Archives for March 2009

When You’re Goin’ Through Hell…

Investor confidence is low by many measures.

As Chris Davis and Ken Feinberg, portfolio managers of Selected American Shares (SLASX), point out in their recent portfolio update:

…investors have suffered through the second worst decade for stocks on record–a record that includes the Crash of 1929 as well as the Great Depression. …it is highly likely that the 10 year period ending this coming December will be the worst decade ever, as it will no longer include the 21% return of 1999.

No wonder investors have no confidence! So why are we so bullish on stocks today? Chris and Ken remind us that a decade like this creates an opportunity for investors over the next 10 years:

…low prices may increase future returns. Because investors are buyers, they should welcome the opportunity to buy the same businesses at lower prices, as doing so raises their returns. Consider a business that generates $100,000 of income. In good times, such a business might be priced at more than $2 million, leaving the buyer with only a 5% return on investment. But if the price falls by half, the return doubles to 10%. This same math applies at the level of the stock market, which is after all simply a collection of businesses, the majority of which will be earning more money 10 years from now than they do today. The data shows that it has always been profitable to invest in the stock market after a decade of poor returns. Specifically, there previously have been ten rolling 10 year periods since 1928 when the S&P 500 Index (and before that the Dow Jones Industrial Average) returned less than 5% per year. In every case, the 10 years that followed produced satisfactory returns averaging approximately 13% per year and ranging from a low of 7% per year to a high of 18% per year. While we cannot know for sure what the next decade holds, it is highly likely to be far better than what we have suffered through in the last 10 years as we are starting at much more attractive valuations.

I encourage you to stay the course at a time when many feel like giving up. Investors often lose confidence and get out of stocks after they have suffered through a period of bad performance but before benefiting from a recovery. As Chris and Ken have pointd out, “an environment characterized by fear and uncertainty creates enormous opportunity for long-term investors.”

Today’s situation reminds me of the lyrics to a country song by Rodney Atkins:

If you’re goin’ through hell keep on going
Don’t slow down if you’re scared don’t show it
You might get out before the devil even knows you’re there
When you’re goin’ through hell keep on movin’
Face that fire walk right through it
You might get out before the devil even knows you’re there

As Tony reminds me, the lyrics might not be theologically correct. But, theology aside, I think some investors “feel like” they are goin’ through hell today. They want to give up. They have no hope. I think there are better days ahead for the economy and the stock market. It seems to me that the best approach is to keep on going, don’t slow down, and walk through the fire!


TV is for Entertainment…Not Investment Advice

Bob Veres, one of the most influential people in the financial planning profession, was recently interviewed by our colleagues, Veena Kutler and Annette Simon, for an article published by Morningstar.

I liked what Bob had to say about the media, and I would like to share his thoughts with you. Here is this portion of the interview:

Garnet: Lastly, Bob have you been following the exchanges between Jon Stewart and Jim Cramer? What do you make of that and the role of the financial media?

Veres: CNBC–especially as personified by Jim Cramer, is the perfect definition of a huckster. The fact is that the media reinforces rather than dissuades herd mentality and keeps it moving in the direction it’s already moving. Media experts watch investors go over the cliff, and then tell everyone to bail out, which makes the cliff longer and deeper. The role of the objective informer has really been taken over by the financial planning community. Unfortunately, we don’t have the reach, and gallons of ink to get the message out. We were the only ones with perspective when the market was booming, advocating caution then, and stickiness now.

Stewart is speaking the language of the fiduciary financial planner. He is pointing out to the media that this is not entertainment, its people’s lives. What Jon Stewart is getting at, and what planners get at instinctively is that money runs much deeper than the numbers, the entertainment value and the news. It is tied up with our psychology, ambitions, and goals–everything that we are as people. Treating it as anything less is trivializing it in a very dangerous way. The market does what it does and the financial media has just become an echo chamber.

