Carpe Annum

As you read the newspaper or listen to the evening news, you hear a litany of reasons explaining our turbulent stock market: the economic recovery has stalled; earnings have disappointed; oil prices are high; deflation seems just around the corner. And to further complicate our nation’s economic situation, the threat of war with Iraq looms on the horizon. It makes a certain amount of sense that the market should be encountering instability as a result of these concerns. But they don’t adequately explain the sharp deterioration in confidence that has gripped not just our nation, but countries around the globe.

It is the combination of all of these factors which has led U.S. investors to what has become a crisis of confidence. Confidence is indeed depressed but the question is why has the result been so unusually harsh? Though our situation seems grim, we must remember that oil prices have been high in the past; the pace of economic growth, while somewhat disappointing, is still positive; deflation is under the control of the Fed; and earnings are up. But upon further inspection, one can see that our market seems to be falling into a cycle. The economy is weak because the market has drained consumer confidence. This crisis of confidence leads to lower market growth and this lower growth means fewer profits. This further drains consumer confidence, the economy weakens further and thus the cycle continues…

There is, however, a light at the end of this tunnel. The cycle can be broken when investors examine the facts and focus on the reality that the U.S. economy, for all the disappointments it’s delivered, is not in bad shape. GDP growth is positive and productivity is rising sharply. The unemployment rate remains near 6%; job growth is positive, if slow; consumer durables and housing are strong; and inflation and interest rates are low. It’s easy for us to lose sight of these fundamental supports when growth doesn’t necessarily meet expectations.

In the short-term, stray factors can influence stock prices and cause valuations to deviate from fair value. Sometimes these deviations can be rather large and last for quite some time, as we saw in the late ‘90s. But eventually the fundamental principles of capitalism will overcome, and the market will reflect a fair price that’s based on real earnings growth. In every market environment, good or bad, there are always opportunities and risks. A good investor will find some of the opportunities and avoid most of the risks. In 2003, most investors will once again be surprised by the market - missing the best opportunities. What will you do?

Published in Westlake Magazine – February 2003

Client Update – January 10, 2003

While the fourth quarter was strong for stocks and high-yield bonds, it was small consolation in a tough year. For the year, every S&P industry sector was down and eight of the ten experienced double-digit loss. It has been sixty years since the market has fallen three straight years, and 2002 was the worst single year since 1974.

In our opinion, there are a number of factors that contributed to the bear market, but without question the biggest was the stock market’s tech bubble. Terrorism and war fears didn’t help, but these only contributed at the margin to the magnitude and length of the bear market. Corporate shenanigans also hurt, but were not the driver—just another outgrowth of the environment of bubble-driven greed.

It is almost a tradition for investment professionals and the media to issue a forecast at the beginning of each year. But in any particular year there are many factors that play out differently than expected (e.g. Enron & Worldcom), and other potential issues that simply can’t be foreseen (e.g. 9/11). This makes accurate forecasting very difficult. Instead, to achieve long-term investment success we believe it is essential that we base our strategies only on analysis that we are highly confident in, not hope or speculation. This necessitates a relatively long-term time horizon, since we have a much higher level of confidence in our ability to assess long-term factors.

As we look out over the next five years we are optimistic and believe financial markets are likely to deliver decent returns relative to inflation. There remains a lot of cash sitting on the sidelines waiting to enter, corporate valuations are moderate, and interest rates and inflation are low. While we won’t be seeing anything like the 1990’s Bull for many years, we don’t expect to be visited by the Bear anytime soon either.

Client Update – January 15, 2002

While we generally look to financial and economic information to assess market conditions, we must never overlook the political forces. Nobel Prize winning economist Milton Friedman said that you cannot have individual liberty without economic freedom; politics and economics are in fact inseparable.

Our long-term positive outlook is attributable to the fact that our country is resilient. Our history has proven that we are able to overcome adversity once we have resolved to pursue a course of action. During most of our lifetimes, we have not seen periods of such patriotism. While the intellectual community likes to portray patriotism as naïve, that is not the case. America’s focus and commitment assures our success.

During the latter part of the summer, it appeared that the U.S. economy was on its way to a slight recovery. But that all changed on September 11. The economic and psychic blow was severe enough to keep the economy in a recession. Fear gripped the market and it dropped precipitously.

Since the attack, the Fed has helped tremendously by lowering short-term interest rates and increasing liquidity. This provided sufficient stimulus and support for the markets to rebound to their pre-attack levels. Anticipating these results, we added heavily to the market in late September and early October.

We believe that the economic recovery will come later this year, but will be quite moderate. At this point, money market and bond rates are unattractive and we do not expect that the stock market indexes will surge ahead since none of the major market indexes are cheap. There are, however, some investments where value is reasonable, such as smaller and mid-sized companies.

America will continue to exhibit the faith and unity required to overcome the obstacles we face. And from our perspective as investment managers, we know that capitalism is the natural partner of political freedom. We view the road ahead with optimism as our Country and its economy confronts its foes and moves ahead.

