Client Update – June 2004

Rising interest rates, fear that the housing market may be starting to roll over, a growing current-account deficit, volatile commodity prices, ongoing turmoil in the Middle East—all of these concerns have been on investors’ minds lately. Looking past short-term noise is important in making good investment decisions; but many of these issues are more than noise, and require that we evaluate and try to put them in an investment context.

Given an almost endless list of positives and negatives to consider, our goal is to make a realistic assessment that weighs optimism and pessimism fairly. We give more weight to factors that are material and knowable, and then try to evaluate how they might relate to a clear argument for making a move in your portfolio. Therefore, over the past several years we have made many strategic changes to portfolios due to opportunities and threats created by ever-changing geopolitical and economic events.

There are problems on the horizon. The current-account deficit, the impact of a slowdown in housing prices, and other macro-level risks could all create scenarios where earnings could decline significantly (e.g., a weak dollar would lead to higher interest rates and a recession; lower housing prices could hurt consumer spending, etc.). Earnings growth is still quite good at the moment, but profit margins are near all-time highs, which leaves little room for improvement. All these variables—as well as others—contribute to our belief that the market is fairly valued at this time.

Though there are still plenty of risks in the outlook, and the U.S. and global economies remain volatile, we continue to find opportunities to take advantage of the market and its volatility. We seek opportunities where others see problems. For example, as the dollar falls in value, foreign stocks and bonds reap the benefit. Thus we are inclined to stay with a positive view and will continue to find investments that add value and minimize risk.

What Should I Do Now?

Taking Control of Your Investments in Turbulent Times

As the investment markets have dropped significantly from their March 2000 highs, you most likely have watched your portfolio value drop unnecessarily. But at the same time a more worrisome drop may have occurred—a drop in your confidence as an investor, a drop caused by both the severity of the declines and a lack of guidance and direction regarding how best to get back on track toward your long-term goals.

Investor “Red Flags”
If that’s your situation, you should know that the key to regaining control over your investing future lies in asking yourself some basic questions:

Has it been a while since you and your advisor reviewed your strategy?
Are you paying large tax bills, even though your investment portfolio has dropped in value?
Most importantly, are you not getting sufficient advice and guidance from your financial advisor on reducing losses and enhancing your chances of regaining lost ground?

Back to the Basics
If you are experiencing any of these “Red Flags,” then this could be an indication that your investment strategy doesn’t accurately reflect your current personal situation. For example, your portfolio now could:

Have become too concentrated in certain industries or types of securities (such as technology stocks) in an attempt to capitalize on short-term market trends;
Contain more risk than you may find comfortable in today’s environment;
Be poorly designed—or not at all designed—to consider after-tax returns;
Be generating significant costs and expenses without providing personalized service and guidance in return.

The best way to correct this situation and take back control of your investing process is a thorough, objective analysis of your portfolio and strategy. This “financial checkup” is one way to ensure that your portfolio is properly managed and your strategy still suitable. A comprehensive portfolio assessment should include not only your individual securities holdings, but also an assessment of your goals and risk tolerance, your tax status and potential liabilities, and a cost/benefit analysis of the fees and expenses you are paying.

Next Steps
If you want to take back control of your investments then you should get this financial review. This checkup could simply reconfirm that you should “stay the course” with your current strategy. More likely, it will help identify if changes are necessary to better reflect your current concerns and needs. A “financial checkup” can help you regain control of your investment strategy and provide a lifetime of benefits for you and your family. What should you do now? Please take the time now to find the right answer for you.

Published in Westlake Magazine – April 2004

Market Update

There are three problems currently facing the economy and markets. First, too much credit was created for individuals, corporations, and government and it needs to be unwound. Individuals and corporations have begun that process and it will continue for several years. Second, the U.S. economy’s recession began near the start of 2008. Even though government statistics masked its existence, it was evident through common sense observation. Recessions are a natural part of the business cycle and need not be feared. They generally last 12-16 months, causing stock markets returns to be low or slightly negative for a few months and bond prices to rise, offsetting some of the stock market’s return. However, the third factor, the recent credit freeze, has caused a powerful flight from risk pushing virtually all security prices much lower. This, in turn, makes the first two problems worse.

The credit freeze is much like a financial heart attack. It does not matter what other illnesses the patient may have, because they become irrelevant if the heart cannot be restarted. If credit does not flow through the economy’s veins, then business will come to a halt. Every week that conditions were frozen will likely add one month to the patient’s recovery. Thus, we expect that the four weeks from mid-September to mid-October will add four months to our recession, taking us out to mid-2009 before conditions begin to look better. The stock market, however, will anticipate the recovery and begin to move higher before the news media can report improving conditions.

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