When Markets Reset 3-27-2009

March 26, 2009 Edition, Volume III

Inside Signature Update

- A Market Cycle or Economic Reset?
- Housing Reports and Inventory Considerations

A Market Cycle or Economic Reset?

Over the last 18 months most investors have weighed the virtues of ‘bull’ and ‘bear’ markets with an eye toward the end of one and the beginning of another - in keeping with the market and economic cycles we’ve come to expect. Market analysts and economists, myself included, have compared current trends with those observed over the last 100 years or more, applied time-tested theorems, and have routinely suggested possible outcomes and directions. In many cases, we’ve offered opinions and forecasts of what ‘must surely come’. While our observations seem well founded and our forecasts may be technically sound, it has become increasingly difficult to envision future trends based on historical outcomes and contemporary guidance.

The recent rally in the equities markets, now in its third week and approaching a 25% increase in broad-market stock values, has been welcome to say the least but may not represent what many investors are hoping for. It likely is the precursor to a long-term ‘bull market’ run-up and predictably is emerging some six months or more before real, measurable economic growth, but it may not be the long awaited ‘bull’ market itself. We may need to see a retrenchment back towards 7,000 on the DOW before a sustainable rally gains strong footing; a ‘W’ shaped bottoming and rebound as is often the case.

With 1st Quarter 2009 earnings reports due out soon, a quick retracing of the recent increase could follow. Added to the earnings scenario is the possibility that a number of major banks, now posting meaningful profits, may very quickly repay their TARP loans to the US Treasury. If this occurs, then it will increase the de-leveraging of our economy and could slow the pace of a market recovery.

On the other hand, there are many respected market economists, who believe we’re seeing a ‘V’ shaped market recovery as opposed to the ‘W’ described previously. Brian Wesbury, Chief Economist for Chicago based First Trust, is unabashedly optimistic and appears confident that the recent rally is the start of a long ‘bull’ rally – he might be right. If 1st Quarter earnings reports are better than expected, or if the banks that are talking about repaying TARP funds are only doing so to send a much needed message to the US House and Senate, then it is possible that we may now be two or more weeks into the next ‘bull’ market. Only time will tell.

Over the last many months, what have appeared to be market bottoms in housing, debt, equities, and commodities have sometimes been resting points. In some cases, events which would normally be met with negative reactions have created upward momentum and vice versa. And too often, the most fundamentally sound principals have proven insufficient while dealing with current events and determining effective strategies. We expect some of this in any market, but the maelstrom of uncertainty and the shifting attitudes and expectations experienced in 2008 and 2009 to date have gained enough weight that they beg the question: Are we experiencing a market cycle or have we gone through an economic reset?

We all understand market cycles, or at least most of us suppose we do. Cycles often help create opportunity for some and uncover problems for others, within the framework of a set of expectations driven by experience and observation. But what happens when a fundamental shift occurs where attitudes and expectations change in such a way as to create a new market paradigm? Our economy and markets reset and, though this may be counter-intuitive, such resets can build great strength and offer unexpected opportunity.

We’ve seen several resets throughout our domestic history, often brought about by calamitous or opportunistic events such as the California Gold Rush, the Civil War, The Great Depression, World War II, the Civil Rights Movement, and the Internet Age in which we currently live. While these events may not all have been troublesome, they each represent water-shed moments on modern US history. Each time, attitudes and expectations have been inalterably changed and have set the stage for meaningful social and economic growth.

Recognizing our current condition as a ‘reset’ doesn’t mean that we can’t expect economic recovery and market rebounds in the coming months and years, but it does mean that the foundations of those gains may be different. For example, the credit crisis through which we’ve just passed has changed the way our business and consumer society views debt and leverage. As such, we should expect that borrowing will play less of a role in future economic expansion and economic growth at lower levels of leverage is more stable, less brittle, and offers a more solid foundation for future innovation.

We’ve spent the last nine months in the midst of a shift from an economy of net-spenders to one of net-savers, and we appear to be closing in on a sustainable net-savings rate of 2-4% (this figure does not include corporate retirement accounts or increases in homeowner equity). Likewise, our institutions of higher education are experiencing a surge in enrollment not seen since the end of the Vietnam War. At the same time, we appear to finally be willing to adjust our expectations regarding sustainable energy sources and to adopt ‘greener’ energy consumption and utilization practices. These very elements, more prudent spending and debt practices, increased levels of education, and greater energy-efficiency expectations, may be the foundation for more competitive domestic businesses and could support the innovation and technology needed to allow us to once again position American as the indisputable leader in global business.