Much of what we see on TV is nothing more than news and entertainment. Decision making about investments should be much deeper than reacting to what we see on TV. One unique thing about this recession is the amount of information and chatter that is out there. During the recessions prior to this decade investors didn’t have the Internet or 24-hour financial news channels. It seems that too much information and talk about the economy has created too much fear, panic, and confusion. Investors should make their decisions by seeking advice from financial professionals who have their long term goals in mind, not after watching a 30 minute financial program on TV.


6 Reasons We Own High-Yield Bonds

We recently allocated a significant portion (10% to 15%) of our our mutual fund portfolios to high-yield bond funds. We funded this allocation with a shift from stock funds. Here are 6 reasons we like high-yield bonds:

  1. We expect high yield bonds to generate returns over the next five years that are as good as or better than stocks with less short-term risk.
  2. Yields on high yield bonds are unusually high. Yields reached their highest level ever (23%) in late 2008, creating a compelling return opportunity even in extremely negative scenarios.
  3. We see potential for total returns into the teens over the next several years.
  4. High-yield offers better downside protection relative to stocks. High-yield will likely lag stocks during strong up days in the market, but we expect high-yield to hold up much better than stocks during a market downturn.
  5. We stress-tested our model by projecting high five-year default rates and still like the return potential. We feel that high default rates are more than priced in to current opportunities.
  6. High-yield bonds are often referred to as a risky or speculative asset class. The fact is, high-yield bonds have a senior claim over equities in the capital structure.

Our exposure to high-yield is through a combination of active managers who have been successful generating long-term returns above the benchmark. Crisis in the credit markets has created an opportunity to take advantage of the dislocations in high-yield bonds. Our approach to this asset class is to hire proven mutual fund managers who can best identify these opportunities.


It’s a Good Time to Review Your IRA Beneficiaries

At the end of January anyone with an IRA should have received a 2008 Form 5498 from their account custodian. This form presents all 2008 IRA contribution information, fair market value of the IRA portfolio as of December 31, 2008, as well as the IRA beneficiary summary statement.

It is wise to review your beneficiaries every year at this time to be certain you still desire the same primary and contingent beneficiary(s) on your account. A frequent mistake is forgetting to add a new child as a beneficiary. Another frequent mistake is naming beneficiaries other than what your estate planning attorney might have recommended. So, take some time to review this form and be sure it matches your intentions.


Arriving Late

During bear markets, the temptation is to reduce exposure to stocks and move to cash. A common phrase we hear is “we’ll wait until things get better.” This inherently means that the investor will wait for some positive news or possibly wait for the market to start rising again in a more sustained manner.

According to my colleague Dirk Hofschire, CFA, “While this strategy may sound reasonable, its flaws are exposed when the bear market comes to an end.” Late investors to a new bull market can miss big returns. This can be shown by the chart below. Dirk finds that “investors moved into a record-high cash position by the end of 2002, during the exact period when the U.S. stock market was bottoming after a 3 year downturn. It took investors roughly until February 2004 – 15 months after the end of the bear market – to reduce their cash position back to an average level, during which time many had missed out on the stock market’s return of more than 30% during the simultaneous bull market rebound.”


THE UPSHOT: Late re-entry to the market can be costly. Historically, many investors overcome with fear have increased cash positions during bear markets but have been slow to reallocate to stocks in the early stages of a new bull market. This sell-low, buy-high approach is preventable with patience and discipline while maintaining a long-term perspective that this too shall pass.

FYI – As I write this morning, the Dow is up over 18% and the S&P 500 is up over 20% from the lows recorded on March 9, 2009.


Source: Lexis Nexis, Strategic Insight, FMRCo

Why Waste a Good Crisis?

The high for the Dow was 14,164 recorded on October 9, 2007.  Since then, we’ve seen a vicious bear market take over as the credit crisis unfolded and the housing market tanked.  17 months to the day later, on March 9, 2009, the Dow reached a new low at 6,547.  That’s a 53% drop in the value of the index!

