Bartlett Commentaries
Market Commentary, 09 / 2008
Recent Market ConditionsA bear market is generally defined as a significant decline (15-20% or more) from a previous stock market high. By this definition, there have been seventeen bear markets since 1950, roughly one every three to four years. Some have been short with markets quickly recovering to new highs (1987, 1990), while others been more severe with lengthier recovery times (1973-74, 2000-2002). The average bear market during these periods lasted eight months with stock prices falling 25%, and it took twelve months for the market to recover back to prior highs. Measured against this historical average, this latest bear market has been quite severe, now in its twelfth month with the Dow and S&P indexes some 35% below 2007 highs. Foreign stock markets have suffered even greater declines. History suggests we may have seen the worst, in terms of severity and duration.
Our ApproachA prudent investor should have appropriate safeguards in place so that occasional market storms can be weathered without compromising living standards. This is why we pay attention to a variety of client factors including time horizon, risk tolerance, growth expectations, income requirements, and portfolio withdrawal rates. Asset allocation, the blend of equity and fixed investments, is extremely important. Time and again in difficult markets we learn of investors with portfolios either undiversified or imbalanced. They suffer significant damage that could have been avoided had prior planning accounted for market risks and established appropriate safeguards. This is why we feel that setting appropriate investment policy is so important.
We have not been bulletproof this year, but our accounts have held up in comparison to most market averages. We are encouraged by the caliber of the securities we own. Our equity holdings are focused in companies with significant competitive advantages and financial strength. These businesses should gain market share at the expense of weaker competitors in these difficult economic times. We expect their profits to hold up relatively well this year and we anticipate a continuation of shareholder friendly actions including dividend increases, share repurchases, and strategic acquisitions.
As for bonds, that market too has been unusually turbulent with widening credit spreads (the difference in yield between Treasury bonds and other bonds) and the tumult occasioned by the Lehman bankruptcy. We feel fairly secure in our bond holdings, which are characterized by good credit ratings and intermediate duration.
The Credit CrunchIn March of this year, Bear Stearns was purchased by JP Morgan Chase. The transaction was supported by the Fed to forestall a broader liquidity crisis that might have resulted from Bear’s bankruptcy. We noted at the time that Bear Stearns was the most spectacular casualty of the unwinding of mortgage debt, even more so than Countrywide, the largest home mortgage lender that was bought by Bank of America earlier in the year.
Corporate crises like Bear Stearns and Countrywide usually occur near the end of financial cycles. Yet here it is seven months later, and more heavyweights have buckled, some nationalized and others sold to stronger companies in desperate transactions supported by the government. Similar failures and/or rescues occurred in the UK, Ireland, Spain, Germany, Iceland, and the Netherlands. The fallout from declining home values has been incredible, and what started with mortgages has spread into other loan categories.
In the wake of these events, the Treasury Department has embarked on the recently approved “Rescue Plan.” This is intended as a systemic solution to the underlying problem of distressed loan values weighing on bank capital, which has resulted in reduced lending and deteriorating economic activity. The plan will entail government purchases of distressed debt from participating banks in an effort to provide liquidity to financial institutions. If the plan works, it should accomplish its objective of stabilizing credit markets while also quite likely turning a profit for the government. This is because an eventual recovery in home prices and the economy should lead to higher mortgage-backed security prices, which favors the government’s investment in these instruments. The Treasury will also get an equity stake in participating financial institutions whose recovery would result in additional dividends and capital gains.
ConclusionSome would compare the present circumstances to the Depression of the 1930s, the last time we had a worldwide financial crisis of comparable severity. We think this is alarmist and sensational. Monetary officials here and abroad have been lowering interest rates while governments are moving actively to restore bank capital. This is quite a contrast to the 1930s, when a series of major policy blunders turned an economic slowdown into an economic catastrophe. We believe a recession is underway, that level heads will prevail and that investment objectivity must be maintained. We are also mindful of Warren Buffett’s wisdom regarding the importance of temperament for long-term investors. Be assured we’re evaluating opportunities for your portfolio on an ongoing basis.
For more information on this topic, please contact us. At Bartlett & Co, we assist high net worth individuals and their families in defining & reaching their life goals.