Market Commentary

The Prepared Mind

April 2009

"Chance favors the prepared mind." - Louis Pasteur

We write in the wake of another volatile quarter in the stock and real estate markets both here and overseas. After declining to reach levels in early March that we hadn't seen in this decade, stock markets around the world rallied quite strongly. As an example, as of April 15th, the S&P 500 is up 26% from its closing low reached on March 9. As we have written and pointed out to you over the past months, this kind of volatility on both the upside and downside is a hallmark of a bear market. In bear markets as in bull markets, we aim for you to have a portfolio that is less volatile than the overall stock and real estate markets while still targeting a return that outpaces inflation and taxes.

The rally has occurred as the unknown future of the American economy and the liquidity of the credit markets becomes slowly more visible, albeit in fits and starts. The bond market continues the recovery in activity begun late last year. The shape of the U.S.'s government's intervention in the capital markets and in American industry – for better or for worse – is becoming more clear, and is getting real numbers attached to it. As the invisible and uncertain have become visible and more certain, relief has come to the market and investors are more interested in investing than they were just weeks earlier.

What is still not visible, however, is the intermediate phase of this economic contraction. What will corporate earnings look like in the next few quarters? We think possibly quite bad. Will financial and other industry stalwarts taking money from the U.S. government continue to report large losses and tussle with their newest biggest investor, the government, over ground rules, compensation, and the use of the funds? Quite possibly. Neither of these bodes well for a quick, permanent recovery of the stock markets. We think more volatility, both up and down, is in store. We also know that every time any government has ever purposefully stimulated the economy – be it democratic, communist, socialist, fascist – the economy has responded. A government-engineered economic recovery will happen, although its impact and shape will probably take the better part of a year to emerge.

We believe that an investment blend of bonds, stocks, and real estate is still the right place to be. Your stock and real estate investments are oriented towards the ownership of businesses that even in these times can stand the test of this difficult business environment. While these stocks and the stock mutual funds that you own have been volatile, we believe that the capital you've invested in these funds has not been permanently impaired, and expect the underlying businesses to survive the downturn and thrive moving forward. Bond investments are oriented toward a mix of very high quality mostly shorter-term bonds that are targeted to retain stable asset value.

But are you in the right mix of assets for the coming few years? We have heard the sound of certain investors calling for yet more bonds in long-term investment portfolios. It is the case that some bond classes have outperformed stocks during many post-war periods – at this point. However, we are value-oriented and contrarian, and our goal for you is for you to grow your purchasing power over time – not to sell (stocks) low and buy (bonds) high. When he was asked how he always seemed to be where the hockey puck was, the great player Wayne Gretzky reportedly said: "I don't skate to the puck. I skate to where the puck is going to be." Buying bonds now seems to us to be like skating to the puck.

Where is the puck going to be? With stock prices now at more reasonable valuations and with an economic recovery in the offing in the next year or two, we think stocks are likely to outperform cash (which is paying 1% or less) and higher quality classes of short term bonds. This is particularly the case if we see the stock markets revisit the lows they made in early March or move even lower. In addition, as the bolus of government spending begins to move through our economy, inflation could rise during the coming one to two years. If market interest rates rise, bonds prices will most likely fall, and overall returns on fixed income assets will then stagnate while real asset prices rise. The assets that do see their values increase in inflationary environments include real estate and commodities such as energy and industrial materials. This is where we think the puck could likely be, and we are watching and weighing carefully whether and when we need to make this shift for you. At this point we feel that is still probably one or more quarters away.

In the meantime, we'll watch and evaluate, monitoring your current portfolios and being in touch as necessary. Please do call us if you have any questions or wish to discuss your planning or investments.

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

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