Market Commentary

Past is Prologue

July 2008

"What's past is prologue; what to come In yours and my discharge." - from William Shakespeare, The Tempest

Shakespeare's The Tempest seems as apt a source as any to draw on, given our continued cautious stance towards the global equity markets. Given that we are a year into what we think is a longer corrective phase for stocks and real estate, we think it is worthwhile to take a look at the capital markets' and our actions of the past years in order to approach the next several years of investment strategy. Past is definitely prologue. Our discharge, as Shakespeare might put it, is to connect where we've been with where we are going. This is how we stay focused on delivering you consistent returns over a long period of time and you should expect no less from us.

Two years ago, in the summer of 2006, we made the decision to begin to tilt your portfolios away from what had been a successful emphasis on international growth investments back towards a heavier emphasis on U.S. based investments. We also made the decision to add to the overall mix of fixed income investments in your portfolio. We did this to balance the risks we saw related to a peak in the credit cycle, volatility in the value of the U.S. dollar, and momentum-driven risk-taking we saw developing in the stock markets, particularly in the more speculative realms of the international emerging markets. During the following year, we became increasingly concerned about global stock markets and continued to balance portfolios towards bonds and stock funds whose managers had a reputation for capital preservation as well as long-term returns. This was not to say that we eliminated risk in the portfolios – to the contrary, most client portfolios remained invested predominantly in stocks, real estate, and commodities – all growth-oriented return vehicles. However, as a question of emphasis, we prepared client portfolios for a tempest.

We were early. One important lesson we know from our years of investing is that we are often early, because we tend to spot both risk and opportunity before they are widely recognized and are willing to wait because we see fundamental reasons to warrant caution or risk-taking. Being early means that when other investors catch up, we are less likely to be scrambling looking for an entrance or an exit strategy, which helps maintain a sense of calm and order for both us and for you about our investment strategy and execution.

Of course, as the past year has unfolded, we've watched a storm arrive. Global stock and real estate markets have entered bear market territory, which means that many markets are off more than 20% from their peaks mostly reached in the fall of last year. Your portfolios are also down on an absolute basis during this period of time. While we do our best to avoid negative returns, we also know that we cannot fully prevent them in these types of market situations, and we work hard to be very frank with you about that. Some would ask – why not pull your money out of the market altogether in times like these? That would to us be as imprudent as staying more aggressively invested, because in the short-term markets are very hard to predict and we want the managers we've chosen to be able to deploy cash when the market is down, and we want you to be invested when prices turn up again.

A good example of how this has played out can be seen in the markets in China and India. We de-emphasized emerging markets in our investments for you in late 2006 and watched these two markets go up by 66% and 73%, respectively, in 2007. We were out early. But, who can call the month, much less the day, of the top? In 2008, year to date, the Chinese stock market has given up two-thirds of its gains since 2006, and India all but 1%.

What of this past is prologue? We expect a continued difficult year for the markets, while we understand that rallies like the one that occurred in February through part of May will come with this bear territory. We don't have any immediate plans for positioning the portfolios any differently than they are today, and will continue to have them invested but with some targeted protection from the storm that is currently going on. We also are assessing every day when we think it might be prudent to shift portfolios towards a balance of seizing more opportunity as opposed to tilting away from risk. We recently met with a mutual fund manager whose philosophy is similar to ours who told us that his stock portfolio was underweight financials and overweight energy. When we asked him what his portfolio would look like two years from now, he said probably it would be overweight financials and underweight energy. Our best estimate looking forward several years is that at some point during the next several years, we will advocate for clients to own proportionately more stocks and more international investments, just as our clients did two years ago. But not today. What goes around comes around, and what is past is prologue. We will be there with you in all weathers.

This is a general assessment of client portfolios and does not reflect the specific circumstance of every client.