Reasons to be cheerful - continued. I hit it in my commentary last week when I discussed that market pessimism had reached extreme levels and a rally was close at hand, as the Dow had a nice rally. More importantly, the bloodletting stopped. In my “Reasons to be cheerful – Intense pessimism often leads to good things” I outlined how many investors seem to have lost all hope. Gloom and doom has become pervasive. The financial press is filled with articles projecting a deepening and protracted decline in equities. A recent survey of investor sentiment shows that more than 70% of investors now consider themselves “bears”, one of the most negative readings ever. This number is important as it is generally a contrarian indicator and the opposite of what is correct holds to be true. Very simply, investor psychology was at a level of despair….and that’s a good thing for the market.

Will the rally continue is the big question. All indications are that it may for some very basic principles.
- Investor psychology remains overly pessimistic and no one believes it is sustainable (my favorite)
- Copper and steel prices are increasing showing signs of rejuvenation in manufacturing
- Other commodities such as oil are rising indicating increased demand

The biggest attractive factor I see is that industrial output is finally matching and/or under producing supply. In simple terms that means that companies reacted quickly, VERY quickly, laying off workers and cutting production in anticipation of depression like conditions, particularly in consumer spending. And in some respects they were right. The consumer is badly damaged and will only get worse due to the country’s demographics of an aging population turning from spenders to savers. However, the ferocious rate of cutbacks now seems to have been overdone, reducing the supply of goods below demand. A basic principle of economic growth.

On a technical basis, many of the pieces for a market bottom are now in place. These include the recent combination of 90% Up and Down Days, oversold reading on all the long-term overbought/oversold indicators, failure to match the recent lows (also called positive divergences) by the various percent issues above their moving averages (10/30-Day, 10/30-Week), by the number of New Lows and by the Average Power Rating Index (APR). keep in mind, we have had many false signals during this bear market.

Does this mean I am predicting a new long term bull market from here on out? Not a chance. There are many challenges, too many to overcome in the short term. The main obstacle is one I have been touting for years. Demographics. I discuss this in depth in my special Report: An Economic Tsunami Lies Ahead – How to prepare for this perfect storm, (available on request) which I published over a year ago before the market collapsed. Our population is aging and turning from net spenders to net savers. This will have a profound effect on our economy for several more years. If you are interested you can download (free to subscribers) my recent special report: Economic Tsunami Special Report – Revisited, (click for the link). However, this rally could have legs. Big, strong legs. And I just love the fact that nobody feels good about it.

The longer term is still plagued by the main obstacle, that being that consumers have run out of borrowing power. The ailing banks who are just fighting to stay alive, (big deal if Citi and BoA are profitable for the first 2 months of this year. Who wouldn’t be profitable if they had an infusion of a few hundred billion dollars from the government?) and a worsening housing market (which I discuss in depth in last weeks commentary) are merely symptoms of the problem. Yes, you heard me right. As of the third quarter 2008, homeowners with mortgages had on average 25% equity in their abodes after all mortgage debt was removed and that number will probably drop to the 10%-15% range with the further decline in house prices. At that level, after a 37% peak-to-trough collapse, almost 25 million homeowners, or nearly half the 51 million with mortgages, will be under water, with their mortgages bigger than their house values. In total, the gap will be about $1 trillion.

The decline in spending from our aging population, rising layoffs, the nosedive in stocks, maxed out credit cards and tighter lending standards and weak consumer confidence has also discouraged consumer spending. Rising medical costs are also a drag on consumers as their co-pays and deductibles mount. For decades, credit card issuers and other lenders encouraged consumers to indulge in instant gratification. Buy now, pay later. U.S. credit card defaults are at 20-year high. Analysts estimate credit card charge-offs could climb to between 9 and 10% in 2009 from 6 to 7% at the end of 2008. In that scenario, such losses could total $70bn to $75bn in 2009. The $5 trillion in outstanding credit card lines (of which $800bn is currently drawn upon) are being trimmed even for credit worthy borrowers with Meredith Whitney estimating that over $2 trillion of credit-card lines will be cut in 2009 and $2.7 trillion by the end of 2010 But now, habits are changing. Debit cards are becoming popular since they deduct charges directly from the user's checking account and, therefore, don't increase indebtedness. Layaway plans are back in style after nearly disappearing.