A few weeks ago, my wife and I got away for the weekend and left the kids with grandparents.  We ended up at one of her favorite clothing stores and I sat on the bench while she looked.  When she finally emerged from the retailer, she looked half happy, half disappointed.  Happy she had gotten what she wanted, but disappointed that she had to pay full price for it because it wasn’t on sale.  She rarely buys things that aren’t on sale, and if it weren’t for some birthday money, she probably wouldn’t have bought it.

Well, today, I can’t predict that the market has bottomed, or that we’re anywhere close to being on our way to recovery.  But I can, with certainty, tell you there’s a fire-sale on a ton of well-managed, profitable companies that are trading at half of what they were just over a year and a half ago.

Ignore the naysayers, ignore the fear-mongering media…I am here to tell you that America is not going out of business!  We are hard at work researching the markets to exploit the number of opportunities this crisis has created.  If a person had some extra discretionary income, I would recommend dollar-cost averaging into the market.  Stocks are on sale, so why waste a good crisis?


Our Outlook For Stocks

On March 5th we sent our clients a “special edition” portfolio update. Typically, we will send a portfolio update once per quarter along with performance reports. However, in the face of an extraordinarily difficult market environment we wanted to share our most current thinking about the overall environment and our positioning. Here are some excerpts:

  • We understand that the powerlessness of watching the value of your wealth decline creates a strong desire to “do something” about it – to take control and end the pain. Going to cash may lock in losses, but at least it creates a certainty amidst a great deal of fear and uncertainty. These are the conflicting forces that every investor faces right now: the certainty of locking in a set (albeit painfully lower) level of wealth, versus the uncertainty of possibly more near-term losses and the hope of better longer-term returns.
  • It is also important to understand that there is a great deal of economic uncertainty and that could take a further toll on stocks in the near term. It also makes it more difficult to forecast the longer-term value of stocks. What we can do about this is make assumptions that are so negative that we believe we have a good margin of error on the downside, and a high degree of confidence at least in the lowest end of our longer-term forecasted return ranges. We have done this work, which includes an intense focus on identifying the most negative scenarios we or other experts we talk to can envision, and factoring those into our analysis. So while we are never confident in what the shorter term will bring, we are confident that our scenarios fully take into account the possibility of a lengthy and extremely poor economic environment (where the earnings decline is comparable to the Great Depression). Based on that analysis, the stock market can still earn good returns from current levels over a five-year time horizon. However, capturing these positive returns will require maintaining that longer-term focus through what may continue to be a very trying period.
  • It may seem impossible to imagine a market rally from here. It can happen, and it will at some point. By definition, investors are most pessimistic at a market bottom. There is a huge amount of cash on the sidelines, which is good. When everyone is hugely pessimistic there are few investors left to sell. Then, as bargain hunters start to step in, a powerful rally can develop. Our expectation is that we could see several rallies and declines before we move on to another bull market. We are confident in our longer-term expectations, but as we have been saying for several months now, we are prepared for a very rocky ride.
  • So while we are confident that from current levels stocks offer good longer-term return potential, we don’t know what might happen in the shorter term. This uncertainty creates a dilemma that is very important to understand. Stocks could drop further, perhaps substantially, or they could rebound sharply. If we try to predict this and invest accordingly, we have to consider the consequences of being wrong. If we go to cash the market could rebound sharply before we can get back in. It is possible we could see a rally of 20%-30% before concrete signs of sustained economic improvement begin to show up. This is because the market is forward-looking and nearly always reaches a bottom well before the economy reaches a bottom. If that happens, we could see a material portion of the good multi-year return potential that we believe exists realized in a short time. At that point we’d need to decide whether the market’s turn was going to be sustained, and get back in, or continue to wait and risk losing further upside. If we did get back in, we could be whipsawed if the upswing proved to be temporary, as commonly happens during severe bear markets.
  • On the other hand, if we remain invested, our analysis gives us confidence we will earn a good return over our five-year investment time horizon, independent of what the short term brings. We also know that we will continue to see tactical opportunities amidst the near-term weakness, and that our active managers [in our mutual fund portfolios] will have opportunities to add value by buying stocks that have been oversold due to fear rather than fundamentals. Longer time horizons have the highest value when short-term fear is greatest, because that is when the greatest opportunities are created, but those are also the times when a long time horizon is the most difficult to sustain.
  • Like you, we find this environment literally gut wrenching. Our response, we believe, has been to raise our game to a level consistent with the challenges we face. We are focused, thinking clearly, and obsessively analyzing data and information every day to make sure we understand the risk and opportunities as fully as possible. We believe that if we continue to stay intellectually honest, work extraordinarily hard to make deeply informed and rational rather than emotional investment decisions, over the longer term that work will pay off in the form of good returns on your behalf.



