Biding our Time
It has been a year now since the current economic
mess began to first unfold. There has been ebb and flow,
rallies and sell-offs, as the tide of prosperity has
receded. It remains uncertain as to how low the tide
will go. Investors have been left to wonder after each
decline whether the worst has passed. So, we have been
biding our time.
Since our last letter there have been continued
financial fires. IndyMac, a California based thrift
recently declared bankruptcy, sunk by (what else?) bad
mortgages. Media coverage of depositors lined up outside
the bank’s offices to withdraw their money prompted a
number of phone calls from our clients asking whether
their banks are any good.
In the housing sector, Fannie Mae and Freddie Mac,
tireless promoters of home ownership (at any cost?), are
in danger of insolvency and subject to a possible
federal takeover. Although the debt of Fannie and
Freddie is backed by real assets, the vast majority of
which is sound, a complete takeover could add $5
trillion to the national debt and federal guarantees.
One wonders how long Uncle Sam would hold onto his AAA
What began as a problem for housing and the mortgage
industry has now begun to inflict pain on Main Street.
With the collapse of housing prices and the stock
market, a weak dollar, $4 gas, soaring food prices, it
is hard to believe that the economy is not in recession.
The trouble on Main Street is affecting retailers, some
tech companies and the auto industry. Credit card
delinquencies are on the rise.
Shades of the Great Depression? We don’t think so.
There will be additional bankruptcies, perhaps large
ones. But Treasury and the Fed have made bold policy
decisions to hold the system together. So far, so good.
We do share the concern, however, that a new
administration will make major policy mistakes like
raising taxes or increasing barriers to trade.
Nobody likes a bear market. The market has fallen
approximately 20% since its peak last October. An
investor’s fantasy is to sell at the top and buy at the
bottom. The reality is that one has to expect setbacks.
Over the long term, clients have experienced substantial
growth. A year from now, the world is likely to look
Stocks have been unusually volatile. A 250-point
decline in the Dow one day is followed by a 250-point
rally the next, with 10% swings in individual stocks
during the course of a day not uncommon. Much of this
volatility results from wild swings in sentiment fed by
uncertainty about the value of assets on bank balance
sheets. We note that volatility does not necessarily
indicate a bottom for the market but market bottoms are
typically accompanied by high volatility.
We don’t know when things will settle down. Our
experience tells us that the bad news will subside and
the economy will right itself. The shrill tone in the
media suggests we are approaching a turn of the tide.
When it turns, fundamentals will still look terrible.
The rise off the bottom will be met with skepticism and
disbelief. Investors trying to “time the market” (stay
out for now and buy before it goes up) will be left
holding their hats in their hands.
As to stock market strategy, we know what we should
do: lighten up on energy and metals, and buy depressed
financials and technology. Lightening up on energy makes
sense, as it has grown to be the largest position in
many accounts. But we are hesitant to commit more to
financials and tech just yet. Previous attempts to find
the bottom have left us chastened.
So, we will continue to bide our time.
Please read our important notice
about these letters and the securities they mention.