Despite some recent signs of revitalization, the outlook for the financial markets remains unclear.  Weak economic growth (e.g., dismal retail sales, rising unemployment, sluggish manufacturing, and surprising poor corporate earnings) portends a troublesome and vicious deflationary cycle.

On the other hand, massive monetary stimulus may spark extraordinary inflation down the road. Either way, it will require surgical precision to navigate successfully between the proverbial rock and a hard place.  

Economic and Policy Backdrop

Central banks are injecting an unprecedented level of monetary stimulus into the global economy. Although campaigns of this magnitude are rare in history, they do teach us that massive monetary infusion is the only potential cure for what currently ails the economy.

However, the precise amount, timing, and delivery mechanisms are works in progress. More stimulus is warranted, at least until clear signs of a bottom emerge. That, in turn, will increase consumer confidence and lessen investor pessimism, both necessary to reverse current economic trends.

The duration of the stimulus program is unknown at present because it depends on a variety of endogenous factors, which represent what is essentially a global game of trial and error. Given that interest rates have already been slashed, the focus will remain on so-called “quantitative easing,” methods aimed at two outcomes:

• Tangible investment results via lower long-term rates (assuming the size of the commitment is sufficient)

• Visible boosts to investor and consumer confidence.

As of now, it is difficult to see an end to the global economic recession. Manufacturing, employment, sales and housing statistics continue to decline, setting record lows or touching levels not seen since the Depression.

Deceleration in the downtrend of certain economic statistics has led some to call the bottom imminent, but this data is notoriously “noisy,” easily reversed month-to-month, and often restated after initial release.

As central banks pour funds into the global financial system, the capital markets are functioning but impaired by “toxic assets” estimated at between $2 trillion and $12 trillion worldwide.

The most troubling aspect of this is that we still have no real handle on the magnitude of these problems. Lastly, the size of the federal budget deficit—both in absolute and percentage of GDP terms—is unprecedented. The risk of inflation and dollar depreciation down the road is significant.

Time to Be in Stocks, or Out?

Fiscal and monetary stimulus ultimately will right the system, but the timing and unintended consequences are unknown. Consequently, many investors are waffling between states of hope and capitulation – two of the worst investment strategies known to man.

Some clients, perhaps overly influenced by the media, are asking whether they should be getting into the stock market, or out of it.

Here’s what we know about that line of thought:

Trying to time the market is a fool’s game. For example, all of the 20 largest one-day gains in the market occurred in the depths of bear markets and recessions. Attempting to sidestep a downturn and then jump back in to catch the big one-day moves is impossible.

The real issue is how much risk an investor is willing to accept.

Identifying, measuring and accepting risk are critical to any successful investment strategy, and should occur before the first dollar is invested.

Risk is not something to respond to after the fact. In addition to the traditional and well-known parameters such as market risk, liquidity risk, interest rate risk and inflation risk, recent events have highlighted several others: counterparty risk, transparency risk and fraud. All must be evaluated very carefully.

Please don’t hesitate to contact your team of experts at City National Bank.

City National Bank, as a matter of policy, does not give tax, accounting, regulatory or legal advice. The effectiveness of the strategies presented here will depend on the unique characteristics of your situation and on a number of complex factors.

Rules in the areas of law, tax, and accounting are subject to change and open to varying interpretations. The strategies presented in this document were not intended to be used, and cannot be used for the purpose of avoiding any tax penalties that may be imposed.

The strategies were not written to support the promotion or marketing to another person any transaction or matter addressed. Before implementation, you should consult with your other advisors on the tax, accounting and legal implications of the proposed strategies based on your particular circumstances.