By David Roskoph, MBA, CFP

The Market Has Left the Launchpad

For almost two years now I have been holding the caution flag high because of the irregularities beneath the market’s misleading exterior. On September 3^rd I lowered the yellow flag and raised the green flag. This market is a rocket that has lifted off the pad and is headed up. Don’t hesitate – get on. This particular rocket has three stages to get it into orbit. First, the Federal Reserve has loaded the economy with 40-year-low interest rates (monetary policy) and billions in liquid capital (fiscal policy) that will provide the majority of the thrust. Once the ship is safely on its way, the next stage of increasing pension plan contributions will kick into the market at the beginning of 2000. The last stage will be the trickle-down effects of the income tax reduction written into law last June. That, however, won’t kick in until the summer of 2003. These three economic boosters are fundamental drivers for our economy and therefore, for financial markets. Despite the tumult and tragedy of recent weeks, investors must focus on the fundamentals that drive financial markets and not the emotion that all-too-often directs their actions.

Markets neither go up nor down forever and many investors make decisions with emotion while ignoring the all-important fundamentals. Even before the terrorist attack, the economy showed signs of hitting its eventual bottom soon. This year’s interest rate reduction is the most aggressive in the Fed’s 88-year history! Even before the recent crisis, the Fed’s interest-rate cuts were unprecedented. With the lone exception of the Great depression, the market has never ignored such rate-cuts; neither will it now. The first 8 rate cuts by the Federal Reserve set the stage for an economic recovery by early 2002. That recovery was only obscured by the events of September 11^th , not stopped. Put in perspective, the terrorist attacks created uncertainly in an otherwise sublimely certain America. Was the threat of further Middle Eastern terrorism more severe than the nuclear standoff that occurred in 1962? Mid September saw emotion take the markets down well past their rational values.

The losses to the US economy from terrorism are real but they did not create the recession we entered at least eight months ago. The unemployment rate, manufacturing capacity utilization and consumer confidence figures all corroborate a recession. Since the economy is strapped to the back of the consumer, however, we’ve been reassured that if we all just hold hands and buy an SUV everything will work out. A quick study of history reveals that markets recover BEFORE the economy. Profit is lost waiting for someone to say “sell” because it’s officially a recession and profit is lost waiting for someone to say “buy” because it’s officially a recovery. By paying attention to fundamental indicators markets can be better anticipated so that less profit is lost in waiting for official pronouncements. When the fog clears, much of the opportunity available now will be gone.

If you’re still not convinced monetary and fiscal policy alone will get this ship off the ground, consider the government’s stealth campaign to take the burden off Social Security. Quietly, the government is taking the pressure off of the mathematically-troubled Social Security system so it will not be the sole source of retirement for so many. A new tier of qualified retirement plans was created in 1997 and, in June of this year, all plans were liberally expanded. The contribution limits for all qualified retirement plans were raised and indexed to inflation. There are across-the-board catch-up provisions that allow those 50 and over to actually contribute more than the rest of us toward their retirement plans. For example: Individual Retirement Accounts (IRA’s) that have been stagnant at $2,000 per year since 1974. They will be going up to $5,000 per year by 2006 and $5,500 per year if you’re 50 or over. It is plain to see that the government is making it easier and more attractive to put your own money away instead of banking on Social Security. Eventually most of those new contributions dollars will find their way into the market carrying it even higher.

Finally, tax cuts stimulate economies - just not immediately. There is always a lag of 18 to 24 months. However, the downward-sloping tax rates will eventually manifest in increased economic activity. Rates are going down in every income tax bracket. For example: the present 39.6% will decrease to 35% by 2006. That’s a 13% reduction in the gross margin! This third, and final stage will carry the market even higher when its effects manifest in a few years. The bottom line to reinvesting now lies not in the fact that we’re in a recession, or that the market has reeled from the terrorist attacks, or that things look cheap, but simply because of the fundamental monetary & fiscal climate. Foremost, the Federal Reserve is prepared to do what it must to get the job done. Liberalization of the private pension system and the income tax cut lead to the same conclusion but will kick in later. The economic headlines will continue to worsen as recession is finally acknowledged and damage from the attack is quantified. Historically though, it is only when a recession is accepted that a market-bottom goes into place. Your emotions (and an onslaught of economic disinformation) may tell you there is no tomorrow for the market. Now is the time to assess the situation intellectually and act against your emotions.

David J. Roskoph, MBA, CFP is a fee-based Investment Advisor and Certified Financial Planner in Gig Harbor. 858-2745.