Rebuilding your wealth: How to invest after the bear market

1. Rebuilding your wealth: How to invest after the bear market Jim Jubak MSN Money Money.MSN.COM jjubak@microsoft.com 6 February 2009

2. The bear: alive and well but maybe getting tired • Since the 10/9/2007 top through the close on 2/4/09, the Dow Industrial Average is down 44%, the S&P 500 is down 46%, and the NASDAQ Composite is down 46% • No where in the world to hide: Brazil down 51%, Australia 60%, China 58% (as measured by EWZ, EWA, FXI ETFs) • But stocks are still above their 11/20/08 low of 752 on the S&P 500 despite the worst January ever. (S&P 500 at 832 on 2/4/09)

3. Putting in a bottom? Possible but will depend on news • The low for this bear—so far--was put in on Nov. 20, 2008 at 752 on S&P 500 and 7552 on the Dow. • The trend still looks downward. A test of the November low seems likely. Holding above that level would be another sign that we’re forming a bottom. • Why won’t the November low hold? In the U.S. the financial crisis still not over. Economy likely to continue to slow through end of 2009. Good possibility of disappointment if stimulus doesn’t work and we require a second package. Bad bank/guarantee mix almost assures a bank balance sheet surprise. • Why won’t the November low hold? European Central Bank seems committed to recession. Asia economies lag U.S. in their slowing by about 6 months. IMF cut its growth forecast for Asia to 2.7% from 4.9% on 2/3/09. • Recession still getting worse in U.S.. Layoffs still increasing. Unemployment expected to peak at 8.5-10% in 2009 from 7.2% now. A stimulus package passed today would take 6 months to start to work. • Wall Street still too optimistic. S&P 500 operating earnings projected to grow by 19% in 2009. Some sectors seem way too optimistic: Consumer discretionary 39%.

4. 5 milestones to a turn in the markets and the economy • The U.S. economy moves clearly into a painful recession. We got halfway there with the fourth quarter 2008 data: GDP down 3.8%. Would have been lower except for inventory build. Will drop more in first and maybe second quarter as companies with inventory don’t reorder. • The U.S. dollar has to stop climbing. It’s climbing not because everybody thinks the U.S. economy is so great and U.S. financial markets are so sound, but on fear. • China’s economy has to stop slowing and growth there has to start climbing again. Economists say that growth in China will drop to 5.6% in the first half of 2009. That’s not bad—until you measure it against 11.6% in 2007. • A new Obama administration has to deliver on its plans to stimulate the economy, to mitigate the mortgage foreclosure crisis, and to put an end to exploding bank balance sheets. And we have to all get disappointed that the recession doesn’t go end immediately. • The comparisons have to get easier. Wall Street looks at earnings growth on year to year comparisons. That makes growth look lousy (or at least sets a very high bar for success) when the year-earlier quarter was great—because that makes the current quarter look slow or worse. Comparisons start to get easier in the third and fourth quarters of 2009.

5. The damage from the bear is huge and comes at a very bad time. • Ten lost years: On June 6, 1997 the S&P 500 closed at 858. It closed at 832 on Feb. 4, 2009. • Housing values more important for household wealth—price of a house according to Case-Shiller index down 25% from mid-2006 peak and down 19% year-to-year as of November. • Consumer debt up $8 trillion (137%) in last decade. Not dangerous as long as consumer real income growing. • Retirement marches nearer for the Boomers. In U.S. 26% of the population will be 60 or older by 2040. Was just 16% in 2000. • Not just a U.S. or developed world problem. In the developing world by 2025 the median age in South Korea, Taiwan, Thailand, Singapore, and Hong Kong will hit 40. The United States, in contrast, won't hit a median age of 39 until 2030. By 2020 China will have a population with 265 million 65-year olds.

6. What comes after the bear: The two consensus scenarios • Scenario 1: Bull/Bear/Bull. A replay of 1987 or 2000-2002. A damaging bear is followed by a raging bull that relatively quickly erases the losses of the bear. S&P 500 peaked in August 2000, hit its bear market low in October 2002 and then recovered to 2000 peak by May 2007 • Scenario 2: Secular bear. A replay of 1973-1975 bear which was followed a do-nothing market until 1982. Recovery from the bottom follows the pattern in Scenario 1 (recovery from 1974 low complete by 1976) but then market moved sideways until 1982.

