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When Will This Economic Chain Reaction End?
by Emily Sanders
May 5, 2009
Bleak... is the word most seen in media
headlines when describing the financial landscape. The constant stream of negative news hits
investors emotionally, even with a few brisk rallies in this bear market. The question is being
asked a thousand different ways amongst financial professionals, on TV, in the halls of power and
at dinner tables: "When will the systemic chain reaction of this crisis end?"
If we're really being honest the answer is: "Nobody's really sure." There's great debate as
to the effectiveness of the government's new economic stimulus packages, and whether "spending"
programs will be more effective than tax cuts. While the markets did show some positive spikes in
March, a slightly more positive new housing report and some improvements in consumer spending, it
remains to be seen if these are more than just momentary upticks.
In a "typical" bear market or recession, improvements in the markets lead the way to an
overall economic recovery. But this is an unusual situation and historical precedents don't
necessarily carry the same weight.
While this painful process continues, risk management is the overriding strategy to preserve
hard-earned wealth. The question of how the global economy has arrived at this point can best be
described by a cycle called debt-deflation.
Debt is at the heart of the world's economic troubles, whether through taking on excessive
debt or lending out too much without regard as to whether it could be reasonably paid back. During
a debt-deflation cycle, it's as if everyone is trying to get rid of their debt at the same time.
The effect of too many sellers and not enough buyers drives down prices of assets. Asset prices
fall much faster than debt can be offloaded, and as a result the overall level of indebtedness
actually increases. Margin calls and debts coming due result in a spiral of forced liquidation of
quality assets that drive prices down further.
Banks and consumers alike have strong incentives to accumulate liquid assets like cash and
short-term government backed securities. Money that would have been used for economic transactions
benefiting the economy instead goes to paying off debts and saving.
The way to ride out this paradigm shift requires patience, as the market hates uncertainty.
A focus on reliable businesses with stable dividends can bring a level of stability to this
picture, even with a growing tally of blue-chip companies cutting dividend payouts. Innovative
companies with strong balance sheets will survive and plant the seeds for future growth.
Cash comprises about 25 percent of clients' portfolios, and gold continues to be held as a
"safe haven." Short-term fixed income is being added to supplement income on historically low
yields on cash. Fixed income instruments of sound quality will remain in demand with higher bond
prices translating to lower yields. The stock market typically turns six months before the economy
does, so expect 2009 to be challenging.
The debt-deflation cycle will eventually run its course. The "Great Recession" is expected
to extend into 2010 and is pervasive in that two components of household net worth are declining
simultaneously: financial assets and real estate.
Near term, the dollar is likely to continue strengthening, not necessarily because other
countries have confidence in the U.S., but because much of the world is paying off
dollar-denominated debt. In time, the dollar will be pressured and inflation will then become the
chief concern.
While this is a difficult time for many, the U.S. has the most innovative, most resilient
workforce in the world and we will come through these times better, wiser and more prepared for the
realities of the new global economy.
Emily Sanders is President and CEO of Norcross-based Sanders Financial Management. She is a locally and nationally recognized investment advisor who is quoted often by the Atlanta Journal-Constitution, CNBC, Bloomberg News and CNN Radio.
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