Stragetists in agreement: This downturn wil be rough

The following transcript is from "What the Crisis Means for Long-Term Investing," an InvestmentNews webcast held Oct. 7. Evan Cooper, deputy editor, and Jeff Benjamin, senior editor, moderated the panel. InvestmentNews: What we're going to do is start off with a little overview of what is going on and what financial advisers should be saying to their clients. Mr. Froehlich: Do we have the next 10 days to talk about this? It's unbelievable. I would like to give a perspective that says not just focus on the Wall Street credit and liquidity crisis but to put that in context. And I think it's very important for advisers, as they speak with their clients, that really it's a confluence of three things — almost the perfect storm in reverse. Yes, we have this Wall Street liquidity and credit crisis that we're facing, but also don't forget the other two parts of this crisis. We have a residential-real-estate market that has basically imploded, and we had booming commodity prices — especially if you go back six months ago when it looked like the next stop for oil was going to be $200 a barrel. That took a tremendous toll on consumer confidence and business confidence. So I think that to sort of set the landscape, you have to say, well, we have three things going against us. And I like to look at it as basically three head winds to the economy, three head winds to the market. It's the credit liquidity crunch. It's the implosion of the residential-real-estate market. And then it's the booming, skyrocketing price of oil. But when you take the scorecard and update it to where we are today, I think you get a little bit of a different picture. Obviously, to me, oil is no longer a head wind, to the economy or to our market.
I think it's actually a tail wind that was tested below $90 a barrel, even though today it's settled back up above $90 a barrel. I think by the end of the year, we could see oil down into the $70s. That's the best tax cut anyone could ever hope for. But because no one's focusing on fundamentals, I don't think it's worked its way through to the economy or through into the market, but I look at this as a tremendous potential catalyst for the market. So that's a good thing. The bad thing is, I don't think the same can be said about the residential-real-estate market. I think it's going to continue to be a negative head wind. There's too much overcapacity. I was just in southern Florida two weeks ago, and they're talking about basically a seven-and-a-half-year inventory overload — that along with the fact that there's no confidence. There's no confidence in our economy. There's no confidence in the stock market. There's no confidence in the political leadership of either political party. So it's very tough for someone to take out the checkbook and write the largest check they're ever going to write to buy residential real estate. So I think that'll continue to be a head wind, which gets us back again to this credit liquidity crisis on Wall Street. This will be the thing that determines what happens. It's going to make the determination for our economy, for our market, whether we head into the greatest depression since the 1920s or whether we're able to turn this around. I don't believe that anyone is smart enough to figure out when we hit the top of a market or the bottom of a market, but I certainly believe we can figure out: Are we in — using a baseball analogy — the first and second inning or the seventh and eighth inning? And if you look at everything that's already transpired, if you look at what happened with Countrywide Financial [Corp. of Calabasas, Calif.], being acquired by the Bank of America [Corp. of Charlotte, N.C.], you look at the nationalization of Fannie Mae [of Washington] and Freddie Mac [of McLean, Va.], you look at JPMorgan Chase [& Co. of New York] acquiring [The] Bear Stearns [Cos. Inc. of New York], you look at JPMorgan being a part, being a player in a big, big way, buying Washington Mutual [Inc. of Seattle], Bank of America buying Merrill Lynch [& Co. Inc. of New York], the theme is obvious — consolidation, consolidation, consolidation, consolidation. The fascinating thing to me is, if you can look beyond this crisis and look at what these companies look like when they come out of this, they have two traits. Trait No. 1, they have a stronger balance sheet. Trait No. 2, they have larger market share. I know it's tough when the market's down 500 points in a given day, but these are very, very positive if you can look beyond the short term, what's happening today, tomorrow, the next day and look for a 12- to 15-month period. I actually look at these three head winds, and to me, I think now we only have one and a half head winds. So we're not out of it yet, but certainly, I think we've more than turned the corner. Mr. Kelly: I agree a lot with what [Mr. Froehlich] was saying. He mentioned, though, the analogy of baseball, being in the seventh or eighth inning. On Sunday night, I was at Fenway Park. The problem is, it went into extra innings, and we didn't end until 1 a.m. in the 12th inning. And the problem is that that's uncertainty. And what we really have here is a great deal of uncertainty. I think if you are talking to investors about where we are right now and what to do right now, I think the first thing is to just recognize that the volatility in markets today really is a barometer of uncertainty. One way you can look at this is this: Over the last 15 years, on an average day, the [Standard & Poor's 500 stock index] has been up or down by 0.75%. In September, the average daily move was 2.5%. Now, 2.5% of the whole U.S. stock market is $300 billion. And what that really means is that on an average day in September between 9:30 a.m. and 4 p.m., the market's assessment of the long-term value of the American corporate sector changed by $300 billion. And that change in assessment, that continual change in assessment, really reflects a great deal of uncertainty. There is a lot of uncertainty.