Gary Shilling, President of A. Gary Shilling & Co., Inc., stated recently that most retirees are financially unprepared. “After 401(k)s were initiated in 1978, those containing stock assets appreciated in the long 1982-2000 bull market, which convinced many that they didn’t need to save. In 1983, 33% of working-age households were financially unprepared for retirement, but the number rose to 40% in 1998 as a result of lower saving and more borrowing, and to 44% in 2006 as the 2000-2002 bear market also depressed retirement funds. Obviously, with the subsequent collapse in house and stock prices, many more – over 50% – are unprepared. In 2007, in defined contribution accounts administered by Vanguard, the median account balance for 55-64 year olds was just $60,740 and only 10% of participants contributed the maximum amount.”

So, for those of you in the accumulation phase of life, how can you increase your chances of being prepared for retirement? Answer: Dollar Cost Averaging (DCA). DCA is the practice of investing a fixed dollar amount at regular intervals (such as monthly) in a particular investment or portfolio, regardless of its share price. In this way, more shares are purchased when prices are low and fewer shares are bought when prices are high. Are prices low right now? I’m not predicting a bottom here, but I can tell you they are a lot cheaper now than they were in October 2007 when the market peaked.

Last week, we posted the 2009 Retirement Contribution Limits. Are you maxing out the tax benefits these Plans or IRAs allow? Doing so will better prepare you for the financial freedom you desire in your retirement years.


2009 Retirement Contribution Limits

Plan or IRA Type

Contribution limits

Additional catch-up contribution** (age 50 and older)





401(k), 403(b), 457*










Traditional and Roth IRA





*Check with your employer about the specific contribution amounts for your plan.

**Catch-up contributions are in addition to the general contribution limit. For example, in 2009, a 55-year-old participant may be able to contribute up to $22,000 to a retirement plan and $6,000 to an IRA.

Nobody Knows!

Recent news headlines:

Some questions that might be on your mind:

  • Have we hit bottom yet?
  • Where is the bottom?
  • When will we hit bottom?
  • Can things get any worse?
  • How much worse can this get?
  • Where will we be six months from now?
  • How long will it take to recover these losses?

The answer to those questions: NOBODY KNOWS! And if anybody tries to tell you they do know, don’t trust them. Nobody knows with certainty where the bottom is or when it will happen. No one knows how long it will take to get back to the October, 2007 highs.

Here’s what I do know:

  • Previous bear markets have not lasted forever.
  • Twelve year lows are extremely rare. It’s also interesting to note that the 12 year low in 1932 was just three months before the end of the bear market. In 1974, the 12 year low was exactly the low for that bear market.
  • Investor confidence is very low. Periods of extreme pessimism occur near bear market bottoms.

My advice:

  • Avoid making any emotional decisions. Fear is a very powerful emotion. Fear can lead to negative investment behavior. The greatest investors are able to control their emotions.
  • Embrace uncertainty.
  • Have patience.
  • Don’t follow the crowd.
  • Get advice from an expert before making major changes to your investment strategy.