Be smart about gloomy forecast

by Stephen Butler

The Bible says, "The lamb will lie down with the lion." "But," Woody Allen would add, "the lamb won't get much sleep."

A computerized Monte Carlo simulation spells out the different rates of return to expect from a portfolio of investments after we apply all probable combinations of good and bad influences. These days, after reading ex-Treasury Secretary Paul O'Neil's account of his experience as a member of the administration, I'm convinced that we are all lying down with the lion.

Why would I stock up on "No-Doz?" Apart from O'Neil's account of the administration's obtuse, hopelessly politicized approach to economic policy, I had the opportunity to spend an afternoon with a walking, talking personification of Monte Carlo simulation. This opportunity came in the form of Alan Beaulieu, an engaging economist and partner at the Institute for Trend Research.

Beaulieu points out that we are approaching what could be a perfect storm's economic downdraft, characterized by excessive debt, high interest rates, an aging population, inflation, high inventories, problems in China, midterm elections, much higher oil prices, and a collapse of home prices.

I can't possibly deal with all these in just one column, but let's say that a third of them come to fruition and the rest fall victim to the domino theory. The Institute for Trend Research is predicting that the economy will unravel in 2008 and that the major impact of the coming recession will hit in 2009. This time around, even housing prices will be impacted because part of the perfect storm will be higher interest rates.

In the recent stock market crash, housing prices continued to climb because interest rates declined and stayed low. This time around, rising interest rates will be part of the problem, and housing prices will fall as a result. Think about what house payments (and values) will do if mortgage rates rise from 6.5 percent to 9 percent. The greatest share of our economy is the consumer sector and this recent period's strength has depended upon people spending what has been the equity in their homes. When this resource dries up, the economy will lose a major portion of its underpinning.

Coincidentally, I'm noticing a shift in emphasis from the asset-allocating gurus like Bob Brinker. Brinker's latest letter suggests that while the markets are still strong, any additional money invested at this point should be allocated over time to benefit from dollar-cost-averaging. This is code implying that the market could "tank" or at least "whipsaw."

His conservative portfolio recommends a 30 percent concentration of short-term bond funds and inflation-protected securities. Dan Wiener of the Independent Advisor for Vanguard Investors is suggesting that about 40 percent of the income-oriented portfolio be invested in a short-term bond fund and a GNMA fund.

All is not doom and gloom. By 2012, according to the ITR charts, we'll be rockin' and rollin' again. That's only six years from now. Reflect on how fast the last five years, with its downturn and subsequent rise, have come and gone. It always helps to maintain a long-term view. New money coming into the stock market over the next six years such as retirement plan contributions will have opportunities to buy stocks and mutual funds at low values. The key for people in business, or those managing their personal affairs, is to not be seduced by today's round of "irrational exuberance."

In case anyone hasn't noticed, the Bay Area is booming. Traffic is worse than it has been in five years, and in many vocations it is difficult to find good people to hire. In this heady atmosphere, it is easy to assume these happy days will continue indefinitely.

To make financial and personal decisions based upon this erroneous belief can lead to, let's just say, "a reversal of fortune."

We each have unique circumstances that call for different decisions than the next guy confronted with the same depressing concerns about tomorrow's economy. Those with a long investment time frame should ignore even the worst economic prognosis. Those close to, or enjoying, retirement should assume that their stocks and the equity in their homes might drop by a third for at least the short term and calculate what that will do to their retirement plans. This sobering thought reminded me of the question: "Other than that, Mr. Lincoln, how did you enjoy the play?"

A sense of humor can sustain us and improve our resolve through what could be tough times.

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