The Biggest Threat Facing Investors; Part II: When and Where

Labor Day each year for me marks the end of summer and the beginning of the fall. And each year, as I get older, the summers go quicker. This Labor Day, though, is a little different for me because of my “extra” concern for the economy.

Yes, the years go by, as the Jerry Lewis telethons mark each passing Labor Day. (For trivia buffs: Lewis started the MS Labor Day Telethon in 1966.) Continuing with the commentary I started this past Thursday, my biggest concern these days is the dreaded deflation.

Let’s look at two important price levels: stocks and real estate. Starting with the most obvious, housing prices in the United States peaked in 2005, and have declined each year since. This is the central problem with the banks: house prices rose steadily for years before 2005, subprime loans were created so marginal credit worthy consumers could buy houses and more houses could be sold, the banks got in on the action, the bubble burst, and the rest is history. House prices in the U.S. have generally deflated every year since 2005.

How about stocks?

If we take a look at the chart of the most widely followed stock index in the world, the Dow Jones Industrial Average, we see that the index sits today at 11,412 which is almost exactly where it sat in the first quarter of 2000. Eight years later and the stock market has gone nowhere.

Sure, investors have made money on individual stocks. (The financial advisory newsletters we publish attest to this, as we’ve made many picks where stocks have gone up by more than 100%!) It is the individual investor sitting with his/her savings or retirement funds in mainstream mutual funds that has seen dismal or no returns over the past eight years.

I have a theory about the action of the Dow Jones Industrial Average. There is no doubt that America had a boom economy from the years 2002 to 2005, but, despite this boom, the stock market has gone nowhere in eight years. Is it a possibility the biggest stock market index in the world is discounting deflation? My theory is that is exactly what is happening.

Economic times are terrible today. Homebuilders and banks are closing. The Fed is bailing out Wall Street. Jobs losses mount, but the Dow Jones Industrial Average fails to fall flat on its stomach. There is something big here with this observation. And I believe the “big” is the market already discounting deflation.

What’s an investor to do? If deflation is indeed where we are headed, the run will be to cash, and by that we are talking the American dollar. The problem with the dollar is that it is presently debt-laden. The next best thing to the dollar is gold. Ideally, you want to be placed in vehicles that produce cash or gold. In other words, stocks of companies that throw off plenty of cash or that produce gold bullion.