Two months ago, the research organization LIMRA International surveyed 700 experienced financial advisors who work with individual clients. When asked about actions they have taken recently, 85% of the advisors said they were reassuring clients to "stay the course."
During this recession, "stay the course" has become an overused mantra that is anything but reassuring to most investors. At a time when people are feeling stressed and insecure, it suggests that professional advisors are hanging on passively, holding onto the past and running on inertia.
One year ago, I wrote a column here called Client Communications in Complex Times, in which I encouraged you to reach out to clients and suggest minimal, modest or major changes for 2008. In that column, I wrote this:
"For many individual investors, the 2000-02 market downturn was a crushing blow, from which they have just begun to recover. Some investors might never be able to recover from another similar experience, financially or emotionally. Financial advisors should avoid communicating to clients that 2008 will be a good year, an ordinary year, or a transition year in which any economic or stock market downturn will be brief or painless."
Now, proactive client communication is even more critical than it was a year ago, for two reasons:
- Many Americans feel they have suffered a huge decline in prosperity in 2008. They can't handle another year of devastating losses and sleepless nights by passively "staying the course." If they can't navigate the next 12-18 months successfully, their chances of ever achieving long-term financial security may be greatly reduced.
- Some basic assumptions on which advisors have built long-term planning are no longer operable, at least temporarily. The "foundation of faith" that has served investors well in the past – and may serve them well again in the future – has been severely shaken in the present.
Early in 2009, I encourage you to meet with all your clients and tell them "everything is on the table." This means that any changes the client wants to make should be evaluated with an open mind and a primary focus on preserving assets and increasing confidence in the near term.
In this column, I'll explain why some major trends of 2008 have momentum that will continue through 2009. I'll also suggest specific areas to review with your clients to help them make smart decisions in a difficult environment.
Head-level Vs. Gut-level Planning
Individuals respond to financial stress on a "head-level" of rational thinking and also on a gut-level of emotions and instincts. It is a natural "head-level response" to believe that this recession, now entering its 13th month, will be like the 16-month V-shaped downturns of 1973-75 and 1981-82. If that is the case, the U.S. economy and stock market may soon recover, and there would be a framework for communicating "stay-the-course" optimism to clients.
However, the emotions that your clients are feeling at gut-level can be powerful and indicative of reality, because they are a natural way humans respond to stress and loss. Just as a truck driver's natural instinct is to slow down on an icy mountain highway, your clients are feeling an instinctive need for caution and preservation of capital in today's treacherous markets. They also feel in their gut that this is a different scene than any other recessions they have previously experienced.
The U.S. economy entered the recessions of 1973-75 and 1981-82 with a growing manufacturing base and a strong personal savings rate. However, this recession began with a manufacturing base that had suffered a decade of depletion, and with many American households saving little and living on mountains of debt.
| Comparison of 3 Recessions | 1973-75 | 1981-82 | 2007-?? |
|---|---|---|---|
| Official NBER start | 11-73 | 7-81 | 12-07% |
| Duration of recession | 16 months | 16 months | 13 months and counting |
| Goods-producing jobs gained (lost) in the previous decade | 4.3 million | 2.7 million | -1.9 million |
| Personal savings rate | 11.6% | 11.4% | 0.40% |
| Consumer credit outstanding per person in U.S. | $896 | $1,579 | $8,409 |
At head-level, this data should be compelling. But your clients don't need logical data to know this recession is different, because their guts are telling them deeper truths. They can see once-powerful domestic American industries downsizing permanently. Now, for the first time, they also are seeing corporate failures and job cutbacks in formerly robust service sectors.
They feel more insecure about their own jobs at the same time that their personal balance sheets have been eroded by too little savings, too much credit, and declines in home equity and investments. At gut level, they also know that the momentum behind these trends is likely to continue through 2009.
