Let History Be Your Guide

There's never been so much uncertainty in the stock market about the future of the global economy. Half think we can slog along with anemic growth, while the other half think we're headed back to recession.

A chart of the S&P 500 Index is looking like an electrocardiogram since the beginning of August, when serious concerns about European debt problems as well as our country's inability (read gridlock in D.C.) to deal with joblessness and lack of capital spending by firms. Oh, and there's a supercommittee of legislators expected to deliver a plan for massive (trillions) federal spending cuts by November's end.

So, when all is in doubt what is an investor to do? For my money, I'm looking back in history to a similar time of tremendous public doubt about government and the future of the financial system. The behavior of investors then is shaping up much like as it is playing out today.

Following the crash of 1932 (2009), stock rebounded sharply over the next few years 1933-1936 (2010-2011). Then there was another pull-back, followed by a slow and steady rise back. But stocks didn't recover to their pre-crash levels for 25 YEARS! Now with new computer-driven trading technology and supposedly smarter traders, I can see that time frame today condensed by more than half. But that still means we have 5-7 years before all the bad news shakes out of the market -- the deleveraging of the global economy is done.

So . . . I'm saying we're not likely to see S&P 1500 for quite a while. It's at 1154 now.

If you look at the chart above, the best point of entry back then was in late 1941 -- after Pearl Harbor when we declared war with Japan. WWII brought on a period of tremendous economic growth and prosperity for our country and investors profited greatly. We may need a similar extreme global event to kickstart our economy again.

I can't envision one yet. I'm still 50% market 50% mattress.

Going Global

Through gritted teeth in my best Dirty Harry voice:

"With the U.S. - the most powerful country on earth - dropping in global competitiveness, you have to ask yourself a question. Do you feel lucky today? Well . . . do ya PUNK!"

US Falls Down Competitive Ladder

I for one am looking for ways to hedge the decline of America and broaden my investment portfolio to incorporate a more global strategy. Most investors have the majority of their retirement savings pinned to the hopes of the homeland for fear of what the rest of the world might be hiding. It's a safe bet, sure enough. There's more transparency of information here, we have a stable government, monetary system and strong property rights.

On the downside however, we have a HUGE deficit, complicated tax code and massive legacy payouts due under social entitlement programs. The US dollar, once the bedrock for international trade and finance, has now come under question to remain the world's currency standard.

In the short-term, I'm extremely cautious with my domestic investments. President Obama has proposed some sensible solutions to get the economy rolling again. We would have been much better served, however, if he did so a year ago and not now when the chances of passage before the mid-term elections are desperate at best. Allowing the write off of investments by corporations and extending research and development tax breaks could, if passed, get the unemployment rate down and revive consumer confidence.

Think of the US like a blue chip stock. Sure you need it in your portfolio. But it's more likely to have enormous contingency issues - lawsuits against it, huge pension liabilities, etc. Growth and opportunities are better abroad.

How To Build A Global Investment Portfolio

I'm still a believer in keeping my cash in dollars with plenty still sitting on the sidelines. But my equity exposure will be by country and not by asset class (i.e. large cap, small cap) or industry (i.e. mining, consumer discretionary). Think of each country like a company and invest in those that are run the best and that offer the best value. For my money, the US is just not one of them.

On The Fulcrum of The Seesaw

I was wrong.

Second quarter earnings did exceed my expectations. I suppose companies were able to squeeze even more from overworked employees and suppliers. Sales, however, continue to look sluggish as evidenced by Wal-mart's disappointing results today. With the future so uncertain, companies will not be hiring, or spending much, any time soon. And the status quo will remain.

Here's two interesting statistics for you: Lottery sales are breaking records and Alcohol sales are breaking records

Put them together and call it the Sin Index. Doesn't make me too hopeful about the future. Probably you too if you haven't been adding any money to equity funds beyond dollar-cost averaging into your 401k plan.

So, what's going to give this market conviction? I predict the mid-term elections in November will bring a HUGE wakeup call to Congress. Long-term incumbents will be swept out like yesterday's garbage. Third-party political candidates will have a very strong showing. A stronger approach to attacking the unemployment problem and keeping the economy from sinking further will be developed. And the market should finish the year stronger. But what will happen until then is anybody's guess. It's as if we're on the fulcrum of the seesaw.