Previously we’ve discussed the possible shape of the coming economic recovery; and while it’s too early to offer an opinion with any certainty, what we may be able to do is see the color of our long-term recovery – green. Green as in more energy efficient… green as in more profitable… green as in more responsible… and green as in more sustainable. I’m actually starting to like the color green.


Housing Reports and Inventory Considerations

Some portion of the recent improvement in the US stock market can be attributed to the recent reports of improved housing figures. Without wanting to take away from the real improvements the real estate market has made in the last month, we can’t expect that figures from January (historically the worst month of the year for housing) to February equate to a trend and signal that fiscal health has been restored to our troubled market – this would be a little like standing in front of a banner proclaiming ‘Mission Accomplished’. It’s just not that easy.

Here are some facts to consider:

- The recent housing sales figures, though better than January are still the second worst in recent
history – that also tells us a lot about January.

- A stable residential real estate market depends on an existing housing inventory of 5-6 months;
our current inventory level is more like 9.5 months.

- With over 1,000,000 excess homes in inventory it will likely take until 4th Quarter 2009 or 1st
Quarter 2010 to reduce inventory to stable levels.

CNBC’s Jim ‘Mad Man’ Cramer has long suggested that June 2009 will mark the bottom of the US housing market; and though we don’t always agree with Cramer or appreciate his theatrics, he appears to be pretty close on this one as real estate price stabilization could finally occur in the late 2nd Quarter 2009 to the mid 3rd Quarter. Recent residential loan applications reflect an ongoing mortgage boom due to historically low interest rates that continues to be dominated by the refinance market. Longer term, most mortgage specialists expect refinance opportunities to decrease dramatically while ongoing activity in the mortgage markets will be forced to depend on lower loan-to-value, new purchase loans on more reasonably priced homes.

Recovery Patterns and Inflation-Deflation Trends

March 18, 2009 Edition, Volume III

Inside Signature Update

- Recovery Shapes and Sizes
- The Ongoing Battle of Deflation vs. Inflation
- An Important Note Regarding ROTH IRA Conversions and Required Minimum Distributions (RMD)


Recovery Shapes and Sizes

There’s been significant conjecture in recent weeks over the size and shape of the coming pattern of economic recovery. Encouraged by an equity market rally of almost 14% on the DOW over the last six trading sessions, most investors are no longer speculating over whether or not there will be a meaningful recovery, and the discussion has shifted to when the recovery will begin, how long it will last, and what shape it might take. Recovery shapes are the stuff of legends and are about as accurately foretold as Bull Market highs and Bear Market lows, but with the proper perspective, may not be that difficult to ascertain.

In most cases market patterns are relatively predictable, however, but data will inevitably be presented to give market insiders the courage to suggest that ‘this time it will be different’. In truth things are rarely different, but for some reason even the most seasoned of investors, asset managers and traders want the emergent patterns of contemporary market cycles to provide different results than when the same patterns were presented in previous cycles.

Some have proffered why the coming recovery will be shallow and may take many years to regain lost market value, suggesting that there will be extended period during which we will have flat economic growth and market values. A sort of an elongated ‘U’ shape.

Others point towards possible Bear Market rallies (perhaps indicative of the recent market movement) that could follow our steep decline, then reverse course one or more times before actually presenting a real market recovery; something like a repeating ‘W’ with multiple internal slopes.

Even though the market declines of the last year have been sharper and more harmful than those seen in many decades, there are patterns that ought not to be ignored, which patterns may well tell us something of what comes next. There appears to be a few important and observable trends that have emerged and which tell us that we are most likely to see a ‘V’ shaped recovery pattern, though one in which the upward trend may be less steep than the downward decline. Those signs are 1) the steepness (or velocity) of the market decline, 2) the seemingly counter-intuitive market reaction to news (positive or negative, and 3) the slope of the treasury yield curve.

