Sunday, November 23, 2008

Hoping for a Bottom

I got my wish. The market has now dropped so far that I’ve had the opportunity to get all the cash from my retirement plan into the market. As you may know, I was lamenting last fall that my “Dollar Cost Averaging on Steroids” system had me sitting on a huge pile of cash after a long bull run with few interruptions. So, I was wishing for some market volatility that would allow me to invest the cash at lower levels. As of last week, it was all in the market.

I should have recognized that time as one of those “Be careful what you wish for” moments. I have to admit I underestimated how painful that might be. Now, I’m wishing for a bottom. Emotionally, that feels pretty awful, but from a logical standpoint the chances seem pretty good to me. Most major bear markets have ended with long term average P/E ratios of around 10. Currently, I believe we are about 10-11. Not that this was a factor in my decisions, of course…my system works on autopilot. But, now it can’t operate effectively until we at least get some significant bounces.

While I would like to have some more cash to invest at these levels, most of what I see on financial shows is about where you can “hide” from the market. So, while I pray for a bottom, I think that discussion is worth some ether ink.

I have to admit it sounds comforting at one level, but I have a hard time believing the best thing to do is hide from a market that is on sale at it’s best valuation in 30 years. The last time valuations were this low was in the 1970’s. Of course, most profess to be ready to get back in once the bottom is comfirmed. When it will come, I’ll admit don’t know, but I heard a commentator on PBS a couple of days ago expressing things pretty much as I see them. His comment was something along the lines of “We’ll only know we have a bottom about 6-8 weeks after the fact when prices are up 30-40%.”

Be that as it may, the vehicle many are choosing as their hiding spot, US Treasuries, seems a questionable choice to me. Granted, according to conventional wisdom, these are the safest bet you can make. But, 3 month treasury bills are yielding well under 1%, and 5 year bonds are yielding only about 3%. This is because of the huge buying related to the flight to safety, but, to me, this only makes sense if you expect massive deflation accompanied by much lower interest rates. While I expect some deflation as a result of the big decrease in energy and other commodity prices, I expect this will be relatively short term. Over the longer term, I worry the massive borrowing governments are doing will lead to inflation. In fact, aside from the immediate borrowing binge, I believe the only way government can get out of the massive federal debt is to inflate their way out. And those in treasuries would be murdered by inflation. No, treasuries don’t sound so safe to me.

An alternative might be US I Savings Bonds. They yield only about 1% over inflation, but at least you are protected from inflation and don’t have to worry about rising interest rates. Unfortunately, the rules prohibit you from parking large sums there. Inflation adjusted treasuries are unlimited, and might seem a good substitute, but these would still be hurt badly by increasing interest rates.

Federally insured short term (up to 1 year) CDs seem like a better choice. They are yielding several times as much as treasuries of similar duration, and for my money are just as safe. You would do well during any deflation and you can be pretty sure you will get your money back with interest. And you can always roll them over at higher rates if interest rates go up over the longer term.

Of course, most who are hiding their money want to be able to jump back into the market at a moments notice once they have confirmed the bottom (Note that, according to the theory stated above, that might be 30-40% above the bottom!). For this purpose, money market funds would appear to be hard to beat. Yields are not as good as CDs but generally are better than short term treasuries, and they will go up rather than down in case of inflation. In the case of deflation they probably would not do as well as CDs or treasuries, but I don’t think they would do too badly. Now, with the extending of FDIC insurance to many of these accounts, they again appear to be very safe.

As for the ultimate in hiding your money, I guess you could consider your mattress… or gold. But neither of those seem too comfortable to me. If you are that worried, buy land. You can't eat cash or gold, but you can always raise your food if you have some land. Though I still don’t expect to really need it, I’ll admit I have my farm, bought and paid for several years ago.