Key Assumptions That Have Changed
| How I Saw This Coming – A Few Examples |
|---|
| In January of 2007, I urged you to offer a macro-economic review & outlook to your clients to help them prepare for changes. An excerpt: "Many Americans have developed a sense of infallibility about their nation's economy. They think it is the American way to work out of tough jams, including economic difficulties. But America's dominance and prestige in the world has been weakened by faster growing economies in Asia, oil dependence, trade deficits, and the economic and psychological costs of a four-year war in Iraq. This is a good time for clients to plan conservatively while hoping for the best and implementing strategies to guard against the worst." The Value of an Economic Review & Outlook to Your Clients The collapse of the U.S. housing market has been one of the biggest factors behind the downturn. In May of 2007, I wrote about the Paul Reveres of the housing blogosphere, who were then sounding alarms on a housing crash. I said their insights were credible and should be heeded: What to Tell Your Clients about Housing: Bottom-up Insights from the Bubble Bloggers In November of 2007, I urged you to offer municipal bond-owning clients a timely review in anticipation of bond insurance woes and rising state/local fiscal deficits. These same factors contributed to price declines in many tax-exempt bonds and funds in 2008. Now Is the Time to Offer Clients a Muni Bond Review In July of 2008, I argued that forward earnings estimates had become an exercise in fiction, especially in small-cap U.S. stocks. Excerpt: "If history is a guide, it is possible that small-cap U.S. stocks are as overvalued now as the S&P 500 was in early 2000."At the time, the Russell 2000 Index stood at about 700. Over the next four months, the index dropped as low as 371 before rebounding modestly by year-end. |
The long-term planning that many advisors have created for clients is based on assumptions that have held true for decades. They include:
- The U.S. economy is the strongest and most reliable engine of economic growth in the world.
- The U.S. dollar is the world's most respected and stable currency – the "reserve currency" for central banks and sovereign funds around the world.
- Over the long term, the value of stocks and homes always increases.
- Key interest rates – such as the Fed Funds target rate and money market yields – do not go to zero.
At some point in the future, all of these assumptions may be true again – but for now they are hanging by a thread. Therefore, planning based on these assumptions no longer passes the gut-check of many clients, and it won't pass until the momentum behind key trends reverses. Here are five such trends:
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Government Intervention - Since September, every major catalyst for the U.S. economy and financial markets has been influenced by the hand of government intervention. This trend probably won't reverse in 2009 due to: 1) the unprecedented fiscal stimulus of a zero interest rate policy (ZIRP) by the Federal Reserve; 2) massive expansion of the Fed's balance sheet; and 3) explosive growth in U.S. Treasury debt to fund a bottomless pit of bailouts and stimulus initiatives.
After nationalizing chunks of the U.S. financial sector in 2008, the federal government now has begun to acquire a large a swath of the domestic automobile manufacturing/finance industry. It is only a matter of time before the government expands its already-dominant influence over the U.S. health care sector.
At gut-level, your clients know that the federal government can cushion temporarily economic declines, but only free enterprise can drive long-term growth. Also, a heavy government hand produces economic distortions and unintended consequences for free enterprise, such as reduced spending by retirees who live on fixed incomes and now must cope with historically low yields on savings. Unwinding government stimulus measures can produce painful long-term consequences, including a continuing drag on real GDP growth and permanently higher taxes.
Currency Devaluation and Inflation - In a few months of 2008, the Federal Reserve did more to dilute the quality and credibility of its balance sheet than previously and cumulatively in its 95-year history. The Fed's balance sheet stands behind the promise to repay its debts – namely, U.S. dollars. Therefore, it has become more difficult for dollar holders all over the world to evaluate our currency's value. Because the dollar's problems are occurring at a time when other leading global currencies also are weak, investors may find it useful to measure currency values against real assets – especially gold and commodities. It is possible that massive government stimulus efforts now underway all over the world will arrest deflationary forces yet trigger a multi-year period of stagflation – sluggish economic growth accompanied by sharply higher rates of inflation.
Corporate Earnings Declines - The U.S. economy is mired in a historic corporate earnings slump that began in the third quarter of 2007. The table below summarizes year-over-year quarterly declines in corporate earnings, according to The Wall Street Journal's earnings data base:
| Quarter | YOY Change in Earnings for U.S. Public Companies |
|---|---|
| 2007, Third Quarter | -21% |
| 2007, Fourth Quarter | -57% |
| 2008, First Quarter | -30% |
| 2008, Second Quarter | -36% |
| 2008, Third Quarter | -62% |
On top of five straight quarters of double-digit earnings declines, U.S. corporations may soon face weaker consumer/business demand and pricing power at the same time that inflation begins pressuring basic material input costs. Earnings may be significantly weaker in 2009 for companies that depend on consumer discretionary purchases (e.g., media and entertainment) and business capital spending (e.g., technology). While financial sector earnings may finally stop plummeting in 2009, there aren't any near-term catalysts for growing the sector's earnings very much.
De-leveraging and Risk-aversion – This wave rolled around the globe in 2009, crushing prices in most asset classes and creating havoc that reached from U.S. home foreclosures to hedge funds unwinds. Recently, some large hedge funds have prolonged de-leveraging by restricting investors' access to redemptions.
Even in un-leveraged assets, such as mutual funds, money flows are moving away from risk. In 2008, U.S. equity mutual funds experienced net cash outflows of $216 billion through November, according to the Investment Company Institute. In only two other years of the last quarter century have U.S. equity funds experienced cash outflows, and they were far smaller: $15 billion in 1988 and $28 billion in 2002. The momentum behind the unprecedented equity mutual fund outflows of 2008 will continue in 2009.
