2nd Quarter 2008

Posted July 18th, 2008

Quarter 2008  

 

I’m going to start this letter in reverse.  What’s the bottom line?  What should you do right now with all the turmoil going on?  The answer; hold on and wait this market out.

 

The market pendulum has swung substantially toward the negative, and you don’t want to be making any major portfolio adjustments at this time.   This is the right advice for most everyone. 

 

Now let’s proceed with the logic that brings me to the above recommendation.  Just when the stock market was starting to show positive signs of life in May, the recent setback has snatched defeat from the jaws of victory (at least for now).   I eat my own cooking, so I’m in exactly the same position as all of you

 Here are a few thoughts running through my mind currently.   

 

  • I keep reminding myself that we hold quality investments in a diversified portfolio.
 
  • I keep reminding myself that one year in every four or five we will have these kinds of setbacks. 
 
  • I keep reminding myself that most of my clients had no intention of selling their investments today anyway.  The stock market has historically returned over 10% per year on average, and the price we pay to gain this kind of return is the occasional negative cycle of the market.
 
  • I keep reminding myself that we have been through tough markets before (2000 through 2003); and my clients were better off in the end with a buy and hold approach.
 
  • Recently, I personally have been buying Warren Buffett’s Berkshire Hathaway stock.  As powerful as this stock has been in the past, its performance in 2008 has been negative by as much as 20%.  People understand to hang onto Berkshire for the long term and historically he has made 15% return, year after year, for his faithful investors.   The same logic should hold true for all of our quality investments. 
 

As you review your statements, keep the following facts in mind as a reference:

 

  1. If you started investing in June of 2006, and you received the average return of the market, your account would be at breakeven today.
  2. If you started investing in June of 2007 with average returns, you would be down 20% today.
  3. If you started investing on January 1st, 2008 with average returns, you would be down 13%.

 

As you review your account, you will most likely see that you have faired much better than these averages.  That’s the value added by holding quality investments in a diversified portfolio.  

  

The recent funk of the market can be explained be a few key concepts.  Oil prices, inflationary concerns and a hang-over from sub-prime mortgages.

 

All of my research suggests that there is no justification for oil to be at $140 a barrel and gas prices to be near $4 a gallon.  The costs of producing oil suggest that a price of less than $100 a barrel is justified.  But high prices are where they are, and we just have to wait until the world’s demand for oil diminishes.  We are starting to see signs that consumers are reducing their gas usage.  The higher prices go, the more attractive alternative forms of energy become.  There is a point where the cost of oil will collapse upon itself.

 

I have to admit that it seems a bit unreal that gas could go from under $2 a gallon to nearly $4 in such a short time.  Corn has also risen from $2 a bushel to $7 a bushel in just as short of time.  The increase price of corn has had a direct impact on the cost of food at the supermarket.  Both food cost and oil cost are starting to influence the overall inflation rate.  These kinds of price adjustments in such a short time frame are simply not normal, and I have a hard time believing that things won’t moderate themselves soon. 

 

With all the negative factors around us, is there anything positive to help us see the light of day?  Here are a few thoughts:

 
  1. The dollar is low, and thus the goods and services produced by American corporations look inexpensive overseas.  Demand has been high for our exports.
  2. In May, personal income gained 1.9% and consumer spending increased as well.
  3. Inflation is running lower than the market’s worst fears. 
  4. GDP growth continues to run at 1%.  Not a high number, but we still haven’t slipped into a recession.
  5. Existing home sales increased 2% in May, and pending sales are up 6.3%.
  6. Government spending, inventories, nonresidential construction and business investments in software and equipment are all up in the second quarter. 
 

But even with a few positive factors, the market mindset is negative and this will probably continue for the summer.  The focus tends to be on the negatives and completely blind to anything positive.

 

 In closing, I would like to remind you of some key market factors; 

 

Factor Influences Current Outlook

Inflation

Interest Rates & Profits

Negative Signs

Fiscal Policy

Interest Rates

Neutral

Monetary Policy

Interest Rates

Bullish

Economic Growth

Profits

Negative

Earnings Growth

Profits

Negative

Stock Valuations

Based on Price/Earnings Ratio.

Modestly Bullish

Exogenous (oil, Iran, etc)

Interest Rates

Oil prices are up.

Consumer confidence is low.

  

As always, I am available to discuss your financial goals and portfolio with you whenever you desire.  

Sincerely, 

Ron Dickinson, CPA, CFP®, MPA-tax