Dion Money Management Blog   Money Management for Retirees and Their Families

Today we learned that second quarter GDP declined at a 1 percent annualized rate, better than expectations of negative 1.5 percent. US stocks failed to bounce, however, after trading flat throughout the week, essentially pausing after a strong month of July. The report pins the better-than-expected growth on the auto sector and smaller decreases in consumption and housing. Most of the growth came from higher government spending at the federal, state and local level.

Today we are selling the small position in Federated Prudent Bear Fund (BEARX), completing the sale of this defensive position, action we first took in April as the markets strengthened. We are buying Fidelity Select Automotive (FSAVX) with the proceeds. This unique sector fund topped the list of consumer-goods funds in the second quarter, and while FSAVX hasn’t drawn much attention in the past several years given poor performance in the industry, I believe it still presents an opportunistic investment.

The “cash for clunkers” program is perhaps the single most successful government stimulus to date. The program that began July 24 has fueled the recovering auto industry after heavy government intervention and reorganization. For more on this program and FSAVX, click here to review an article written for TheStreet.com.

Earlier this week, we sold Federated Kaufmann (KAUAX) and bought Federated Small Cap (FKASX) with the proceeds (please remember that we are able to buy these A shares on Fidelity’s Institutional platform without paying commissions). I wanted to increase portfolio exposure to small growth companies in the financial, technology, and industrial sectors. We have owned this fund in the past during other opportunistic periods.

Last month, we increased our weighting to ICON Asia-Pacific Region Fund (ICARX) in order to maintain exposure to a diverse swath of this fast-developing region, which includes significant positions in China, Hong Kong, Japan, South Korea, and Taiwan. China’s central bankers have pledged to maintain the country’s current monetary policy, which is highly accommodative and supportive of growth. This week Japan’s Nikkei Index reached levels not seen since last October.

Currently inflation adjusted yields are at their highest level in 15 years due to recent deflation, and this is an intermediate-term bullish case for high quality bonds. Investors bought heavily in the second quarter due to attractive yields and increasing risk appetite. In a deflationary environment, default risk is the top concern. Bernanke has said interest rates will remain low for some time, and it’s clear that the Federal Reserve does not anticipate inflation in the near future. For this reason, I have maintained our position in Federated High Income Bond (FHIIX), a fund that has returned 36 percent since its December lows.

Disclaimer

The corporate earnings season got underway on Wall Street this week when Alcoa’s (AA) earnings exceeded estimates, helping to kick off the 2nd quarter results on a positive note. The company’s CEO also noted that signs of strengthening could be seen in the aluminum market.

Rising commodity prices have been linked once again to Chinese demand. But the implications for the U.S. hinge on whether that demand is permanent. I believe that rising prices so far have been due to a combination of the depressed market and their massive loan growth. Chinese companies found themselves flush with cash as the banking sector became a tool for stimulus and they faced a world with severely depressed commodity prices. It is probable that the recent demand was not a resumption of previous growth levels, but future demand packed into a few short months. Nevertheless, the U.S. has its own stimulus dollars that may keep commodity demand elevated for some time.

Economic data was light this week. The ISM Services Index showed a better-than-expected improvement in the service sector, although it still illustrates a contracting economy. The initial unemployment claims data released Thursday was slightly better than expected, but with more than 500,000 people filing for unemployment claims, the number is still too high for comfort. Ongoing claims hit another new all-time high of nearly 6.9 million. Unemployment is hitting the retail sector, where sales are still falling at a 5 percent or greater clip.

The weak sales and rising unemployment have caused many politicians and pundits to panic, with growing calls for a third stimulus package. What few entertain is the idea that the stimulus spending itself may be the problem. Increases in government spending move workers and capital out of productive private production and into inefficient public projects.

Despite the bad retail and employment numbers, the stock market hasn’t performed terribly. The decline from the recent high is about 7 percent, which is still within a normal 10 percent correction. Considering the S&P 500 Index climbed 42 percent off its lows, a correction was inevitable and overdue. The index remains very close to the 200-day moving average and that average will slide in the coming weeks, preserving a bullish technical signal for the market. If there is a successful effort to pass a third stimulus, optimism will return and lift stock prices to new highs.

I would like to remind each of you about the Worker, Retiree, and Employer Recovery Act of 2008, which allows investors to suspend their 2009 Minimum Required Distributions (MRDs). If you wish to suspend your MRD for this year, you must initiate the change. Please call or email your Dion Money Management client representative, and we can place the one-time request for you. If you do not make a change, your distribution will proceed as scheduled.

Disclaimer

The record volatility in the stock market last year was enough to rattle the steeliest investor’s resolve. Naturally, the first inclination most of us have during these periods is either to head for the safety of bonds or to cash out of the markets entirely. Usually, we resist this urge. If we don’t need our money right away, we may be able to sit back—albeit uneasily—and console ourselves with some bit of wisdom or maybe a statistic we read somewhere about how “the market always comes back.” Those of us in or nearing retirement may take a very different view of things. As we watch our investments shrink in value, the prospect of living on a reduced income prompts us to take some sort of action.

