Do you ever wonder why two seemingly similar people react to the market meltdowns so differently?  I believe it is far too simple to say the recent rapid correction was the reason for the stress that many individuals have shown the past few weeks.  Of course, it would be equally unreasonable to assume that it was the culmination of the past three years that caused the emotions that arose. To use either of those reasons would not explain why two married individuals would react completely differently during times of financial stress.

To explain the differences in stress levels, I am looking to things far deeper and further back in our pasts. Some researchers will point to gender since many studies have shown that women, in general,  are more risk averse.  While I have found this assumption to be true in my twenty year practice, I have long realized that each of us has a unique story to tell about our early life as it relates to money.

In many cases, this story is unknown even to the spouse of many years. These stories include divorces that have lead to food stamps, failed businesses that have lead to bankruptcy or unemployment that wipeout savings. For older clients who are children of depression era parents, the stories of hardship and fear are even more vivid. While describing these memories, clients can often re-experience the raw feelings of insecurity, fear and shame. After unearthing these emotions, clients often realize the root of their reactions to present day financial stress.

Understanding an individual’s early life with respect to money can often help a financial advisor explain why a client with massive net worth, experience stress over relatively small temporary market losses while other less well to do clients are amazingly calm. In other cases, advisors are able to understand why children of the Depression Era are unable to spend on themselves despite advanced age or ample savings. It is not uncommon for older clients to always want to be in the accumulation phase of life even twenty years after retirement. Conversely,

individuals who have experienced loss at an early age including losing both parents, are sometimes prone to reckless spending and an outward lack of stress based on their inherent belief that “life is short” so why save for tomorrow?

As I write to you today, August 3, 2011, I am one of millions of people trying to digest the aftermath of the debt ceiling vote and understand what is happening to the economy and why equity markets throughout the world have corrected so quickly over the past week.

In order to help provide insight, I decided to go back to the last period following a recession, October 2002 through February 2005.  I chose that period because that 29 month period was equal to the time that has passed since our markets bottomed in March 2009.  What I found was an interesting similarity.

October 2002 - February 1 2005 Dow Jones Industrial Average -Source BigCharts.com

March 2009-August 3, 2011 Dow Jones Industrial Average-Source Bigcharts.com

Now that I established that the two recoveries were similar from a market standpoint,

I then looked at how the Dow Jones performed after 2005 and the economic circumstances that we were experiencing at the time.

Here’s what I figured out:

• The economy in February 2005 was stronger than today as the Fed was actually raising interest rates in order to slow down a housing bubble that was in full ready to pop mode.  In 2005, consumer confidence was higher as was the trajectory of government spending and private sector technology and equipment spending.  More importantly, the financial sector was much larger and more willing to lend during the time prior to the collapse of Lehman Brothers and the government reforms created after the financial crisis in 2008.

• Today the economy vacillates between slow and getting better and one mistake from another recession.  The recent GDP, employment and manufacturing data have confirmed this reality.  This information added to the confusion and lack of leadership coming out of Washington leads to lower corporate and consumer confidence which accounts for nearly 80% of overall economic activity in the US.

I will not bore you to the point where you believe I can predict the future of the world’s economy with any accuracy.  Instead, I will state what I feel are the important conclusions that I can draw from the past few days.

The equity markets are correcting because data was released that indicates that the economy may be slowing to the point that often leads to recessions.  The data caught most people by surprise, especially those who were fixated on the debt ceiling deal.  Whether recession actually occurs, we will not know that until it’s over, but investors hate uncertainty.  Bad news can be measured, a fog of political and financial uncertainty can not be measured.  Some investors feel the best way to handle uncertainty is to sell.  Investors need clarity.  That clarity will happen as the details of what the government will cut become public, and then think tanks will begin to crunch the effects of these cuts on individual issues and whether the cuts will be detrimental or beneficial to our fragile economy.

Let’s look at the bright side; both parties ate crow but got a budget deal done that addresses the issue of reducing debt over the next ten years.  That’s the first step.  US corporations who are financially strong, are waiting for clarity as well.  Clarity on healthcare and regulation will allow them to employ cash reserves to hire more employees necessary to capture additional sales currently coming form overseas.  More sales should lead to higher profits and higher stock prices.  More employees and additional sales will lead to a stronger economy.  The average American needs leadership, leadership that leads to job creation and small business lending. More jobs means more income, more confidence, more spending on housing that leads to more construction that leads to more economic growth that leads to more taxes being paid.  At that point, stock prices will have already risen along with consumer confidence and the argument will begin as to when the next recession will start.  That’s how it should work.

Lastly, let’s not forget it’s August.  The good news is that it’s not uncommon for stock prices to drop this time of year.  So don’t be surprised.  The bad news is that according to data from the past 100 years, August is one the three worst investing months of the calendar year.  The other two are September and October. Let’s pray for snow!

While most people are frustrated with the waste associated with earmarks, the reality is that 92% of the Federal debt comes from entitlements such as Social Security, Medicare, Medicaid, defense and interest on our national debt.

