Why the Economy Could Take Another Downturn—and What the Average Investor Can Do To Protect Themselves
The following article was written by Daniel A. White, CLU, ChFC , President, Daniel A. White & Associates:
To the casual observer, the economic headlines look promising. To be fair, there are a few positive indicators. Unemployment figures are gradually improving, retail sales are on the upswing, corporate profits are up and consumer confidence is surging. Unfortunately, the reality is much more complicated. To many financial advisors and investment professionals–myself included at Dan White and Associates–there are reasons to be cautious. A closer look at historical comparisons and advanced metrics behind the rosy headlines reveal cause for concern.
Trouble looming?
One of the biggest underlying reasons I suspect we might be headed for another 2008-type bubble in the not-too-distant future—is my skepticism regarding the pace of the current recovery and the factors driving it. Standard and Poor’s (S&P) earnings are on pace to hit $91/share by August; up nearly 13 fold from the March of 2009 lows of $7/share and surpassing the all-time high of $90/share in the 3rd quarter of 2007. There is nothing wrong with profits, but why are we seeing those profits?
The short answer is pretty simple: the government is printing more money as part of a strategy called Quantitative Easing (QE2); monetizing the national debt by purchasing securities and turning government bonds into circulating money.
So what happens when the government turns off the spigot? We can get a pretty good idea by looking at other government incentive programs. Whether it was a home-buying tax credit or a “Cash for Clunkers” promotion, the markets dropped off sharply when programs ended. It’s also worth noting that after the last round of Quantitative Easing–in the months after April 2010–the market plunged.
PE ratios and commodity oddities
Since QE2 began last August, the price of Silver is up 70%, crude oil and coal are up close to 40%, and a number of other commodities are up sharply. And when you see the U.S. Dollar down 10.6% at the same time, that’s a recipe for trouble.
Perhaps most concerning, is the historical pattern of the price to earnings (P/E) ratio and what it means to investors. When you get in the market at a low P/E ratio, things tend to work out well, and when you get in when the P/E ratio is high, that doesn’t bode well. The current S&P 500 P/E 10–is at about 24. It has only been at 24 a handful of other times in history.
What can you do?.
* Be conservative. Investing in healthy companies with large cash reserves is fairly safe, but commodities and other risky assets are a bad idea.
* Plan ahead, be cautious and don’t get overextended. The first sign of trouble is likely to be short-term interest rates starting to tick up. If you see that happening, reduce your exposure.
* If you are retired or almost retired, all of this is particularly relevant. Be extremely vigilant and pay close attention to the subtleties of the marketplace.
Founded in 1987, Glen Mills, Pa.-based Daniel A. White & Associates is a financial planning firm specializing in asset protection and transitional and retirement planning. Through a team of knowledgeable experts, Daniel A. White & Associates provides comprehensive financial planning for retirees and pre-retirees in estate planning, asset protection, wealth management and wealth transfer strategies.