Those who know me know that I don’t see a lot of value in predictions. It’s not that they’re
not a lot of fun, mind you. It just seems that whenever a prediction of any kind is made it’s so easy to naturally buy into it. I mean, the people who so often make predictions are likeable because they give us a glimpse of what the future might hold. They get us to see possibilities, and we like that. Who wouldn’t want to know what’s going to happen next? It’s an age-old wish and, because it’s so easy to feel helpless against forces that are larger than ourselves, we naturally want to know how it all ends.

Because the markets have been so dynamic this year (isn’t that a good way to put it?), I’d like to go out on a limb. Two limbs actually, because I firmly believe that the story of investing is really quite simple: time and time again, markets experience periods of boom followed by periods of bust followed again by periods of boom. For many investors (large and small), successfully navigating both can be a significant challenge, and along the way the stress of
either participating in too much bust or not enough boom can be maddening.

This point cannot be made any more forcefully, confidently, and clearly: the reason that so
many investors, advisors, and institutions have such a difficult time with successfully navigatingbooms and busts is that they only prepare for one, most often for the boom. We’re all optimistic creatures, we all believe in the adage that tomorrow will be better than today and, as such, we often tend to be overly optimistic when it comes to investing. I firmly believe that it makes more sense to be realistic, to be open to the possibility that markets don’t
always go up, and to recognize the tremendous opportunity that exists (and the tremendous
advantages that you have) from preparing for both.

Make no mistake, there are sizable risks in not preparing ahead of time for the busts, and it comes in the forms of large portfolio losses, a significant erosion of purchasing power, cashflow problems, unemployment, contraction of lifestyle, and worry. All in all, not a good situation, but one that I think can be largely managed.

Going out on a limb or two…

From this point forward, I believe there are two probable paths the markets will take: 1)
they rise significantly from here; or 2) they will continue to fall significantly from here. So, here’s my two-fold case for how the current market and economic drama will play out over the next two years and why investors need to prepare ahead of time for both.

Case #1: Bust. I start here, not because I believe that this is the more likely scenario, but it
happens to be the one on a lot of people’s minds right now. And with good reason. Credit is
the grease that makes our global financial engine run smoothly. Because of the flood of bad debt, and the escalation of defaults and delinquencies, it appears less and less likely that most banks will be in a position to lend as freely as they have in the past. A lot of credit
was extended by the ultra-low interest rates and easing initiated by the Federal Reserve, with Fed Funds rates hitting a low of 1.00% in 2002. You remember all of the zero-percent financing that the auto manufacturers offered, right? The ultra-low mortgage rates? Getting pre-approved credit cards in the mail every day? Easy money did exactly as planned, with trucks flying off the lots, a housing boom, ballooning credit card debt, and all sorts of commercial building and expansion. Boom, right? But remember that boom is so often followed by bust.

The biggest challenge I think that we’re facing is really a condition of overcapacity. Too
many houses with too few buyers. Too many expensive trucks with consumers concerned about fuel costs. Too much unfilled commercial real estate because of the natural slowing of the economy. It happens time and time again.

This time, though, it could get much worse. If banks aren’t willing or are unable to lend at
the same pace that they were just last year, it will be impossible for the economy to grow as fast, corporations won’t be as profitable as they were, consumers won’t feel comfortable spending as much, and the spiral could continue for some time.

And that’s the key: time. The Federal Reserve and the U.S. Treasury have played a game of “chicken” with the U.S. Economy, deliberately failing to support the falling dollar in an effort to help our domestic exporters. And it’s worked, to a degree. But the falling dollar has gotten way out of control, and now we’re backed into a corner. The inflation “genie” is now out of the bottle (largely because of the falling dollar), and it will probably take a series of rate hikes over the coming 18 months to get it back in the bottle. This is bad because the last thing we need right now is higher interest rates to constrict lending even further.