Few would argue that the recent market declines were anything other than swift and steep. Tens of trillions of dollars of market capitalization evaporated in just a few short months; sometimes at a pace of nearly a trillion dollars on any given day. We experienced record point movement on the DOW, and the VIX (volatility index) broke records on a regular basis.

Too many times, negative economic news was rewarded with temporary market gains while positive economic results garnered counter-intuitive market declines. The argument after these trading sessions invariably included commentary regarding the market having already been discounted for the bad news or having over-anticipated the good news. True perhaps, but virtually impossible to gauge.

The yield curve, which traditionally represents longer duration debt instruments attraction of higher yields and shorter term bonds, notes and bills provision of lower returns, reversed itself. For a time, longer debt maturities provided lower rates of return than did those of shorter duration. In eight out of the last ten recessions an inverted yield curve accurately foretold a coming recession and in hind sight, last summer’s inverted curve was an excellent barometer of the market that lay in front of us. Too many of us succumbed to the ‘this time is different’ attitude as we experienced market phenomenon never before presented, but in some respects it was the equivalent of not being able ‘to see the forest for the trees’. Alternately, a traditionally sloping yield curve reflecting greater reward for longer term investing is a relatively accurate indicator of market gains and over time, the steeper the upward slope of the curve, the steeper the upward movement of the market in the coming months. This time it will likely not be any different

This set of circumstances, which appears so obvious in retrospect, most often yields a ‘V’ shaped recovery. True, we may not have experienced a market with identical dynamics to the one in which we now operate, but the bigger picture has been seen before. It’s not unlike the ‘boy meets girl, boy loses girl, boy gets girl back’ story line of oft repeated Hollywood love stories – every time it’s told it’s just enough different to make you wonder what comes next, but inevitably romance comes next – because this time is not that different from the time before.


The Ongoing Battle of Deflation vs. Inflation

In recent months the economy has been haunted by concerns over a possible deflationary cycle in the value of goods and service, and ultimately labor. Decreasing energy and commodity costs, coupled with higher unemployment have heightened this concern and economists are closely watching the Producer Price Index (PPI), Consumer Price Index (CPI), and other manufacturing indexes for ongoing deflationary signs. Somewhat counter intuitive, is the sense that at the same time, consumers and others are leery of another round of inflation similar to what temporarily surfaced with last summer’s surge in energy prices.

Most economists agree that mild inflation is healthy, but deflation of any kind can be devastating. Last summer we repeatedly discounted long-term inflationary pressures as being unsustainable in the face of decreasing employment figures. This remains true today. However, the inverse is just as true; rising unemployment can fuel deflationary pressures, and this is a far more likely scenario; at least in the short-term.

The recent increase in the domestic money supply, as a result of stimulus packages and recovery efforts, will likely lead to longer-term inflationary pressures, rendering the markets in a pseudo manic-depressive mode as it pertains to inflation-deflation pressures. So… what comes next? The February PPI and CPI figures.

PPI data was released Tuesday and suggested a stabilization in the wholesale price of goods in our economy. The index increased 0.1%, led by a 1.3% rebound in energy prices. Core prices, which exclude food and energy goods, rose 0.2% for the month. CPI data was released early Wednesday and reflected a seasonally adjusted increase of .4% for February, or .2% higher than February 2008.

These moderate numbers are a welcome sight as they hint that prices may be stabilizing, not falling into a deflationary spiral that could extend and worsen the global recession. But elsewhere in the PPI and CPI reports, deflation lurked.

Prices of crude goods (mostly commodities) fell for the seventh straight month, down 4.5%. Prices of intermediate goods (which are partially processed goods) fell for the seventh straight month, down 0.9%. Prices of core intermediate goods fell 0.6% in February and are now down 0.1% in the past year, the first time they've been negative since 2002. As recently as last summer, core intermediate prices were rising at a 12% pace.

Over the past six months, farm product prices have fallen at a 35% annual rate. Chemical prices are falling at a 25% rate. Metals prices have fallen at a 38% rate, including an 80% annualized drop in copper scrap prices. Commodity prices are ruled by the forces of global supply and demand, so their path will be determined largely by how deep the global slump turns out to be and how quickly it turns. It takes more than dropping commodity prices to get persistent deflation in consumer prices. Labor costs need to fall as well. That hasn't happened yet, but as the unemployment rate inevitably rises, the pressure on workers to accept wage cuts will increase.