From a valuation perspective, the market is fairly priced from a historic P/E (price-to-earnings) Ratio perspective. But that is based on earnings estimates that are fairly rosy. So here's the rub . . . Either you think that company earnings - and from a broader perspective, the economy - will grow by double digits (11%) or more over the next year, in which case you're in; OR you think growth will remain slower, in which case you're out.

As for me, I see the seesaw tilting toward the slower growth scenario. Thus, my cash position remains quite robust (don't get me started on bonds - that's a market for fools right now). I'm betting on the market to fall another 10% during the third quarter (historically the most volatile - see Black Monday, The Great Crash) before I put more money to work. It 's a fool's game right now. And nobody knows the rules.

Is This The Quarter The Cracks Begin To Show?

Larry Kudlow has it right:

Business-Power Neglect

Stimulus hasn't created jobs. Businesses aren't hiring. Banks aren't lending, which has kept inflation low at the expense of business growth. Congress is gridlocked and awaiting November like tourists on the beaches of the Florida panhandle. And consumers are getting tired. Meanwhile, tax increases are looming next year. And state and local government workers are facing the cold reality that they too may join the unemployment line.

The only way out of this mess is to offer REAL incentives for businesses to hire and allow them to write off capital investments more quickly and take an axe to government spending as Reagan did in the 80s. Drastic action is needed now, but it won't be coming.

Bunker down for a volatile earnings season. There's certain to be some disappointments and cautious outlooks for the remainder of the year. The question is what degree this has been baked into the market. I'm waiting for earnings forecasts to come down again before investing more, which could take us to near 1000 on the S&P.

Markets Are Dropping, But Not For The Right Reason

The data I had expected is finally coming out:

Retailers Posting Disappointing Sales In April

Sovereign debt default fears throughout Europe may be driving the recent market "correction." But the real concern to the US economy should be that growth may once again stall and send us into another recession.

Let's look at the facts:
Government spending is drying up:

• No more homebuyer tax credits
• No more government purchasing of mortgages
• Unemployment benefits are expiring

Meanwhile, foreclosures remain high. Unemployment remains in double-digits, when accounting for unemployed and under-employed. Personal bankruptcies are on pace to exceed last year. And now, the consumer is beginning to realize that their own spending must be curtailed.

Since February, I've been warning about a slowdown in consumer spending, which is the primary driver of the US Gross Domestic Product (GDP). I still believe analysts haven't factored this into their predictions for current quarter corporate earnings. I expect earnings disappointments by mid-summer.

Time to stay defensive, with plenty of cash on hand and your equity account stocked with quality dividend paying stocks. My mutual fund choice for long-term holding remains AIM Diversified Dividend Fund, which I own.

Deal Shows Stocks Remain Undervalued

Comcast and General Electric have just agreed to a deal for a joint stake in media giant NBC Universal, which is currently a unit of GE. They value NBC at $30 billion.

For some investors like myself, this represents another strong signal that the stock market remains highly undervalued. The reason is that this is a real-time valuation that puts the network at almost 2 times annual sales ($30 billion/~$15 billion annual sales), while the average media network today is selling at just over 1 times sales.

Why are these companies valuing NBC at twice the market? Either because NBC is twice as valuable as the average media network, including stalwarts like Time Warner and Disney, (this I doubt) or that the overall market is undervalued.

One of the greatest mutual fund managers of all time, Bill Miller, uses current deals like this and asset valuations from recent bankruptcy filings as a basis for valuation of all his holdings. His record attests to this process.

As I explained in my earlier post, Time to Put Money to Work, there remains significant upside to this market based upon its current valuation. The bottom line is that the stock market's value is whatever investors are willing to pay for it. And today, for GE and Comcast, that is a lot more than what it costs.

