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August 16, 2007 Market Commentary...We planned for this! We planned for this and so did you. That’s why you all are invested in diversified portfolios of stock, bonds, cash, etc. Those of you who visit our office for initial investment planning and regular ‘staying on course’ review meetings; have seen the Ibbotson chart we keep in the conference room. It charts the rise of stocks and bonds over the last 80 years and clearly illustrates that they have not risen in a linear fashion. Rather, the go up and correct, go up and correct, and/or meander aimlessly at times. But over long-term periods they perform exceptionally well and provide substantial value---better than any other asset class. If we, as money managers, expected that the stock market would go up in a straight line we would place you in a portfolio of 100% aggressive stocks. In fact, over long periods of time, despite market corrections, a 100% aggressive portfolio would have always yielded the highest returns. |
But the reality is that you need to sleep at night--- and if you can’t sleep at night neither can we. So, therefore, we diversify investments, in order to ‘smooth out the lines,’ knowing that at any moment the next problem to spark short-term volatility may be around the corner.So, irrespective of the sub-prime mortgage mess (I’ll get to that soon), I can state from a macro point of view, that I really don’t care why the market corrected over the past couple of weeks. During periods of robust (“over-exuberant?”) increases, such as the one we had been experiencing, there is always a correction on the horizon---- when it arrives, investors always panic late in the correction and drive prices lower then expected ---- later, stock prices always rebound and, ultimately, to points higher than can be sustained----This cycle repeats over and over with one constant result… long term investors always come out on top.
SUB-PRIME MESS EXPLAINED—FRYE STYLEIt’s always about greed, speculation, and a lack of respect for risk….Buckle up your seatbelts, kids…the following is a brief description of the scenario that led to the current weakening of credit markets. AT FIRST… Real estate prices were climbing--- so builders kept building and building--- Realtors were selling anything with four walls--- Appraisers were pumping up values… Mortgage lenders were loaning money to anyone with a social security number and loaning and re-loaning and re-loaning; firsts, seconds and thirds with adjustable rates that offered crazy low initial rates to be followed by crazy high interest rates----Lenders were shelling out these loans knowing that what ever business they wrote and put on their books they could sell and ship out to Wall Street for a profit---Wall Street was packaging the loans and selling them as pooled investments to wealthy investors and hedge funds---the hedge funds kept borrowing and borrowing to fund purchases of more and more of these highly speculative mortgage pools---until…until…WHOOPS!!!—Too many condos started glutting up the market (driven around Brickell and downtown Miami lately?) ---THEN…prices started to fall here---there---everywhere---Joe Homeowner from Miami’s jaw dropped when he saw what his mortgage interest rate has risen to and what the equity in his home had fallen to. He missed a mortgage payment or two or three and was unable to sell his home. Banks began to foreclose---mortgage pool values started to tumble---AND NOW ……hedge fund assets holding the mortgage pools are losing value---banks need cash and are calling in the loans they had made to the hedge fund managers—hedge fund managers are not able to resell the mortgage pools---some hedge funds are going belly-up---defaulting on their loans--- banks are getting stiffed, and are calling in more loans---talk of liquidity problems is sparking world wide panic---ouch! BUT YOU’RE OK—I’M OKThe end result will be that the mega rich who invested in these hedge funds may lose their entire investments and the unfortunate, struggling families who bought real estate they couldn’t afford or over-leveraged their properties, may lose their homes---that’s the brutal reality as I see it. Ultimately, as far as the stock market is concerned, the companies included in your portfolios, for the most part, have excellent earnings and good balance sheets. Over the long run, that’s what drives stock prices---not panic or speculation. As far as the credit markets and the bank problems, the United States Federal Reserve Bank and other Central Banks throughout the world, are closely monitoring liquidity issues and pumping in cash when necessary, to avert a catastrophe. I am confident the current crises will work its way through the system and the downdraft in the equity market will end---as it always does. I am also 100% sure that after stocks rebound, there will be some other crises down the road a few years hence, and I can send this same commentary out to you again. It is precisely this kind of market turmoil that makes the case for a well-diversified portfolio, that avoids the excessive risk associated with big bets on exotic highly risky securities, and which includes some non-correlated and protected vehicles to further hedge against volatility. But most of you know this already---you just need me to remind you of this every now and then---you’re all OK---so I’m OK. So, for those of you out there who are a bit unsettled and are experiencing a feeling akin to the one expressed in a line from an old Grateful Dead song, “Cause when life seems like easy street, there is danger at your door,” I say, calm down…better to learn from experience and use the line “this too shall pass” as your daily affirmation during the current market climate.Until next time, Austin A. Frye, MBA, JD, CFP® Securities and advisory services offered through LPL Financial-- Member FINRA/SIPC
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