What may all of this portend for our economy? We expect deflationary pressures to loom through late 2010, along with higher than optimal unemployment figures in the 8% + range. In the interim, the domestic money supply will increase as stimulus and recovery efforts pour money into various sectors in the market, the stock market will likely stage a sustained rally in advance of real economic growth, perhaps with enough strength to close out 2009 at or above 9,000 points on the DOW, and the resulting inflationary pressures will counteract what otherwise might have become a troubling deflationary cycle. Regardless, and without economic foundation, the current administration’s temptation to increase income and capital gains taxes, coupled with the US Congress’s appetite for spending, is likely to prevail and may slow both market gains and economic growth, stretching a recovery out over several years before we recapture the losses experienced in the last 17 months.


An Important Note Regarding ROTH IRA Conversions and Required Minimum Distributions (RMD)

Many investors understand that if one holds a traditional IRA or a former employer 401(k) plan, these accounts may possibly be converted to a ROTH IRA and the investor may benefit from the different tax rules that govern these types of accounts. A Roth IRA includes after tax dollars which may be withdrawn free of federal income taxes for retired investors, whereas a Traditional IRA includes pre-tax investment dollars that may become taxable when withdrawn during retirement – both types are governed by rules of age, income and amount and may garner penalties if not handled properly.

A ROTH IRA conversion, or the conversion of a tax deferred retirement account into a ROTH IRA, may be attractive when one values the tax advantaged nature of this type of IRA over the tax-deferred structure of the Traditional IRA. The conversion comes at the cost of the investor having to declare the value of the converted IRA account value as taxable income for the year in which the conversion took place. With careful planning, this may yield great benefits; entered into hastily, such a conversion may compound an existing tax problem.

Many investors are looking at what may be lower retirement account values this year, in light of the market declines, and are choosing to perform a ROTH IRA conversion under the presumption that the tax bite for 2009 will be more than offset by the tax advantaged value of the investment account as it may regain value in the future. Not a bad idea, but one that deserves careful consideration before executing.

In 2010 the IRS will allow a ROTH conversion and at the same time offer the investor the opportunity to spread the resultant tax liability over two years, accepting payment in 2011 and 2012. As with all ROTH conversions, or any other type of IRA investing, there are income limits that dictate whom may or may not be eligible, but for some this will represent an opportunity that ought not to be ignored.

Also, a few months ago the IRS announced that the Required Minimum Distribution (RMD) will be suspended for 2009. The RMD, which affects retirement account investors over the age of 70 ½, forces many such investors to make taxable withdrawals from their accounts, regardless of whether or not they need the income. With the reduced market values of so many of these accounts the federal government is allowing for an RMD holiday for 2009, which some expect to continue into 2010. Stay tuned.


Signature Update is offered by Richard Haskell, Managing Director of Signature Wealth Management

The Process of Recovery 3-12-2009

Inside this edition of Signature Update

- Straight Talk From Industry Strategists
- Market Potpourri
- Inflection Points
- Yet Another Perfect Storm


Straight Talk From Industry Strategists

As one might imagine, during most weeks I have opportunities to participate in discussions with senior economists, chief investment officers, and market strategists across the country. This last week was no different, but the tone of some of these conversations represented an interesting shift in attitudes we haven’t seen for some time and I thought a few of their remarks might be meaningful here.

The first of these discussions was on conference call on Monday, March 2nd that included Linda Duessel, Federated Investors, Inc., Senior Vice President, Senior Portfolio Manager, and Equity Market Strategist. A week later, on Monday, March 9th, Bob Carey, Chief Investment Officer, First Trust Advisors, LP, presented at a luncheon in Salt Lake City. Though neither Duessel nor Carey are economists, they are each seasoned market strategists who have earned excellent reputations. Their firms manage tens of billions of dollars for some of the largest companies in the world and they have access to the best data and research available.

