It does, however, highlight the complexity of the modern financial system and I think that the new, and hopefully thorough, regulations will help to avoid this type of excess in the future.
What we have faced in the last nine months is the biggest threat to the world financial system since the 1930’s and, although progress has been made, we are by no means out of the woods. The actions taken have just addressed the immediate imbalances and recklessness exposed in the financial system and they do not address the very real problems evident in the economy itself.
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 April 17, 2008 |
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| Investment earnings 2008 |
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| Investment Earnings 1981-2008 |
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| S&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&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.
The crisis that we were knee deep in at the time of our last report has now abated, but many of the same risks remain. Bear Stearns is gone and the nervousness is dissipating, but the potential for crisis is, by no means, permanently removed.
How could things have come to this pass?
Since last summer, the government has pumped nearly $1 trillion in direct and indirect support into the financial system, yet cracks still appear. The Federal Reserve and the Governments around the world have taken unprecedented steps to re-regulate, assist and influence the financial markets.
I think this time, finally, they may be right, but this is by no means guaranteed so I remain cautious and careful and exceedingly watchful.
So I repeat “How could things have come to this pass?”. 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.
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 year. 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.
This
is what we have and will do:
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, but we are increasingly confident that, this time, we will avoid a total melt down of the financial markets.
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. If the world manages to muddle through this
crisis (which now seems more likely) 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.
9. 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.
10. Our nervousness has led us to establish significant short positions to offset some of out existing stock positions.
11. We have positions in real assets (real estate and commodities) of 6% and a 2% positions in foreign currencies and a 5% position in 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.
13. For the first time in several years we are starting, tentatively, to dip our toes back into the water in the real estate sector (although we have always maintained a nominal position). This is not a buy signal for residential real estate and I think there is still quite a lot of pain still to be experienced in that sector, but I now believe it might not be as bad as some of the direr predictions. The dramatic lowering of interest rates, although terrible for the currency, should help a LOT of homeowners cope with their adjustable rate mortgages. There will still be a lot of pain, wholesale foreclosures and distress and prices will need to revert to normal relationships viz a viz incomes, but I now believe it will be survivable without massive dislocations.
e. Conclusion
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 but I increasingly believe that we will, in fact, “muddle through”.
There
are, of course, very real problems domestically and internationally which,
in no particular order are:
We do, indeed, live in interesting times.
UPDATE:
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. We are so pleased that April 15th has passed and now we can
concentrate our endeavors on more productive tasks. :)
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