Fagan Associates Archive for September, 2008

Investors, no Americans, might want to take heed of some of the notable quotes from a variety of different sources that were reported over the past week or so. More than anything else, what struck us was the sense of urgency emanating from the lips of these individuals.

Warren Buffett, being interviewed on CNBC television this past Wednesday, September 24. “Last week, we were at the brink of something that would have made anything that’s happened in financial history pale.”

Regarding the potential for a $700 billion recapitalization package from Washington, Buffett notes that he is “not saying the Paulson [Treasury Secretary Henry Paulson] plan will eliminate the problems but it’s absolutely necessary, in my view, to avoid going off the precipice.”

Now, given the fact that prior to these comments, Buffett’s Berkshire Hathaway had just invested $5 billion into Goldman Sachs, many readers may cynically think that he was just feathering his own nest, realizing that this $700 billion package would have made his investment much more secure. We disagree wholeheartedly. We believe that Buffett, like many others, is attempting to make a point regarding the tenuous nature of the current situation in the financial markets.

Regarding whether or not the issues affecting Wall Street will end up affecting Main Street, Buffett employs the following analogy. “The economy is a little like a bathtub. You can’t have cold water in the front and hot water in the back.”

Federal Reserve Chairman Ben Bernanke, appearing before Congress, comments also on the impact that a severe downturn on Wall Street will have on Main Street, noting that “I believe if the credit markets are not functioning, that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP [Gross Domestic Product] will contract, that the economy will just not be able to recover in a normal, healthy way.” Sobering words from an individual who is an expert on causes of the Great Depression.

Jack Welch, former CEO of General Electric, before the World Business Forum in New York, stated that “I now believe that we are in for one hell of a deep downturn.” Welch, who had been relatively optimistic regarding the economy added that “I am now caving. Get ready for real tough times. They’re coming. There is no credit available.”

Finally, like a sharp stick in the eye, German Finance Minister Peer Steinbrueck said that although “the long-term effects of the crisis are impossible to gauge, one thing seems probable to me. The U.S. will lose its status as the superpower of the global financial system. The global financial system will become multipolar.” If that didn’t get your attention, nothing will.

What to do? Make certain that your investments conform to your long-term objectives, time horizon, tolerance to risk, financial obligations and family concerns. Review your holdings at least once a week during these times. Buy and homework, not buy and hold. Furthermore, be conservative in your estimates of future growth.

Now, regular readers of our column will note that we have not been bullish regarding the short-term outlook for either our economy or the U.S. stock market However, we thought then, as we think now, that investors in stocks over the next two to four years will be rewarded above the other asset classes, namely bonds and cash. If you differ in your outlook, sell your stocks/equity mutual funds now. This is your call.

Our thoughts regarding the $700 aid package or a semblance thereof, we believe that this is not the time for theoretical arguments as to the ultimate impact on our capitalistic society. We think that now is not the time for the theoretical discussion as to whether this package continues the slippery slope toward socialism. We do believe that our economy is on fire, our economic house is burning and that our politicians must act in such a manner, regardless of the upcoming Presidential Election, that extinguishes this fire. When it is out, they can then figure out how it started.

It was a little less than one year ago, October ninth to be exact, that the Standard & Poor’s 500 last closed at a record high. Since that day when the S&P finished at 1565.15, as of the close of business this past Wednesday, this index has fallen 26.12% which is, by definition, a bear market. (The widely accepted definition of a bear market is a decline of twenty or more percent.) Furthermore, the Dow Jones Industrial Average has fallen 25.10%, once again marking a bear market. All of this carnage begs the question as to when it will all end.

It is safe to say that given the fact that we currently exist in a fear driven trading environment, much different from the commodities driven greed that existed a little over a year ago, nearly anything can happen. We have often pointed out that all trading in securities can be categorized in one of three ways. That is trading driven by greed, rational trading or fear driven trading. The reason why fear driven trading trumps the other two is that with fear comes concern for “self-preservation,” the greatest force of all! Eventually though, reason will once again take hold and as a result the market will bottom and again move along a rational path. (Yes, we do consider the current depths to which the market has fallen, irrational, just as the events during the late 1990s were irrational.

Investors may find some solace in the fact that since World War II there have been nine bear markets and that the average decline in the S&P500 was thirty percent. In addition, the average bear market lasted fourteen months. Given the fact that the S&P500 has fallen over twenty-six percent these past twelve months, it stands to reason that we are in the vicinity of a bottom. That said, nobody has the ability to pinpoint the exact bottom. History will provide the answer.

Despite the elusive bottom, equity markets have tended to respond favorably over time to declining interest rates, rising money supply and tax cuts. One must assume that this bear market will ultimately succumb to these forces as well. One must also assume that, given the nature of the decline in the stock markets, we are much closer to a bottom than a top and opportunity exists for investors with a one to three year time horizon.

Meanwhile, what is an investor to do? First and foremost, if you are withdrawing money from your portfolio on a systematic basis, review your investments to make certain that you have two to three years of income in either fixed income or cash positions. Those that do not need income from their portfolios, your asset allocation depends upon a number of variables, including time horizon, risk tolerance, financial objectives, financial obligations, pension structure, social security projections, and so on.

Another important trait to help you weather this bear market is patience! The markets are not going to turn around over night. Remember, a watched pot never boils! Turn off the financial news networks (the negative impact these networks bring on the investors psyche is a story for another column!), stop valuing your portfolio on a daily, weekly or even monthly basis and enjoy life!