Neither Duessel nor Carey are noted optimists, but both were surprisingly upbeat. Duessel is one of the sharper minds in the investment management business and has a reputation for straight talk. Carey has guided First Trust’s investment operations for years and has helped the firm become the one of the top equity unit trust companies in the market. In the midst of a terrible week for the markets, both spoke optimistically about the direction of the markets over the coming year. When challenged, they each responded with facts and figures to support their conclusions, but deftly left room for the possibility that if certain events transpired in the coming months, then the markets would react contrary to their observations.

The bottom line for both Carey and Duessel is that we have been at or very near market bottoms and that there will be observable economic growth by the 4th quarter of 2009. They each expect the markets to begin sustainable rallies no less than three months in advance of increases in GDP and they see 2010 as a strong year for the markets. Carey notes that there is way too much information available in the markets today, but not nearly enough knowledge on the part of most decision makers. Like others in their field, each agree that it has been too late to sell for many months now, but perhaps not too late to reposition.

This week’s rally in the DOW certainly seems to support their positions.


Market Potpourri

Over the past several weeks, market sentiment had declined to -70, the lowest level in more than 20 years and lower than the negative benchmark -68 established in 1990 (on this scale zero suggests neither bullish nor bearish sentiment, less than zero is bearish and greater than zero is bullish). At the same time, the yield curve steepened (reflecting higher interest rates for long term borrowing and lower for short term) continuing a trend reversal of an inverted curve established in early 2008 (an inverted yield curve represents higher yields for shorter maturities and lower yields for longer maturities). Each of these indicators suggest a market rally in the coming months; the very earliest part of which may have been seen on Tuesday as the DOW climbed nearly 380 points. Other factors leading to Tuesday’s increase included unexpected earnings performance by Citigroup, supportive comments offered by Fed Chairman Ben Bernanke, and continued discussion over the ‘mark-to-market’ and ‘uptick rules’.

Thursday’s retail sales report also represented better-than-expected retail sales for February and an upward revision of January’s already positive results. This is yet more significant than many might suppose in that it not only bodes well for retailers, but signals a reversal in a troubling decrease in the velocity of money in our economy. Over the last several months the velocity of money, or the rate at which currency changes hands, had decreased to a rate of 5.5 versus a more typical rate of 7. When the rate at which money moves slows, it represents lower spending on the part of consumers and businesses, as well as decreased lending on the part of banks. In this case it also represented a shift from net-spending to net-savings in our society. The reversal of this trend is not only healthy for retailers, but suggests that consumers are prepared to lead the way out of the recession as they have done for nearly every sustained recession our economy has experienced in the last 100 years.

General Motors signaled that it is likely to file bankruptcy in the coming months, simply asserting to the public what had already been a foregone conclusion to the investment markets. Both GM and Ford have announced restructuring plans for their senior debt obligations and Ford has successfully renegotiated its labor contracts. These steps, taken without additional government intervention, are likely the most meaningful steps the US automakers have taken towards restoring fiscal health. Though we will likely see a very different GM emerge from bankruptcy, it is refreshing to see them taking such bold and necessary action on their own. What remains to be seen is whether they will file for a restructuring plan or an outright dissolution; either would be preferable to seeing them limp along under the weight of high interest debt and stifling labor contracts.

Credit market spreads widened further over the last week (the difference between treasury yields and those of lower rated corporate bonds of similar maturities), suggesting an expected increase in junk bond default rates. The increase in potential reward has been sufficient for many investors to step up and accept higher risk of increased potential default rates in return for the higher yields offered for BB and BBB rated bonds.

“Beware of the crowd at extremes” is an old investment adage implying that, when enough investors believe something is going to happen with regard to a particular investment, it is usually a good time to look in the other direction. Some recent examples might include:

· 1999 – “I’m moving all my money into technology stocks. Can’t you see technology is the wave of the future?”

· 2006 – “I’m putting all my money in real estate. You know, real estate investments have never gone down.”

· 2008 – “Oil stocks and oil futures are the only sure way to make money. We’ll never see oil below $75 per barrel again.”

2009 – “I’m going to invest all my portfolio in gold and cash. Can’t you see gold is going to $3,000 an ounce and stocks are going to zero?”