With regard to what [Mr. Froehlich] was saying about those three head winds, I agree with him on the commodity issue. I always felt that this was a commodity bubble, and I think it has now burst, and I think lower energy prices will be a positive. I'm actually a little bit more optimistic on real estate and maybe a little bit more worried about the credit problem. On real estate, he's quite right that there is no movement right now in the market. But I do want to emphasize something. Over the last 40 years, if you look at — match up demographics to housing starts in the United States, given our population growth of about 3 million people per year, housing starts ought to be in the range of about 1.6 to 1.7 million units. We're now at a level of 895,000. We are clearing inventory of unsold new homes. Obviously, there aren't many buyers in the market, but construction is at such a low level — it's at the trough that we saw back after the 1991 recession or in the 1982 recession, when the population was smaller. Given that level, I think we do have the potential for a bounce in real estate if we can get any stability here at all. I would also say that housing is no longer expensive in the United States because of 6% mortgages, because of declining home prices in the last few years and rising in-comes. The mortgage payment that you have to make on the average new home as a percent of income is actually lower than it's been for most of the last 30 years. So I think we're a little further along in real estate. But the credit market issue really is uncertain. We just don't know how much — how far this panic will go. And of course in the stock market, if there are no buyers and there are lots of sellers, the market goes down. I would say — and I don't want to be too long-winded here — but I do think that what we have right now, as Robert Frost would put it, is two paths in a wood. They diverge. They're going in different directions. We're going to have weakness in the fourth quarter. It's going to be a lousy fourth quarter, a lousy holiday retail season. They may call this a double-dip recession because of it. In the New Year, if the credit crisis subsides, if the Fed and the federal government are able to do that, I think there are cyclical sectors of the economy which are ready to bounce. We could get stronger economic growth. And if we do, I think the stock market will do much better. But there is also the other path, by which some other part of the world credit markets or world financial system is dislocated by what's going on right now and consumers are just getting more and more negative, in which case we could languish for a while. But my last point is that even if these two paths diverge in the short run, over the next year or over the next two years, a short recession or a deep recession, eventually they meet up again. Five years from now, very likely, we will be back at close to full employment, [with a] strong, growing economy, and profits [will be] doing very well — and an economy which justifies a much higher level for stocks, and indeed higher Treasury interest rates, than we have today. So I think long-term investors just need to take a deep breath, remember they are long-term investors, and if this isn't money you intend to touch in the next five years, then I think it's important to stick with a disciplined financial plan. InvestmentNews: Now that we have heard from two optimists, let's hear from the Prudent Bear, David Tice. Mr. Tice: Well, I wish I could be more positive, and [Mr. Kelly] and [Mr. Froehlich] outlined some fair points. However, I feel kind of like a mosquito invited to a picnic. And I know there [are] a lot of financial advisers [who] would like more-positive news. I also realize that people are negative right now, and the more the negative talk, it tends to create more negativity, etc. But I have to be as honest as I can. I've studied this for a long time. We've been calling on this for a long time, and I'm going to advise you just the way I would advise my sister if I was sitting at the breakfast table. And unfortunately, I see we are not out of the woods yet. This has been a massive credit bubble like we've never experienced before. We grew total credit market debt as a percentage of [gross domestic product] from November 1982 from 170% to 350%. We completely screwed up our economy. Here's a quote from Bill Gross, the manager of [Newport Beach, Calif.-based Pacific Investment Management Co.] made in December of 2004: "The [United States] spends too much, eats too much, drinks too much, and we pay for it with our debt and 80% of the world's excess savings. On the debtor side, the United States will shop [until] it drops. The only question is one of timing." And unfortunately, what we've done is, we have — this is much bigger than just subprime — we have geared our entire economy towards credit growth. [Merrill Lynch chief investment strategist] Richard Bernstein was on CNBC this afternoon talking about the fact that a lot of the growth stories were really geared toward — were geared from credit. And credit growth is no longer available. And we believe this is not just an illiquidity issue; it's actually an insolvency issue. There are a lot of debts that are not going to be paid back, there are a lot of loans that will not be made in the future, because our economy is so screwed up, and we have been so geared towards luxury consumption. We have too many movie theaters, gambling casinos, restaurants, high-end hotels, etc., and we will have to restructure. And I am positive about getting back, in a few years, where we have a better-adjusted economy. But unfortunately, it's likely to be a depression. Hopefully, it's not a Great Depression, but we will have to readjust. And a lot of businesses are going to be shut down. A lot of people are going to be laid off. And those people are not going to be able to spend as much money, and therefore, we will end up having a vicious cycle instead of a virtuous circle. InvestmentNews: Do you believe the bailout plan is going to work, and what kind of an impact will that have? In addition, do you see a need for more bailouts in the near future, both public and private? Mr. Tice: I think we did have to do this type of bailout, because our financial markets were freezing up. And I'm a believer of the Austrian School of economics, and generally the Austrian School would say, "Let all this sort out," and that this is going to make it worse. However, we at Prudent Bear don't believe that we had any choice. We do believe that [Federal Reserve Board Chairman Ben] Bernanke and [Treasury Secretary Henry M.] Paulson are doing all they can to keep money markets functioning. I think that is a good thing. However, I still don't think confidence is going to come back quickly enough to avoid a very, very bad recession. We still have too much real estate, and we have to restructure this economy. InvestmentNews: So you see the bailout as necessary but not enough?
Mr. Tice: It's not enough. And I wish we had a policy prescription. We're believers, and Henry Kaufman [president of Henry Kaufman & Co. Inc. of New York] responded when we sponsored a symposium in New York in September 1999, and he asked at that time, "What should we do?" And he said the Fed missed its timing. And I'm of the same mind, that I don't really have a great policy prescription. We are going to have to adjust. We will have to take pain. We will have to encounter a severe recession, potentially a depression, and the market is going to go down. And it is going to be ugly. And I wish I had a better solution. But government cannot fix this kind of problem. Mr. Froehlich: I'll give you a solution. But first I need to congratulate [Mr.] Tice, because, David, you certainly have been absolutely spot-on in calling what's happened in this market, and you should be congratulated for that. Mr. Tice: Thanks, [Mr. Froehlich]. Mr. Froehlich: And I mean it sincerely. You've done a phenomenal job. As I look at this [Troubled Asset Relief Program], though, and try to assess the potential success of it, I look at it not in isolation, but I look at it as part of a couple things happening, and maybe that's why I have a little bit more bullish perspective of what I can see happening. You see, I see the TARP program as actually making money for the federal government. I mean, I truly believe, when we go out three to four years, this $700 billion that's going to be buying distressed assets, distressed mortgages, commercial mortgages, residential mortgages, and I'm going to assume that — as Bill Gross assumed — that maybe they buy them at 65 cents on the dollar. Well, if you do that and the underlying value is zero, well, then you spent $700 billion and didn't get anything back. But if conversely, you think maybe they're worth, I don't know, 50 cents on the dollar, then all of a sudden, that's only $150 billion. [Moreover] the federal government is going to get warrants in the financial institutions that participate in this. And keep in mind these bank stocks have really been beaten down. To me, I look at this policy response and say, "Look, it may not be the best thing, but I actually think it can clean up some of the balance sheets in a big way, and I actually look at it as a money maker, not a money loser." But I don't look at that in isolation. I look at two other things that I see happening that are very important. First, the Federal Reserve is now saying, "Look, we're going to buy commercial paper from non-financial companies." This is a huge, huge victory for the commercial-paper market. That was the critical liquidity issue that we faced ever since the Reserve Primary Fund [from Reserve Management Co. Inc. of New York] broke the dollar [and] money market funds [and] commercial paper dried up. So I give the Federal Reserve huge points for stepping up to the plate and doing that. And sort of the final thing for me is, I'm waiting to see if the move in Australia today [the Reserve Bank of Australia cut its benchmark interest rate by 1 percentage point to 6%] was the beginning of a consolidated major interest rate cut around the globe, not just in Australia but in the United States, in the Bank of England and then in the European Central Bank. So if we take all these things together and not just look at TARP in isolation, I think we're seeing an unprecedented response from the public-policy front. And if you can look beyond the headlines of today or next week, we actually could see a light at the end of the tunnel. Mr. Kelly: I agree largely with what you're saying, but I do think that this TARP program was necessary. I do think that Congress screwed it up, though, by not passing it initially and without modification. And the reason I think they screwed it up is because this is a confidence issue. And one of the items that we've always — one of the tenets of American finance — has always been that if the worst came to the worst, the government would step up, no questions asked, and fix the problem. So we had the very unfortunate situation of Mr. Paulson and Mr. Bernanke having to really look haggard and describe the situation in the starkest and gravest terms to induce congressmen to do the right thing, and then find to their chagrin, that even that wasn't enough to get them to do the right thing. So they managed to scare the public, scare the market and then not get the response they wanted from Congress. If they had been able to achieve this with less fear injected and with a more automatic response from Congress, I think it would have worked better. But I do want to get back to something else [Mr.] Tice said, because I accept, [that] obviously, living in America for the last 25 years, we are consumption-crazy. But I don't believe that there is any answer for the economy [other than] to live within our means. Because this is very much — I mean, [Mr. Tice], you said you're sort of [from] the Austrian School. I have to say that for the most [part], I'm of the Keynesian School, which is that there is a circular flow of income. And it is true that for many years, Americans have been living beyond our means, but by living beyond our means we've been creating this flow of income and jobs which has essentially allowed us to create the means by which we live. And I do think that — I think it's probably right for the economy to get back to full employment. I think the next government will very likely pour money at this problem. There's no danger of inflation taking off. They will pour money at this problem until they get enough demand to get us back on the road towards full employment. So I don't think we're going to see a great depression here. I do think there's a lot of uncertainty over the next year. But over the next few years, I do think that we will get back to close to full employment in the economy, and I think eventually that will be reflected in a much stronger stock market than we see today. InvestmentNews: Let's go from the big picture to the small picture. Let's make an assumption. I'm a client. I'm about 60 years old. My wife and I are thinking about retiring soon. I have somewhere between $300,000 and $500,000 in assets that are diversified according to my adviser's wise recommendation. It's today. Two questions — give some advice to advisers: What would you say to a client like that? What would you do? Mr. Kelly: Well, the first thing I would say — I mean, it depends, of course, on what sort of standard of living they're trying to maintain, but given an environment which I think we'll have of relatively low inflation but also relatively low interest rates, the temptation, of course, is to keep this [client] in cash. But we could be looking at cash returns of 2%, 3% for years to come. And 3% of half a million dollars gets you $15,000, which is not much in the way of supplementing Social Security. So, first of all, you don't have enough money there, probably, for most people to achieve their goals, nor can you quite afford to be entirely in cash. But at the same time, at that age, you're not that many years from retirement. You need to have some balance. So I would say do approach this with discipline. Have a balanced portfolio. Have some stocks in there, maybe 50/50. Of course, it depends on the individual. But also think carefully about this issue of [when] you're going to retire. Well, if you retire at 60 but you live to your mid-80s, or you retire at 65 and you live to your mid-80s, that's not enough money. And I think people need to make lifestyle choices too. Although I expect the economy will get back to a growth path, as individuals, I would probably suggest to people that they really should think about what size of house do they want to live in, how many cars do they need, what kind of vehicles? Make some lifestyle choices. How long do they want to work? Because that kind of money in this kind of environment is not going to grow if you stay in completely safe assets, and it's not really going to finance a satisfying retirement. Mr. Froehlich: I couldn't agree more, and I think the advice that I would give them is to [recommend they] stay fully invested and [that they] stay fully diversified. Think about a 60-year-old, who when he reaches the age of 65, life ex-pectancy today says that [he will] live another 21 years. He is going to live to 86. So what we're talking about with a 60-year-old is maybe a 30-year investment time frame. What are investors doing today? They're putting together a 30-second investment time frame, trying to figure out what to do getting in and out of the market. So in that backdrop, what I'd do is say, if you take a longer-term view, what I still would be telling people is you want to overweight the stock market. I would underweight the bond market, but within that underweighting of the bond market I'd want to be overweight municipal bonds. Whenever municipal bonds trade through Treasury bonds, it has always been a screaming buy. I think that is one of the great buys we have right now, especially for someone that's risk-averse, [someone] in their 60s. Make sure they are buying some municipal bonds. I don't want to be in cash. I would underweight cash, especially with a longer-term investment time horizon. The interest rates are going to continue to come down. You are not going to be paid to sit on the sidelines. Then I guess the final three things I'd say to them is I would want to overweight real estate. Even though I think that residential real estate in the United States is going to be under some pressure in the short run, I think there are some opportunities outside the United States, especially in commercial and industrial real estate. I would want to be overweight commodities. Even though I see a correction in oil, I don't see that happening in broader-based commodities, especially with a longer-term picture. And I also would want to have some exposure to infrastructure as an asset class — toll roads, airports, highways, bridges, especially the privatization story. So to me, it would be: "You've got 30 years. You want to stay broadly diversified." I would overweight stocks, underweight bonds, underweight cash, and I'd overweight commodities, real estate and infrastructure. Mr. Tice: I would agree with something that [Mr. Kelly] said as far as lifestyle choices in terms of individuals' [having] to tighten their belts. I'd agree with that first and foremost. Second, I would say this is a time for protecting principal and buy trying to have return of principal rather than return on principal. And even though we all would like to have more money, and therefore, we should take more risk, we don't think this is the time to take more risk. Now is the time to conserve what you have, in our opinion, be-cause things are likely to be so dire for some time. The other thing I think people should consider is that longer-term secular bear markets tend to last a long time. We had a 17-year secular bear market starting in 1929. We had a 17-year secular bear market starting in 1966. This is likely to be a 20-year secular bear market. There will be rallies in between, but it's likely to be ugly. And there's some dispute about if we started the secular bear in the year 2000 or if we started it in the year 2008. Mr. Kelly: But [Mr. Tice], bear markets are not like the planets going around the sun. They don't move to — nor should they ever move to — a mathematical cycle. They are, to some extent — they are reflective of psychology, and I think that's true. But they're also reflective of underlying economics. And if you look at what happened in the 1970s experience, what happened was, the economy just got worse and worse and worse from both perspectives as the decade went on. We had profits go down and down and down as a share of GDP. We had inflation hit its peak in 1980. We had unemployment hit its peak in 1982. And so that continual worsening of the economic performance, I think, caused that bear market to last as long as it did. InvestmentNews: Why couldn't that happen this time? Mr. Kelly: Well, there is a degree of uncertainty about that. But I believe there are a few reasons why I think not. The first one is, I don't think we are facing anything like the same inflation problem. The real problem in the 1970s was that the government was working with one hand tied behind its back, because every time it tried to deal with the cyclical slump, inflation spiked up. But this time around, even with the strongest world economic growth we've seen in decades in the last five years, the U.S. overall inflation rate only hit 5.6% at the peak, and the core inflation rate hit 2.5% at the peak. So I don't think we are as threatened by inflation. That allows policymakers to address this problem with a singular focus on generating stronger economic growth and stronger demands. And I think that will get us back to full employment much faster than we saw in the 1970s. But I admit there is uncertainty because of the complexity of financial instruments and the complexity of financial markets. And so I wish I was 100% sure of that. But I think that we should be able to pull out of this much better than we did in the 1970s. Mr. Tice: I think this dialogue back and forth is great, but [Mr. Kelly], I [think] that government tends to make things worse. And government thought [it was] doing the right things in the 1930s. Government thought [it was] doing the right things in the 1960s. And I just do not believe that you can rely on government to make all the perfect moves. And I do believe that the long secular bear markets occur because of the excesses and imbalances created in the prior secular bull markets. And we had huge imbalances, huge excesses and imbalances, massive amounts of debt, massive amounts of infrastructure that has been geared toward [high-priced residential real estate]. Our whole global economy was geared around luxury consumption in the United States. And unfortunately, we have to cure those excesses, and that will take some time. And government unfortunately will screw things up instead of making it better. InvestmentNews: Let me follow up here with a question from the audience about this. In light of that, should our hypothetical 60-year-old couple just be in cash and wait it out? What should they do if we are in a secular bear market? Mr. Tice: Yes. As far as my suggestion would be, I do believe in Treasury bills, even if you earn 1%. I do believe in foreign-sovereign-debt obligations, even if you earn 1%. The markets are not out there saying, "Oh, well, I need $50,000 to live my lifestyle; therefore, I'm going to give this person a 9% return." So don't reach for a 9% return because you need that much money. The market will do what it's going to do, regardless of what you as an investor need. The other thing is, I think you should protect yourself with precious metals. [Just] look around at the bailout packages. We're bailing out money market funds. We're bailing out mortgages. We are bailing out Fannie and Freddie and [New York-based American International Group Inc.], etc. [Bailouts] are going to come. There will be trillions [of dollars] of bailouts. And therefore, we are creating new debt obligations, and gold is stability. Mr. Kelly: If you invest in Treasury bills and you're right about the government printing this much money and that causes inflation or devalues the value of U.S. debt, then you end up with inflation, which eats away at those 1% Treasury bill returns. Mr. Tice: I agree with that. Mr. Kelly: So — and as for gold, I personally like investing in companies that generate a stream of earnings. I mean, right now, if you look at the last 12 months of after-tax profits for all U.S. corporations and you divide that into the value of the stock market today, it is about 10-to-1. In other words, the earnings yield on stocks for the whole U.S. stock market over the last 12 months has been about 10%. Now, I am not saying jump into stocks with both feet right now, because, frankly, it's a dangerous time and it's a volatile time. But I do think that you can get better earnings in the long-run from common stocks than you're going to get from Treasuries, particularly, in fact, because the government's printing so many of them. Mr. Froehlich: I wanted to just dovetail on something that [Mr.] Tice said a little while earlier, because I think it was a very, very important, catchy line. And I loved it completely where you said, "We're going to have to change the focus and talk about protection of principal," because what you want to make sure [of] is [that] you have that return of principal. I think that is a great mind-set change. But I want to get back to sort of what my advice was for that 60-year-old, because I think it ties into your comment, [Mr. Tice]. And that is, when I was saying, "I want you to have exposure to commodities, I want you to have exposure into real estate, I want you to have exposure into infrastructure," these are all alternative asset classes. And the fascinating thing is, if you look over the last 10 years at the endowment to Harvard [University of Cambridge, Mass.] and Yale [University of New Haven, Conn.], and some of their unbelievable numbers of 15% to 17% average return over that time frame, so much of it was driven by 50%, 60%, sometimes 70% exposure in alternatives. But actually, we're taking less risk. And so I love this focus on return of principal. And I think one of the ways that individual investors [can do this while] working with their financial adviser is to broaden the scope of what they're looking at. Look at a market-neutral product. Look at infrastructure. Look at real estate. I think that's going to be the new age of investing. You're going to have to get as broad of exposure you can get to as many different asset classes. InvestmentNews: Speaking of some of those broader asset classes, alternatives, it seems that everyone agrees that you have to have a time horizon of about five years. What do you all think about investing in some of these mortgage-backed securities that the bailout is buying up? Mr. Froehlich: Well, again, you're going to need that same time frame. I mean, if you look around — it all depends on what your view of the world is. If you think the world's heading into a recession, then I don't care if you get them at 65 cents on the dollar; you don't want them, because you think the next stop is going to be a global recession. I, on the other hand, don't look at us in a global recession. I think we're heading into a global slowdown. I think there's some intrinsic value in those mortgage-backed securities. This is not like the Enron [Corp.] scam. When we woke up, we all said, "What in the world was that all about? There's nothing left. What was down there in Houston?" With these mortgage-backed securities, there [are] real, tangible assets there, and I think there's some great value. And it goes back — although I'm not as bullish as [Mr.] Kelly, who made some phenomenal points about the potential to turn around this real estate in the United States. I just have a little bit longer time horizon. But with these mortgage-backed securities, there's a tangible piece of real estate behind them, and I would not be afraid to be a buyer, especially because I don't believe we're heading into a global recession. I think there's a difference between a global slowdown and a global recession. Yes, I'm concerned of all the slowdown that's happening in China. They're down 20%, which means their economy is growing at 8.9% instead of 11%. You still have a lot of economic activity at that level. Mr. Kelly: Actually, I'm not sure that I'm more optimistic than you are, [Mr. Froehlich]. I think we may well be headed for a global recession in 2009 because of what's been going on in the last few weeks. But I do agree [that] your basic point about real estate is absolutely right. People need to realize — and I think you get a distorted view if you look just at Florida and Southern California — the problem with this real estate bubble was who the mortgages were [sold] to and how they were constructed. We've had plenty of housing booms and busts before. But the real reason this thing is such a problem is because of who these mortgages ended up with — people who did not have the ability to make the payments. Now, going forward, that doesn't change the nature of the house. It doesn't change the nature of the land. And because we are not now constructing very many new houses at all, we are gradually clearing inventory. So, again, I don't think housing's about to turn around in the next few months or be strong in the next few months. But I think we are at very low levels here, and I do think that over the next few years, starting from here, real estate won't turn out to be that bad an investment. Mr. Tice: I'd like to agree with something that [Mr.] Froehlich said as far as alternative investments. I do believe that individuals should go out and look at [many] different investments. I can also see some wisdom in buying some infrastructure plays, road building [and so forth], because I think there is going to have to be a lot more [money] from the government in infrastructure-type projects, and as the rest of the world grows — China, India — that is going to grow. I do believe that we are in a global recession right now, as we speak. And we have started a global recession. It is going to be very painful, and I would not be buying any of these mortgage-backed securities. In addition, I have some real concerns about if these mortgages clear at 70 cents on the dollar, I do not think many institutions are going to be able to sell them at that level, because it will essentially wipe out their equity. InvestmentNews: Should U.S. investors be U.S.-centric or are there places elsewhere in the world where there are opportunities? Mr. Kelly: I think if you go a few years into the future, I think countries that have a burgeoning labor force are probably in a better position than countries [that] are relying more on a commodity sector. I know people have talked about — and I believe in alternative investments — [but] I'm not sure that commodities quite make sense right now, given this global slowdown. But I think what we've seen really in the last 30 years from China, and seen from many other developing countries, is that increasingly, on a secular basis, we are getting to a point where these developing countries can catch up and are catching up. They will continue to beat the United States in terms of productivity growth. So as a long-term play, I think many Asian emerging markets still make sense from an economic perspective. You do, of course, still have to look very carefully at the securities you're actually being offered to buy, and there is a certain amount of volatility there. But I'd want some emerging-market exposure in a portfolio right now. InvestmentNews: Mr. Froehlich, what do you think? Mr. Froehlich: Yes, I agree with that completely. I think when we finally get the market to turn around, and we have this rally, I do believe it will start in the United States. So I think, as an investor, you want to set some exposure here in the U.S., because I think that we have to show to the world that we are — that we can turn it around. So I think that basically, the whole world is watching. I think that some of the sell-off that happened outside the United States actually was a result of what was happening inside the United States. So I look for this market rally to begin in the United States. Then, as [Mr.] Kelly was saying, outside the United States, there [are] going to be some great opportunities. But I'm not afraid to mix the developed markets with the emerging markets in Asia. I would consider positioning a China-Japan play along with Taiwan, South Korea, Singapore and India. I think you put a basket of countries together like that, and have a five- to 10-year time horizon, you're going to be very happy as an investor. I also like what I see — it almost plays upon the same thing [Mr.] Kelly was talking about, again, only this time in Eastern Europe. I like what I potentially see there — the unbelievable embracing of capital, the work ethic that people have there, including the Czech Republic, Lithuania, Poland. I think that emerging-market story, especially in Eastern Europe, could be another very interesting place to be. InvestmentNews: And Mr. Tice, what do you think about international opportunities? Mr. Tice: Well, right now, I can agree with a lot of what [Mr.] Kelly said as far as where we are going to have to transition to an Asia-centric growth model. And as I started my initial remarks with the Bill Gross comments, I think that we have a dysfunctional global system, where too much of the world's growth has been dependent upon the United States spending far more than we've earned. And, unfortunately, U.S. constituents are going to face a pay cut. And that's, unfortunately, the bitter message here. But I do not think it's time to get into emerging markets now. I do think they're in upheaval. I think this will be a global recession. There will be significant pain around the world. In two to three years I agree that Asia-centric, India, Eastern Europe, [and so forth] are nations that will grow. InvestmentNews: Let me go back to the hypothetical we had before about the 60-year-old couple and move the clock ahead to a 70- to 75-year-old couple, people who are already in retirement, who are drawing down their assets. Many of our adviser listeners have clients like that, too. Again, what would you tell them to do? Mr. Froehlich: Yes, I think when you move up to that age bracket, obviously the risk tolerance changes a little bit, and certainly your time horizon changes a little bit. But there I would really be talking about municipal bonds. I really think that muni bonds are probably one of the best investments out there right now. Again, I had mentioned earlier, history has shown us whenever they trade through Treasuries, that's always been a good buying opportunity. I believe municipal bonds, in addition to being a nice, safer investment, or perceived safer investment, are also playing into that infrastructure story, as well. InvestmentNews: Given the record of Moody's Investors Service and Standard & Poor's [both of New York] in rating mortgage-backed securities, how could you tell which municipal bonds are good buys? Mr. Froehlich: Yes, well, I would tell you, I think what you'd want to do is to look to larger issuers that have a strong, diversified economic base. And maybe look to some of these revenue bonds [where] you're buying not so much a muni issuer but buying [a] revenue stream. For instance, a water and sewer bond that you know in good times or bad economic times, assuming they can manage the system, that you are probably going to be OK. InvestmentNews: Mr. Kelly, what would you say to our 70-year-old couple? Mr. Kelly: Well, I would absolutely agree with [Mr.] Froehlich that munis look like they're an extremely good value right now. And I'm not quite so concerned about the rating agencies. The problem with the mortgage securities [was] that a lot of them were actually constructed to get a rating. So it's not quite the same game when it comes to municipal bonds, which I think is a more conservative rating process. At least I hope it is. There are many things you can do for somebody of that age group, but I would also encourage financial advisers to talk to younger people, too. If I'm having that conversation with a 70-year-old, I'd also say, "I would love to talk to your son, or I'd love to talk to your grandson or granddaughter about their money." Because one of the problems we have right now — and I know financial advisers are dealing with this — is by the time somebody comes to you for advice, your options are limited. So what we really need as a nation, of course, is for people to make better decisions in their 20s and 30s, so they've got more options at this stage. From a professional perspective, if somebody wants to build a career as a financial adviser, I think it's important to not just talk to their older clients, though many of their clients will be older, but to make sure they can move down that age ladder. [That way] you're actually dealing with people who have more options and with whom you can build a better long-term plan. InvestmentNews: I want to go to Mr. Tice to answer that question, but let me just preface it with a question that came from one of our attendees, who called you a perma-bear. Is there any time you were ever bullish, and would you let us know when that happened? Mr. Tice: Well, we did start our fund in 1996, and we were too early. And we made a lot of money from 2000 to 2002. A gentleman who's at the Federal Reserve Bank of New York, Bill Dudley, who was at [The] Goldman Sachs [Group Inc. of New York] from 1996 to 1999, even came out and said that we — the Fed — essentially kept monetary policy too loose during that period. So, yes, we have been too early. We've lost money in certain periods. But we've been calling on this credit bubble for a long time, and we see that it is playing out. The economy came back from 2003 to 2007 because Alan Greenspan, [former chairman of the Federal Reserve Board] and President Bush encouraged people to go into the shopping malls, and Bob McTeer [former president of the Federal Reserve Bank of Dallas] said we all need to hold hands and buy new SUVS. However, we'll see how smart that played out. So we want to be bullish again, believe me, but right now we don't think it's the time. InvestmentNews: OK, so tell us again what you'd do for a 70-year-old couple. Mr Tice: Yes, I would say similar to what I said before. I do believe in precious metals. I do think it's the time to protect principal. I do think you should rein in spending. I agree with what [Mr. Kelly] said as far as getting younger people to save money. That's part of the problem with this country, [that] we have not saved enough money. The other thing in terms of muni bonds, I'm not quite so complacent about those. I do still question the rating agencies. I do believe that [ratings of some] of our municipalities have been based on reckless policies and tax receipts that have gone up with this credit bubble. And those tax receipts are going to decline, and it's going to get tougher. Now, the federal government will probably stand behind those, just like they're standing behind everything else. There will be bailouts. People will probably get their money anyway, given what we've seen so far. But that's more of the reason to hold gold. Mr. Froehlich: Because everyone views [Mr.] Tice as the perma-bear, wondering when he's ever going to [be a] perma-bull, when he's going to get bullish, I'm also accused of being all the time bullish and never getting bearish. And so I want to defend [Mr.] Tice for just a minute and explain my view as well. I think the lesson at the end of the day is no matter what economic cycle we're in, no matter what market cycle we're in, there is money to be made, and there's also money to be lost. And if we would just take that as reality, [we would realize that] not everything is going to go up all the time, and not everything is going to go down all the time. And I think [Mr.] Tice has done a phenomenal job identifying some of the downward drafts in this market and helping people along the way. And I'd look at myself and put myself not nearly at the platform where [Mr.] Kelly is, but I respect what [Mr. Tice] has done in looking at where to make money. And I think we sometimes tend to simplify this. Not everything's going up. Not everything's going down. But we're going to have a chance to make money and lose money in every market environment, and I think that's how we really add value in this industry. InvestmentNews: Speaking of making money in the long term and short term, where do you each see the indexes at the end of 2009? Mr. Kelly: I don't have a target number over the course of a year, because in the short run, markets are very emotional and psychological. I don't believe that you can really know what other shoes will drop on the good side or the bad side, and it takes a few years for the markets to line up with economic fundamentals. Over a five-year period, if we were starting from a fair-valued market, then I think the stock market could produce about an 8% total return per year over the next five years. However, I think that is probably a low-ball estimate of what the market's going to do, because I think the market is in fact very cheap right now. It could get cheaper, and it may well be that at the end of 2009, we are lower than we are today. But I think over the next five years, we'll do a lot better than 8% per year, because I expect that within the next five years, we will get back to a healthy economy. And if [that happens], I expect the stock market to reflect that, at least to some extent. Mr. Froehlich: I would echo those comments, and I actually would be a little more bullish, or I guess I should say a lot more bullish on what I'd see happening by the end of 2009. I would not be surprised to see the Dow Jones Industrial Average back up around 12,000, so that's a pretty phenomenal move from where we're sitting today at below 9,500. And I see the potential because I look at a couple of things. I look at this unprecedented tax cut that we're getting with oil, and I could see oil below $70 a barrel. And I think that's going to be a huge catalyst. I also look at the interest rates and falling rates, and the 10-year Treasury, before we know it, it could be below 3%. So I look at the catalyst that those two things are going to provide. And then, more importantly, I look at the thing that got us in trouble. And to me, what got us in trouble was unbelievable greed within the U.S.-based monoline investment banking system — greed and leverage, greed and leverage. Well, basically, it's gone. I mean, I look at the five parts of the U.S.-based investment banking system, and [The] Bear Stearns [Cos. Inc. of New York] is now a bank. It's part of JPMorgan [Chase & Co. of New York]. So they can't take the same type of risk in leverage. And then you have Lehman Brothers [Holdings Inc. of New York] that's now a British firm and a Japanese firm. You have Merrill Lynch that's now a bank. And then you had Morgan Stanley [of New York] and [The] Goldman Sachs [Group Inc. of New York] saying, "You know what? We want to be a bank as well." So I think the risk parameters have changed. I think there's a different amount of leverage and greed that's going to come into play. So I like the new environment that I see going forward. It's going to be very difficult for anyone to pick a number. But I will tell you, I think the trend line is certainly in our favor to have the markets moving higher as opposed to moving lower, at least based on the catalyst from falling oil, from falling interest rates. I would like to think that the leverage and risk landscape has changed completely with the changing of the investment banking industry. Mr. Tice: I know no one will want to hear this news, but I do believe that the Dow can easily fall to 5,000. And as [Mr.] Kelly said, the markets will overshoot fair value, but I don't feel as if they're anywhere near close to fair value. Earnings estimates for 2009 are going to come down dramatically. We're going to have massive layoffs. We're going to get into this vicious cycle rather than the virtuous circle that we were in before. Many people that invested in stocks for a long time are going to sell those stocks, and it's going to be painful. It's going to be ugly. And I wish I had a better prescription and better news, but secular bear markets tend to take a long time. And unfortunately, we're go-ing to have to get back to milk and cookies and enjoying times with our neighbors and not all want to drive Mercedeses and [own] $600,000 homes. And we'll be able to get through this, but it's a time when people aren't going to aspire to being millionaires. There's going to be massive bailouts, and therefore, the currency is going to remain at risk. It's hard to say exactly where the nominal level of the Dow declines to, because the Dow in dollar terms might not decline that far, but we'll see how much that dollar buys us. Mr. Kelly: Well, [Mr. Tice], I mean, I think that the picture you paint is very bucolic and rather interesting. But I don't believe the dollar is going to fall or inflation is going to take off here, because you can't really start inflation in a downpour. And you can either have [a very soft economy] in the 21st century or you can have runaway inflation. You're not going to get both. And I think there is a real issue of continued credit crunch and possibly a very severe recession in 2009. I think we may avoid it, but we could have it. But either way, when we come out of it, we're going to see labor still subdued. We're going to see compensation costs held down. We should see productivity growth [that is] strong, which means that profits will be good. Moreover, I think we will come out of this with relatively low interest rates. So we've got low interest rates, strong profits. And I think the stock market is very much on the cheap side of fair value, and if we do have a stronger economy in the next few years, I think the stock market ought to go up significantly to reflect that. InvestmentNews: What do you think about the upcoming election, who do you think will win, and what does that mean for the market and the economy? Mr. Froehlich: Well, I think the winner is going to be us once the election is over. I don't think it really matters what candidate's in office. It will only determine what sectors will lead this rally. I don't believe it's as simple as saying a Republican will do this, a Democrat will do that. I believe a relief rally is going to happen. It'll just look much differently. Under [Sen.] Barack Obama [D-Ill.] we'll see alternative energy [rally]. We'll see the paper and steel industry [rally] because of tariffs that they've put up in place. And we'd also see the automotive industry rally. Under [Sen.] John McCain [R-Ariz.], I think we'd see a big energy rally. I think we'd see the financial services industry rally because of his tax treatment. And I also think you'd see the deep-discount retailers rally, because they need to have free trade, and they don't want to have any changes in the labor law. So I think we could potentially see the relief rally happen regardless of what candidate is in office. InvestmentNews: Mr. Kelly, what do you think? Mr. Kelly: Well, I do think it makes a difference. I'm not sure — I mean, I'll try and be apolitical about this, but if [Mr.] Obama wins and brings in a Democratic Congress, then I think he will be able to do much more in the way of forceful government action to attack the problem. Now, the real question: Is that for good or for bad? And I think [Mr.] Tice would probably argue that it will be bad or that the things the government will do may make the situation worse. That may be the case. But I do think there will be a difference, because if [Mr.] McCain gets elected, I doubt if he'll bring in a Republican Congress, and because of that I think the government will be less activist, and so it'll be more up to the animal spirits of the market or the private sector to renew itself. So I think who wins will have a big impact on whether the government is leading the charge or whether the private sector leads the charge next year. InvestmentNews: Mr. Tice, what is your opinion? Mr. Tice: Well, it's probably better for the country if [Mr.] McCain wins, because then we would have divided government. And as [Mr.] Kelly said, I don't believe the government will do the right thing. However, I believe that [Mr.] Obama will probably be the winner. It does not seem as if [Mr.] McCain has too much of a policy prescription. People are really ticked off about where we are right now. There's going to be outrage against where we are. People are losing their jobs, losing their houses, and they're going to vote for change, and it's likely to be [Mr.] Obama. He's not going to be able to fix things. Government can't fix things. And in fact, it might make the period getting out of this even longer.