After 401(k)s were initiated in 1978, those containing stock assets appreciated in the long 1982-2000 bull market, which convinced many that they didn't need to save. Rising housing prices led most to believe that their house would always be an available piggy bank. Time to wake up and smell the debt. As households increase their saving rate, their spending growth will slow, a distinct contrast from the decline of the saving rate from 12% in the early 1980s to zero recently. The effects, then, of a consumer switch from a 25-year borrowing-and-spending binge to a saving spree will be profound for the U.S. economy. Even more so for the foreign economies that have depended for growth on American consumers to buy the excess goods and services for which they have no other ready markets.

A quick note on inflation: Many people expect inflation to pickup because of all the money that's being pumped out by the Fed and other central banks as well as the Treasury to finance the mushrooming federal deficit. When the economy revives, they fear, all this liquidity will turn into inflationary excess demand. However, at least presently, the Fed's spending spree isn't getting outside the banks into loans that create money. When cyclical economic recovery finally does arrive, it will probably be sluggish and lenders will still likely be cautious. Any substantial increase in loans will probably continue to be more than offset by the continual destruction of liquidity as write downs, charge offs, elimination of derivatives, etc. persists for years. The deepening recession and spreading financial crisis is the beginning of the unwinding of about three decades of financial leverage and spending excesses. The process will probably take a little longer than most believe to complete as U.S. consumers mount a decade-long saving spree, the world's financial institutions delever, commodity prices remain weak, government regulation intensifies and protectionism threatens, if not dominates. Sluggish economic growth and deflation are the likely results.

My Strategy: Play the rally, if you have the will, but on a conservative basis. As I have previously discussed, “Buy and Hold” appears dead or is the process of killing anybody who is left doing it. That’s why I developed our unique (and trademarked) investment management style: Top-Down Tactical (TDT™) that employs top down analysis with tactical asset allocation. (TDT™). (click) Use a tactical investing strategy along with “real return” investments. Those are high dividend paying stocks and good quality corporate bonds with high yields. Be careful though, as simply buying based on yield, dividend or rating is difficult and dangerous. That’s why I recommend using someone that knows what they are doing. By the way, “Hope” and not opening your statements is not an investment strategy. Be proactive and get a 2nd opinion on your finances.

In conclusion: No, I am not a party pooper. I like the fact that optimism is taking root. I’m sick of all the negativity to. (I’ve been right on a lot of things and I haven’t slept in months!) I am also a big believer in the American way. We can and will overcome this, as well as anything that comes our way. However, slow-downs occur. They have too and they’re natural. After you run a marathon, you have to at least take a nap. And that’s where we are…nap time. There are ways to survive and make money during this cycle. You just have to be prepared. For a free 2nd opinion of your finances, just ask.

Speaker available: As a member of SOFA, (the Society for Financial Awareness), a 501C-3 non-profit speakers bureau, I am available to for free financial workshops to your company, civic or church group if you like. Just let me know.

Why I am so optimistic for the future:
Have you seen this picture of Josh. I think it’s my favorite. He’s getting so big now, finishing up his freshman year at Christian Brothers. He’ll be 15 this summer, (where does the time go), a size 11 shoe and just a hair shorter than me. Oh, and a good kid. I’m so proud of him.

Keith Springer is President of Capital Financial Advisory Services, a registered investment advisor, providing Wealth Management and Mortgage Consulting Services.  For more information on how to build and maintain a solid retirement plan, please contact Keith at
916-925-8900 or Keith@KeithSpringer.com