First some brief portfolio data and then I will continue with the commentary:
a. Statistics
Details of the overall portfolio in 2008
are as follows:
| Portfolio Return-actual |
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| Portfolio January 1, 2008 |
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| Portfolio March 10, 2008 |
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| Investment earnings 2008 |
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| Investment Earnings 1981-2008 |
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The major indices have fallen as follows in 2008:
| S. and P. 500 |
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| Nasdaq |
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b. Performance
Our goal is to mute, but not eliminate (that isn’t possible), the downside and capture much of the upside. Our success in that regard is well documented (see the investment policy statement).
The investment markets are always challenging, but never more so (with the exception of the period from 1929-1933) than over the last 10 years. Commentators and mutual funds might suggest that things, with the exception of the technology stock debacle, have been fine, but the data suggests otherwise.
The S. and P. Index has increased a miserly 18% in the decade. Folks that isn’t 18% per annum, but rather 18% in total! The NASDAQ has actually lost value since 1998 by 20%. Both performances would be increased by the annual dividends which added an average of 1 – 1.5% p.a. Clearly most people would have been better off in money market funds.
Our record, as you know, has been quite different over the last 10 years and also over the life of the practice.
c. Current Situation
I won’t bore you with repetition of everything that got us to this juncture, but I strongly recommend that you reread some of the highlights of the reports that I have written over the last year.
I wrote this last week “We now seem to be in the third wave of the crisis
and I can’t emphasize enough the chaos in the world credit and currency
markets. Both of these get less coverage than the stock market, but they
dwarf the stock market in size and in their overall influence. Things that
seemed impossible a month ago now seem commonplace. The following very
large companies have all had their futures seriously questioned in the
last week – Citicorp, Bear Stearns, Sallie Mae (student loans), the Federal
National Mortgage Corporation and the Federal Home Loan Corporation. We
are now in new and scary ground, and it is unclear how this will resolve
itself in the short and longer term”.
Here we are a week later and, essentially, Bear Stearns is dead and their
demise occurred with astonishing speed. The discussion now is of the position
of Lehman (another major investment bank), UBS (the giant Swiss bank and
money manager) and the institutions mentioned above. As I said before the
very fact that these institutions are even ON the list is mind boggling.
How could this be? Since last summer, the government has pumped nearly $1 trillion in direct and indirect support into the financial system, yet cracks still appear.
The
answer is simple. The modern world economy is built on a financial system
based on promises and in the belief in the rule of law and the fundamental
solvency of the key institutions and Governments.
This is now what is in question. There have been
many crises over the last 60 years but this is the most comprehensive and
challenging crisis and the solutions may well prove to be devilishly difficult
to implement.
The credit markets (bonds etc) are experiencing serious upheavals on a daily basis as liquidity dries up and multi billion funds and companies have disappeared rapidly in this debacle. The critical feature that all of the failed companies have is a reliance on a large amount of borrowed funds (leverage in the trade) and no backup plan when those funds dried up. This was true for Bear Stearns, Thornburg Mortgage, Countrywide Finance and Carlyle Capital all of whom have, effectively, become insolvent in recent weeks. The extent of the carnage and losses hasn’t really permeated the public consciousness but the fear and uncertainty are already present.
The Federal Reserve is doing everything it can to stop the panic but, significantly,
without having any obvious effect on the ongoing crisis.
d. Our Plans
We are now faced with an environment where there is already considerable consternation about the plight of the US $, where job losses are mounting and where the idiot economists are now suggesting we might experience a mild recession. As I look around I see a national real estate market in disarray, palpable fear in the professional investment community and a growing disquiet amongst the public. It may not yet be panic but I think we might only be a bankruptcy or two away from that and, as events have shown, these days they develop at lightening speed.
There are two key issues here. The first is what will be driven down in price in the short term and the answer is almost anything. The second, and more important, is what will result in permanent losses.
The difficulty in the present situation is that there is nothing that is guaranteed to be safe (and by that I mean retain its purchasing power) under all the different scenarios that may develop in the next few months. I am not that concerned about things we own declining in price but I am very concerned about permanent losses.
To deal with the uncertainties I have taken the following approach which offers the best approach to preserving our capital in any of the different scenarios.
So to reiterate this is what we have and will do:
1. The portfolio has 35% invested in common stocks of the highest quality. The average dividend yield is 5% and the companies are well financed and thus not vulnerable to liquidity concerns. They are selling on average at 35% off their highs of the last 12 months so they have already suffered mightily in the market upheaval. Only a trivial amount of the portfolio is in the financial sector and none at all in banks.
2. They may decline in value and we will buy more subject to our limits. The companies have a definite multinational tilt and have significant assets in the international sector.
3. We are still watching for system breakdown.
4. We will almost certainly have negative returns (on a year to date basis) at various points this year. This is not a concern.
5. I am becoming more positive about our prospects for the next few years.
6. Hold on to your seat belts.
7. We have been and will remain calm.
8. We are avoiding all obviously risky assets like the plague. This is risk as defined as the risk of permanent loss of capital. This includes lower quality bonds of any kind, poorly capitalized or second tier stocks, some real estate and most obligations of the banking system (except that we DO believe in the doctrine of too big to fail so we do not believe that any of the largest banks in the world can be allowed to fail). But this doctrine will not save the stockholders of the failing institutions but it should save the bond holders.
9. If the world manages to muddle through this crisis we will do very well and if the crisis expands we will be hurt in the short run, but will be fine in the medium term and we will better off than 95% of market participants.
10. Our nervousness has led us to establish significant short positions to offset some of out existing stock positions. We are now also noticing that our variable rate bonds are being battered and we can expect more of this punishment although there should be no long term effects in that sector.
11. We have positions in real assets (real estate and commodities) of 5% and similarly sized positions in foreign currencies and gold. All of these categories should move independently of any decline in the U.S. paper currency.
12. Although we are watching very carefully we
do not believe that we will experience a complete meltdown of the U. S.
(and by definition the world’s) paper currencies. But it may be a close
run thing and we are “healthily” cautious.
e. Conclusion
We are now in the midst of the crisis and
the market and the economy may well remain page one fodder as they have
been in recent weeks. The history of the U.S. is reassuring in the sense
that we do tend to get into messes, often of our own making, but our financial
system is remarkably flexible and has a history of bending, but not breaking.
I am, of course, watching very carefully to see if this time is different.
For the next 8 days I will be in England but I will be glued to my trading
desk throughout the entire market day and I will be in constant contact
(broadband) to the office.
UPDATE:
At 10.00 pm after continuous meetings Bear Stearns was just sold to JP Morgan for $2 a share. This represents a loss of 98% of its value over the last year. The Federal Reserve also took further emergency action but, at this point, gold is soaring and the markets are in disarray. You can be sure that you have a firm hand at the helm but this WILL be a difficult time. The early indications are that foreign markets are down around 4% and domestic indications suggest a decline of 2+%.
Please don’t hesitate
to call or write with questions, although I would prefer them after 4.00
pm as the market is very, very demanding these days. I apologize for anyone
where routine financial planning has been delayed as all our endeavors
have been deployed to the portfolio and that seasonal bugbear courtesy
of the I.R.S.
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