So Where do Investors put Their Money Now?

These are exciting times, some call them scary. For investors, remember the foundations of fortunes are built during bust cycles. The U.S. Senate just passed the Emergency Economic Stabilization Act, more commonly referred to as the Bail Out Bill. I was against the bill, but as I've always maintained, I can't influence policy so I adjust and see how I can best profit from policy.

This past Monday, the U.S. House of Representatives rejected the Bail Out Bill, the market dropped over 700 points. The following day the market rebounded 450 points.

A review of the current financial climate shows the following. There is a credit crunch. The Federal Funds Rate is 5%, the Fed's target for that rate is 2%. The yield on the three month Treasury bill is at .65% - in a normal environment it should also be close to the Federal Funds Rate. The Libor, which is the European equivalent to the Federal Funds Rate, is also at 5%. All of these indicate the unwillingness of banks to lend to each other, thus the premium. Assuming the U.S. House passes the Emergency Economic Stabilization Act on Friday, these rates will start to go down. Banks currently won't lend to each other because many are carrying the toxic assets that the the Stabilization Act will buy up. As these toxic assets come off the banks balance sheets, and the banks are recapitalized, credit markets will ease.

What can investors expect to see? There are published studies that show that the length and depth of economic contraction is inversely related to state intervention. In other words, the more the Government spends to buy itself out of a recession the shorter and less severe is the recession. We are in a recession. Investors can expect the recession to continue. Even as credit markets ease up, there is little guarantee that the banks will pass down to consumers the ease in credit. In fact, this being a Capitalist society, banks will probably take the opportunity to profit from the increased spreads.

Home building is down, commercial construction is down, and manufacturing has contracted. As mentioned earlier, the long term effects of the bail out are inflationary. Wages haven't kept up with inflation, and assuming consumer credit remains tight, investors can expect a continued demand side contraction. The effect is to drive down asset prices.

In terms of stocks, investors need to buy strong balance sheets. You want companies that have the ability to do well in a long recession. Buy long, and look at the winners. In financials those include JP Morgan, Bank of America, and Goldman Sachs. Look at discounters. People don't have the disposable incomes they had during the boom periods, but they need essentials, and they want to pay discount prices for those essentials.

The question for many investors is where is the bottom? The short answer is if you buy quality and buy long, finding the bottom is less important. However, if your looking for a bottom, there are some indicators. One is the Volatility Index or VIX, the VIX is currently at 46.72. The last time the VIX was this high was the last time market hit bottom in 2000. Another indicator is commodities, when raw material pricing starts to climb, manufacturing is increasing, this signals an end to the bust cycle.

A good friend of mine has chosen to take a wait and see approach. He will put his money in money market funds, which as of September are guaranteed by the U.S. Treasury. When he feels the market has bottomed, he'll invest. His rationale is that even though he'll lose some return to inflation while the money sits in a money market fund, he'll more than make up the difference on the upside when the economy comes back.

Personally, I'm a hard asset guy. I like investments in which I have some control. Just ask Lehman and Wachovia investors how much control they had. If you are looking at Real Estate understand that appreciation is slow or non-existent in the current environment. Focus on investment properties, that is properties that throw off income streams. Focus on maximizing the return on your cash investment in the property. Look at diversifying your tenant base. In this environment be wary of single tenant investments. If you lose that tenant, you've lost your income stream.

If you have staying power, now is a good time to land bank, even if you are not a developer. There are many fully entitled projects on the market at fire-sale prices. The entitlements don't have a lot of value right now, but will become increasingly valuable when the economy returns. At that point you can sell, take out the appreciation in the dirt, and profit from the entitlements. I've over simplified the process, but if you know what your doing, or hire someone that knows the process you can make some great investments in this environment.

In short, these are are exciting times and offer incredible opportunities. Don't panic, study the environment and take advantage of the situation.

For information contact Chris at christofer.pacheco@gmail.com .