January 2010

What a year!

We have never seen anything like what we have been through. Last year ended well, although it didn’t start that way. By year end large company stocks were up 65% from their lows in March and up 23 percent for the year as a whole, both as measured by the S&P 500. Even corporate and municipal bonds had large gains. However, it was not an easy path. Despite the challenges in 2009 we have much to be thankful for as the year came to a close.

In early 2009 the US stock market began by continuing its steep drop from 2008. In the carnage of the bear market most asset classes dropped in value and there were few places to hide. Then in March, 2009 the US stock markets and prices for many other investments came roaring back producing the largest gains that most investors have probably seen.

The global financial meltdown we faced and government responses to it are unprecedented. Most of us had never been through anything like this. It was ok to be scared. As we entered 2009 we faced the real risk of entering a depression. A year later, as we enter 2010 the US economy seems to have started a recovery. The switch in investors’ expectations from depression to recovery can explain much of the markets’ moves.

For two years we have been studying and analyzing the unprecedented global events unfold. Our newsletters last year, starting with the January “Sea Change”, then April and August carried many observations which are still relevant. We won’t repeat the information here, but we can send you copies if you like, or you can access them on the Kreitler Financial web site ( They are still good reading.

Changes were global. At home President Obama changed how the US interacts with the global community as it started sharing decision making with other international players. The coordinated international monetary policy responses by many countries deserve commendation as their actions probably prevented the world from entering a depression. In most other areas the joint decision making appears to be a work in process. Not to be forgotten with all the global changes, is that a country’s super power status is dependent upon its wealth and although still probably the strongest financially in the world, the events of the last two years have dropped the US down a peg.

Another significant trend was the continued strength of emerging market countries, particularly China. For the first time in modern history China led the world out of recession, traditionally a US role. China is fast becoming the second largest economy and its influence is growing. China is experiencing no recession and its economy is growing strongly at around eight percent per year. The emerging markets together provided most of the world growth even before the downturn and this is likely to continue.

Europe and the US struggled to deal with the impacts of what is now popularly called the “The Great Recession.” Their responses were quite different with Europe being much more “socially conscious” as it managed production cuts and lowered labor requirements. It will be interesting to see how the recovery unfolds for both. Our Canadian neighbor is on better footing because the government never over stimulated the housing market and because of its orientation toward natural resource production.

Another change we have been tracking is the political shift to the left in the United States as the government takes on a larger role in the economy. The year end passage by the House and Senate of the Health Care legislation is the most obvious example. We expect to see governmental influence increase in virtually all business areas but particularly as Washington tackles financial regulatory reform.

At Kreitler Financial we have argued that with all the changes we are seeing, investment strategies need to change too. The pace and magnitude of current events is much larger than what we have previously experienced. Because of this, last year we made significant changes in portfolios. As the new world continues to evolve, which we expect, we will most likely continue to recommend more changes. We never have seen investing so challenging.

Looking into 2010

The range of scenarios that are feasible in 2010 is unusually broad. Some of the experts we pay attention to think, at least initially in 2010, there may be pleasant surprises from the overall feeling of pessimism. The economy may do better than expected, corporations may surprise with good earnings, and stock prices may continue their upward trend as the government holds interest rates to unusually low levels. Negative surprises are certainly possible and they can come from anywhere as evidenced by the recent problems with governments in Greece and Dubai. Other governments face problems. We have learned that problems in one part of the world can quickly spread globally. State and local governments are struggling and unpleasant surprises could come from their pension promises if they are found to be based on unrealistic investment assumptions. Governments’ efforts to back out the stimulus they have provided to stave off a depression seem to be particularly fraught with risk. Other scenarios range from deflation to inflation.

As a foundation to our investment management we will continue to acknowledge that the future is uncertain and that we don’t know what it will bring. However, we will still need to make investment decisions. Additionally, protecting capital is more important than the risk of reaching for large gains. Last year we introduced the concept of “Multi Scenario Investing” to deal with the much greater levels of uncertainty and we will use the concept in 2010 as we construct diversified portfolios and attempt to protect portfolios against the unexpected. There are of course no guarantees. Protecting real assets (so as to protect buying power), in particular against potential government devaluations, will be a priority. We recognize for many of our clients protecting capital is a higher priority than was thought several years ago.

Some specific investment themes we expect to follow include:

  1. Take a global view of investing and treat the US as an important region.
    • Don’t overly focus on the US markets which most investors and the press are prone to do.
  2. Try to protect buying power in a world in which governments have created immense quantities of debt and they may be tempted to pay it off with depreciated dollars.
    • Stocks, which represent ownership in real business, and gold investments which are an alternative to currencies, have the potential for maintaining wealth during periods of dollar depreciation or inflation.
    • At some point we would like to be able to re-enter the commercial real estate market that we exited in 2008 and early 2009.
  3. Benefit from possible continued growth in emerging markets.
    • These markets have had quite a run so we will cautiously increase positions. We expect them to be volatile.
  4. Maintain diversified positions in bonds to provide greater stability than stocks even though we expect interest rates to increase. This eventually helps bond owners but over the short term may result in losses.
    • In 2010 it will be virtually impossible to repeat the excellent bond performance we saw in 2009. Because bonds are in most investors’ portfolios, they should expect lower overall returns in 2010.
  5. Deal with very low interest rates the Federal Reserve has created.
    • Low interest rates are particularly problematic for those dependent on their portfolios for income. The low interest rates will encourage investors to move to riskier investments as they seek higher returns. We will advise caution because of the high risks involved.

Investors need to be wary with financial regulatory changes coming out of Washington. Politicians of both parties blame everyone but themselves for the current financial crisis and do not admit the role they played (For example, the federal government used a variety of programs to spur home ownership and drove up housing prices.) We expect to see new laws and regulations and these will likely create new problems. Creating effective rules and regulations to guide individual and company behavior is particularly challenging. The law of unintended consequences is triggered far too often.

Bob Kreitler
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