Keep an eye on those indicators

Many financial advisers know that some of their clients' portfolios contain a higher level of cash then they would normally allocate.

Many financial advisers know that some of their clients’ portfolios contain a higher level of cash then they would normally allocate.

Moreover, some advisers are obtaining clients that have even higher allocations to cash than their existing clients.

Perhaps those investors are making the right choice, given that we suffered through the worst year for the equity markets since 1937, the collapse of Lehman Brothers Holdings Inc. of New York, the failure of Washington Mutual Inc. of Seattle and Bernard Madoff’s alleged Ponzi scheme. Whether the decision to maintain higher cash levels was made by the adviser or the client, the adviser needs a road map for reinvesting the cash.

One option is to invest all of the investor’s cash immediately. Pursue that approach if you think it is acting in your client’s best interests and the client is comfortable with it. However, many people are nervous and too uncomfortable to invest like that.

In addition, many investors feel disheartened over the buy-and-hold strategy.

This leaves financial advisers to develop a sensible strategy for investing excess cash. For instance, some advisers will elect to dollar-cost-average over a six- or 12-month period.

Another approach is to follow a few sensible economic indicators that should point to a lower-risk buying opportunity.

Here are a few indicators to track:

• The number of homes for sale needs to decline without further depressing home prices. If this happens, it may signal a turnaround in housing and that home prices are nearing a bottom. Mortgage rates have been hovering at around 5% over the last month, though mortgage applications have surged.

Low mortgage rates might slow the decline in housing prices, but until the excess inventory is removed, prices will continue to fall.

However, the bulk of the applications were for refinancing. Further, the gap between mortgage applications and approvals has widened because of slumping home values, job losses and the declining net worth of many people.

• The economy needs an easing of credit by the banks. Despite massive easing by the Federal Reserve, the majority of banks have been tightening credit standards. Credit is the main artery to the financial system, without which the economy shuts down.

An easing of credit has occurred before every economic turnaround, and improvements in consumer spending, which has fallen for six straight months, will be a positive for investors.

• Commodities prices need to stabilize. Prices have flat-lined in the past several weeks, so hopefully, they have found a base. Also, look for a pickup in manufacturing activity, increased shipping volume rates and an increased demand for commodities such as steel, lumber, aluminum, oil, copper, rubber and plastic.

• The unemployment rate is moving in the wrong direction. While a rising rate has been priced into the stock and bond markets, it is an important indicator to follow. This will most likely be a lagging indicator, which reflects a sustainable recovery; however, pay attention to how the unemployment data are doing, compared with expectations.

• We are experiencing a deflationary spiral that includes worldwide debt liquidation, tumbling commodities prices, a decline in consumer spending and a tightening of credit.

Financial institutions, businesses and individuals are desperately attempting to repair their balance sheets; many are selling assets and slashing expenditures. This further depresses asset values, damaging balance sheets and causing liquidations.

So advisers should monitor this spiral and look for signs that the various economic-stimulus packages are working. Look to see if money is flowing, spreads are narrowing and trust is returning to markets.

You may also want to track some technical indicators, such as the 200-day moving average of the Standard &Poor’s 500 stock index.

If the market goes above the average and the average is moving higher, it is usually a bullish sign. (On the flip side, a breakdown below the moving average last year signaled the start of the bear market.) However, we have a ways to go before this happens.

Bryan Sadoff is an investment adviser with Sadoff Investment Management LLC of Milwaukee.

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