Tactical Asset Allocation Explained

By Dan Lowrey, CFA
Manager Woodshed Investments

If you're like most investors, you have a 401k or retirement account filled with a diversified array of mutual funds, likely selected by your financial adviser. You may also have one or two Exchange Traded Funds (ETFs) or maybe some hot stocks you are hoping to generate some "mad money."

You no doubt have suffered major investment losses since last year as your financial adviser didn't have the foresight, or better yet the incentive, to get you into cash before the market tumbled.

Face facts. Investment advisers don't get fees when your accounts are in cash. They get paid commissions to recommend mutual funds and they also get a percentage of assets invested. When was the last time a financial adviser told you: "Hey, I think we should park your assets in a low-yielding money-market account for a while" ? Moreover, the mutual fund managers making the macroeconomic decisions with you money don't have your back either. They want only to match or beat the performance of an equity or bond index. Few are willing to take decisive action to protect assets or deviate from a stated investment strategy.

Tactical asset allocation (TAA) is the wave of the future. Your adviser will tell you that it's nothing more than market timing, which studies have proven time and again cannot be done. They'll tell you strategic asset allocation and sticking with a buy and hold strategy is best. I say TAA is being done and those investment shops with the best and brightest such as Goldman Sachs are doing it quite well ($3 billion in profit last quarter).

What's driving the demand for TAA?

1. Investor discontent with their mutual fund managers'
fees and performance.
2. Investor discontent with Wall Street profitability
at taxpayers' expense
3. The proliferation of ETFs

ETFs allow for a quick and cost-efficient vehicle for tactical asset allocation. Investors don't have to worry about short-term trading penalties associated with mutual funds. There are lower trading commissions (no loads, management fees, etc.) and lower tax implications. And there is a huge and liquid market for these products. A highly diversified portfolio can be created with just these ETFs:

1. S&P 500 SPY
2. US Investment Grade Bonds AGG
3. Treasury Inflation Protected Securities TIP
4. Gold Bullion GLD
5. Europe, Asia, Far East Index EFA
6. Emerging Market Index EEM

Optimally 4% SPY, 4% AGG, 1% EFA, 35% TIP, 37% GLD, 20% EEM

However, in periods of extreme financial distress even once uncorrelated assets show high correlation. Thus, bonds offered no protection from collapsing equity markets. Everything except cash and Treasuries plummeted. Having a portfolio, or at least a portion of your portfolio invested in ETFs and committed to a tactical asset allocation strategy is your best hope to swiftly react to quick changes in the market environment.

Ask your financial adviser about tactical asset allocation and they'll probably try and sell you another "product." Next . . . Entry and Exit Signs.

Time to Put Money to Work

By Dan Lowrey, CFA
Manager Woodshed Investments

I'm still bearish on analysts' estimates for corporate earnings next year. I believe they are too high. But even still, my estimate for corporate earnings next year ~ $67 for the S&P 500, based on current labor productivity, puts the forward operating P/E ratio for the index at 16, below the historical mean of 19.

With expected additional fiscal stimulus and a very gradual reversal in the unemployment rate, I'm forecasting the S&P to be around 1270 by early next year, almost 16% higher than today. My estimate is derived based upon the current civilian labor force, which today is about the same size as it was in 2004. Baring any unforseen shocks to the market, such as higher than expected unemployment, we should have operating earnings similar to that year, in my opinion.

Driving stocks further upwards, is most directly linked to accomodative monetary policies worldwide (cheap cost of funds with rates at almost zero here in the U.S.) Retail investors are still sitting on the sidelines. But the current pop in risky asset prices is being driven by investment banks and institutional managers. I forecast another strong quarter for investment banks as they seek to borrow for almost nothing and put this money to work in higher-performing equity and bond markets, especially those dominated in outperforming foreign currencies. Additionally, institutional investors (mutual funds) are chasing performance as the year draws to a close.

I'm recommending a 10%-15% over-weighting of the market account, with an emphasis on large cap equities and the technology sector in particular. (Note: This is a tactical asset allocation recommendation and short-term in nature. Strategic asset allocation decisions should be maintained in the long-run and apply to each individual's investment objectives and constraints. Consult your financial adviser for an appropriate strategic asset allocation.)