Back To Your Future

Consider the past 18 months as your future. If your advisor has guided you through these rough times with little damage, you’re in good hands. However, if your feel your retirement has been jeopardized, your stock portfolio is down over 30%, or your balanced portfolio is off more than 10%, it’s time to seriously consider a change and seek out a few other advisors and their clients to see how they’ve done.

The stock and bond markets today face great opportunities and sizable threats. Your current portfolio should look different than it did a year ago. Much has changed and so should you. Has your advisor properly repositioned your portfolio, or are you still holding the same old stuff hoping it will come back?

The market’s roller-coaster ride has not only continued throughout 2001, but has turned into quite an “E” ticket over the past 6 months. Prior to the tragic events of September 11th, it had already been falling consistently for several weeks due to weakening economic conditions and falling corporate profits. As conditions deteriorated even more due to the tragedy, however, the probability of a sharp rebound in stock prices increased dramatically. While stocks were primed for a near-term rally, it was too early to be certain that a new bull phase was about to begin.

Late in the summer, it looked like companies were beginning to spend again and the leading economic indicator signaled a recovery, but the terrorist attacks changed both. In addition, consumers had the rug pulled out from under them by falling stock prices, layoffs, and a mood of uncertainty. This dramatic deterioration of events demanded action. The Federal Reserve and our Government are now both working overtime to stimulate the economy. No government will match the massive reflation effort now underway in the U.S. While the market will remain turbulent, it is only a matter of time before these actions take hold and our economy rebounds.

The past 20 years have witnessed the birth and death of a great bull market for stocks and bonds. Most advisors and their clients did well through 1999, but only a few have been successful since then. Markets will always be volatile, so your advisor must be willing and able to take action. The period from 1995 to 1999 was an exceptionally low volatility, high return stretch of years that made most advisors look smart. Since then, however, many market indexes have fallen 30% or more, and many advisors have severely damaged their clients’ future. This type of market activity will continue so you need to be able to trust your advisor to guide you through the next 20 years. As of today, you know all you need to know about your advisor. It’s time to fish or cut bait!

Published in Westlake Magazine – December 2001

Pinto or Porsche…What were you sold?

Many people find that working with their investment advisor is as awkward as dealing with an auto mechanic. We’ve all had that uncomfortable feeling that we’re being taken advantage of, but have no ability to prove it. Just because they hand you back a bag of dirty parts doesn’t mean they really fixed anything or if they are really any good. These concerns relate directly to the quality of investment advice most people are receiving. All portfolios, like automobiles, are designed, built and then maintained. Your performance is dictated by the ability of the professionals doing the work.

Engineering: Who designed and built your portfolio? We all know that there is a large difference between a Pinto and a Porsche. Did your portfolio blowup when this bear market rear-ended you? Unfortunately, most investors’ portfolios suffered major damage because their advisor convinced them that they were driving a Porsche, when they really had a Pinto. If the firm that engineered your portfolio was any good, you should have avoided the damage.

Maintenance: Who takes care of your portfolio? Just like a high-performance automobile needs professional care and consistent maintenance, your portfolio requires attention as well. Portfolio maintenance is making adjustments as market conditions warrant. Most advisors lack the background to adequately build and maintain a portfolio. As such, they hang their hats with large firms that provide them marketing support to grow their client base, analysts to help them suggest investments to clients, and then legal support when things go wrong. Portfolio management is the primary skill that you desire them to have, yet it is precisely the area in which they have little or no real education or experience. Fancy certificates from 3-day seminars at Pebble Beach will not make them a portfolio manager.

Sales: It is through this well marketed business model that most investors have found their advisor and suffered steep investment loses in recent years. In reality, most of these advisors are merely “Used Stock Salesmen” acting as the marketing arm of large financial services firms. Though they are experts at describing features and making us feel comfortable with a purchase, none of us would ever consider taking our cars back to the salesman on the car lot for maintenance. Yet, these firms have convinced their clients that the salesman is really a mechanic as well. Just as selling hundreds of cars does not make the salesman a good mechanic or automotive engineer, convincing hundreds of investors to open accounts does not make the salesman a competent advisor.

While this market will eventually improve, it will not go back to the easy money of the 1995-1999 period. As always, investment skill and risk management will be needed. Consider the past 18 months as your future. If your advisor has guided you through these rough times with little or no damage, you are in good hands. If your advisor let your portfolio suffer during this downturn, then it is time to make a change.

Published in Westlake Magazine – October 2001

Mad Dow Disease

Since December 31, 1999, the Dow has declined 7%. For many years, the only technology stock in the Dow was IBM. But, due to the great returns of technology stocks, there was great pressure to add more technology stocks to Dow so it would be more competitive with the S&P 500 index. So, Microsoft and Intel were added. Since then, they have proceeded to drop 40% and 60%, respectively from their highs, causing the Dow to drop further than it would have without them. While we agree that the Dow should have had more technology representation, it is interesting to note that even the “keepers” of market indexes were caught up in the hype.

