December Outlook: How to Preserve Capital

A conservative investor needs to be defined as the situation changes the definition.

Prior to 2008, my definition of conservative investing was high risk stocks, funds, ETF’s, rental properties, commodities and a little gold thrown in for good measure. I learned long ago you either engaged the market for the maximum return, or you ended up with returns lower than just putting your money in a bank account. Except for the dot-com bubble, this approach served me well.

I have lived off of my portfolio since 1995 and it has still grown nicely in size even discounting for inflation. You see, in 1995 at 45 years old, I walked away from a senior corporate position and raised the sails on my yacht starting my first world circumnavigation. Try adjusting your portfolio from Cocos Keeling, St. Helena, or Fernando de Noronha. I needed a portfolio which would reliably provide for my lifestyle with little maintenance required. I love bull markets.

After going around the world a couple of times, I began using Malaysia as my base of operations beginning in 2002. If you own a boat, you will understand. Malaysia is a completely wireless country with high speed internet even in some jungles. No matter where I anchored, I had internet. My ability to research and to trade was better than many places in the USA because of internet access.

And along came 2008. My portfolio was starting to drop in value, and the dot-com type nightmare began again. I started liquidating to cash as each sector began to show weakness. I was not going to hold on like I did in the dot-com bust. I swore I would not ride a market down again. And whatever remained in my portfolio was sold the day Bear Stearns failed.

So in December 2008, my definition of a conservative investor is one who chooses not to risk capital.

Not everyone is or should be a conservative investor. If I was 35 and working, I would be investing monthly - I have been there and done that. But if you are retired, or a baby boomer, loss of capital at this point may change your life. Investing should not be a crap game where you are risking your lifestyle.

All the economic forecasts today are guesses as we have sailed the economy into uncharted waters. I have heard over and over all recessions are the same, they will all end, and we will live happily ever after. Sorry, I am not buying this argument this time. This will end well only for investors who can retain wealth during this down cycle and position themselves to take advantage of opportunities when they present themselves.

At this point no economic event would surprise me. We have a government which has just stated they are printing money to buy their own debt. Consumer and government debt is outrageously higher than any point in history. Oil falling $100 from its peak to under $50 a barrel. Ninety day T-bills yielding almost zero return to investors. GM on the ropes. Does this sound like a stable situation to anyone?

Shortening the investment horizon:

It is impossible to forecast government action, financial events (like Lehman’s bankruptcy), natural disasters, or international events. Very smart people have been very wrong about what happens next. Each of us have an economic messiah who has shown us the way in the past, some have even predicted this economic maelstrom, but literally all have failed to properly identify the investment path that we should have been on for the last six months. Few predicted CASH but it was indeed one of the winners.

There is a problem with timing. These very smart people could be correct on their predictions but missed the timing. What they are predicting to be the correct investments may very well happen in the near or not-so-near future.

So this leads to my investment strategy. I do not want to arrive early to any investment. My strategy is to preserve capital. Being early could put you into an investment that could lose money for a long period. There needs to be clear signs in the fundamentals that a certain investment strategy is becoming the way to make money – and I do not care if I catch it at the bottom.

The economy is like an ocean with currents, weather cycles, storms and seasons. And we are in a ship crossing this ocean. The near term weather is predictable (what-you-see-is-what-you-get). After that, it is anyone’s guess. I have decided to ignore the forecasts in my investing horizon. I am positioning myself to be able to react to whatever situation I or the forecasters postulate. So my investment horizon is now only 30 days and this is how I see things for December 2008:

Economic Outlook

I said you should ignore forecasts but ECRI has not been wrong. I have followed their work for many years. They correctly documented and published, beginning in December 2007, the forecast for the recession we are in. In June 2008 ECRI correctly predicted this deflationary patch we are now entering. There will be deflationary trends in December. The economic conditions will continue to worsen. These trends are predicted by ECRI to continue through their six months forecast period.

So for December 2008, investors should expect to see a little worsening from November. It is Christmas and consumer activity picks up in December. My bet is the average consumer will get caught up in this season of giving so it will not be as bad as it could have been.

Cash: Accumulate

I want to position myself to be a vulture to buy when the time is right so I am accumulating cash. The dollar should remain strong for this month so cash will remain in dollars. Sell what you can, and what you do not need. My cash is invested in Money Market Funds which is guaranteed by the government. For new cash accumulations, buy treasury bill mutual funds offered by most fund families which is government debt and as safe as anything. Buying T-Bills directly makes your money less liquid. Further you need to continue to validate that your bank or financial institution is sound. Spreading your money between several institutions is prudent.

Gold / Silver: Accumulate

In December 2008, there is no strong driver for gold to rise in value. However, instead of wasting your money on a plasma TV, this Christmas give your family physical gold coins, gold bar or gold jewelry. A few years from now when you are trying to pawn off the TV for groceries, you will be kicking yourself for not buying gold. Gold does not lose relative value. The advice for gold also holds true for silver.

Commodities: Caution

I see nothing in the next 30 days to drive prices up.

Equities: Caution

Stocks are very volatile and have no place in a portfolio that is designed to preserve capital. Stocks could rise or fall 1000 points tomorrow and it is no longer news. If I day trade, my investment horizon is usually counted in minutes – I hold nothing overnight.

Bonds: Caution

I have discussed treasuries (T-bills) under cash. Small investors should own bonds inside of mutual funds for ease of disposal. This year many bond funds are under water – and most bonds therefore should not be in portfolios whose purpose is preservation of capital. As states and municipal governments have budget shortfalls, these bond groups are not recommended. I am very uneasy about corporate bonds in this current economic climate.

Real Estate: Dispose

Get out of dodge. Do not pass Go. Sell, sell, sell. I sound like Cramer. This is the most difficult decision. I believe real estate in many places in America will fall another 20%. If you have real estate as an investment – such as rental property, you need to sell it. Most rentals make you a little money but your big gain was the appreciation of the property when you sell. Real estate appreciation does not appear as possible for many years looking ahead.

If inflation occurs, interest rates for mortgages will rise, pushing down the price buyers can pay. I had a 12% mortgage in the late 70’s. Home prices move up out of sync with inflation. In fact, if you could consider the home you live in as an investment (and not a home) – sell your house and rent. Use your cash produced by the home sale to be a vulture at the appropriate time. The added advantage is that it is cheaper to rent than to own.

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