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May 14, 2009

2009 2nd Quarter Newsletter

Normally, we start each quarterly letter with a review of the prior quarter and discussion of economic conditions. We feel a strong need to deviate from the norm, and simply give direct advice.

The question on everyone’s mind is whether stocks are still a valid part of a portfolio. Is there still a reward or premium for the risk of owning stocks? Returns in U.S. stocks are now basically flat for the last ten years. Some are calling for the next ten years to be just as bad. We caution you against watching too much financial news on TV, or relying too heavily on statistics that end in a terrible year like 2008. We are reminded of the famous Business Week article of August 1979, that followed 10 years of flat returns in the equity markets. It was entitled “The Death of Equities”:

The refrain sounds familiar. After the article in 1979, the market promptly increased by 50% and for the next ten years produced a 17.8% annualized return. The average return for global equities for any 10 year period since 1972 is 12-16%, depending on which index you choose.

We think the answer is that the equity premium still exists. We believe world GDP will grow, that capital markets will exist, and that there will be companies we can invest in that will make money.

The reward for investing in equities will likely begin prior to the end of the recession but we don’t know when. This is a good time to examine the amount of equities in your portfolio. We should choose a level to take advantage of a possible reversion to average equity returns. But we also need to choose a level where we can emotionally tolerate losses. If we can’t, for example, emotionally tolerate a 20% short term decline in our equities, we may need to re-evaluate the equity target in the portfolio.

Outside of equities, a few additional themes have emerged. To start with, we do not recommend cash and Treasury bonds as investments going forward. The yields offered by relatively safe municipal bonds, corporate bonds, TIPS and mortgage-backed bonds are much better than cash or Treasury bonds. The reward of earning 5-6% on bonds right now is likely worth the risk of leaving the safety of cash.

We are also encouraged by the performance of alternative investments. As equities have continued to decline this year, mutual funds or private placements with hedged strategies have been essentially flat so far this year, have actually made money in the last 10 years while stocks have not, and have more upside than treasuries or cash.

Finally, we believe that commodities/energy and real estate are both protective against inflation. Income producing real estate (with no leverage) is also attractive because the yield at current prices is also worth the risk relative to cash or treasuries.

In addition to investments, there is an important financial planning theme resulting from the current environment. While this period is not a Depression, it is not a typical recession either – ten years of capital growth in stocks and houses has been wiped out. Much of that wealth was being propped up by too much debt. In response, consumers and businesses are becoming more rational. Consumers are actually saving more to reduce debt and rebuild retirement accounts. The personal savings rate increased to 5% in January of 2009 – the highest rate in the last five years.

We and other high net worth advisors agree that debt reduction for our clients is critical. As families are trying to reach goals or preserve capital, the determining factor of success or failure will be our debt and spending in relation to our wealth. These are variables that we can completely control. We cannot control government action or the economy itself. What we can control is our own financial plan and the structure of our portfolio. It is our job to help you get both sides of that equation right.

Sincerely,

Wagner Wealth Management