Once again, the more things change, the more they stay the same. Over ten years ago, our country was obsessed with the growing budget deficit and the banking crisis. The media was busy whipping up the public into a fearful frenzy. It was the end of the financial world and everybody knew it. At the top of the best-seller list was Ravi Batra’s book The Great Depression of 1990. What followed, however, was a great decade of prosperity and economic strength.

During the last few years of the 1990s, the U.S. economy was very strong and wealth creation seemed so easy. Dow 36,000 and The Roaring 2000’s hit the bookshelves and sold like crazy. Again, the general public was all worked up—but this time with greed. You couldn’t attend a social event or turn on the TV without being aware of how quick and easy money was being made in the stock market. Again, what has transpired in the past year was the opposite of what was expected by most investors. While the bull market may be dead and gone, the market in “bull” is still booming. Over the past 10 years, investors would have missed out or lost substantial wealth by following the crowds. In investing, the hype is always wrong.

Going forward, the erosion of stock market wealth will clearly affect spending in the months ahead, perhaps enough to cause a recession. Over the next few months, there will be more bleak earnings news so the stock market is not out of the woods yet. However, the Fed’s rate cutting has reaffirmed its determination to stabilize the economy and has likely put a floor under stock prices. Just as prices started falling last year before earnings dropped, they will begin to rise again before earnings improve. In the past nine bull/bear cycles, the S&P 500 rose 32% on average before earnings began to improve. However, we believe a more modest gain is likely this time.

While it would be great to know exactly which way the market was going to move next, it really doesn’t matter because it is possible to earn a good return on one’s money in most market cycles. Many advisors have failed their clients by having too much money in the wrong sectors of the market at the worst possible time. While these advisors will take credit for the money made during a rising market, they blame it on the market during tough times. As an investor, you need to question your advisor’s advice over the past year. First, did your advisor proactively adjust your portfolio to the changing conditions during 2000. Second, if you’re an aggressive investor you should be down no more than 15% and if you believe your account is conservative, you should actually be up a little. If you did worse than these, it is not the market’s that failed you, but your advisor. Only during tough times does skill, or lack thereof, make itself evident.

Whether you desire to grow your wealth conservatively or aggressively, our success comes from professionally managing your investment portfolio and working to align your financial decisions with your goals. Our goal is to grow what you have and protect what you’ve earned.

Published in Westlake Magazine – June 2001

Stocks: From Lemons to Lemonade

You should not look at the stock market to make you wealthy. You should think of the stock market as a place where your wealth can be protected and grown if managed prudently. Over $1 trillion in value has been lost in Cisco Systems, Microsoft, and Intel. Very few people have actually created their personal wealth solely by investing in the stock market. Most people create their wealth through their personal initiative and hard work. No matter how you create your wealth, it is important to protect, grow, and manage it to meet your goals.

We have a unique mix of financial and estate planning services. Our goal is to identify and understand our client’s goals and assist them in protecting and growing their assets. Our emphasis is on formulating comprehensive family wealth and investment plans to avoid excessive market risks and the burden of taxes.

The following are just a few ideas to consider. Before implementing any strategy, you should check with your advisor.

Stock Losers
If you have substantial losses in any stock in a taxable account, you should consider selling it to “bank” the capital loss and put up to 50% of your loss back in your pocket. You can repurchase it 31 days later or immediately buy something similar to replicate the position.

Capital Gains
In this volatile market, many investors have tried to hold onto stocks for a few more months just to get the long-term capital gain tax rate. In so doing, they have often seen their stock price fall more than the tax savings would have been. Don’t let the “tax” tail wag the “investment” dog.

Re-pricing Stock Options
Many companies are considering re-pricing their stock options so that their employees are not so far out-of-the-money. While this may be great for the employees, it can really hurt the company’s P&L. Instead, consider canceling the options and issuing stock for notes.

Acquisition Bailout
Many key employees of companies with depressed valuations or cashflow concerns are hoping for a quick buyout to pop their stock price up. While this may appear to be a windfall, it often triggers costly “golden parachute” issues for key executives.

Covered Calls
Whether your large holdings are up and you’re worried they might go down, or they’re down and your not sure how quickly they’ll recover, consider writing covered calls on them to take in fat premiums. For example, January 65 2002 calls for Amgen currently at $63 will pay you $12 per share. This 19% current return caps your upside at $77 and protects you down to $51 per share.

Private Wealth Management takes control of your financial situation and creates a strategy to insure that your wealth is not squandered by taking speculative or unnecessary risks. We work with our clients to understand their goals and then create and manage a complete portfolio. We take care of business, which to us is protecting and growing your money. If you’d like to understand the difference that professional wealth management can make, please call 805-495-4405.

Published in Westlake Magazine – April 2001