Do some research and as a result make a “wish” list of the investments that you want to buy and at the price you want to pay for them. Should they fall to these prices, double check your research and if still attractive, dollar cost average into them. Once again, don’t expect them to skyrocket overnight.

Last, but not least, recognize that the stock market has many of the characteristics of a bully! It wants to inflict the most amount of pain on as many people as possible! Once it has accomplished this and stocks are in the hands of their rightful owners, it will end.

Learn from this market. We keep notes as to our accomplishments and errors. At some point in time, when the bear is back in hibernation, we will be certain to relate them to you in the form of a column.

During these difficult times, let us hope that we get some rational way of thinking into the market!

Two months ago most economists and investment gurus had written off the American consumer. The reason was simple, $4.00 a gallon gas was choking off everyone. Foreclosures were going to be more common place than a disgruntled Yankee fan. Corn prices were rising like blood pressure in a traffic jam. Everywhere you turned the consumer was dead.

It’s amazing the difference a month or two and a $47 move down in a barrel of oil makes.

The hottest sectors over the past couple of months have been the retailers, the homebuilders, the restaurants, the transports and, surprisingly, the financials. Historically, these are precisely the sectors that perform best coming out of an economic slowdown. They are known as early cycle stocks.

As we have repeatedly noted within past columns, the stock market usually moves approximately six months prior to changes in the economy. Currently, stocks are forecasting a more consumer friendly environment during the first quarter of 2009. By “consumer friendly,” we are referring to lower interest rates along with lower energy costs and lower food costs.

Despite the above, there are many false starts and investors should be careful not to jump on the sectors as many of the most known names in the consumer space are laden with debt. Recently, we have made purchases of DSW Warehouse recently, a discount shoe retailer with no debt and one that we believe would benefit even if the economy does not strengthen. Restaurant chain McDonald’s is one of our fifteen largest holdings and it too balances between benefiting with a cost conscious consumer as well as an improving economy. We can suggest investors look into Exchange Traded Funds that invest in early cycle sectors such as the S&P Retail ETF, S&P Homebuilders ETF and the S&P Consumer Staples ETF. As always, check with your investment advisor prior to making any investment.

We strongly advise the novice investor to stay diversified and not try and time the markets. As the past few weeks have shown all, the stock market moves confound even the most seasoned investor. Take care and stay invested according to your objectives, tolerance to risk, time horizon and financial obligations. Sometimes the most blatantly direst of economic times produces the strongest of market advances. Timers can miss these moves waiting for a “safer” time to get into the market.

With only three trading days having passed thus far in September, the Standard & Poor’s 500 has already declined 3.59% confirming what investors have known for years, that September has historically been a challenging month for stocks. If this September is like past ones and, given the dismal Jobs Report released by the Labor Department this past Friday, there is little indication that this September will buck this historically downward trend.

In addition to the recent decline in payrolls noted above as well as the corresponding rising Unemployment Rate from 5.7% to 6.1%, there are many other issues dampening the bullish outlook for stocks. These issues, unknowns and concerns are like a “perfect storm” and include those of geopolitical, political and economic natures.

The geopolitical concerns weighing on the stock market include the ongoing potential threat of terrorism in the United States; the war on terrorism in Afghanistan and Iraq; the ever present threat of military conflagration between Israel and Iran in the Middle East; and Russia’s encroachment into the country of Georgia and the repercussions for NATO and therefore the United States.

The political concern impacting the market is obvious, the upcoming Presidential Election and the potential for changes in the structure of how both individuals and corporations are taxed. Individuals may see changes in both earned income in the form of a higher marginal tax bracket and unearned income in the form of higher rates on realized capital gains and dividend income. Corporations may also see changes in how they are taxed with an appropriate emphasis on deductions or credits for those companies that are domiciled and hire in the United States.

During this election season it is appropriate that trumping all of the concerns noted above is a quote that former President Bill Clinton stated during his initial run for the presidency in 1992, “it’s the economy stupid.” It is painfully apparent that despite some progress and as a result of proactive action from both the U.S. Treasury Department and the Federal Reserve, the financial services industry as well as the housing sector remains in a deep funk. Obtaining credit, the lifeblood of the American economy is difficult, at best as lending institutions struggle to rebuild capital. The result has been a precipitous drop in demand for housing and therefore housing prices, a cessation of leasing by some automobile manufacturers and subsequent layoffs.

Thus far, declining oil prices have done little to help lift stock prices as many wonder whether oil moving from $145/bbl to $105/bbl is more a symptom of a sluggish global economy and therefore a decline in demand than anything else. If this is true, corporate earnings will remain weak.

After reading the above, one might wonder whether the glass is more than just half-empty. Despite our short-term concerns, investors must remember that stocks do “climb a wall of worry” and that they historically make a bottom during the months of September and October. Finally, some of the recent selling may be “forced liquidation” coming from hedge funds and those entities that must raise cash in order to meet redemptions. We are also experiencing a transferring of stock from weak hands to those that are willing to assume short-term risk for longer-term benefits.

First and foremost we recommend that investors allocate their assets between stocks, bonds and cash according to their needs and tolerance to risk. Secondly, as noted within past columns we urge investors to focus on the next two to five years rather than the next two to five months. If one is able to accomplish these tasks, we believe they will be well rewarded.