Where We Stand
October 13, 2008
Given the historic events of the past several weeks and extreme levels of market fear and uncertainty, we want to take a minute to provide everyone with an update regarding our thoughts on the financial markets and the global economy.
First, we would like to begin with a summary of the actions we took on Friday. Given the tremendous selling pressure we were seeing around the globe heading into Friday’s U.S. market open, we became highly concerned that a significant sell-off was possible. We felt in light of these circumstances that some action to hedge against this possibility was prudent. We debated various approaches. Given the intensity of trading, we needed to act consistently for all clients and at the opening bell of the markets. We were absolutely convinced that selling everything was a complete over-reaction; however, we also believed that doing nothing in light of what we were witnessing was irresponsible. We came to the decision to fractionally reduce widely held market index exchange-traded funds to provide an additional cash cushion in the event the market did come under severe pressure. This enabled us to largely leave portfolios in place. Additionally, we took the opportunity to reduce or eliminate other portfolio holdings that we viewed to have more limited near-term recovery potential. In reality, this was a no-win situation: with perfect hindsight it is easy to look back and question why we didn’t reduce exposure weeks or months ago while, in light of the markets performance early today, it would be easy to say we acted too soon.
However, at that point in time in the wee hours of Friday morning, we believed the best strategy was to stay the course and we still believe that this day. Please note that everyone will benefit nicely if the rebound that appeared underway in the futures trade and in early market performance holds throughout the day to the close.
As we have previously communicated, we are seeing very good value at the individual stock level. The sell-off over the past 52 weeks has brought share prices for many high quality companies down to more attractive levels, and we intend to take advantage of this not only with the proceeds from the recent transactions but also with cash reserves we’ve held on the sidelines. That said, we caution that the market recovery may be choppy for some time. It is likely that there will be more stomach-churning volatility. Although it is not out of the question we could have a relief rally that brings stocks back from the brink, it is still too early to pronounce the beginning of a new secular bull market. Indeed, the intensity of trading and declines last week may have finally met the definition of a true capitulation that could establish an intermediate term bottom and good relief rally; but many risks and uncertainties remain. Yes, a “VShaped” recovery would be uplifting, but in that scenario the market might be at risk of going “too far too fast”, a point made this week by veteran money manager Jeremy Grantham in Barrons magazine. Beyond stocks, we also see good opportunities for income and total return in high-quality corporate bonds, master limited partnerships and U.S. Treasury inflation-adjusted notes. We intend to put money to work in all of these areas in the near future.
Looking ahead, it is important to remember numerous risks still remain. The credit markets may be finally on the mend in light of the announcements made this weekend by the G-7 world leaders; however, the devil (as always) is in the details of implementing these actions. Additionally there still remain numerous exposures that could cause more dislocations ahead. Specifically in the credit markets, there are rising auto loan and credit card delinquencies. In the derivatives market, $55 trillion of notional credit default swaps (CDSs) remain outstanding that could give rise to further counterparty credit issues. Numerous hedge funds face liquidations with the potential for more forced selling. There is also the risk that actions recommended by the world’s governments and central banks will be unsuccessful at unfreezing the credit markets. Finally, the global economy has been weakened by all of the credit market turmoil. A recession is likely in the U.S. and Europe, and growth in other regions of the world has decelerated substantially. Hopefully the developed world recession wild be mild and of short duration, but the key is stability in the labor markets and a recovery in housing that may still be months away.
With respect to upcoming year-end meetings, we intend to take this opportunity to review your overall financial picture, refine goals and objectives, and re-balance your investment portfolios to be optimally positioned for the eventual recovery in the economy and the markets. We will also look at your income tax situation for 2008 and discuss year-end actions that could help minimize or defer current income tax liability.
In closing, we want to reiterate our belief in the financial markets. Yes, there are short periods that can be highly disruptive and unnerving, but they have always recovered and moved to higher levels. We may not make an immediate return to the all-time levels of last October, but the returns will be earned as the market slowly makes the climb back.
Michael Joyce, CFA, CFP
President & CEO
Jack E. Payne, CFA
Chief Investment Officer