7. What’s most likely? A combination of the two scenarios • Phase 1: After one more sickening lurch lower in the summer of 2009, in the last half of 2009, as the stock market anticipates the end of the economic recession in 2010, stocks rally with the “new bull” culminating in another commodity/financial/housing stock (whatever sectors down most, bounce most) lead blow off. • Phase 2: The blow off “new bull” runs out of steam as developed world hits its very low 1% to 2% growth speed limits as costs (higher interest rates, lower investment, higher taxes) of financial crisis hit. Investment in the developing economies “squeezed out” so only big surplus economies have capital to grow

8. Look closely: Can we already see the secular bear in place? • Stagnation in the S&P 500. S&P 500 sat at a peak of 1527 in March 2000 and then next peaked at 1565 in October 2007. That's a total gain of 2.5% peak to peak in roughly seven and a half years. Trough to trough looks roughly the same: The price at the close on Feb. 4, 2009 832 is only a 6.9% gain from the bottom in October 2002 at 778.

9. So what do you do? First, make lemonade • The bear has put yield on sale. Stock up. You can get 10% in a energy partnership, 10% in a high grade corporate, a way above-Treasury yield in a muni. • This is your chance to build future cash flow—think of it as buying cash flow and not as a yield. • Anticipate future big cash needs (college) and build yield ladders • Think of corporate bonds and preferred stocks as a way to buy the sectors that will rally while getting paid to wait for the rally. (Bonds of FCX, DHI, XTO; preferred of JPM, USB, CHK WRB; MLPs of ETP, EEP, OKS).

10. So what do you do? Second, buy scarcity in commodities • The recession is resulting in wholesale and still growing cancellation of capacity additions in oil production and refining, in mining, in farming, in electricity. Reversing these cancellations takes time, creating a huge capacity gap once recession is over • Buy agricultural commodity stocks now: POT, MOS, MON, YARIY, DE. Declines in supply running ahead of declines in demand. • Buy oil and natural gas, copper, molybdenum, iron in second half of 2009 (or whenever the market starts to anticipate an end to the recession.) Prices of these still falling—but rate of decline slowing—and stock piles still building in copper, for example, but falling in iron ore. Watch for price negotiations between iron miners and steel producers this spring. A cut of 25% or less is good news for the iron producers after two years of 70% or so annual increases. • $100 billion in energy projects canceled in past 12 months. Enhanced recovery spending being cut back. Result is that production decline rate of 3.4% annually in giant fields, and 10.4% annually in large fields is inching upwards.

11. So what do you do? Third, go overseas • Emerging markets are on sale • Emerging markets aren’t as risky as they were • Emerging markets provide more return for the risk • If you measure peak to peak or trough to trough gains on the MSCI Emerging Markets Index (EEM)--March 31, 2000 to Oct. 30, 2007--the gain on the emerging markets index is 168%. Trough to trough (or at least trough so far) the gain from the bottom on Sept. 28, 2001 to the Nov. 20, 2008 low close is 101%. • The comparable figures for the S&P 500 are peak to peak a 2.5% gain and trough to trough a 10% gain. • Volatility is higher but not that much higher. 60% loss for the MSCI Emerging Markets index versus 46% for the S&P 500 in the current bear. • Key emerging markets are natural resource suppliers (Canada, South Africa, Australia) and emerging growth markets (China and Brazil) with the cash to investment in their own growth. Remember the developed market capital squeeze out. (U.S. Treasury expected to do net borrowing of $1.5 to $2.5 trillion in 2009.)

12. So what do you do? Fourth, follow 9 more long-term trends • Global blue chips • Who will manage all that money? • 20 years of inflation • The end of cheap oil • The commodity crunch • Food is the new oil • Save the world; make a buck • Hidden tech stocks • The stability premium • Find more on each of these 10 in my new book (on sale now), The Jubak Picks, and on MSN Money.