Employment and Savings - In the first eleven months of 2008, the U.S. civilian labor force lost 1.9 million jobs, and a big acceleration in unemployment occurred near
year-end. For 2009, economists' estimates of U.S. job losses range from about 2 million to 5 million, and the major variable is the speed and effectiveness of federal stimulus programs. Private sector hiring expectations have not been this low in decades.
When workers become fearful about employment, they save more money in anticipation of rainy days. In 2008 the U.S. personal savings increased steadily, from roughly zero at the start of the year to 2.8% in November. This trend has momentum that will be positive long-term for U.S. financial markets. But over the short-term, increases in the savings rate dampen personal consumption, slow real GDP growth, and can lead to higher unemployment. With by far the lowest personal savings rate of any developed nation in the world, the U.S. need years of thrift and frugality to replenish national savings.
Specific Ideas for 2009 Client Reviews
According to some financial professionals, the toughest question they have been hearing from clients lately is: "Why didn't you see this coming?"
The object of the question ("this") is everything that negatively affected clients in 2008 – including stock market losses, declining home values, decreased job security and an economy in turmoil.
Few advisors seem to have a confident answer, although some recognize that "staying the course" is not an adequate response. In my opinion, the most effective answer is this:
"It is true that I, and many other financial professionals, did not see all this coming. But now that it is here, let's not sell it short. The conditions we are facing today are both unusual in U.S. economic history and powerful in momentum. They may continue for some time – and in the interim we should make whatever adjustments are necessary to increase your security and confidence."
Here are five key areas to explore with clients in 2009 annual reviews. Collectively, they may help you recommend appropriate adjustments:
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Job security - Ask non-retired clients whether they are more or less confident about job security than a year or so ago. If you uncover insecurities, probe for specific reasons, and the probability that income may be interrupted.
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Financial liquidity - Spend time evaluating whether clients have adequate liquid assets to cope with a job loss or setback. The old rule of keeping six months of living expenses in cash, often ignored during economic expansions, should be put back on the table during the recession.
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Debts - Ask clients how comfortable they feel with their current debt loads and mortgage burdens and what steps they are taking to reduce or refinance debts. Also, ask if they are concerned about their credit rating or access to credit.
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Stress and anxiety - "Not sleeping well at night" has always been a financial metaphor, but lately it has become a reality for millions of people who have suffered heavy investment losses and a diminished sense of security. Ask clients if they are having sleepless nights and what specific factors may be causing them.
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5. Loss of faith in financial markets and firms - As bailouts of financial companies continue and as scandals like Bernie Madoff stay in the headlines, some investors no longer believe financial markets are fair or rewarding. So many big-name "financial experts" were wrong in missing the severity of this recession that investors no longer know whom to trust. Also, the aura of success that the financial industry created in the past has disappeared, and a new era of consumer skepticism and regulation lies ahead. Therefore, ask clients if they are still as confident that the financial system and markets can work to their advantage.
Focusing on these areas will help you steer the conversation away from "head-level issues" (such as recent investment performance) and uncover clients' gut-level instincts and emotions, which are the key to making adjustments in this period of uncertainty. They can include:
- Downshifting risk by choosing a different asset allocation model.
- Increasing liquidity to be better prepared for a setback.
- Taking steps to preserve assets until more customary financial conditions return.
- Moving portfolios heavily to cash to reduce anxieties – so the client can sleep well at night and go to work confident and productive the next day.
- Increasing exposure to traditional inflation hedge investments, such as gold and commodities, in anticipation of stagflation.
- Reducing exposure to long-term Treasury bonds in anticipation of dollar devaluation and higher inflation.
The Value of Proactive Advice That Arrives in Time
In closing, I would like to offer my own personal answer to the question: "Why didn't you see this coming?"
I did see it coming.
I've been writing this column for Sales Insight for seven years. Over the last two years in particular, I've tried to help you anticipate the challenging economy and markets that you and your clients now face. All of my columns are archived on this site, and none have been revised or updated since they were posted.
My only goal in writing this column is to help you become a better advisor. You can review my columns, if you want, and decide if I have been successful. (The sidebar to this article may help you.)
A few years from now, your clients will look back at your track record of advice in the same way. The proactive guidance you give them today will determine how successful they will be in meeting the historic, unprecedented challenges of this recession, regardless how long it may last.
If you tell them to "stay the course" and the course leads astray, they will not be successful, and neither will you.
However, if you tell them "everything is on the table," uncover their gut-level concerns and make appropriate adjustments in time, you have done the best job for your clients possible, and you will be rewarded.
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