Barring a catastrophic Monday, It Looks Like The Dow Will Be +7% For 2007

Not A Bad Performance, Considering The Major Events of The Past Year

December 30, 2007
By: Jerry Cole - Retirement, Investment

Barring a catastrophic event on Monday, it looks like the Dow Jones Industrial Average will end the year on the sunny side of 7%. Although below average, that is not a bad performance considering the major events that took place in 2007.

To put it into prospective, use the rule of 72 in which you take the number 72 and divide it by the rate of return you are getting to arrive at how many years it takes you to double your investment. Ergo, the 7% return on our market investment would double in a little over 10 years on a compounded basis.


Now compare that to what has happened to your home value over the last 10 years. Has it doubled? In some cases the answer is yes. We have had a remarkable increase in home values in the past 10 years. But how about over the last 20 years? Is it worth 4 times what you paid for it 20 years ago?. Probably not in our area, but in some parts of the country, home values are more than 10 times what they were 20 years ago.

So it isn't too surprising that we are witnessing a correction in home values. And this has been responsible for all manner of problems on Wall Street and at the nation's banks. It has hurt us individually as well, especially if you have had a job change, are retiring or have to move for other reasons and wish to sell your house.

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Last week, the Commerce Department reported surprisingly weak sales for November. Sales fell at a monthly pace of 9% and were down more than 34% annually, the largest drop in 17 years. This caused bond prices to jump as investors became more fearful that the economy could slow and they were looking for the relative safety of bonds. In a worst-case scenario, the weak housing market could hurt consumer spending as it cuts into homeowners' ability to borrow against their home to buy goods and services. In turn, weak consumption could hurt corporate profits and the broader economy.

But this doesn't mean you should go out and buy just any old bond or bond mutual fund. For example, the worst performing bond fund category this year has been the bank-loan funds. These funds invest in loans made by banks to corporations, typically ones with lower credit ratings. They have gained just 1% this year, and even lagged behind junk-bond funds, which buy riskier corporate bonds. Like junk bonds, bank loans were punished when subprime issues took center stage last summer and investors flocked to the safety of Treasury bonds.

Bonds are debt securities. They are contracts whereby an investor loans money in exchange for the corporation's (or government's or agency's) promise to pay a given rate of interest, and to repay the loan at a given time (maturity date, or maturity). As a rule, debt securities provide income, rather than "growth", in a portfolio.

There is an enormous variety of debt securities out there, not to mention the features and terms of the various types. Although it is probably safe to say that every portfolio should include at least some debt securities, not every debt security is suitable for all investors.

As in any financial crisis, such as the credit crunch brought on by the subprime debacle, there will be opportunities. You have to be well aware of your risk tolerance and know your timing to take advantage of these opportunities. Some that are cropping up are beaten-down sectors such as financial stocks, high quality municipal bonds and even risky high-yield, or "junk" bonds. Banks such as Citigroup Inc. have announced multi billion dollar write-downs because of their mortgage exposure, yet their underlying business is relatively strong. This could produce decent earnings over the next few years and provide a boos to their stock.

It is always difficult to predict a bottom and it is no easier to predict a top. Depending where you are in the investment cycle of life, it is often more prudent to stay the course. In any event, remember to keep your risk within your tolerance and keep ahead of inflation.

I invite your questions.

(The opinions expressed are solely those of the author and not Gen worth Financial Securities Corporation.)