Greenville Business Magazine 2009 November : Page 12››columns The Patient - One Year After the Financial and Banking Accident BY ALLEN GILLESPIE | PHOTOGRAPH BY ASHLEY FULMER “ I n the January 2009 issue of Greenville Magazine, I suggested investors apply the principals of emergency medicine when examining their portfolios and deciding what to do next. In short, I wrote that you should not panic. Instead, realistically assess the situation and separate terminal companies (the ones that go out of business) from broad market investments which do not go out of business. Then sell only for valid reasons because selling in a panic can actually do more harm than good. I added that a recovery would likely begin with the least injured patients: the higher parts of company capital structures like bank loans and other fixed income instruments like bonds, convertible bonds, and preferred equity, recovering first, later to be followed by stocks. My final suggestion was that once the patient had stabilized, the final step in the recovery process would be to diagnose any longer-term issues and to develop a rehabilita- tion and recovery plan. Nearly one year later, the patient has stabilized and asset prices have risen sharply since January. Unfortunately, the long-term issues and recovery plan suggest we may be in the eye of the hurricane, the calm within a financial storm that 12 GREENVILLE BUSINESS MAGAZINE | NOVEMBER 2009 The growth of government spending crowds out consumer spending because someone has to pay for it. ” is still raging. Why the eye of the storm? Valuations and this equation: C+I+G+(X-IM) = GDP. I will explain. Today the dividend yield on the S&P 500 stands at a paltry 2.5 percent. At its March lows it was yielding over 4.5 percent. Historically, dividends and reinvested dividends account for a majority of an investor’s returns. Because companies reinvest the earnings not paid out as dividends, over long periods of time, stocks have appreciated an addi- tional 4 percent per year. One could argue that dividends are too low because companies are conserving their cash, which is true. But what are they reinvesting in and how much are they holding back? This leads to the C+I+G+(X- IM) equation. It stands for consumer spending (C) plus business investment (I) plus government spending (G) plus exports (X) minus imports (IM) equals aggregate demand — or put another way — the size of the economy. Our patient has stabilized because the government ramped up its spending through deficit borrowing in order to replace the drop off caused by bankrupt consumers. Also helping was the X-IM part of the equation. Crude oil imports account for the majority of America’s trade deficit, so the collapse in oil prices has been beneficial to our economy. When will the back half of the storm appear? It all depends on the growth of government spending, which is totally dependent of its taxing and borrowing ability. There are limits to both. The government hopes that consumer spending will return, but demographics suggest otherwise. Given that we just got a new administration and Congres- sional turnover in 2008, my guess is that it will be 2,4 or 8 years before we see significant policy changes in government spending. However, when we do, I suspect markets will return to their pre-government intervention levels. Following the panic of 1907, which I mentioned in the January article, markets recovered 100 percent over two years, then bounced around sideways for four years before falling all the way back to their 1907 lows in 1914 when war broke >>columns - The Patient - One Year After the Financial and Banking AccidentAllen GillespieIn the January 2009 issue of Greenville Magazine, I suggested investors apply the principals of emergency medicine when examining their portfolios and deciding what to do next. In short, I wrote that you should not panic. Instead, realistically assess the situation and separate terminal companies (the ones that go out of business) from broad market investments which do not go out of business. Then sell only for valid reasons because selling in a panic can actually do more harm than good. I added that a recovery would likely begin with the least injured patients: the higher parts of company capital structures like bank loans and other fixed income instruments like bonds, convertible bonds, and preferred equity, recovering first, later to be followed by stocks. My final suggestion was that once the patient had stabilized, the final step in the recovery process would be to diagnose any longer-term issues and to develop a rehabilitation and recovery plan. Publication List |
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