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The U.S.
economy appears to be on the verge of a recession. Of course we
won’t be able to say for sure for several more months since a
recession by definition requires six consecutive months of
negative economic growth. Nevertheless, many of the signs are
there. Retail sales are disappointing, housing prices continue
to fall, and lenders are becoming more reluctant to lend money
as we appear to be experiencing a global credit crunch.
The recent
massive rate cuts and economic stimulus package indicates that
the government thinks the economy is in worse shape that many
had originally expected. While these actions may indeed boost
the economy and financial markets in the short-term, over the
long-run they may lead to an even worse recession in the
future.
One of the
primary issues with the current economy is that the average
consumer is very highly leveraged. They have taken out home
equity loans and racked up high credit card balances to support
a lifestyle they couldn’t afford. The sub-prime loan crisis was
in large part caused by individual’s sense of entitlement to
houses they couldn’t afford.
The
motivation behind the Fed’s recent rate cuts is to make money
cheaper by enticing consumers and businesses with lower interest
rates. Unfortunately, giving highly-leveraged consumers access
to cheaper money may hurt the economy in the long-term as they
use cheap debt to continue to fuel a lifestyle they can’t
afford.
Greed and
indiscretion has led us to this point. Government handouts and
cheaper debt won’t correct the situation. And it goes much
deeper than just the housing market. Household
spending, consumer debt, financial sector profits - all need a
correction to get back to sustainable levels. That's bad news
for investors and the global economy, which still depends
heavily on U.S. consumption for growth.
So how can
you navigate the current market volatility without losing both
your money and your mind? Well, maybe the most important advice
is to take a step back and remember that it’s just money. Money
should serve you, rather than you serving money. That being
said, there are some specific investment strategies you can take
to benefit from the current market conditions.
Bear
Funds
There are
several mutual funds out there which hold “bear” portfolios.
These are funds that sell short, buy put options, use leverage,
or employ other strategies to increase in value as stocks
decrease in value.
Bonds
When the
stock market begins to decline, investors often run to the
safety of bonds. This ends up driving their prices up and their
yields down. Also, the recent Fed rate cuts have also hurt bond
yields. A 10-year government bond currently yields around 3.5%
while a high-quality corporate bond yields around 5%. So while
bonds tend to be much safer than stocks, don’t expect them to
deliver spectacular returns.
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