By Scott Moser, CPA, PFS, MST   

David Roche authored an article published in the October 2008 Far East Economic Review.  His premise was that all empires undergo a pattern where “ideology loses sway, the economic model fails, the currency loses favor and finally military power wanes.” He argued "Unsustainable living standards at the empire's core, which were enjoyed but not earned, depend upon flows of wealth from the periphery.  The empires were those countries where consumers spent briskly regardless of consequences and the peripheries were those economies where consumers saved more than they spent” and debt was discouraged.

This theme may bring back memories of history lessons from past school days. Has the U.S. reached its moment of peak influence upon the world and headed into decline?  This thesis should scare the daylights out of any avid fan of Denny Crane, the patriotic star in the hit TV series Boston Legal. 

Americans are facing a crisis of confidence and the U.S. government is fighting the war by infusing massive amounts of liquidity into our financial system.  Foreign governments have pursued  a similar strategy.  So what should investors do in response to these unprecedented disruptions to capital markets?

Here is a summary of steps we’ve taken in the past 6 months in response to the crisis along with some insight on future direction:

·          The worldwide infusion of liquidity is likely to result in significant future inflationary pressures. So for the first time in 10 years,  we started buying gold when it hit $700 an ounce and we have continued buying as it appreciated to over $900 an ounce. 

·       Our equity portfolios tend to be heavy on NASDAQ listed stocks - positions we believe will lead the market in the future. However,  in order to protect portfolios from what we anticipated would be a short-term downside (we estimate the market bottom at +-6,300 on the DOW index), we included a short position on the NASDAQ index in most portfolios;  that is,  the inverse of the NASDAQ composite. 

·       We continue to add to other securities that protect against inflation such as energy stocks, inflation protected treasury bonds (TIPS) and we’ll likely add broad exposure to commodities as the market stabilizes. 

·       Treasury bonds have reached extremely rich levels, so we have sold virtually all T-bonds except for TIPS to lock in those gains.  Other government guaranteed bonds are available with more attractive return prospects-- such as Ginnie Mae’s mortgage bonds. 

·       We anticipate a protracted recovery where dividends may represent all, or a large part, of investors returns. So we have increased exposure to high yielding securities such as preferred stocks and reduced overall exposure to common stocks. As we gain more confidence that a recovery has taken hold, we anticipate  increasing exposure to high dividend paying stocks.      

These moves have generally had a positive impact on client portfolios over the past 2 quarters by slowing the rate of losses. Our client’s composite portfolio for the first two months of 2009 declined by an estimated 8% (net of fees) while the S&P 500 declined 18.2% and the Lehman Aggregate index declined 1.3% in the comparable period.  While we may not be able to save the empire, we’re doing our best to protect our clients. 

Disclosures:  The above comments are not recommendations or an offer to buy or sell securities.  Your investment strategy should be determined in consultation with your investment advisor. We offer no guarantee of performance and your portfolio may be worth more or less than your original investment when you withdraw funds.  Interim performance figures represent our best estimates;  index returns were those published by Standard & Poor and Barclays Capital.