Portfolio Reclamations Project

"We haven't the money, so we have to think"
-Lord Rutherford


Times change so very quickly. Fifteen months ago the US stock market was scaling new all-time peaks. Unemployment was comfortably under 5%. Consumer confidence was near six year highs. Goldman Sachs was paying its average employee in excess of $660,000 a year. Banks were, well, solvent. Home prices in my region (Seattle) were very close to their all-time highs. In short, life was good. People were feeling ebullient, at least when it came to the economy.

Fast forward to the present. The overall stock market is down almost 45%. Unemployment is over 7% with many (myself included) thinking it is headed towards 9%. Consumer confidence readings are at record lows (and they have been charted since before I was born!) Home prices have declined between 20-25% nationally, with some markets being savaged even more brutally. Hundreds of billions of dollars have been needed to prop up a banking system that would otherwise be insolvent. On Monday of last week alone, IBM, Texas Instruments, Pfizer, Sprint, Phillips, Home Depot, Caterpillar and ING announced layoffs totaling over 50,000. Here in Seattle, Boeing, Starbucks and (gasp!) Microsoft have all announced layoffs as well.

Even the poor suffering souls at Goldman have had to tighten their Italian belts and figure out a way to get by on average salaries that barely exceed $360,000. Oh, the horror! By the way, we the taxpayers paid for about 91% of those salaries thanks to the $10 billion bailout package the former investment bank received from Uncle Sam (find your happy place Mark, find your happy place)!!!

I do not bring up these sobering statistics to boost the sales of anti-depressants. Rather, given the regular influx of inquiries I receive from people about what in the world one should do in this catastrophic economic climate, I am breaking with my general policy to avoid providing specific investment advice. These are very dire times. Individuals in this country have collectively lost trillions of dollars, largely based upon the actions and recommendations by the very financial service professionals that either directly caused the present crisis, or failed to see it coming.

Let me provide a few provisos and one general observation before proceeding. First, each household has unique financial needs. Hence, one should not simply apply these thoughts without first determining what your unique financial circumstances are, and which of these investment ideas are appropriate for you and your household.

Second, as an investor I simply try to find assets that in my estimation have the best risk-reward profile. But there is no investment of which I am aware that has no risk in the long-term (including US Treasury bonds). And usually the investments that offer the greatest opportunity for reward carry some of the largest risks. Hence do not take any of these thoughts to be the equivalent of "sure things."

Third, I believe in long-term investing. This means I am using at least a ten-year horizon. I do not attempt to divine the direction of any asset class in the short-term. Indeed, I am probably the world's worst market timer. I am used to purchasing assets and seeing them decline in value for months, and in some instances years. So there is a real possibility that even if some of these ideas are successful in the long-term, one may see ongoing short-term losses.

As for the general observation - act defensively when it comes to financial matters. If given the opportunity, savings should be favored over spending (even more than would be the case in normal economic times). Debt reduction should be one's highest priority (particularly consumer and other high interest debt). The main reason for the economic crisis we are in is debt (see blogs below). There are those (whose glasses are generally roseate) who think that we will see the economy come roaring back to life sometime this year. I do not fall in that camp. The problems we face economically are systemic and chronic. While assets markets may rebound significantly in the short-term as news becomes "less bad" (again, I am not the person to ask), there is not any easy fix for our broken economy.

So, in light of all of that, the investments I like:

Treasury Inflation Protected Securities (TIPS). Never heard of them? Well do not feel bad, you are not alone. In essence, these are US Treasury bonds (considered by many to be the safest investment in the world) that pay two types of interest. The first is a base amount that is guaranteed to be paid every year. It is typically quite small, a handful of percentage points. Not very exciting or interesting so far. But the second is based upon what the Consumer Price Index is each year. So in effect, you receive back your money, plus the rate of inflation, AND the base interest rate. In times where preservation of capital is paramount, I can think of no better place to have money parked where it is both secure, and is assured of providing positive after-inflation returns (the only returns that should matter for any investor).

