Paul Ferraresi

I hear so many people bemoan that “if only they had known about the stock market drop from 2007 to 2009, they would have avoided losses and saved their retirement plans.”

Hmmm. Seems like all the signs were there, especially the weak financials from 2001 to 2007 on Fannie Mae and Freddie Mac. Those two quasi-government agencies were the major reason for the housing crisis (isn’t it funny how in the new Financial Reform Law, Fannie and Freddie were not even mentioned, or anything done to reform them?!). And, yes, Fannie and Freddie are still up their old tricks.

Take a look at human nature – people in America rarely connect the dots or project into the future. In everyday life, they sadly state after a long dry spell….geez, it will never rain. Sure enough, soon after that statement flooding, rain comes. After a prolonged rainy season, people cry out “it will never be sunny again,” soon followed by a drought. All things in life move like a pendulum from one extreme to the other. Both extremes are only momentary, as also for the mid-point or average. The same is true in business, love, and economics.

In economics we go for long periods of robust growth and then into recession. During boom times, people think it will last forever; and during recession times, they think we will never get out of this…ever! Stock prices moves the same way. Getting the picture? Just like my days of playing baseball. My batting average was .302. Thus 30% of the time I got a hit. When I went into an “0 for 20” slump, I had confidence that I would probably get 10 straight hits (which I did) and got back to my average.

Note how the crowd invests at the top of the stock market. They take money from bonds and banks and pour it into the stock market (buying high). Soon after stocks drop, they pull money out of the market (sell low) and place it into cash or bonds (safe). As people bid up the price of bonds (buy high), naturally the yield (or interest rates) drop. At the same time, with the stock market and economy in distress, the Federal Reserve will try to stimulate the economy by lowering interest rates. The masses wanting safety continue to pour money into bonds. Soon the economy begins to revive and the Fed begins to raise interest rates. As interest rates rise, the price of bonds drop and the small investor dumps bonds (sells low), losing money. As the economy begins recovering, the stock market anticipates this and begins to rise.

Our heroes, after losing above in stocks and now bonds, see the market has gone up xx% and want to get on the train that has already left the station. Again, they buy in at the top and sell at the bottom. Do you have the picture?

Those people that have money in bonds and bond funds – BEWARE. Interest rates are the lowest in about two generations. Short rates, set by the Fed are at 0% to .25%. They cannot go lower. In fact, they cannot go negative! Duh! (Remember the pendulum.)

The economy will begin a slow recovery, rates will rise and bonds (safe) will get hammered. The experts are stating “this is a bond bubble.” The drop in bond prices in the future will make the stock market drop of 2007-2009 look like a cake walk. In a rising interest rate environment, those bonds with the longest maturity will suffer the most. Keep maturities short and/or do a laddering. My statement is not a prediction of impending doom tomorrow, but it is on the horizon. The signals for the 2007-2009 drop were showing up in 2005.

Get your advisor to help you. Another alternative, as stated many times, is to get into investments that rise when investments go up, but you do not participate in any drops in the market. Oh, they also grow tax-free, and you can withdraw the money tax-free – anytime, and when you die, the money transfers income tax-free at death.

Oh, one more thing…for ten years, tax rates have been real low and like a pendulum. Well, you know the story come 12/31/10.

Discipline or regret….