To Buy or Not to Buy, That is the Question

February 16, 2009, With the stock market down 45% from its high in October of 2007, most investors are still suffering from the trauma of losing so much of their accumulated wealth.  They are scared and indeed uncertain about what the future holds for them.  President Obama is not helping much as he continues using the word catastrophy in some form when referring to the future of our economy.  He is making speeches about how bad everything is and saying that it could become a lot worse.  He refers to Wall Street generically as people who have acted irresponsibly.  This is true in a handful of cases but counterproductive if he wants to rebuild the financial structure of the country. This is hardly the basis for people to feel confident about their future.  He predicts horror if Congress doesn’t pass his (really Nancy Pelosi and Harry Reid’s) economic stimulus bill.  He continues to speak as if he is still on the campaign trail.  The President’s rhetoric suggests that he and his Administration want to move the country toward a greater role for government in our society, and one has to wonder if our market based economy will be subjugated to policies intended to create a more socialist type of capitalism.  If the role of government is seen by American Voters to properly have a major, perhaps primary, role that replaces personal responsibility, contract law and our security markets for the purpose of allocating capital among manufacturing and service industries, then we indeed are well down the road to some kind of socialism, perhaps best described as social capitalism. 

For the past century, our country has grown into the world’s largest and most productive economy in the world as a result of individual initiative with investors assuming economic risk for allocating their capital savings to ownership of businesses by the means of free markets.  Ownership benefits were realized by the individual risk taker.  Excesses in price were corrected by changes in market demand and supply that in some cases crushed the value of companies that were unreasonably priced.  Investors assuming the risk of ownership in a company with stratospheric appraisal sometimes saw the price of their stock in free fall as ”Mama Market” corrected the excesses built up by unreasonable demand for its shares.  As these distortions in value were adjusted by the forces of free demand or supply for the stock of a company, those who bought it thinking stocks that go up always continue to go up got hurt or at least saw the monies they committed to the position shrink, even in some cases, fall to zero.  In these cases over the past Century, these corrections were healthy albeit painful for those who experienced them.

But now we are in different circumstances.  The financial industry has imploded with many banks and investment companies facing bankruptcy or desperately in need of more capital to support their operating norm of high leverage given the collapse in market prices for the mortgage and derivitive assets that they hold.  With the requirement by GAAP to use “mark to market” accounting principles for assets that are difficult to price or don’t have a public market, investors in real estate during the period of rising market prices were able to increase the value of their stated assets based on the most recent sale of comparable properties thus allowing them to claim increases in net worth and borrow additional funds for further investment.  While this decision was dangerous and should not have been pursued, regulating agencies saw no reason to object and the stupidity it built and compounded.  This accounting process set the trap for the collapse of the private mortgage and investment banking industry.  Now after the bankruptcy of some of our largest investment, mortgage and commercial banks holding what has come to be called toxic assets (sub-prime mortgages and their derivitives), the door has been opened or maybe I should say the requirement is manifest for the Federal Government to take over the banking industry and to become the major source of funds for companies needing financing.  Of course the funds they use are taxpayer dollars and the necessity to burden the country with debt and repayment obligations will require more  tax revenue over the next several years and therefore will mandate an increase in tax rates.  So what do we do with our investment portfolio?

Even though it is probable that the U.S. and Global economies flounder along in part for the next year feeding upon The Economic Recovery Programs that the Congress has authorized, it is probable that we will begin to see at least a small improvement in our business activity or GDP by the end of this year.  Prudent investors should begin to analyze the investment opportunities that are out there for the long term.  One major area of opportunity I see for the next 5 years is health care.  Although this industry will be negatively impacted by the Administration’s effort to nationalize most of the nation’s delivery systems for health care services, some companies in this field will no doubt experience major growth as the baby boomer generation begins to experience a greater need for pharmaceuticals, and other health care items and services.  Companies like Johnson and Johnson, Stryker Corp, Walgreen, CVS and Longs Drug should see some eventual steady growth in their business.  Other companies like Jacobs Engineering, a company that will benefit from infrastructure spending, equipment, etc. should also do well.   In addition to this field, investors should begin to look at companies in the heavy construction business like Caterpillar as they should benefit from the Administration’s spending program for infrastructure.  The energy stocks are at fairly low multiples of normalized earnings and generate such large amounts of cash flow, they should be interesting investments at current depressed prices.  I believe that investors should have approximately 30% of their current assets invested in equity with the remaining monies invested in a mixture of cash and quality municipal bonds.  If the market prices of U.S Government notes and bonds begin to correct their excess price level, the tax exempt bonds of high quality issuers now yeilding 4-5+% should begin to appreciate somewhat to correct the current spread that is too great on a normalized basis.  The high probability of increased tax rates also makes municipal bonds look attractive.

While it is difficult to commit our cash to equity at this time, the opportunity to buy good cash rich companies at bargain prices suggests that we should make a token commitment at this time.  Even in a socialist capitalist economy there will be opportunities to make money.  The difference from the past periods is that the rising tide will not raise all ships.  For that reason, investments should be limited to a few of the most attractive companies and  large majority of investment capital held in fixed income securities, preferably tax free securities.

One Man’s Opinion,

Bud Brewer