Like many of you, I have been concerned about events over the past year or so, including the recession and the progress of political events as they impact business conditions. The value of my retirement accounts took a significant hit in spite of having a high quality, professionally managed portfolio. Most people who are nearing retirement experienced the same concern about declining asset values, forcing us to reevaluate our investment strategies and the length of our working lives.
While there is plenty I could complain about, the objective of this tome is to cite reasons for optimism and to bring a measure of perspective to these events. I stress there that these ideas are my opinions, though I hope they will be helpful to you. The following factors are reasons to have hope about our future:
Recessions Are Part of the Normal Flow of the Economic Cycle
Recessions have been a feature of economies around the world for hundreds of years. We have experience them before and will experience them again. In fact, we went a very long time since our last recession, so one was probably past due. It did not help, of course, that policy makers likely caused the real estate bubble that drove our economy into the tank.
While U. S. consumers have retrenched in their spending and are working on long-overdue corrections to their household balance sheets, they eventually will need to increase spending on cars, homes, major goods, vacations and Christmas. Consumer spending will rebound! Inventories have now become relatively low, and will need to be replenished. These factors are very important to the lifting of the recession. I think consumer lack of confidence, in large part, has been caused by uncertain political events and unprecedented government spending, but those factors are also likely to be modified.
Political Swings Have a Way of Self-Correcting
We are seeing the start of a self-correcting political cycle. Overreaching policy makers are beginning to see the consternation of the general public about excessive spending and aggressive health care plans. While we all want improvement to health care, the public is starting to demand a better remedy. Even if some poor policies are enacted now, remember that by 2010 the public must be satisfied or there could be major changes in the House and Senate. Even the United States is not immune from economics; it can’t sell an unlimited amount of debt. One of the strengths of our political system is that when the pendulum swings too far from center, then changes are made to force a more moderate course. Even enacted legislation can always be changed by a future Congress. Therefore, I am optimistic that over time reasonable policies will be enacted. We might remember that strident news is created to sell, not to inform.
Reasons the Earnings of Companies Will be Higher in the Future
The discipline of the recession is forcing companies to get even leaner and meaner. This is good. While it hurts those who are laid off, our overall economic efficiency is improved as companies are forced to reduce fixed costs and to increase their operating leverage. What I mean here is the well-known fact discussed in financial text books that companies who increase their operating leverage can improve their ability to generate higher net income increases in the future.
Have you ever noticed that percentage sales increases or decreases don’t match changes in profits? In large measure this is due to a company’s built-in operating leverage. In other words, once fixed costs are covered, an increase in sales brings a greater than proportionate increase in net income. This also works in reverse during recessions; reductions in revenues bring greater than proportionate decreases to net income. So as our economy rebounds, corporate profits are likely to rebound at a greater percentage of increase than is reflected in the percentage of sales increase. This will help the value of your retirement accounts because stock valuations reflect expectations for future profits. Neat, huh!! This fact helps to bring some perspective on cycles of economic change and what they really mean to your own finances.
Well, Will My Portfolio Rebound?
Really, who knows! But, based on my own experience as an investor and training in this field, I think the most important thing is to construct a high-quality portfolio that will suffer less of a decline in downturns and have a greater probability of rebounding as the recession ends and the vagaries of the stock market occur. In doing this, just a word about what is relevant and what is not. Relevant to an investor’s decisions are realistic expectations about future events. Not relevant are losses already realized; they are water under the bridge that you can’t change. We should not hold on to poor investments for long periods of time just in the hope of a rebound; neither should one overreact to temporary declines in value by selling at the market low point.
The tricky though only relevant question is – how will the investment perform in the future? You might consider whether the decline was just in “lock step” with the overall market, or was the decline due to company specific factors suggesting that the investment is not likely to rebound quickly, if at all? Depending on the type of investment, relevant indexes are available, such as the S&P 500 index, to help one sort through this question. Becoming knowledgeable about your investments is important.
I think that your portfolio will likely rebound or improve, as long as you have a high quality portfolio, because earnings will likely rebound for the reasons I explained above. If you don’t have a high quality portfolio, then remember that you are in control of that decision. I caution that because investments are such a personal decision, a professional advisor approach is probably best for most people. This helps you avoid the tendency to overreact and buy or sell out at the wrong times. Buying and selling decisions are both very important. How you liquidate your retirement portfolio is just as important, and may be more important, than how you go about building the portfolio in the first place.
What Else Gives You Optimism?
A number of factors provide a great deal of optimism about the future. Our economy and land are the home of the free and the creative! We now have fantastic new tools, such as the internet, PCs and Blackberries, available to all to enable business wherever and whenever we choose to do so.
We have an egalitarian society. A great deal of opportunity is open to all who are smart, creative and dedicated. Yes, uncertainty has increased, but opportunity has increased as well. I hope this piece will give you reasons to look for the “silver linings” rather than just the problems as you confront your day today.