In January of 2000, the Dow Jones Industrial Average (DJIA) enjoyed a record closing price of 11,722.98. From that record close and the tech bust, the DJIA ultimately fell 38% to a low of 7,286.27 by October 2002 before beginning its slow march upwards. In October of 2007 the DJIA hit its most recent all-time high close of 14,164.53, but has subsequently tumbled about 17% and fallen below the 12,000 threshold as of this writing.

During periods such as this, with nothing but bad news seemingly coming from all directions, what should an investor do? Do you stay the course or reverse course? Do you take money out of the market or add new money to your investments? With the caveat that market movements are inherently unpredictable (see the accompanying article), here are a few observations:




Fixed Income
Bonds and other fixed income investments often attract people during times of uncertainty or when recession threatens. However, there are two great enemies for fixed income investors - rising interest rates and inflation. We are already experiencing greater inflation and if the anticipated stronger economic growth does appear over the coming months, the Fed will be looking to increase interest rates. In this environment, I would avoid putting too much in fixed income.


Equities There are many reasons not to invest in equities right now, but let's examine some reasons why this may be a great time.

• Historically, market bottoms, and therefore the greatest opportunities for gains, occur when investor psychology is extremely pessimistic - and investors are certainly pessimistic.?
• An accommodating Fed has kept interest rates low.?
• Expectations are that most of the bad news on corporate earnings is already out there and therefore already reflected in today's market. A turnaround in corporate earnings in the second half of the year would give the markets a lift.?
• The dollar is cheap, and this does create risks for our economy, but it also gives exporters and large, multinational companies a substantial boost and competitive advantage. ?
• Looking down the road a year after headline events, such as the Bear Stearns failure, we often see that they represented a turn of the tide and markets have moved higher.?
• We don't know where the bottom is in the housing and credit crisis, and won't until it is over, but it seems we're getting close to it.?
• By many measures, today's equity valuations are attractive. A common valuation measure is the earnings yield of equities (the inverse of the price/earnings ratio) compared to 10-year Treasury Bonds. This ratio is at its best level in 30 years. Financial stocks now trade for about 1.2 times their book value, the lowest level since the last major credit crisis in the early 1990's. Another interesting ratio is "Tobin's q" - a ratio of the market value of a company to the replacement cost of its assets. When the "q" is below 1.0, it indicates that the stock market trades at a discount to its replacement cost and it is therefore cheap. At the height of the tech boom, this ratio almost reached the unthinkable value of 2.0. The long-term average for this ratio is 0.75, and the current ratio is 0.68, indicating a reasonably valued market.

No one will ever announce an "all-clear" signal for investors. By the time you feel it is safe to go back in the waters the market will have already moved. The time to invest is when you can think of 100 reasons not to invest. Sounds like now.


Gerald A. Townsend, CPA/PFS, CFP^®, CFA^® is president of Townsend Asset Managment Corp., a registered investment advisory firm. Email: Gerald@AssetMgr.com

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