Chris Lau - Seeking Alpha

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Wednesday, February 11, 2009

Notes from Frontline Weekly Newsletter

"$3 trillion! -- Senate, Fed, Treasury attack crisis
Tuesday February 10, 9:41 pm ET
By David Espo, AP Special Correspondent
Senate, Fed, Obama administration team up for unprecedented $3 trillion attack on recession"

3 Trillion dollars? This is even bigger than a recent post I had made, again from John Mauldin's newsletter. Please see here.

Below are points I have taken from John Mauldin's February 6, 2009 newsletter. Link is at the bottom for those who wish to read his complete newsletter.

  • The US stock market drops by an average of 43% in recessions. I saw no reason to be in the stock market, as there was just too much risk of a serious bear market. Further, since international markets now have close to a full correlation with the US markets, foreign stock indexes would be in trouble as well. I also said interest rates would be coming down and deflation would be a problem before we got through this recession.
  • (As an aside, there are a lot of very well-known perma-bearish analysts who called the recession, but were very bearish on the US dollar and positioned their clients in emerging-market stocks or other markets. Their clients have been mauled. Just because you get the economy call right doesn't necessarily mean you can call the right investment shots. Before you invest with a manager because he seems to have been right about something, look to see what his actual investment strategy has done. And that includes me or my partners.)
  • As I wrote last month, we will probably be in recession for the full calendar year 2009, with the same lengthy multi-year Muddle Through Economy I originally envisioned, albeit from a lower base. So, what does that look like? Let's look at a likely set of facts, in no particular order.
  1. Consumers are going to save more and spend less.
  2. The stimulus package is simply a pork-laden, misguided piece of legislation
  3. There is way too much spending on items that have very little current effect on the economy. ... Hopefully, they will not put into service the notion of a large "bad bank," but rather go ahead and put the zombie banks to sleep and help the healthy ones survive. But if US taxpayer money is involved, then shareholders should be wiped out first. If the rest of us have to lose on our stock investments, then bank investors should not be in a special protected class.
  4. As I have noted for almost two years, it will take until at least 2011 for the housing market in the US (and bubbles elsewhere, as in England and Spain, etc.) to stabilize. It will take several years for the creation of a new credit system to rationally replace the old "shadow banking system." This is why the recovery will take so long.
  5. The US government will run multi-trillion-dollar deficits for at least two years.
  6. The main driver in the economic world is deflation ... Commodities are likely to rise in price again, but not in the near future.
Mauldin's Conclusions:
  • We are going to some new lower level of GDP and consumer spending, maybe as much as 5% lower, which is a serious recession. And the "recovery" is going to be slow. We don't get back to 3% GDP growth in 2010.
  • [For] businesses which are dependent on the US consumer, their world is going to be smaller for a long time. We are in a period where the economy is going through what economists call rationalization. We are going to have to reduce the number of retail stores, coffee shops, automobile plants, fast food restaurants, car dealerships, etc., until we get to a level that makes rational sense for the size of the economy.
  • Now is still a time for absolute returns and active management. You want to arrive at the dawn of the next bull with as much of your assets as possible. How will we know when we are there? Because valuations will be low.
John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore

S&P 500 Earnings Forecast
There are many value investors who have been bottom fishing, using P/E as a guide for low valuation. The risk associated with this investment strategy is that if projected trailing earnings for the S&P 500 for 2009 falls to $15.90 ending June 30, the P/E would be 54.7. In short, if earnings don't improve in the summer, the stock market will continue to trade downwards in the summer.

My Analysis and Conclusions:
Even though one may make the right call, it is the action we take that is the only thing that matters for investing. It sounds to me that Mauldin was referring to Peter Schiff on the first two bullet points...what do you think?

My own assessment of the stock market's behavior has been on the right track. I believed the rally in December was too unconvincing to be sustainable. The most recent rally appears to be unconvincing as well. Fundamentally, the stock market was trading on very high hopes that the stimulus package would quickly fix the market's problem.

As illustrated by Mauldin, that fix will not be a quick one. The most appropriate investment will be a defensive one and an active one. It is not a good time to "buy and hold" but it is a time to build a watch list of companies that are inexpensive (low P/E), high cash flow, and low debt/equity. As illustrated in my kaChing account (it also has the attention of 150 followers), it would be prudent to continue to build on a cash position, but to still be invested.

We may have been scared off by the bear, but over-analyzing and over-watching the markets can leave a long term investor paralyzed, unable to step it up when it will matter. Let us all not be one of them.

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