Wednesday, December 10, 2008

How Bad Can It Get?

This is reprinted with permission from Bridget Sullivan Mermel. This really helps us to keep perspective on the current economic times.

So I revisited an article that Bert Whitehead published recently. Originally written in 2001 after 9/11, the article addresses the often unacknowledged fears that the country as a whole is experiencing. Yes, even the upbeat folks like me and my clients share the fears. Bert has been in the business since the 1970s, and his home base is outside of Detroit, which I think both contribute to his broad perspective. So, after I reread his recent article, I decided to scrap what I planned, and send along what Bert has to say in full.

It's time to get our heads out from under the covers and face our worst fears. The financial crisis is world-wide, and the U.S. is actually better off than most countries. Iceland is bankrupt, and others (including Russia) are teetering. What happens when a crisis turns into a complete collapse?

Keep in mind that the worst possible outcomes are short-term. We'll take a look at those and
then look at the reality of the long-term.

Short-term Possibilities:

Scenario #1: Complete Financial Collapse.
Likelihood = 1% - 2%.

This could rival the Great Depression scenes we see in old movies with bread lines, tent towns of
homeless, etc. You're not able to use your credit cards, or write checks. In the worst case, where
faith in US dollar evaporates, bartering or using gold becomes the basis of commerce.

This extreme outcome could be produced in our current economy if one or two extremely destructive exogenous events occur in the next year or so. These traumatic events could be anything from a huge California earthquake, Al Qaeda usurping power in Saudi Arabia and
strangling the world's oil supply, or severe weather changes brought on by global warming, etc.

We have suggested that clients who are genuinely concerned about this worst-case scenario keep 1-2% of their portfolio in gold bullion.

Scenario #2: World-wide Deflation.
Likelihood = 5-20%.

Countries try to protect their economies using tariffs, which sets off retaliation in other
countries so global commerce dries up. Shortages become a way of life. Widespread
deprivation kindles violence, terrorism escalates, and a large scale war may loom.

Even in this case, the dollar would likely be the world's safe haven. Decreasing prices enable
those who have cash or U.S. Treasury bonds to survive and prosper.

Scenario #3: Recession Reaction.
Likelihood = 15-35%.

Panic sets off contraction in consumer spending which cascades through the economy. Classic
recession response, including lay-offs, unemployment of 10-15% in US, higher in other countries. The Euro may be destabilized by conflicts in monetary policies of member nations. Cutbacks in inventories closes factories; bankruptcies increase. Portfolio Panic Reaction leads many people to take foolish risks.

We work closely with clients to manage their endogenous risks, rebalance portfolios accordingly, make sure that adequate liquidity is maintained.

Scenario #4: Volatility Eruption.
Likelihood = 25-40%.

We are likely experiencing this phase now. Market prices in securities, commodities, housing, etc. take huge swings in waves of panic trading. Investors retreat to the sidelines, so trading volumes vacillate. This is how the market finds price balance, by testing the extremes. This could be a relatively short phase followed by onset of recession which could be severe, or gradually recover as markets begin to bounce back.

This is most difficult time for investors. In today's economies this scenario usually stirs
government intervention in the markets. This brings the danger that the money supply is
increased faster than productivity gains which can trigger spiraling inflation. Having a long-
term fixed rate mortgage is the best protection against inflation. Survival in this phase requires
clients to turn off the TV.

Scenario #5: Bounce Back.
Likelihood = 15- 35%.

If governments are successful in shoring up confidence in their economies, and adequate
liquidity is available in capital markets, stable commerce will again emerge. Housing prices
will drop to the point where entrepreneurs can buy up excess inventory and rent out homes
with a positive cash flow. New business formations provide most new employment
opportunities.

The stock market is likely to start rebounding a year or so before this phase kicks in. Clients
guided by Functional Asset Allocation, which we preach, will prosper in this stage since they
will not have sold off their stock holdings. Those who have continued dollar-cost-averaging, (e.g. through their 401-k's, etc.) will enjoy rapid accumulation in their portfolios.

Long-term Outlook:

Likelihood = 98-99%.

As this downturn is relatively severe, it may take another 2-3 years to substantially recover.
Then we will enjoy approximately 5.5 years (on average) of prosperity, which we will soon take
for granted. On the next downturn, we will be again surprised. We will go through though
another down-cycle as we have for the past century. Again we will think that 'it is different
this time.' A year or so into that downturn we will again anguish about "How Bad Can It
Get?" Then I will send out this article again, as I did seven years ago in Nov. 2001…

Sleep well tonight! Bert

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Tuesday, April 03, 2007

Back to School!

FOR THE WEEK BEGINNING MARCH 12, 2007

INSPIRATION FOR TODAY:
"A little learning is a dangerous thing."
~ Mark Twain

LESS IS LESS!
The beauty (and humor) of Twain's observation lies in its double-edged irony. On one level, it seems to suggest that a little learning makes us more formidable - more dangerous - than someone with no learning. Then again, it also suggests that the false sense of security that a little learning gives is, in itself, a dangerous thing.

In today's rapidly changing economy, just a little knowledge is indeed scary. The fact is we need education - early and often. According to economists, one of the best returns on an investment occurs when we spend for training and re-training ourselves. This investment in the future allows us to hone our skills, stay on top of changes in our profession, and adapt to changing technologies.

Take the recent trend in outsourcing. Many businesses have found it beneficial to send technology-related services to overseas operations in countries that have invested heavily in technology training. Like it or not, the companies save money, and the overseas employees doing the work are typically among the highest-paid in their communities. If we stop training ourselves, we lose out to those who appreciate the value of continuing education.

Perhaps most importantly for us, investing in ourselves also buys us some time for reflection and assessment. We can't find out where we're going if we can't figure out where we are. We need to commit the time and the resources to take advantage of continuing education opportunities. As retirement age rises and people work longer, we all want to feel good about our jobs. Expertise is often the edge we need. Quite simply, we're worth it.

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