But consider the cost of not acting: inflation spirals out of control, nations hoard resources
for themselves, the dollar’s decline continues unabated making it even harder for inflation to be reined in. Housing prices fall dramatically (because no one is buying the glut of homes that are already on the market), new projects cease and the construction industry experiences
double-digit unemployment.

What about the markets? Under this type of a scenario, not much works well. Buy and hold strategies are crushed, most notably 401(k) accounts which continue to hold only traditional funds that are designed to participate in everything the market offers (both good and bad). Balanced buy and hold strategies like Fidelity’s Freedom Funds, M&I’s MAAP Funds, Vanguard’s Target Date Fund Series and hundreds of other inflexible asset allocation funds experience significant losses in both their stock AND bond holdings. State investment boards, college endowments and other institutions experience significant portfolio losses due to their inability to break their cycle of market correlation.  Perhaps most meaningful, local and state governments experience escalating budget shortfalls as their ballooning infrastructure costs outpace the revenue they generate from property taxes.

Hold it right there! Doesn’t all of this seem plausible? It sure does to me. I could see how ALL
of these things could really happen given the mess we’re in right now. If this scenario does come true (even if half of it does), are you ready?

Case #2: Boom. And I’m talking the kind of boom that legends are made of, the kind of
boom that will set up your children and their children for a lifetime of comfort and security. The kind of boom that only comes around once a decade. One that you wouldn’t want to miss out on.

Here’s how it unfolds: The human heart and spirit are resilient, and our minds have a penchant for problem solving. Right now, our greatest minds are working overtime to fix our
energy problems, our economic mistakes, and our endless thirst for consumption. The ultimate benefit of economic hardships like we’re facing right now is innovation. You know the famous saying: “Necessity is the mother of invention.” It’s how the system works, and although it’s painful to go through, it’s necessary for us to advance. It always has been (just
ask your elders), and it always will be (just ask your neighbor).

One key benefit of having oil priced at $140 a barrel is that it makes previously unnecessary
energy innovation economical. Imagine a world in which we were able to grow our own energy right here in America. Ethanol you ask? Better. Celulosic ethanol. This is a 2nd generation bio-energy source made from agricultural waste, like corn stalks. It can also be made from paper sludge (anybody know of a place that might have some, perhaps near Appleton?) and it can also be made from switch but it is in Canada, so we should prepare now to invade Ontario. Anyway, can you imagine how liberating it would be if we could grow our own energy, year after year after year? It would change the world politic as well as the world economic.

I’m also reminded that the demographics of the United States are very favorable, as it appears more likely that we will continue to experience a growing population, perhaps adding up to 100 million more citizens over the next 25 years. Just as Japan and Russia and parts of Western Europe are experiencing population declines, the United States would be able
to continue to grow our economy, adding smart infrastructure, smart housing projects and smart commerce. We’re talking efficiency in transportation, efficiency in energy usage, and a quality of life that is every bit as rich as what we experience today.

After the carnage of this credit crunch is over, our banking system will be more resilient, more aware of risk, and hungrier than ever to meet the needs of a growing population. Financial institutions will go back to doing what they do best, be it insurance, be it lending, be it investment banking, be it brokerage. The strong survive, and thrive.

Hold it again. Doesn’t this seem equally plausible as our case for bust? Sure does. Again, I can see how all of these positive scenarios play out. And who wouldn’t want to be around for them?

Truth is, the future is most likely to hold a bit of each scenario in it, and progress often

unfolds just as a pendulum swings from side to side. Balance in the middle, followed by boom, followed by balance, followed by bust, and all the way back again.

Thriving through both environments will take just the kind of flexibility that The Appleton Group Wealth Management Discipline™ alone can offer. Through both good and bad market environments, our discipline has enough flexibility to address periods of boom (like 2003), periods of bust (like 2001) as well as periods of transition (just like now). Keeping losses
in any year to single digits (and probably not eliminating them, mind you) is extremely useful
because it keeps you in a position to participate nicely when the bust inevitably changes back to boom.

(c) Appleton Group Wealth Managment

www.appletongrouponline.com