Inflection Points

We can look back to two pivotal weekends in September 2008 as inflection points for the market downturns we’ve experienced as market volatility reached all time highs and multi-hundred point movements became a daily occurrence. As Paulson, Bernanke, Bush and others were revealing their fears over the credit market crises, other elected officials and populist commentators repeated the rhetoric and consumers and business owners began to react by curtailing spending plans, designing layoffs, and reducing production. We may never be able to tell the ‘chicken’ from the ‘egg’ in this scenario, but one thing is certain: the bloody picture displayed before us of dire economic consequences served to make those consequences radically and swiftly worse than they may otherwise have become.

Afterwards the market began to climb back towards more realistic levels and eventually topped 9,000 on the DOW, but has since retreated by another 15-20%, in reaction to the current administration’s taxing and spending plans. While the Bush administration and Alan Greenspan may have been responsible for much of the DOW’s decline from its 14,000+ high, the Obama administration has certainly contributed to some 2,500 points of the recent drop in values.

We’re now looking towards another inflection point, the point at which the market will make its next significant turn. Just as we can look back to September 2008 as a turning point, we’ll also be able to look towards a point in the 3rd or 4th Quarters of 2009. When markets sour as rapidly as they did over the last year, we know that recoveries can be just as violent on the upside. Investors who have followed the market’s downward slope may find the ride up to be just as exaggerated. The palpable fears of the last six months may well give way to exuberance, only this time it will likely be more rational than it was when Greenspan made note of it some years ago. While we’re not suggesting that we’ll see a climb back to the 14,000 level in a similar time frame to that which we went from 14,000 to 6,500, this may take years, we do expect that the rally signaling the end of the bear market will be swift and steep.


Yet Another Perfect Storm

In the last 12 years we saw a ‘perfect storm’ develop in terms of economic policy errors. The Congress’s repeal of the Glass-Steagall act (the legislation that kept banks and investment firms separate), the SEC’s elimination of the ‘up-tick’ rule and virtually ignoring naked short selling violations, the Treasury’s implementation of ‘mark-to-market’ accounting, the Federal Reserve’s easing of monetary policy, deregulation efforts that ultimately allowed for the CDO, CDS (collateralized debt obligation and credit default swaps), and rampant speculation in the oil markets all culminated in the disasters we’ve seen in the last 18 months.

It took years for the storm to build and will take a few more for it to completely subside, but our economy will heal and rebuild just as do our cities and towns in the wake of other, more natural disasters. Some good first steps have been taken to this end, but the next step is likely to be an important change in ‘mark-to-market’ accounting.

While this process has clearly helped make the value of certain types of assets to be more transparent, it has also devastated the financial markets and capital ratios of lending institutions. Rather than simply eliminating these rules, we’d like to see them changed to retain the transparency of the value of assets on corporate balance sheets, thus effecting stock prices, but not force the regulatory agencies to restrict lending practices based on hard-to-value assets. This provides the proper incentive for financial institutions to make prudent investment banking decisions without crippling the rest of the economy by freezing the credit markets.

Over the next two weeks the SEC and the Treasury are likely to make changes in the ‘up-tick’ rule and ‘mark-to-market’ accounting standards. As they do so, the financial sector (banks, investment banking and brokerages) may experience significant increases in valuation and which may be followed by more realistic lending practices. Additionally, the economic recovery, or stimulus packages recently passed through the House and Senate may be given a substantial boost. All of this points to a strong 2nd half of 2009 and even stronger 2010 for the economy as a whole.

A Sobering Start to Spring

March 3, 2009 Edition
Volume VIII


Inside this edition of Signature Update

- A Sobering Start to Spring
- Still, there are positive notes that we ought not to ignore.


A Sobering Start to Spring

Last week’s declines in the major US market indices were troubling to say the least. The market ‘flirted’ with a bottom that had been set in November 2008, but by mid-week it became apparent that the critical support level would not hold. Monday’s decline stretched the equity market’s slide into the third consecutive month of the New Year and raised investor fears that there may be more to come. By the close, the market had experienced a virtual free-fall and the DOW closed at less than 6,765 – its lowest level in more than 12 years.

Analysis reflects that the market is severely discounting for even lower-than-expected 2009 corporate earnings. Investors are making a clear statement that they do not expect the government’s recovery efforts to provide any measurable benefit to the economy, and while this would be tragic, it would also be reflective of the growing frustration over the ineffective, even damaging, partisan rhetoric of many of our elected representatives and media fear mongers.

