SEPTEMBER 2009 NEWSLETTER

From early October 2008 until now, cash has been king of the investment world. For the past tumultuous year, some investors could crow about being geniuses of timing and moving to cash at the right time. Others could only lament the opportunity lost.  Now, however, the investment markets have rebounded from their March 2009 lows, and have gone 6% above those early October 2008 values. Those who were not blessed with the gift of perfect market timing have weathered the storm and must now look to the future and make their plan.

As you know, Dominion Wealth’s research leads us to believe that we are experiencing the eye of the storm. There are many signs of economic recovery in the U.S. and around the world. The question is: Can economies be primed and begin pumping prosperity when the well is actually dry? Demographic research is clear that humans and families go through very predictable cycles of development and therefore consumption. As Matt and I were discussing just yesterday, the kids move out and still have to eat, clothe and house themselves…as do Mom and Dad. So what changed in the process? Mom and Dad are not going to buy that next bigger home. They may go on little vacations, or even a big splurge on an Alaskan cruise, but these are miniscule expenditures compared to a buying a home. Houses can cost hundreds of thousands of dollars and are most often financed with an 80% (or less) mortgage. This bulge of consumption flows through other families as they live through normal predictable phases of life in other neighborhoods and at all socio-economic levels. Remember our economy is really driven by what we like to refer to as the “Homer Simpson” model. That is, a family of four earning approximately $52,000 per year.

We have seen what the bursting of the housing demand bubble can cause. Strange financing techniques developed by banks, investment bankers, shadow banks and quasi-government agencies centered on the concept that real estate markets will always go up. Well, imagine an economy and an investment market built on a similar concept. Personal consumption must always go up because it has done just that for the last 25 years! This is simply not the case.

At this point in time, the U.S. consumer has been given the responsibility to not only maintain that pace of consumption, but to increase it as well. The stock market demands continual growth to support upward momentum. Otherwise, how could a company’s stock be worth 12 to 100s times it annual profits (price to earnings ratios)? Are you willing to wait 12 years just to get your money back on your investment? More than likely you want it back much sooner than that, AND you want to have seen it grow in the during the time it was invested.  Historically, personal consumption makes up 60% of what the United States produces in a given year (gross domestic product or GDP). Today the consumer makes up close to 72% of GDP! The other 28% is purchased by corporations and governments and shipped overseas in the form of exports.  The real question becomes: Can a government (be it U.S., European or Asian) borrow to buy the huge amount of goods and services needed to fill the void caused by the decreasing demand of the ultimate consumer, you and me?  Our opinion is that total demand will shrink and therefore the economy will shrink as well. When the economy shrinks, investment markets will reflect the overall lower profits and decline in value. It is a vicious cycle that we have already seen play out in the housing market.

This leads us back to the future. We have begun an orderly exit from the investment markets and are protecting your portfolio from what may be a dramatic decrease in value. The risk, or really the guarantee, is that we do not time it perfectly. We also may be wrong entirely and the stock markets go straight back to the trajectory of the last 25 years.

Balancing the risk and reward of stable investments with steady interest or dividend earnings against the risk and reward of more aggressive stocks leads us to advise an overweighting toward stability. Ask yourself, would you rather have 3-6% earnings relatively assured or 15% growth with a risk of 50% loss?

The technical indicators read that the markets are showing signs of being dramatically overbought. The risk at this point is that the greater fool will not arrive with more cash to bid prices up even further (as is the case with most bubbles before they burst). So when the first fool tries to sell, it is at a lower price and each sale is made at a lower and lower price until the enthusiasm turns to selling versus buying. This is the time, in my opinion, to begin quietly leaving the party before the punchbowl is removed.

Until next month,

Your Advisors at Dominion Wealth