“Mrs. Jones, with your cash now earning nothing and stocks down 40% from a year ago, isn’t it time to jump back into the stock market, or at least into longer-dated Treasury bonds? How about corporate bonds, given what they’re yielding over Treasuries?”

Yes, Mrs. Jones is going to hear an earful. And with Federal Reserve Chairman Bernanke reiterating how long he intends to keep interest rates at zero — a not-too-subtle message to push savers out of risk-free cash investments — I’m sure she won’t be alone. In fact, I expect a lot of retail investors to be dragged at pen point down the Trail of Tears into taking risk.

Candidly, I can see the temptation. After 15 months of often steep declines, everything feels like a bargain. And, honestly, from the perspective of every US recession in our lifetime, these truly are bargain prices.

Unfortunately, unless you’re in your eighties, what we’re living through today doesn’t in any way resemble an event from your past. This one is global – and it is secular, not cyclical. And, while they can put a higher floor on the bottom than would otherwise be the case, history suggests that central banks and governments are limited in their ability to counteract this unwinding deflationary cycle.

What this crisis requires is time. And despite all the price cuts we’ve seen, not enough time has passed to say with confidence we’ve reached the bottom. At best, I’d offer that we’re only now just seeing the second derivative of the financial deleveraging that’s underway. And, unfortunately, there are more hard times ahead.

With the passage of time, the pressure on Mrs. Jones and her peers, all earning zero on their savings, will intensify. And I expect many will succumb to the impulse to take on more and more risk, particularly as benefits like the 401(k) match are cut and the need for return in order to one day retire grows.

As much as I wish it were done, I don’t believe it is. In fact, I fear the next 12 months will require even more courage and discipline than the previous 12. During this period, doing nothing (i.e. staying in cash and maximizing liquidity) will feel increasingly lonely as pundit after pundit shills one “historic” opportunity after another.

But in reality, nothing about this crisis is particularly historic. In fact, the first chapter of Charles Kindleberger’s Manias, Panics, and Crashes is “Financial Crisis: A Hardy Perennial.” In it, he goes on to say that “chain letters, bubbles, pyramid schemes, Ponzi finance and manias are somewhat overlapping terms.”

So sorry, Bernard Madoff, but the history books are filled with your ilk.

A quick MarketBeat canvassing of a handful of market strategists shows investors are anticipating anywhere from a stellar, 45% turnaround in the stock market, or another dreary year of grinding losses that ends with the S&P; around 600 to 700.

One commonality among those polled: A lack of conviction in forecasts for the coming year, or as Robert Pavlik of Oak Tree Asset Management put it after predicting the S&P; would hit 1030 by year-end 2009, “you’ll be better off asking me on 12/31/09 at 3:59 pm.”

Overall, strategists find themselves weighing the positive impact of the Federal Reserve’s considerable efforts to pump money back into the economy, along with an expectation of a massive stimulus package from the government that focuses on tax cuts and infrastructure improvement. A rebalancing of positions away from bonds and into stocks as corporate markets begin to improve may also enhance the value of equities.

But several commentators said 2009 presents more than the usual vagaries when determining the direction of the economy and corporate earnings. Charles Rotblut, market strategist at Zacks Investment Research, notes that the consensus S&P; earnings estimate for 2009 stands at $64.69, down 6% from 2008, but he adds that “given the trend in estimate revisions and the lack of visibility, I have no little confidence that this number will be accurate.”

One emerging consensus — which, of course, makes it a dangerous one — is for a first-half rally, built on the back of optimism as the new administration takes office, an expectation that the usual year-end avoidance of risk will reverse, and expectations for economic recovery due to a spate of mortgage refinancings.
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The second half, however, is more problematic, and this is where opinions diverge. James Paulsen of Wells Capital Management, the most optimistic in MarketBeat’s poll, expects about a 45% gain in 2009, with the first 20 percentage points coming rather easily, and the rest more slowly.

It’s not just a temporary wave of Scrooginess that’s to blame for a retail-sales drop of 7.4% in November and much worse expected for December. It’s the combination of two tidal waves of demographics and the global business cycle combining to swamp the middle class, the wealthy and corporations as the recession enters its second year.
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During the real-estate slowdown of the early 1990s, many boomers were in their 30s and still in accumulation mode as they bought homes, cars and early versions of home theaters that started with VCRs. The bursting of the dot-com bubble hit the average boomers’ retirement portfolios while they were in their 40s, the prime earnings years, and they were therefore able to quickly bounce back and resume the move toward bigger homes, cars and vacations from 2003 to 2007.