• 1/5 of all American children are on Medicaid; 1/3 in New York City.
• 55% of all healthcare costs are spent on a person’s last two years of life.
• 50% of Americans make $30,000 or less; 66% make less than $50,000; 80% make less than $72,000.

With healthcare costs and premiums rising much faster than wages it is not difficult to understand the problem our country is facing on how to pay for the care we have come to expect.

• According to the CBO.gov website, if the government taxed every working American 100% they would still have to borrow to fund our Federal Budget.
• At the present time, the average American is concerned with the following issues:
  • Rising oil prices,
  • Healthcare,
  • Potential reductions to future Social Security and pension benefits,
  • Inflation,
  • Food prices,
  • Paying for college,
  • State and local government taxes,
  • The next black swan event that can reduce asset values,
  • And, saving for retirement.

Van Mueller gave us a question to ponder: having witnessed periods of great volatility over the past ten years and knowing that our country is facing many difficult challenges over the next ten or more years, what strategies do we have in place to deal with or take advantage of future good and bad volatility?

I believe every plan has to address these issues and plan for increased volatility in financial markets.

Recently, I had the opportunity to meet, listen and ask questions of eight portfolio managers.  Here are a few things I learned and who said it….

Tom Wetherald, Equity Portfolio Manager

Tom feels that with the US economy maturing, blue chip company earnings will grow more in line with the mature US economy than smaller companies.  While this is not a new idea, it does give pause for thought.

Joe McDougall, Equity Portfolio Manager

Joe feels the free cash flow of companies favors equities over bonds over the long term.  He used the example of a blue chip paying a 3.5% dividend as compared to a bond carrying a 2.9% coupon.  He said that equities had delivered positive returns 98% of all ten year rolling periods going back 150 years. Of course don’t count the last ten years!

I asked a question about comparing performance of active management versus index or ETFs with lower costs. Joe made a good point that if returns are equal between the two, volatility is usually lower with active management.

Jim Swanson, Chief Investment Strategist

Jim feels that corporate health is very good because cash on balance sheets is at an all-time high and that the cash currently being produced is actually back to pre-2007 levels (that’s good).  Jim highlighted that declining interest rates has allowed corporations to lower borrowing costs which increases profits.

As for consumers, Jim talked about US consumers spending increasing 2.2% over last year as compared to the decline of 1.8% during the recession.  He reminded us that the housing mess has led to a peak in housing affordability as measured by the affordability index that takes into account interest rates, prices and earnings of consumers.  That may have led to the stability in home prices recently seen in 16 out of 21 regions nationwide.  As for automobiles, Jim tells us that the average auto is now 10.2 years old as compared to the historical average of 8.3 years.  That is good news for future auto sales!

When asked why corporations aren’t hiring, Jim explained that hiring is approximately the 5^th or 6^th action that they take with accumulated cash.  They have done the first four to a great extent already.  For the record they usually upgrade technology next before hiring in any meaningful way.

Maura Shaughnessy, Utility Portfolio Manager

Maura stressed the opportunities that exist outside the US that has resulted in investments in companies in such countries as Spain and Portugal.

I asked her to explain the ramifications of not passing the “carbon tax” included in the failed energy bill.  She indicated that the delay will cause further confusion for utilities on how to be more efficient and reduce costs of generating energy and will delay benefits to consumers.

Ward Brown, Fixed Income Portfolio Manager

Ward talked about the opportunities investing in emerging country’s debt.  As a reminder, emerging countries are for instance, Brazil, Australia, Poland, India, China etc.  He looked back 12 years and noted the 180 degree turn around of their balance sheets from that time when they welcomed foreign money but had structural deficits that led to high risk and eventual defaults.  Not for the faint of heart but certainly food for thought.

Tom Melendez, International Portfolio Manager

One comment struck me.  He indicated that in 2010, approximately 50% of the world’s GDP is produced outside the US.  When considering allocations to companies with regards to their domain, he suggested we look at a cross section of global money managers to assess how much opportunity they feel lies outside our borders.

Eric Fischman, Growth Portfolio Manager

Eric made a lot of good points but my rain was beginning to fry but I did note one point:  prices of equities are ultimately driven by earnings and earnings are driven by fundamentals.  Eric described how valuable it is to be able to understand a company’s fundamentals by speaking to their management before making decisions whether to invest or not.

As the day ended, I realized how fast the world is changing and that there are no shortage of opinions on how to best profit from these changes.

These discussions do not constitute investment recommendations but instead are solely intended for educational purposes.  Any information that might be used to make changes should be discussed with a professional to verify accuracy and relevance to your specific situation.

Securities offered through Securities Service Network, Inc. Member FINRA/SIPC. Jay L. Gershman, Registered Representative. Fee based services offered through SSN Advisory Inc, Registered Investment Advisor. Office of supervisory jurisdiction 9729 Cogdill Rd Suite 301, Suite One. Knoxville, TN 37932 865-777-4677