We are reading about signs of sustained recovery and that the recession is over. For sure, there is some good news and things are far better than they were a year ago. Nevertheless, there is still plenty to worry about. It’s not time to relax and return to the ways of the past.

Recent reports of improved GDP were fueled by the “Cash for Clunkers” program and the “First-Time Homebuyers’ Credit”. Many of the homes being bought by first-time homebuyers have been financed via FHA mortgages that required only a pittance down (3.5%). When you couple that with the $8,000 First-time Homebuyers’ Credit, many of those purchasers have essentially none of their own capital at stake. Wasn’t that what got us into this mess in the first place?

Although sales are improving in the residential market, recent forecasts are for substantially more foreclosures next year. This will drive home prices down further and hold back the recovery. The commercial real estate market has approximately $1.7 trillion in commercial loans on bank books, or 25% of the assets for the average bank, according to an article titled “Why This Bust is Different” (Business Week, November 16, 2009). With commercial real estate prices down substantially, many businesses will have great difficulty qualifying for refinancing. This will also be a drag on the recovery.

The budget deficit is growing rapidly with more government spending in the works. Unemployment remains in excess of 10% with Congress considering an expensive jobs bill. Healthcare reform will cost nearly a trillion dollars over the next ten years (The cost is really more if you consider that the spending does not start for about four years). More than likely, if healthcare reform is to be deficit neutral it will mean more taxes.

To top it all off there’s worry about long-term inflation and higher interest rates. Some worry about the crash of the dollar and others are dumping their money into gold (We ask, is that the next bubble?).

The bottom line is that we should remain cautious. Pay down your credit card and other debt. Build up your emergency fund. Cut back on discretionary spending. Increase savings. Avoid chasing the latest hot asset classes and maintain broad portfolio diversification. Rebalance your portfolio at least annually. Pay special attention to your investment advisor fees, your mutual fund expense ratios and the tax efficiency of your investment assets.

In summary, don’t get too excited about the recovery. We expect it will take considerable more time before things return to near normal. At this point, a defensive stance will very likely serve you well.