Economic & Market Update
By Richard Morey

June 22, 2009

This is the most difficult time I have ever seen in which to judge the state of our economy. For the last few months, politicians and economists have been talking about the "green shoots" indicating that the economy is beginning to recover. However, there is a small group of economists and investors who are much less optimistic. Unfortunately, I consider this group to be the most insightful, objective, and historically accurate. In this report we’ll look first at the optimists and their green shoots. Then we will look at our more cautious economists. Finally, I will discuss what all this means for investors.

Green Shoots? We have seen improvement in some economic numbers in recent weeks. The unemployment rate appears to have slowed down. Home sales have begun to pick up in various parts of the country (though a full 50% of sales in some States have been foreclosures). Inventory levels of most manufactured goods are low, which could mean manufacturing may soon begin to recover. In addition, two-thirds of the larger corporations exceeded earnings expectations in the first quarter. And then we have the larger banks, most of whom announced unusually large profits in the first quarter. Those that were deemed by Treasury to need additional capital were able to find private investments (except Citigroup). Finally, all of this has been occurring even though hundreds of billions of dollars worth of government stimulus hasn’t yet been spread out into the economy.

These positive developments have been sufficient for many to predict the economy will again begin to grow later this year. Expecting this, investors have driven up the prices of stocks. Happy days are here again!

Is a Drought Coming to Kill the Green Shoots? Normally all the positive news would indeed herald the coming end of a recession. However, these are not normal times. This recession will undoubtedly end; the only question being when. Unfortunately, a comprehensive look at our situation leads the best economists to expect this recession to last beyond 2009. The small group of economists and investors we follow at Secure Retirement are split, with half expecting the recession to end in 2010 and half in 2011.

Before explaining why, let's quickly look at who these pessimists are. Included in this group are Nobel Prize-winning economists Joseph Stiglitz and Paul Krugman, Nouriel Roubini, a well-known economist who predicted the credit crisis, Dr. John Hussman, one of the most accurate macro-economists in the country, and legendary investor Jim Rogers. While not as clearly negative, Warren Buffett has also mentioned 2012 as a time when the economy is likely to be growing sustainably. Of course, this implies that the next 2+ years may be difficult for us.

At Secure Retirement, we pay no attention to the number of economists and analysts who believe something will happen. Instead, we focus exclusively on the views of those who have a long history of turning out to be correct. And the group listed above has an unsurpassed track record of clearly seeing the big picture.

Why is this group so negative? I can answer this with one word: debt. Until last fall, our entire economy was highly leveraged, meaning we were swimming in debt. And when an individual, a corporation, or a nation unwinds debt, this leads to lower economic activity, i.e. less corporate and consumer spending. Our debt was an unusually large wave, and now the tide is going out. Yes, we will recover, but the size of the debt wave was so large that it is likely to take significantly longer than normal before the economy can grow on a sustainable basis.

One of the main reasons the best economists remain cautious is that the mortgage market is most likely facing another huge round of defaults. While we have gotten through a substantial percentage of the subprime mortgages that have defaulted, an even larger number of adjustable and "Alt-A" mortgages are coming due, with the largest group needing to be refinanced in 2010. The Alt-A mortgages are particularly troublesome, as they are larger in size than the subprime mortgages. The problem is that they were often referred to as "liar loans," as many lenders did not require proof of income. As a result, it is estimated that up to 70% of the borrowers misrepresented their income. When they have to refinance, the homeowners will be faced with the prospect of having to prove sufficient income and prove that they have enough equity in their home to get a new mortgage. With housing prices way down and lending requirements way up, many of these homeowners would not be able to refinance today. Clearly, if something is not done to change this equation, we are likely to have a huge new wave of foreclosures.

But it gets worse. Commercial real estate loans are larger in total size than any type of loans except prime mortgages, and most experts in this field say a wave of defaults is now coming to this market. And then we have a trillion dollars+ in credit card loans that are deteriorating.

When you put these pieces together, you can see a severely weakened financial system that is going to experience even more problems going forward. This would then lead to a further tightening of credit, which would choke off economic recovery and lead to more and more job losses, leading to more foreclosures. On the consumer side, we then have a populace that is already over their head in debt, facing more uncertainty, more job losses and foreclosures. This leads to people spending less, which leads to lower corporate earnings, etc., etc.

None of this means we will experience the level of crisis and panic we had last fall, and it doesn’t mean the U.S. economy won’t ever grow again. But it does mean we could very well find that this recession lasts much longer than many people expect at this time.

Investing Your Retirement Money in This Environment

I also have a one-word answer to this dilemma - and that word is caution. There are many ways to value the stock market, and I won't go into the details here. However, I will share that if the pessimists turn out to be correct, the Dow Jones Industrial Average would be fairly valued around 5,600 at the end of the year. This would be a further loss of one-third, putting it 60% below its high set in 2007.

Of course, if the optimists are correct, the Dow could go a third higher by year's end, or the market could go up and down with no overall change. My question is, would you be fine financially if your stock investments did go down an additional 33%? For most of our readers, I am pretty sure I know the answer to this question. Yet very few investors have plans in place to deal with this distinct possibility. At Secure Retirement, large losses are never acceptable. As a result, we have taken steps, and are prepared to take additional measures, to protect our clients’ retirement money should the economy and markets resume losing ground.