Things are much different this time. The median boomer came into the current downturn in his or her 50s, edging closer to retirement in a state of precarious financial health. After a 20-year buying spree, nonhousing durable-goods assets nearly tripled to $40,000 per household. Fueled by the twin forces of a declining birth cycle and the increased availability and acceptability of credit, this accumulative phase is coming to an end.

Bankers, the new villains in America now that we’re tired of just blaming CEOs, deserve a lot of the blame. The repeal of the Depression-era Glass-Steagall Act in 1999 — which brought down the wall separating commercial banking and investment banking — combined with low interest rates and heightened risk appetites to feed a credit binge that caused U.S. debt-to-income ratios to go parabolic. All of this was unsustainable because it was powered by rising asset values, not income growth.

Our new economic reality — our “frugal future,” in the words of Merrill Lynch economist David Rosenberg — will be marked by reduced discretionary spending, higher savings rates, asset liquidation, debt repayment and reduced accessibility to consumer credit. It will also not be buttressed by rising flanks of new consumers, because the children of the baby boomers are a smaller cohort and immigration policies are unlikely to change drastically.

The dynamics of this economic future have much more in common with our distant economic past. While a typical post-WWII recession has lasted 10 months, the average length of a recession dating to the Civil War has been 18 months. And recessions spawned by credit crises have averaged 20 months.

Since the current recession began a year ago this month, we can therefore expect a slow recovery beginning late next summer at best — but more likely in early 2010. ISI Group in New York is forecasting U.S. gross domestic product to contract 3% next year, which would be the worst calendar-year span since manufacturing crashed after World War II in 1946.

The mediocrity of the recovery would stem from the decline in household purchasing power: Falling asset values, both households and retirement portfolios, have caused household net worth to drop more than $7 trillion over the past 12 months, compared with a $2.8 trillion loss during the dot-com bust. Yeah, it’s nearly 2 1/2 times worse this time. The historical relationship between net worth and disposable income has Rosenberg looking for the savings rate to rise to 4% as households rebuild their balance sheets, which ought to result in a four-alarm calamity for retailers.

Indeed, during the third quarter, nearly $30 billion in consumer debt was repaid. This is the beginning of an epic change in the way society views financial profligacy and prudence. As a result, a recovery in housing, autos and other consumer discretionary categories will be long and painful. And without some stability in the housing market, it will be difficult for the incoming Obama administration to stabilize the financial system while trying to spur enough government spending to offset the newly frugal American consumer.

Anyone hoping for a gigantic stimulus package to bail out the economy will be very disappointed, because when you combine a massive housing downturn (5% of GDP) with a massive business spending downturn (10% of GDP) and add a massive consumer spending slowdown (70% of GDP), you would naturally need an incredible amount of new spending to emerge just to create an offset. If fiscal spending amounts to $600 billion next year, it would only replace the amount of private-sector spending expected to withdraw from the marketplace in 2009, not add anything really new. Merrill Lynch has calculated that just to keep the unemployment rate from topping today’s 6.7%, a 15-year high, a stimulus package of $1 trillion would need to be added on to the $1 trillion deficit the U.S. is already running.

Now the somewhat scary thing is that even if you are pretty bullish, it’s hard to come up with a target for next year that’s very exciting:

Say you figure that earnings will rebound 15% and investors will decide to pay a 20 multiple. That would be $53 in earnings per share, times 20, or 1,060. That level is 19.5% higher than where we are today, which is great, but in terms of time it gets you back only to the start of October.

I am retired, age 71 and disabled and need more cash each month due to the debased dollar. I can get what I need from a yield of 5-6%.

The only place I can find such yields are in open end corporate bond funds. I would buy them but am concerned about getting out when inflation takes hold as I think it will.

I am looking at a 1/3 position in Vanguard short, intermediate and long term corporate bond funds.

I own a position in Harbor Bond and am considering Loomis Sayles (LSBRX) multi sector bond fund for about 10% of the portfolio and 10% in PFF I shares ETF holding preferred shares of financials as its yield is 9.7% fluctuating with the value of the underlying shares. The last 2 picks have taken a beating and nothing says they can’t go down more but if it is not an unreasonable risk I will take it as I need the cash and can wait for the NAV to recover someday.