REVISIONS AND REALITIES 8/19/2008

Last week I offered a more light-hearted discourse about middle-aged men and their Harley’s. I should admit here that I don’t have one; I’m more of a Corvette guy and enjoy driving my Mercedes, but I love that men and women my age have the financial where-with-all to drive the toys of their dreams. Today it’s time to get serious again.

The investment markets have long been understood to be markets of forecast rather than reflection. Today’s news has little bearing on today’s markets other than to influence the emotion and volatility of the DOW and S&P 500 for a few hours or days. The markets, analysts, traders, and forecasters recognize that what’s done is done, and it’s time to look forward 6-9 months into what’s likely to come. This is why, in the face of some recently reported, mixed economic data, the DOW is up from its mid-July low by almost 800 points.

At the same time that the DOW has staged a rally of over 7% in recent weeks, gold is down over 18%, oil is off over 22%, and the dollar has strengthened considerably – this is all great news. It’s also an indicator of our economy 6-9 months into the future, not our economy today, and there is a difference. Reported data tells us what our economy has done, the markets strive to forecast what it will do in the future. Much of the reason that the markets have been down so severely over the last 9 months is because of the slow down those markets were forecasting for our economy in the first half of 2008. The recent market rally would suggest that growth lies somewhere ahead of us in early to mid 2009.

Let’s look at some numbers released in the last few weeks while the markets have been showing strength and resiliency:

The CPI (consumer price index) rose .8% in July representing an uncomfortable, though unsustainable level of consumer inflation.

Retail sales were down .1% in July (inflation adjusted) suggesting consumers had less money to spend – the truth is that retail spending always dips in July and rebounds before school starts and as we slow down our outdoor recreation activities.

The US Department of Commerce reported 1.9% positive economic growth in 2^nd Quarter 2008, but revised 4^th Quarter 2007 to a decrease of .2% versus the earlier report of a .6% increase. Is it likely that 1^st and 2^nd Quarters 2008 will see similar revisions? Possibly so, but in economics, the past is always in the past.

The US Trade Deficit decreased to $56.8 billion in June, reflecting a stronger US dollar, but also suggesting a weaker US economy.

Non-farm productivity increased by 2.2% over the last year – not exactly robust, but better than the projected decrease.

The ISM (Institute of Supply Management) non-manufacturing index rose to 49.5 in July – anything over 50 suggests market expansion, under 50 suggests contraction. The import here is that the index rose to a level above the expected 48.8, the first such rise in months and in direct correlation to the June and July rise in durable goods orders.

Our economy has struggled, to be sure. Families have had to cut back or do without, and that’s not likely to change overnight. Real estate values, new home construction, and investment values will take many more months before we begin seeing any meaningful increases. But if the markets are accurate indicators of what the economy will look like 2-3 quarters out, and they always are, then right about the time we’re inaugurating a new president, we’ll also be enjoying renewed economic growth – regardless of who that new president may be or what party he represents.

FANNIE MAE AND FREDDIE MAC – REVISITED - AGAIN

Over the last few weeks we’ve seen and heard more about the bad news from Fannie Mae and Freddie Mac – in fact, the DOW’s precipitous decline a few weeks ago, and again today, have come largely on news of the losses these organizations had posted for 2^nd quarter 2008 and the possibility that getting the additional capital they’ll need to make an ongoing stream of mortgage loans may be more difficult than might otherwise be expected. But what’s the news here? Where’s the revealing story?

Hadn’t all the news, weeks earlier, regarding Fannie Mae and Freddie Mac already heralded terrible earnings for these two Government Sponsored Entities (GSE’s)? Of course it had, and the markets rebounded within days, but here’s the more concerning issue: As we hear from all but the most knowledgeable market watchers, business leaders, and economists regarding Fannie Mae and Freddie Mac, we continue to hear about how the US taxpayer has had to bail out both of these entities, when in truth there has been no bail out… none whatsoever. US Treasury Secretary, Henry Paulson, while vacationing at the 2008 Summer Olympics in Beijing, participated in a 45 minute interview with Tom Brokaw and once again set the record straight. He reminded Brokaw that the Federal Reserve and Treasury had indeed set up a credit facility that Fannie Mae and Freddie Mac could access in the event that they needed additional short-term capital, but asserted that neither organization had done so and affirmed that he didn’t expect that they would do so in the foreseeable future. He admitted that setting up this access to capital had much more to do with quieting concerns in the financial markets some weeks ago than it had to do with a real need by either GSE.

The misinformation concerning the activities and fates of these GSE’s and the market reactions to news of them is unfortunate. The media is partly to blame, of course, but so is the individual that repeats something he or she heard from someone who has little reason to actually know, but who might enjoy being perceived as knowledgeable.

Fortunately, volume in the major markets is light towards the end of summer as many active traders and market makers are vacationing, minimizing the impact of some of these less-than-rational market movements. As Wall Street gears up again, right about the time school starts, saner heads typically prevail and values are driven back to more rational levels. In the mean time, these dips translate into lower portfolio values, simply adding to the concern of individual investors.

The recent run on, and failure of, Indy Mac brought about a similar wave of concern that had little foundation, but certainly raised the blood pressure of many depositors in other, very healthy banks and credit unions. Such concerns were unwarranted by these federally insured institutions, but that didn’t keep their officers from having to work overtime to reassure depositors and avoid a possible run against their liquid assets. Now, weeks later, such concerns have taken a back seat to more important, or at least, more interesting news and events.

One of the most difficult things for individual investors to do is to keep focused on their all-important long-term goals and investment objectives, and to not be swayed by temporary or less meaningful trends. Such distractions bring about poor decision making and tend to help investors extend their losses rather than structure their portfolios to maximize future gains.