Unusual Investments for Unusual Times

We continue to believe that the “muddle through” investing scenario that we forecast in January is on target.

The Dow Jones Industrial Average hovers around 8,500. Despite the sense of volatility that we all still have, the market has remained fairly stable since last November – with one notable exception. The exception was when several political heavyweights began considering whether or not to nationalize major portions of our banking industry. The market recognized this potential travesty by spiraling down to a low point where the market traded at roughly down 25 percent before the folks at the Treasury realized that maybe it wasn’t such a good idea. As soon as Katie Couric and the political talking heads moved on to other subjects (e.g. how wonderful was our new President’s first 100 days), the market recovered.

There have been signs of improvement, though I still read them as signs that the downward spiral has come to an end. This week the Conference Board’s Leading Economic Indicators were released. The latest number was positive. While half of the indicators have stabilized (in recession), the relationship of short-term interest rates to long-term interest rates (i.e. the “yield curve”) and monetary policy (the amount of cash that the Treasury is shoveling out the door) were both positive. A third indicator, the U.S. stock market, was also a positive – although I think that just reflects the fact that the politicians stopped talking like imbeciles, which isn’t exactly proof of better things to come.

The real economy, as reflected in the average manufacturing workweek and “vendor performance,” which attempts to measure the timeliness of vendor deliveries, were both very negative. Would indicators do you trust these days? Washington policies? Or how the heartland is responding to them?

For my money, I remain a bit cautious. Corporate profits have all but disappeared. They are down 90 percent. The real question, of course, is how long this environment will last. At current profit levels, stock valuations are extremely rich. I do believe that we’ll see a significant recovery in profits from current levels, to how much and how quickly, neither I nor anyone else have a clue.

Stock market investors remain fully exposed to this earnings risk. Our portfolio, with its emphasis on high yield bonds, is mostly betting that today’s companies are here to stay. Betting on the broad stock market, it would seem, requires more – a significant upturn in the profit picture for corporate America. I’m not sure that I’m ready to bet on that. Not yet.

One thing that is working is what we call our “inflation trade.” Year-to-date, energy stocks have been very strong, and gold is moving up again. The value of the dollar is falling. Long-term interest rates are moving higher. Next week the Treasury Department will put over $100 billion of treasury securities up for auction.

Like it or not, the U.S. government has chosen to inflate our way out of the 2008 banking panic. One could argue that they had no choice. In any event, the portfolios that will work in a stagflationary quagmire aren’t your typical S&P 500 stocks.

If the current portfolio looks a bit unusual, it is because we live in unusual times.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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