Week of 09/25/2008

In This Issue:

Most Economists Believe The Rescue Plan Will Work
Others Say It Will Only Postpone The Inevitable
We Think The Optimists Are Right
Meanwhile, Here's An All-Weather Investment Plan
The Bottom Line This Week

We've been suspicious for several weeks that Mother Market was not happy about taking a back seat to the recent Olympic games in China. To gain back some of the limelight she has been making bigger swings, jumps, and dives than anything we saw in Beijing. Her efforts are clearly working because nothing else has been able to push financial news off the front pages.

Last week, the market made yet another volatility record, not that anybody wanted to see it. On four of the five days, prices changed over 300 points. Nevertheless, when the dust settled, and the bodies were swept up, the Dow was only down a miniscule 0.3%. The Nasdaq actually managed to rise 0.6%. If you happened to be in Transylvania during the festivities, you might not have known how much fun the rest of us had.

The race for new records continued when the market opened on Monday of this week, and stocks dropped 373 points. Prices started to settle down on Tuesday and Wednesday when stocks fell 162 points and 29 points respectively. Given the circumstances, it is too much to hope that the high volatility will end anytime soon.

Most Economists Believe The Rescue Plan Will Work

The reason for the market's extreme moves is nobody knows for sure if the government's unprecedented rescue package will help the economy or ruin it. Pundits with equally impressive credentials have embraced both opinions. Because so much is at stake, even small changes in the outlook are triggering big stock market swings.

Weighing in on the positive side, many economists believe that Uncle Sam's $700 billion cash transfusion to our financial service industry will keep many essential firms alive to provide the credit the economy requires. The proponents also believe that we will eventually grow our way out of the hole, and everybody's books -including Uncle Sam's - will be balanced again.

There is precedent for believing that the bailout plan will work. Japan used it after its soaring real estate market collapsed in the 1980's and the country's banks went into a death spiral. Although the country subsequently endured a 12 year recession, it wasn't particularly hard on its citizens. In any event, the long recession was infinitely better than the depression that might have otherwise been Japan's fate.

Big cash infusions also rescued the U.S. economy at various times in the past. For example, the Great Depression dragged on for over a decade until preparations for WW-2 flooded the economy with money. The theory goes that using the same technique early in a downturn can prevent it from starting in the first place.

Others Say It Will Only Postpone The Inevitable

Critics of the Treasury's rescue plan believe the bailouts will only delay more bank failures and a sharp recession by a few months. The most vocal naysayers are adamant that the delay will make the inevitable problems worse. They also insist that the bailouts will put the Treasury in the same dire straits as the industry it is trying to rescue. 

Furthermore, the bailout opponents argue, since the government will ultimately get the money from the American people, the rescue plan represents a gigantic case of robbing Peter to pay Paul. The critics go on to cite many examples where the hot potato game of passing the debt didn't end happily.

We Think The Optimists Are Right

We are of the opinion that the government's rescue package is more likely to work than not. However, the bailout money itself won't be its biggest contribution, at least not directly. Instead, Washington's support should make lenders willing to put their own funds at risk once again, and at affordable rates. 

Contrary to popular belief, there is plenty of capital available in the private sector to keep our economy chugging -or at least inching— along. The problem is, nervous lenders have become very reluctant to let loose of it. Many banks are even refusing to make overnight loans to other banks that are known to be sound. Home loans, car loans, and the like are also becoming tougher to get. The squeeze is cutting economic growth across the board.

However, just the announcement that a rescue package was in the works resulted in more capital being made available. Passing the bill should have an even bigger effect. We will soon know how the financial service industry will react because Congress seems likely ready to pass the bailout measure within a few days.

If the rescue package doesn't work, there is no Plan B. Most likely, the Treasury will simply expand the payments from the original $700 billion to who knows how much. Some economists think the final tab could approach $2 trillion, and might still fail to solve the problem. All we can do is wait to see what happens.

