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This Is How It Is

By: Ted Allrich
Posted: 10/25/2011 4:58:00 PM

Times are tough.  There is no easy solution for making them better.  No one politician can come in and make our problems go away just because he/she was just elected.  We tried that with the President almost 3 years ago, and just look where we are now.  (I know, he inherited so much of it, but still, there has been no real progress in mitigating the economic malaise.)  Unemployment stays stubbornly high.  Houses aren't being bought.  Nothing will change these two important sectors of the economy, except time and a plan.

The most important part of that remedy is time.  Time has a way of healing all wounds, even economic ones.  That's because, left alone, the economy will rectify itself.  The homeowners that couldn't afford a home will lose theirs, and people who can afford to own one will buy one.  Businesses will cut their employment levels to the minimum until demand increases and requires more people to produce what a business makes.  Supply and demand.  Elementary, of course.  But it needs to be repeated: when you mess with market forces by imposing political "fixes" you usually end up with more mess than when you start.

Cruel?  Perhaps.  But history shows over and over again the cyclicality of economies.  There is boom (see the 90's).  And there is bust (see the last decade and this one).  There was a pronounced version in the 20's (boom) and 30's (bust to the max).  Go back further in other countries (see Germany in particular in the 30's for the bust part or most of the world in the early 40's when the World War was going on).  Up and down.  High and low.  It's how economies work. Because economies reflect the human psyche.

Here's how that works.  When times are good, the natural inclination is to believe they will stay good, most likely forever.  But they don't.  All booms eventually bust.  They have to because it takes more and more of everything to make booms increase.  There isn't more and more of everything.  There are finite amounts, whether it's money or water or gold or dirt or Cadillacs or anything you want to name.  That's forgotten as we humans enjoy resurgences in the economy.  Money flows more freely.  More things are bought because humans like things.  Things make us feel better, if only for a moment.  We like to feel better.

Then one day, we wake up to find that the boom is over.  Just like that.  Housing prices (which theoretically could never go down) go down.  Stocks, expecting the worst and discounting news 6 to 9 months on the horizon, go down, dramatically.  Then some more.  Jobs are lost.  Then more houses get sold at lower prices, and housing goes lower.  The economy stops growing.  Discounting the future, stocks go even lower, until March of 2009, when they hit a bottom, realizing that if they keep going, they will be at zero.  And no one believes, at least most don't, that stocks are worth zero.  Some do and buy gold.  They are rewarded.

So here we sit.  No longer at the lows of the market but well, well below the highs which may not be seen again for a decade or two (the Nasdaq traded above 5000 in its best days....or were those the worst since valuations were beyond explanation for many companies?) (Remember when dot coms were valued on the number of eyeballs that visited a site....with the belief that somehow, someway, those eyeballs could be turned into buying consumers....turns out that was wrong....way wrong)  What can investors do in this malaise with a forecast that doesn't look any brighter?

First, think only defense, not offense.  Sure, there will be days that see stocks spike but fight it with every fibre not to buy on those days, thinking that it's the beginning of a rally.  It isn't.  Only when housing and jobs show signs of real, sustained growth can you start to believe a rally of any substance can occur.  And don't believe one politician can make a real difference.  The rhetoric sounds nice, but the reality is that all laws require a consensus from the House and Senate.  That's the way the system works.  So don't think the next president will ride into the White House on a white horse and slay the dragon of recession.  Won't happen, no matter how likable, smart, savvy, wise, popular he/she is.

So stay defensive.  That means buying stocks with large capital bases, ones like GE, IBM, Intel (INTC),  Apple (AAPL), Google (GOOG), Exxon Mobil (XOM).  They have the capital to withstand years of slow or no growth.  Buy the ones with solid dividend growth, the stocks that have improved dividends yearly, no matter how the economy has performed.  Ones from the list of Dividend Aristocrats would be a good place to start.  They've been increasing dividends for the last 25 years annually.  Some of the larger ones are Johnson & Johnson (JNJ), Chubb Corp. (CB), McDonald's Corp. (MCD), Becton, Dickinson (BDX), McGraw-Hill Cos. (MHP) and PepsiCo Inc. (PEP).  (For more on these dividend stars, see The Online Investor Income column.  Look on the left of the current income stock and click on "Dividend Aristocrats"

Don't reach for yield at this point (or any other).  The higher the yield, the more likely it won't last.  The average yield from all stocks paying dividends is about 2.5%.  If you venture into areas closer to 10%, look out.  There's a reason the stock is paying more, and it's usually not good.  Remember risk and reward are still highly correlated.

Now isn't an optimistic time in the stock market.  Don't fight it.  Be aware of it.  Invest accordingly.  It won't get better for a while.

- Ted Allrich
October 25, 2011