Gold. I know gold is neither considered a traditional asset class, nor is it recommended by the vast majority of investment professionals. It is after all, a "non-performing asset." It is not like investing in a business, where one can at least hope for/expect revenue growth. Nope. Gold just sits there. But that is sort of the point. You see gold will buy you roughly the same amount of food and other basic necessities as it did back in the times of Christ. There is not much gold. The entire world's supply of gold would occupy a cube 60 feet by 60 feet by 60 feet (granted it would weigh 160,000 tons). It is a storehouse of value. And in today's environment, where "Helicopter Ben" Bernanke (see below Looking Ahead to 2009) promises to litter the landscape with increasingly worthless dollar bills, having a tangible storehouse of value whose supply is not subject to any electronic printing presses is a nice thing. Furthermore, it is one of the few assets that is not someone else's liability. Other tangible assets potentially worth having some interests in are silver, platinum and oil, along with those companies that dig the stuff up.

High Quality Stocks. Now this is not a recommendation that I expect will yield the kind of returns to which people have grown accustomed. Again, I am pretty bearish on the future state of the US economy. And if the economy is not zipping along, it is hard for corporations, and their stock prices, to excel. Having said that, I think there is some upside, and not a ton of downside, in stocks that meet at least four of the following five criteria: 1) have little to no debt; 2) pay solid dividends; 3) are "wide moat" businesses (dominate an industry or area of business in such a way so as to make entry by competitors difficult, if not impossible); 4) trade at very cheap valuation multiples (such as price-to-earnings, price-to-book, price-to-cash flow); and 5) are not in the financial services industry. Frankly, there are not a lot of those companies around (although I understand one of them has some campus in Redmond).

As for investments to be avoided:

Residential Real Estate. I do not expect houses to be a good investment as an asset class for the rest of my life. Seriously. My favorite question I posed to housing market bulls during the heady earlier years of this decade was: For the 105 years prior to 1997, what was the average annual after-inflation returns for residential real estate in the US? I typically had guesses as low as 5%, and as high as 10%, or even 15%. The answer: -.5%. That is not a typo (forgive the others). Houses, as an investment, did not even keep pace with inflation for over a century. And when one thinks about it, this should not be surprising. Like gold, a home is a non-performing asset. Unlike gold, it actually falls into a state of disrepair over time. Roofs must be replaced, paint reapplied, pipes fixed, etc., etc. I always encourage people to view their home as a way of avoiding paying rent, not as an asset likely to intrinsically appreciate beyond the cost of living. Unlike stocks, I will be shocked if housing prices rebound in the near term. In addition to all the bad news regarding prices well known by one and all, the following should be a sobering fact for those expecting an imminent upturn in the housing market: according to the Census Bureau, a record 19 million homes were uninhabited at the end of 2008. Think we might have some more over-supply to work through?

Long-Term Treasury Bonds. I have already written about the basis for thinking these are terrible investments below (see Looking Ahead to 2009), so I will not rehash. Suffice it to say that since I wrote that blog, long-term treasury bonds have declined in excess of 15% in value. There should be considerable downside yet to come.

US Financial Institutions. This is the call that has the biggest chance of going awry. Indeed, the wise, hoary Warren Buffet is on the opposite side of the trade with me on this one. The argument for investing in these companies is two-fold: 1) they have been absolutely bludgeoned senseless, and have to be cheap at these levels; and 2) the big ones now have the express backing of the US Government, and are thus not going under. As a deep contrarian, I am quite sympathetic to the first point. And I do not rule out the possibility that there are well-run banks out there that have been taken to the woodshed and smacked silly by the market along with all the culpable/incompetent financial institutions. But as a whole, I still think the risks for the sector exceed the potential rewards. As a nation, we are still choking on debt. Banking bulls pin some of their hopes on the scuttlebutt concerning the creation of a US "Bad Bank" that would pool all or many of the toxic assets held by US banks and transfer the losses to . . . (any guesses?) the US taxpayer. Well, in addition to being yet another "Bad Idea" that has come from DC in its handling of this financial crisis, I do not think that will be enough. As long as the housing market languishes (and we know my thoughts on that), more impaired assets will find themselves on the balance sheets of many US banks. And while bondholders get bailed out when the US government takes over a failed bank, the stockholders generally do not.

There you have it. As things stand now, you could do a lot worse than simply squirreling money away in a low-interest bearing account. And again, I think being cautious and defensive at this time makes a great deal of sense. Nevertheless, there are always opportunities to judiciously put money to work.

In an effort to address the specific interests and concerns of those of you who follow these periodically penned meandering thoughts, please feel free to pass along any question, comments or suggestions.