Where's your GPS?

Today’s history has an international flavor which seems apropos with China having a stimulus package, the G20 convening this week and Pirates making the headlines. Interestingly, in 1876 Spain approved a bill to establish democracy, certainly the cultural shift we’re experiencing today. In 1889, Harper’s Weekly featured a cartoon about the open door policy towards China. The Pirates fascinate me! They seem to have a better GPS system than current market conditions.

Let’s look at what our GPS is toggling to tell us.

One of the fallacies about our recent turbulence is we’re in uncharted territory, that we have no historical precedents for the uncertainty, volatility or panic. Ned Davis Research has some great charts on this (http://www.ndr.com/invest/public/publichome.action)! As I mentioned previously, each new crisis looks unique when in fact they are not. In 2007 our market was characterized by a rich valuation and overbought conditions. I like what Dr. John Hussman has to say on where we are: No thoughtful investor "calls a bottom" in the markets. Stocks are undervalued here, but they could decline further. Economic conditions are poor, but may be over or under-reflected in stock prices. Investors will find out over time, and the ebb-and-flow of information is slow enough to allow very large market fluctuations in the meantime. Current market conditions are extremely compressed, to the extent that the market could soar by 30% even in the context of an ongoing bear market. At the same time, investors remain skittish, and we should allow for fresh weakness into next year or perhaps a wide and prolonged trading range. We continue to have something of a line-in-the-sand at the October lows…”

In keeping with those thoughts let me reiterate that all market conditions present opportunities. The 1970’s brought us Intel, Microsoft, Southwest Airlines, Fed Ex and Apple. All of whom are here today and have proven to be profitable investments. Yet no one looks to the 70’s as a time of great stock market highs !! Keep a disciplined buy/sell process in place. Veterans like Warren Buffet and Jeremy Grantham have a good handle on historical data and they embrace the concept that stocks are a long-term stream of future cash flows. Take Toyota, for example, they were willing to take it in the chin from Wall Street’s analysts for the last 4-5 years and now they are cleaning GM’s clock. My point is investors need to get beyond looking at quarterly returns and focus on what’s on the horizon. Get ahead of the curve and look for trends. Ignoring the paralyzing fear in our markets today is a clear way to take part in those long term streams of future cash flows.

The stock market is a discounting mechanism. Any plan you had even 6 months ago is flawed and needs revisiting. Re-assess growth – if you’re down with the market (38%) you have to come back 66% just to break even. Look to constantly align your risk in proportion to the return. Our primary activity is not to identify tops and bottoms. If you manage risk and correlation (in that order!) return is a natural by-product.

Look to drive down your marginal tax bracket this year. Beware of capital gains distributions in your mutual funds – YES, they are coming even if you are down 40%! There are ways to prevent this. But you have a limited window left !



Sources: John Maudlin, John Hussman and Merrill Lynch Research – QuEST Report 17 Nov 2008.. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of November 18, 2008, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Merrill Lynch to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to the Alternative Minimum Tax (AMT). You cannot invest directly in an index. Discuss your investment needs with your financial professional before investing.