can use stocks as an inflation-hedge.
Unemployment is a much more difficult issue. I hear two "voices": The administration and congressional Democrat leaders insist their stimulus bills are working, "saving millions of jobs which would otherwise be lost". By contrast, non-political observers see little evidence of this; in fact, only one third of the stimulus money has even been deployed, with the rest set to be spent this year and in the next. I see the stimulus improving things slightly this year, and contributing heavily to inflationary pressure in 2011. Truth be told, were the McAllister expectations to guide policy, remaining stimulus provisions would be cancelled!
Government stimulus programs simply have never proven effective. They did not work in the U.S. during the Great Depression, nor have they worked in Japan for the past 23 years, nor did they work for Great Britain in the 1970's. The stimulus "exercise" serves only to remove assets from one part of an economy (through taxes or borrowing) and to spend it elsewhere (on unemployment and other human benefits or even on infrastructure improvements that would have occurred eventually anyway).
My expectation for employment, therefore, is not a happy one. High unemployment is not going away any time soon. At best, we may find the rate down to 9% or so by election season. Even that reduction will be achieved, exactly as it was last December, from workers leaving the work force and dropping off the unemployment rolls, rather than from actual economic growth.
Traditionally, privately owned businesses in the U.S. have led in job creation during recoveries. That has not yet begun to happen this time around. Unfortunately, I do not expect business to be readily able to accomplish hiring increases, due to the administration's adopting programs directly detrimental to small business growth and innovation, with more such programs promised in the near future. Business owners are faced with tax increases, higher requirements for mandatory employee benefits, less flexibility, more regulation, more government bureaucracy, and reluctant bankers. Can business leaders stage a comeback? Yes, but not, in my expectation, until the heavy hand of Washington eases.
On another investment topic, gold, several readers have asked for my thoughts. Gold investing is heavily touted these days on cable TV and in newspaper and magazine business sections.
While my expectations may diverge from the popular view, I've always maintained that gold, along with other precious metals, diamonds, and gems are more attractive for psychological reasons than as investments. In my forty-eight year career as investment adviser, these "hard assets" have not performed sufficient to earn my enthusiasm going forward.
The ads for gold investments are very clever in picking the starting points for their comparisons. Much is made of the fact that gold has tripled in the past three years or so. As an advisor, I must point out that managing expectations indicates a more realistic time horizon. Gold is up only about fifty percent in the past thirty years (from a peak of $800/oz.), not nearly enough to keep up with inflation. Since the beginning of 1980, in fact, gold investment results have badly lagged not only those of stocks, but of U.S. Treasury bonds as well. It certainly bears mentioning that, during the economic meltdown of the fall of 2008, gold dropped 15% from $820 to $700 per ounce. It is difficult to defend the expectation that gold will serve as the haven from loss the ads would like us to expect!
In view of the inflation I see ahead, I continue to discourage holding or purchasing bonds of more than two years' maturity. The exception is U.S. Government TIPS, which adjust quarterly for inflation. Since these adjustments are taxable as they occur, such bonds are best held in non-taxable accounts, such as IRAs.
For income in taxable accounts, I continue to favor industrial preferred stocks, which yield 2-4% more than bonds from the same companies. As the economy and corporate earnings improve, the expectation is for the "spread" between preferred and common stocks to lessen. I expect yields to come down on new preferred stock offerings, which should result in capital gains on existing holdings of "preferred"s. Our investment managers have been working on some specific strategies for our clients in this area.
Investing is all about expectations, one might say. And, since managing one's own investment expectations, in many instances, proves an even more difficult task than the proverbial cat-herding effort, that's where the reasoned guidance of experienced investment professionals can be expected to provide true value!
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