Archive for April 2008
Mr. Market and his sidekicks
Those of you who know us well, know that the Gold Medal Waters team would never attempt to forecast the future, nor would we try to predict the direction of the equity markets. To do so contradicts our philosophies and sets the wrong expectations.
Instead, we relish our work helping to create properly constructed portfolios that match our client’s needs (ie. your financial plan) and are goaled to reduce risk through diversification and through asset allocation.
However, recently Mr. Market and his media sidekicks – namely Mr. CNBC, Mr. CNN, Ms. Reuters, and few others – have had some idle time on their hands. Unfortunately, we have watched Mr. Market’s recent negativity become the focus of the media.
So, we figured that we better take a moment and address a few of the topics that have been on the tongues of some of these reporters (most of whom have a degree in Journalism and not Economics).
Let’s begin with the word they all love to say…Recession.
The word comes from the Latin language – recessio, from recessus.
In the English language, it could be used to describe many things – among them, thinning hair and clerics heading to the exit of a church – however, when it is framed in the context of Mr. Market and economics we have to look elsewhere for a definition…
According to The Economist magazine a recession is “a period of slow or negative economic growth, usually accompanied by rising unemployment.”[i]
The Dictionary of Economics has a similar definition. It claims a “recession is the lower phase of a business cycle, where most main macroeconomic indicators (GDP, national income, employment, consumer spending) are declining. Most economists define recession as the state of an economy in which the GDP value has been declining for at least two or three consecutive quarters.”[ii]
Both definitions point to a recession as a period of slower growth and most definitions of recessions hold that the GDP must be declining for at least two consecutive quarters.
Given these definitions, it follows that the only point when we can actually “proclaim” a recession is…after one has occurred. (And even if one is “discovered” it is only valid if you truly believe that GDP is an accurate measure our well-being and growth – some economists argue that GDP as a measurement itself is flawed).
Definitions aside, this raises two essential questions. First, if we don’t know whether or not we’re in a recession until after it has actually occurred, why is it that so many media outlets are shouting the word? And second, are any of them qualified to determine whether or not we are actually in recession?
My answers to these questions: 1. To sell newspapers/magazines. 2. Absolutely not.
If we are in fact in a recession, this is probably an appropriate point to discuss what to do during periods when the economy slows.
Paradoxically, our natural and rational reaction is most likely to become more cautious about spending. Yet, this only serves to make our collective situation worse.
Our behavior (or our reduction in spending) is a reaction to our expectations, and pretty soon we begin to get what we expect. If we all believe that the economy will get worse, then it most likely will. For example, a business owner’s decision to cut costs might end up costing you your job – a self-fulfilling prophecy, if you will, and quite a vicious cycle.
One of the first steps then, is to continue spending. And this is being encouraged – with incentives from Uncle Sam.
Another phrase being used in the media: Tax Rebates
When the government uncovers signs that the economy might be headed into difficult territory, they have the ability to employ one (or both) of their available tools: Fiscal Policy and Monetary policy.
Fiscal Policy uses the government’s ability to spend money and reduce taxes to get the wheels of the economy in motion. InvestorWords.com defines fiscal policy as “decisions by the President and Congress, usually relating to taxation and government spending, with the goals of full employment, price stability, and economic growth. By changing tax laws, the government can effectively modify the amount of disposable available to its taxpayers.”[iii]
We’ve already seen the government take action. On February 13, 2008, President Bush signed a $170 billion dollar stimulus plan aimed at spurring the economy. Among other things, this package included a major tax rebate to help encourage spending.
Another hot topic: Interest Rate Cuts
The government’s second tool, Monetary Policy, is like one of those highly caffeinated “power drinks” – it can jumpstart the economy with blazing speeds. The Chairman of the Federal Reserve, Mr. Bernanke, can enact this policy by raising or lowering short-term interest rates with simple phone call.
As the chart below shows, the Federal Reserve has cut interest rates 6 times in the last 7 months taking interest rates to their lowest levels since post-9/11. Lowering short-term interest rates makes it less expensive for consumers to purchase houses and other big-ticket items, again stirring up the economy.
So, what can we take away from all this?
Well, the structure has been put in place for the economy to make a resurgence 6 to 9 months from now, but it all will come down to how the “collective we” reacts with our wallets.
At Gold Medal Waters we adhere to our philosophy that one cannot consistently predict the future of the economy and capital markets. We can certainly observe that the behavior of the capital markets may follows similar economic stimuli, as it has in the past, but determining how the market will respond to these stimuli would be considered “a good guess” at best. In the meantime, it becomes crucial to keep your portfolio intact and diversified to capture any potential upside down the road.
As always, if the recent market volatility has caused you any sleepless nights or concern, then it may make sense for us to revisit your risk tolerance and portfolio allocation. Please know that we are here for you and are happy to help you at any time.
[i] Economist.com term Search, 2008
[ii] www.economyprofessor.com, 2008
[iii] fiscal policy definition, 2008
[iv] New York Fed, 2008