Meanwhile, Here's An All-Weather Investment Plan

Although there is little that individuals can do that will have any effect on the national crisis, we can at least protect ourselves. Many of the most useful strategies have been discussed in this newsletter. Here's a summary of what we think investors should consider now:

1) While the storm is raging, your principal goal should be the preservation of capital. The closer you are to retirement, the more conservative you should be with the majority of your nest egg.

Paradoxically, the U.S. Treasury offers the most protection for your liquid assets. Although Uncle Sam is many times deeper in the hole than Fannie, Freddie, Lehman, or AIG (or even all of them combined), the government can create the money it needs to pay its debts.

Three and six month T-Bills are the safest places to stash your cash until the financial turmoil quiets down. You can set up a Treasury account and buy T-Bills using the agency's website: http://www.publicdebt.treas.gov/tdhome.htm

2) Next up are much better-paying, FDIC insured, certificates of deposit from secure banks. As with Treasury obligations, the government will print whatever amount of money is needed to make sure that accounts insured by the FDIC are restored if your bank fails. In an extreme case, you might need to wait a few days for your money, but you will get it.

As we said two weeks ago, you can get a list of current CD rates from top banks from Bankrate.com. www.bankrate.com Stick with banks that have at least a 3-star (***) rating. Here's an updated list of what's available now:

The Best CD Rates In The U.S. From Secure Banks
Bank 1-Yr APY 2-Yr APY Address Min Deposit
Zions Bank 4.16% 4.31% https://www2.zionsbank.com/ $1,000
GMAC Bank 4.35% 4.35% http://www.gmacbank.com/ $500
Capital One 4.00% 4.15% http://www.capitalone.com $5,000
Centennial Bk 4.10% 4.44% http://www.centennialbank.com $10,000
Nationwide Bk 4.05% 4.25% http://nationwidebank.com $500

For larger amounts of cash than the $100,000 FDIC limit, you can buy a jumbo Insured Advantage Certificate of Deposit from EverBank. Everbank.com See the September 11 issue of this newsletter for details.

3) If you are comfortable with a little bit more risk, we recommend the Permanent Portfolio Fund (PRPFX) that is structured to balance the ups and downs of our economy and stock market. http://finance.yahoo.com/q/bc?s=PRPFX The fund rarely does as well as the stock market during booms, but it almost never does as badly during downturns. Instead, the fund seeks a happy medium and generates attractive long-term gains without taking big chances.

The Permanent Portfolio Fund achieves its goals by investing primarily in precious metals, hard currencies, and secure bonds. Holdings include cash, gold in various forms, silver, and U.S. Treasury securities. The fund's portfolio also regularly includes Swiss Confederation bonds, high grade corporate bonds, and the stocks of companies with proven assets.

Although the Permanent Portfolio Fund sticks to a limited range of investments, the balance between them changes with the economic outlook. Currently, the fund is structured for tough economic times and a weak dollar.

4) The best use of a stock market scare is to buy good long-term stocks while they are dirt cheap. You may not make any money from them until the rebound comes, but you will be handsomely rewarded when that happy day arrives.

To that end we recommend the iShares Dow Jones Select Dividend Index (DVY) that tracks the 100 highest-yielding stocks in the Dow Jones Total Market Index. http://finance.yahoo.com/q/bc?s=DVY&t=1y As a glance at its price chart will quickly reveal, DVY is down sharply from its recent high. In a year or so, we think it will be back up again. 

The Bottom Line This Week

Over the past three weeks, investors practiced the old adage, "When the going gets tough, the tough get going." Only this time, many of them decided to get going straight for the door.

Taking a time out when everything is in turmoil isn't a bad idea, provided the goal is to use the downturn to prepare for the eventual recovery. Good places to park some of your money include T-Bills, insured CD's and the Permanent Portfolio Fund.

For far greater gains, however, we think you should put some of your assets into the iShares Dow Jones Select Dividend Index and other blue chip investments that are currently very cheap. Because the ETF may become even less expensive over the next few months, we think you should make your purchases a little at a time.

Until Next Week

The AIA "Advocate For Absolute Returns", a weekly publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next Thursday...


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Posted 09-25-2008 12:29 PM by Research & Editorial Staff
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