That’s almost always a bad idea.

That bit of wisdom you’ve heard about the markets coming back is on target. Historically, corrections of 10 percent—or even more—in the markets aren’t unusual. In fact, they’re the norm. Stock prices, which represent the present discounted value of a company’s future stream of earnings, are inherently volatile. Over the long term, however, the path of the overall stock market has been upward. Investors who keep their assets working for them through short-term gyrations are better positioned to take advantage of the big moves to the upside than those who try to time the markets in an attempt to avoid the drops.

In the parlance of professional money managers, investors who cash out or head to safe havens like bonds during periods of stock market volatility take “opportunity risks” with their money. In other words, market timers are likely to miss out on the best chances at generating a good return on their investments. According to data from Fidelity’s Market Analysis, Research and Education group, the S&P 500’s five best-performing days from January 1980 through December 2006 accounted for 26 percent of its return. What’s even more amazing, the S&P 500’s 30 best-performing days accounted for 73 percent of its return during this period.

So the big moves to the upside are rare: 30 days in 26 years. But wouldn’t it be possible to hit those 30 days simply by generally staying invested when the economy is doing well and getting out when it tanks? The short answer is no. Indeed, as the data indicates, quite the opposite seems to be the case. According to Fidelity, since 1926, the best five-year period for the market began in May 1932, during the Great Depression. Investors saw a 367 percent return in the ensuing five years. The second-best period began in July 1982, in the midst of a pronounced recession.

Most market timers, however, don’t pile into stocks during these rocky periods. Rather, they wait until economic conditions improve—and stocks go up—before buying. To put it another way, market timers typically mis-time their trades and wind up “buying high” at prices above where they sold.

For do-it-yourself investors, thoroughly researching a stock or fund before buying it and then holding that investment for the long term makes far more sense than moving in and out of the market based on the latest headline or earnings report. Our emotions, however, can easily overwhelm our facilities for rational decision-making, particularly when the markets become volatile. There is an entire field of academic study devoted to understanding why we make certain investment and economic decisions called behavioral finance. Researchers know that even the most sober-minded among us can become irrational risk-takers when it comes to avoiding a monetary loss. Behavioral finance studies also demonstrate that when dealing with the stocks, bonds, ETFs, and other securities we’ve selected, we have a tendency to be overconfident and to move with the herd.

While a short-term, paper loss is certainly unnerving, missing a key day of market gains—or exacerbating losses by improperly timing market exits and reentries—can do real damage to years of careful planning and investing. At a certain point, some of us may come to realize that our portfolios are too big, too complicated, or simply too important to our future well-being to be managed alone. A professional adviser who acts in your best interests but at an emotional distance from your portfolio can insulate your holdings from occasionally irrational and costly mistakes.

We received new employment figures today. Unemployment failed to reach the expected 9.6 percent in June, but that was due to a continuing exodus of unemployed workers from the labor force. Job cuts were higher than expected and the U.S. markets opened with losses of nearly 2 percent.

Economic fears spilled over into commodity markets, with oil and gold losing ground. Today is shaping up as a repeat of the Tuesday losses that closed out an otherwise impressive second quarter of 2009, when the Dow Jones Industrial Average gained 11 percent.

A relatively quiet rally occurred in the high-yield debt market as well. Federated High-Income Bond Fund (FHIIX), for instance, has climbed 25.4 percent off its March 9 lows. The steep rally from the lows was the easy part. Going forward, the gains will be smaller and take longer to realize. Nevertheless, it is positive to see the credit spreads falling because without access to capital, business would find it nearly impossible to invest for future growth.

As opposed to improvements for business, the public debt sector is headed for turmoil. California issued IOUs today to contractors and taxpayers expecting a rebate. Some banks have said they will accept IOUs, but it is not mandatory. California is essentially printing its own money because it cannot pay its bills, but no one is required to accept them.

Of course, California is not broke and has the money to pay its bills. This is a political crisis because the state has two options: raise taxes or cut spending. Voters rejected a slate of revenue-increasing measures in May, leaving only the option of cutting spending, which Governor Schwarzenegger agrees is the only option. Legislators were working on a deal to close some of the deficit yesterday, but the “Governator” said he would veto any bill with tax hikes or that does not close the gap once and for all.

Investors must not get swept up in negativity surrounding government budget crises. Just as people often confuse the stock market with the economy, governments are not the economy either (though they can be more influential than financial markets). Despite the negative news that California and other states’ budget woes generate, the economy is driven by the private sector. Where the ax falls on the public sector, it is bullish for future growth, but where it falls on businesses and consumers, it is bearish.

Disclaimer