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Nervous? That’s Healthy!

Stock Market News

April 2001

Nervous? That’s Healthy!

I'm sure no one has to tell you that the current financial climate is volatile and the future is uncertain. In fact, the only consensus among the experts about this country’s economy is that the future is unpredictable. In times like these, the worst possible attitude is complacency. So if you’re nervous, this is a good thing. It is a good start. The task though, and the point of this article, is to move from anxiety to a level of confidence that we are reasonably well prepared for whatever the current economic turbulence brings. But what do we do? What are our guidelines for investing? Do we need to take measures to protect our long-term investments? What are the possibilities for the future? In the brief time afforded us by this article, we will provide you with a few suggestions for managing well in an uncertain economy. From our perspective, the immediate financial future will fall into one of three general categories: not so bad, bad, or tough times.

Not So Bad means a short-lived recession. The market undergoes an adjustment, but credit remains fairly stable and deflation is mild. This is what everyone is hoping for.

Bad is a combination of inflation and stagnation called “stagflation.” This is simply stagnation in the economy accompanied by a rise in prices. In this scenario, assets drop, unemployment rises and the budget expands while tax revenues fall.

Tough Times would be the collapse of the US dollar. The dollar is the world’s reserve currency and if confidence in the strength of the dollar erodes, this could trigger the collapse of financial markets and our economy could go into a depression. The result is hyperinflation.

Here the real difference between the three scenarios painted above is the degree of strength of the dollar. If the strength of the dollar holds, then our difficulties will likely be less severe and shorter lived. If the dollar collapses, well, we’re in for tough times. Whatever the outcome, we have some suggestions that are likely to minimize the impact of an economic downturn, regardless of its severity.

Stay Calm: One good way of whittling your expectations down to size is to take a sober inventory of your assets, their liquidity, your credit and other such factors so you can get an accurate picture of where you are financially. If you are heavily invested in the market, how much of your “assets” are leveraged? Do you have your investments hedged? Are you buying into reports of “The Miracle Economy “ that, in reality, only serve those touting it? What we are collectively recovering from is a time of unprecedented growth. But upon examination, it has been fueled by the Fed bloating the money supply and expanding credit and by the enormous hype over technology.

Our money supply has grown 60% since 1995 by $2.6 trillion. And the stock market (as measured by the S&P 500) has grown 190% (873 points). Total credit creation has increased by a whopping 54% ($9.3 trillion) to $26.5 trillion. This scenario can easily create an illusion of prosperity. But a careful look reveals a house of cards.

Observe Indicators Carefully: Keep an eye on the bell-wether indicators of the economy. We have listed a few of the more prominent ones.

Remember we talked about the strength of the dollar playing a central role in all this? Well, the single most important influence on the dollar is the consumer. Watch for lowered levels of consumer confidence, a rising savings rate and falling retail sales as indicators that the consumer is going into hibernation. This is a widely accepted indicator of a coming recession.

In the area of business, look for similar events such as rising inventories, decreasing levels of production, and declining profits. Capital investment by the business sector is another prime indicator of the health of the economy. If profits decline, then capital spending will be cut back and this will further weaken the economy.

In the financial sector, monitor the response of the stock market to the rate cuts by the Fed. If the Fed lowers the interest rate and the market does not move to a new high, this is a strong indicator that a bear market is here to stay for a while. Other events to watch for are rising bankruptcies, tighter lending policies by banks and widening credit card spreads. These are all signs of tightening up on credit which will in turn decrease the amount of capital available for business and thus limit growth in earnings.

Get Ready For Change: Be prepared to change your financial strategies should the economic environment change drastically. Review your financial picture. Project, based on current earnings and projected earnings, where you will be by the end of the year. Keep one eye on your personal financial picture and the other on the financial health of the economy. Develop long-term financial plans, ones that have stood the test of time and the economic fluctuations of the past. In one word: Strategize.

One such strategy we suggest you consider is investing in gold coins. The value of gold coins varies inversely to the prices of many other assets such as stocks, bonds and the US dollar. Thus it makes an ideal hedge in uncertain times, not to mention that the price of gold is now at a 20-year low.

Another strategy to consider is good for any market condition, though especially valuable in a wobbly economy: Get out of debt. It’s only paper money. Liquidate your margin accounts, reduce your overhead and/or mortgage payments. Debt is dangerous at any time. It is the old maid card. Don’t get caught with it in your hand.

Put more money into savings and liquidate what you can. Liquidity provides flexibility. Should you need to maneuver in response to changes in the economy, having cash on hand can save you in a pinch. Being stuck with a once-very-expensive-piece-of-property will do you no good should you need some ready cash. Cash will also allow you to take advantage of the opportunities that abound in a down economy.

Parting Thoughts: Let us remember that the health of the dollar, as a worldwide economic standard, affects not only the US economy, but also the economies of foreign markets. The US is the single largest consumer of the world’s surplus goods. Should US consumer spending decrease, imports will slow, affecting the health of the foreign markets that produce the goods. This could have a domino effect on the global economy. Monitoring the health of imports and the countries that produce them can alert you to immanent changes in the US economy, especially if that is coupled with a drop in US consumer activity.

We hope this article will inspire you to seek further expert advice, tailored to your specific needs. We believe that sound decision making is not possible without the proper data. So, armed with enough of the right kind of information, you can create a margin of safety for yourself in these uncertain times. Give us a call. We’d be glad to help. That’s what we’re here for.

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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