Making Money Even if the Market does not Go Up.

Nobody knows for sure which way this market is headed in the short run. My firm’s motto is “Being prepared is more important than making predictions”. We cannot predict market movements with certainty, but we can assess or estimate probabilities-that is part of being prepared. But it must be remembered that an 80% probability of something happening is still 20% from being certain.

In my previous blog, I mentioned that it looks like we might already be in a period that is similar to the 1970’s. Casual conversations with friends or family and business conversations with clients invariably displays a level of pessimism and fear not seen since Jimmy Carter was President. Fear of inflation, fear of losing a job or business losses, fear of general economic decline.

Inflation is obviously present in the price of petroleum, commodities, and food. So, what’s the cause? Extraordinary global economic growth is the reason. Developing economies are experiencing “demand pull” inflation with rising wages. Developed economies are experiencing “cost push” inflation which is restraining wages. Demand pull inflation tends to feed on itself, generating more inflation and a boom/bust cycle. (The recent home price bubble in the US is an example.) Cost push inflation tends to result in an economic correction and a general pessimistic feeling--that of "being out of control". (Having to pay more for our corn flakes because the farmer is now getting $7 a bushel for his corn instead of $3.)

Oil and commodities are priced high because of strong demand. According to Fed President. Janet Yellen, since 2000, world demand for oil has increased by 11 million barrels a day (14%) without a corresponding increase in supply. And commodities that are not traded by speculators are up as much or more than oil that is traded by speculators. We have a classic demand pull inflation going on. Probability is high that such booms are followed by busts. I personally think that commodities and oil can continue rising, but the probability is better than 50% that we are very near the top. Be careful not to jump on the bandwagon just before it falls of a cliff.

Although we like to think of real estate as an investment, for the vast majority of people, real estate is a cost. As the price of real estate declines, it creates deflationary effects. Housing is in the process of becoming more affordable. While the price of gasoline and food rises, the demand for most everything else declines. This also can cause deflation. While the price of fuel may cause producers to want to raise prices, there has to be demand or nothing gets sold. Money supply growth drives inflation and a decline in the money supply creates deflation. The credit correction we are experiencing is causing huge pressures toward a reduction in the money supply--offset (maybe only in part) by aggressive moves by the Fed. The probability is high that risks of deflation are almost the same as inflation.

Inflation produces winners and losers. You may not like paying higher prices for food, but even though few admit it, farmers are experiencing better results than they have seen in decades. While this is a difficult market for home-builders, there is still demand for housing and apartment owners are doing pretty well. This is the point of the mantra—“You must own a diversified investment portfolio”.

So as Franklin Roosevelt said, “We have nothing to fear but fear itself”. And, my view is that markets are more affected by fear of the unknown than fear of any known event or trend. Although we never really know the future with certainty, we feel better when we think we do! In periods of fear, be "courageously cautious" and seek out bargains that will be the source of out-sized future returns.

It is highly probable that markets are closely correlated with corporate profits. And corporate profits have been declining since the 2nd qtr of 2007. It is highly probable that corporate profits may continue to decline or remain flat for quite some time. So, our investment portfolios should be adjusted to focus on diversified sources of rising income. These sources are companies that have corporate profits that are predictable and relatively stable.

There are three sources of investment income: interest, dividends, and capital appreciation. Most likely interest and dividend income will be relatively more important in the near term than they were in the boom periods of the 1980’s and 1990’s. Choosing companies that generate real income and reinvesting that income will produce rising income over time. Choosing the correct mix of dividend and interest income will depend on each individual’s circumstances. More “certain” income from fixed income investments is generally recommended if you are taking income from your portfolio. This has become relatively more important. And, given the deflationary pressures discussed above, a laddered portfolio of fixed income investments will probably approach historical norms for total returns.

So, is the market going up or down? History teaches that it is probably going up in the long run. And we believe that the current market is likely to move up as we approach the end of summer. (60-80% probable) However, given political risks associated with the elections (because of changes in tax policy) and the chance that we are near the end of a boom period in developing countries, we are advising a slight reduction in international exposure and more emphasis on stocks that pay attractive dividends. Look for opportunity where prices have fallen and dividends are higher yields than historical averages-and where the dividend would still be attractive even if cut by 30-40% in the short run.

Take a look at companies like FR, DRE, FPL, IBDRY and BMY. (Not a recommendation—suitability is determined by many factors and a decision to buy or sell should not be made until having first consulted with a qualified financial advisor who will help assess your current situation and risk tolerance.) Companies that provide necessities and where the “trend is your friend” are the stocks you want to own going into the near future. BMY is in health care and will benefit from the aging population—even with more government controls on costs. FR and DRE are REIT’s that benefit from the trend of growing world trade. FPL and IBDRY are electric utilities that are leaders in alternative energy from wind. Avoid speculative positions and holdings--the chance of being disappointed is very high.

By carefully selecting the correct assets and allocation, you can make money, even if the markets do not go up.

Note: Strout and/or Strout's family have positions in FR, DRE, IBDRY and BMY.

See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the SEC. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as President/CEO and Chief Compliance Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC or Pershing LLC. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC.