The Hotline of Wednesday, October 12th recommended a change to the allocations for Venturesome and Conservative investors. The allocation for Moderate investors was left unchanged. The new allocations were prompted mainly by our view of the outlook for the domestic economy looking out over the next six months or so. The timing of our recommendation was influenced by the tremendous rally the U.S. market has undergone since October 3. We had already been contemplating cutting back; we felt the rally offered a unique opportunity to do so.
Specifically, here are the exact changes we recommend. For Venturesome investors we recommend a cut in the domestic stock fund allocation from 55% to 45%. We also recommend a cut in the international stock fund allocation from 35% to 25%. For Conservative investors, we are reducing the domestic stock fund allocation from 35% to 25%. A further recommendation is that the funds being raised by the sales be invested in money funds at the moment. This applies to both types of investors.
Why are we cutting back at the very time when the domestic economic news has improved and the Europeans are apparently serious about tackling the festering sovereign debt issue? We are cutting back because we are wary about the outlook for the U.S. economy over the next half-year. As we read the economic outlook, after absorbing the views of economists we respect, we have concluded that the economy will be facing extremely strong headwinds as we end this year and move onto 2012.
We are not looking for a recession, though the risk of one has risen, but for very slow growth. We expect growth to be slow enough that we might well say the economy is approaching stall speed. That is the danger as we see it as we move forward into next year.
The basic cause of the stall outlook is federal policy as set by the debt-ceiling agreement. We are already facing a substantial cut-back in Federal spending coming by the end of this year. There is another cut-back coming later, either from the recommendations of the Congressional "supercommittee" charged with cutting spending or, failing that, by automatic spending cuts extending throughout the Budget. Estimates of the impact of the budget cuts on the economy run from 1.5-2.0%. When this is subtracted from the economy's expected growth without the spending cuts, there is not much growth left.
Considering our outlook for the economy, it is legitimate to ask why we are sticking with equities at all. The answer is twofold. First-and very important-we are not looking for anything we can call a recession. A recession is not just two quarters of negative growth. It is something deeper happening to the economy, and that is not our outlook. We see no reason why profits cannot continue to grow under our outlook, though at lower rates than recently.
Second, the vast pool of investment money has to go somewhere. So long as there is some growth, cash, yielding zero, is unacceptable. At the same time, stocks remain cheap, though not quite as cheap as they were. This is a recipe for further flow of funds into equities. It is why we continue to favor stocks for risk-taking investors.
At the same time we recognize that risks have increased. Our new allocations are our recognition of that development.
Walter S. Frank has been the Chief Economist and Chief Investment Officer for Moneyletter for the past 25 years. He has had a long and distinguished career as an economist, financial advisor, and money manager. Mr. Frank is a regular contributor to Barron's and The Economist magazine.
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