Some Relief and Perspective

This update is in three parts. The first two parts are links to articles of mine that were recently published in the Concord Journal. While these pieces are written for a less sophisticated audience, I hope you find them informative as I try to put the pieces together from last year’s events.

The first article addresses the dramatic shortcomings of the SEC and politicians, who effectively lay the groundwork for the market collapse that occurred in October of last year. Yes, we can point fingers at greedy bankers and amoral hedge funds, but in the end they did exactly as we as a society encouraged them to do. Click here to read.

The second piece reviews why the collapse was so remarkably devastating to the nation as a whole. Again, I point the finger at mutual funds as a business, and their myopic reliance on asset allocation as the sole form of managing risk for their portfolios. With diversified mutual funds down 50% and “safe” retirement funds down 25%, many families are facing tough choices from college funding shortfalls to dramatic deficiencies in retirement assets. Click here to read.

The remainder of this email is a look at the past month. While the nation’s psyche went through a remarkable change, the facts from the month are notably unremarkable.

Since my last update, the state of the markets has changed dramatically, while the state of the economy has remained largely the same. As I reflect on March, I come up short for anything of substance to report on how our world has changed in reality. Instead, the significant difference is perception.

March saw an outstanding rally in the equity markets. At one point the S&P 500 was up 13%, to close at a gain of 8.8% for the month. The first days of April have been equally impressive, with a 7.9% gain as of this writing. The larger picture is far more sobering: for the year to date the equity markets are down 4% and the bond market is down 5%. In any other year, this would be considered an alarming performance. In the context of where we have been, however, this is a relief.

The key differentiator is the near collapse we faced in 2009. With the equity markets down 37% last year, another 8% in January followed by 11% in February, it looked like the world was ending on March 6 when the S&P 500 hit a level of 666, a highly inauspicious number. CNBC was literally counting the days until the equity markets hit zero.

What has changed between now and then is perception. As I’ve outlined in last week’s article, the market reaction to the economy was exacerbated by greed and lax regulation. This in turn drove the economy far further into a recession, and at the same time created mass financial panic. The reality has always been the same, however. The economy does have a stable footing and the financial system will remain intact. Yes, the system needs help, and time, to regain its prior strength, but it will recover.

In a bubble of fear, the market overreaction seems to have exhausted itself. From that low point of 666, the equity markets have made a steady climb back to levels from the beginning of the year, before the banks reported their 2008 losses and the markets lost faith in the Administration’s response to the crisis.

That does not mean that a bull market is upon us and economic recovery is as imminent as the spring blossoms. We are many months away from economic growth, if not a year or more. Jobs will continue to be shed at a rate of over 100,000 per week and some companies will fail. What we are looking for are inflection points – moments when job losses are slowing down and company losses are no longer growing. If we can establish that the point of inflection is within our immediate grasp we can begin to establish the bottom to the economy.

Currently, we are in a rally that is working to establish a bottom in the markets, a predictor that is typically six months ahead of the economy. It is our belief that we will again see declines from these market levels, and that volatility will continue. In effect, we are working to establish the market bottom as well. And this is all predicated on the assumption that there are no “events” to further shock the system, such as the collapse of a major bank, or worse.

In our investment strategy we continue to hold a position in the equity markets that is underweighted from our long-term goals. The excess funds are being put to work in either money markets or the bond market, where we can seek consistent gains irrespective of the equity market volatility. As the market bottom is established, we will be increasing equity exposures into firms we believe have tremendous upside given the current stock levels. In some cases, we will also start to again use Exchange Traded Funds to gain diversified equity exposure where individual holdings are not appropriate.

As always, please feel free to write or call with questions or comments and wishing everyone a very enjoyable spring.

Regards,

David B. Matias, CPA