Patient Investors Stay the Course: Opportunities Lie Beyond Today’s Market Pessimism
by Jim Baird
Universal Advisor, 2008 Issue No. 1

Inflection Point: The U.S. Economy

The degree of uncertainty surrounding the near-term outlook for the U.S. economy rose materially in the latter half of 2007. Although the final estimate for third-quarter growth in Gross Domestic Product was a relatively strong 4.9%, the advance estimate of fourth-quarter growth came in at a softer-than-anticipated annualized rate of just 0.6%. In anticipation of a slowdown, treasury bonds rallied while the equity market continued to sell off into the early weeks of 2008. While most broad market U.S. equity indices posted positive performance for the year, those returns were well below the mid-year gains that were partially surrendered under the crush of negative news in the latter half of the year.

Early indications for 2008 have only reinforced our view that the economy is likely to continue to soften. The nation’s unemployment rate spiked to 5.0% in December. That level is a key psychological barrier, but more importantly one that from a fundamental standpoint suggests that labor markets have weakened considerably over the past six to nine months. As a lagging economic indicator, this degree of weakening provides further evidence of the slowdown in the rate of GDP growth during the prior quarter. Recent data from the Institute for Supply Management also indicates that manufacturing activity in the United States is slowing. Couple these matters with a soft housing market, tightened credit conditions, rising energy costs, and inflation concerns, and the likelihood of a cyclical increase in market risk should not be surprising. It’s the very re-pricing of risk in the market, however, that will create opportunities for patient investors who stay the course with their long-term plans while awaiting the beginning of the next bull market.

Prepare for a Bumpy Ride

The resurgence in the level of market volatility and incremental uptick in investor risk aversion in 2007 was noteworthy after a multi-year stretch of relatively placid conditions dating back to 2003. Given the degree of uncertainty that continues to hang like a black cloud over the market, the pending election, and a first-term president in 2009, we expect volatility to continue into next year. The severe downturn in the housing market is now entering its third year since peaking in 2005, and there continues to be little evidence of a bottom. Leading economic indicators have turned negative in recent months, although they offer little indication of the potential severity or duration of the slowdown. From a policy perspective, the current lack of a clear leader for the Democratic Presidential nomination will also likely contribute to market volatility as potential policies are evaluated and the market handicaps the election results. In short, whether or not the stock market finishes 2008 higher or lower than where it began the year, investors should be prepared for a bumpy ride.

From Uncertainty Come the Seeds of Opportunity

The key to success during periods of uncertainty does not lie in attempting to tactically move in and out of the market. That type of day-to-day decision-making amidst market volatility is more often than not likely to lead to sub-par results, especially when trading costs and tax consequences are considered. A well-crafted investment plan actually incorporates the effects of inevitable cyclical bear markets into the plan’s long-term assumptions. It’s true that day-to-day decisions can have a substantial impact on one’s long-term success in both financial and non-financial matters. Myopically focusing on the day-to-day gyrations of the market, however, seldom increases the probability of achieving one’s goals, particularly if the result is an ill-advised act that’s contrary to one’s long-term, established financial plan.