Tuesday, October 7, 2008

The Current Economy and Opportunity

Two weeks ago, I said that now is the the time to be buying. Some are calling this a recession, others are afraid that it might become a depression. I call it OPPORTUNITY!

Opportunity is an auspicious state of affairs or a suitable time: "If you prepare yourself . . . you will be able to grasp opportunity for broader experience when it appears" Eleanor Roosevelt.

Before I discuss the opportunity that is available, let's backup so that you have a better understanding of where we are economically. Maybe I shouldn't rehash what the media, the financial experts, and the politicians have said over and over again in the last several weeks. Greed, leverage, poor oversight created one of the biggest threats to America's financial system since the great depression. This is not new? Henry Clew wrote a book called, "Fifty Years on Wall Street" in 1908 in which he surmised that in every crisis, the primary cause was a large amount of credit in the market. Sound Familiar? What's really interesting is that he wrote this book before the 1929 crash.

What caused the 1929 crash? The same thing: Too much credit, too much leverage and poor, very poor, oversight.

What happened this time? The absurd amount of credit in the marketplace involved the American home. In 1929, it involved stocks. Creditors assumed that home values would go up in straight line and the borrowers would not default on their home loans. People who should have not been given credit where given credit. Lots of it! And then, the investment banks packaged, repackaged and futher repackaged the loans intermingling the good credit with bad credit to the point where no one could assess the value of these loans anymore. The good was mixed with the bad. These packages were called MBS (mortgage-backed securities) which were then packaged into CDOs (collateralized debt obligations) which were then sold and traded on the stock market.

Then housing market took a downturn. I wrote about the reasons two week ago. The downturn had an adverse impact on the holders (large banks, investment banks, funds, etc) of these MBS assets. Many of these institutions were leveraged to the hilt. Some as much as 50-1. As underlying value of the collateral, residential real estate (aka, the American home) declined, the value of the MBS assets disappeared rather quickly (some would say, "in the blink of an eye"). Confidence eroded and the two oncoming trains, the train from the west called liquidity and the train from the east called credit, collided bringing the system to near collapse.

So where is the opportunity, you ask? First, let's look a some economic indicators:

1. The Consumer Confidence Index, which is an indicator of the degree of confidence Americans have in the economy, for September was 59.8. This is probably the second lowest number in ten years (see graph below):

2. The S&P 500 stock index has declined 35% from circa 1550 to near 1000.

These two leading indicators tell me one thing...we are headed for a recession. The big question is how deep and how long? The average length of a recession in the US has lasted 10 months. The shortest was six month and the longest was 16 months. Bear in mind that this recession is atypical.

So where is the opportunity? Three areas to invest your money: startups, real estate, and other alternative investments. There is still opportunity in the stock market. The opportunities to get the best returns from the stock market requires that the "buy and hold" strategies have to be scrapped. I can prove with a high degree of certainty that the average investor has lost money in the stock market since 2000 using the old mantra buy and hold. The better strategy is Trade.

Stay tuned for more about the three areas to invest your money and my stock market trade strategy.