The truth is that the credit markets and the banking system continue to be under tremendous pressure and though literally trillions of dollars have been funneled into the system, little appears to be coming out in the form of loans through the extension of credit. The result is lower GDP, employment rates, real estate prices and equity market valuations. Even though the M1 and M2 money supply figures (indicators of the amount of money circulating within our economy) have exploded in recent months, the velocity of money (the rate at which money changes hands) continues to be at a near standstill. The financial services sector (banks, brokerage firms, etc.), a major contributor to US GDP and a significant US services export, has been decimated and share value declines of 80-90% are no longer the exception. Other stock values have suffered, but most other declines pale by comparison to the reductions seen by the more influential players in the financial services group.

Federal Reserve Chairman Bernanke, while recently testifying before Congress, accurately stated that the banking and credit markets must be stabilized before the economy can improve. He went on to discount the likelihood of any ‘nationalizing’ of US financial institutions, and repeated his position in similar testimony Tuesday morning by stating that he didn’t believe ‘nationalization’ was either warranted or necessary. Treasury Secretary Geithner has offered similar comments in various
public statements. Bernanke also commented on the government’s 76% and 36% equity stakes in AIG and Citigroup, suggested that if further capitalization is necessary for these institutions to resume normal credit operations, it will be provided, and affirmed that greater federal oversight will be provided both AIG and Citigroup in an effort to assure the operation (credit and investment decisions) of these institutions meets the government’s goals. Any way one looks at it, this represents ‘nationalization’ – like it or not – and, as can be observed by Citigroup and AIG’s stock values, free market forces clearly do not like it.

The unemployment rate currently rests at 7.6% and will almost certainly trend higher towards 9% - the Federal Reserve estimates unemployment at 8.8% by year end, declining through 2010 and 2011. GDP declines were revised to .3% and 6.2% for the 3rd and 4th Quarters of 2008, and are expected to continue with 1st and 2nd Quarter 2009 declines of 5.0% and 1.7% respectively before making 2nd half increases of 1.0% and 2.1%.

These markets offer the very definition of ‘financial pain’, but from pain comes growth. The question is when? The S&P closed at just over 700 points Monday, clearly a buying opportunity to many, but if the S&P falls below 600, then an S&P and DOW at 50% of today’s levels would not be unthinkable – horrifying, but possibly within reason.

Still, there are positive notes that we ought not to ignore.

The US dollar continues to strengthen and has gained 9% against the Euro, 7% versus the Japanese yen, and has edged higher against the British pound. Though this will maintain pressure on US exports it also signals that global investors continue to bet on the dollar; it remains the currency of choice around the globe. The domestic equities market fell dramatically in 2008, but still closed the year as one of the best performing of the global markets; and foreign economies anticipate that the US market, which led the way into the recession, will also lead the way out.

As recently as December 2008, over 50% of money managers across the country were pessimistic over the prospects of economic recovery by year-end 2009; today barely 6% expect the global economy to be worse off one year from now (source: Merrill Lynch).

Inflation, which surfaced as a major concern in mid-2008 has become a non-issue as the year closed with the lowest inflation rate since 1955. More concerning is a possible deflationary trend that most economists suggest as far more damaging than inflation. Those proponents of the ‘absolute value of money theory’ recognize that an increased money supply, coupled with higher currency ‘velocity’ creates inflation. Given the current state of the credit system, it will be some appreciable time period before currency ‘velocity’ is high enough to support any inflationary environment; even with the recent growth in M1 and M2.

It is difficult not to fear the types of markets we’ve experienced for the last 15 months. Though unemployment rates and GDP declines offer no comparison with the 1930’s, we’ve traced roughly 60% of the market decline seen in the depression. Is it possible for us to lapse from recession to depression? Certainly. Is it likely? No. I love the adage, ‘that which does not kill you only serves to make you stronger’, and these are times in which strength will ultimately be rewarded. Even Warren Buffet, whose Berkshire Hathaway shares have fallen from $151,000 to $75,700, and whose net worth has plummeted, proclaims this as a time in which the courageous may become wealthy. Thank goodness for that.

Signature Update is offered by RIchard Haskell, Sr.,

Managing Director, Signature Wealth Management