APRIL 4, 2008
APRIL 2008 COMMENTS - A MONTH FOR THE RECORD BOOKS
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March turned out to be an extremely volatile month in equities as the mortgage/debt situation took its toll in a violent way. Rumors invaded the former stability of some of our largest institutions as the market went from a sell-off mode to panic. The culmination of that panic lead to the demise of one of our oldest brokerage/financial institutions, as liquidity for Bear Stearns' paper dried up and lenders walked away. The result was a Federal Reserve led bailout of Bear that stabilized a destabilized stock market and led to the short-term rally. Why the panic? The leveraged nature of the instruments that were created to fund the housing/mortgage boom have lost much of their underlying asset value that supported those instruments. The main problem facing the industry is trying to value these derivative products and, as a result, the write down of such values is a moving target. Until the market for such paper stabilizes, asset values will continue to be a moving target.
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While this housing/financial recap sounds somewhat dour, the good news is that lower house prices increases affordability, making the likelihood of inventory-clearing greater. We have indicated in prior comments that the economy is resilient, owing to lean corporate balance sheets and a much lower dollar. While negative growth for a quarter or two is likely in the first half of 2008, the massive liquidity and lower interest rates from the Federal Reserve, coupled with tax rebates from the executive and legislative branches of our government, will likely stabilize the economy.
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We continue to maintain a conservative position in your portfolio carrying some cash and being very defensive in the financial sector via an underweight in financials versus the S & P 500 index. Additionally, we have a significant weighting in non-bank financials within the financial sector, a commitment that has enhanced performance, as those companies are not exposed to the mortgage-related issues that traditional financials face. Also contributing to the performance in your portfolio is a commitment to consumer staples and energy, both of which have held up well in this economic downturn. We are looking for opportunities to tilt the portfolio to benefit from the expected economic recovery in 2009 in areas such as industrials and materials. You will begin to see these changes in the near future.
The Bear Stearns incident, while probably isolated, is indicative of the skittishness of investors and lenders today. While the average home has dropped 12% in value from the peak, the more startling number is that 10% of the housing stock or 9 million homes are in a net-negative equity position. Simply put, this means that those homeowners owe more on their homes than they are worth. If housing prices slip further, the number of houses in a net-negative equity position will increase.
IS THE END IN SIGHT?
BEACON INVESTMENT STRATEGY
THIS MONTH'S FOCUS - "UNPRECEDENTED" FED RESPONSE, PROPOSED REGULATORY OVERHAUL AND FIXED INCOME PERSPECTIVE
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The Fed's "unprecedented" intervention (directly assisting an investment bank, not a commercial bank) in the Bear Stearns (BSC) situation will surely be the grist for conversation, legal confrontations, "moral hazard" debates and book-writing for some time to come. Noteworthy is the fact that at the time the Treasury and Fed announced J.P. Morgan Chase's "purchase" of BSC for an adjusted $10 per share, the market was in a difficult situation and, at least publicly, there were no other potential buyers, or solutions to the problem to be found. Despite the "Wall St. Bailout" comments by some, the $10 per share purchase price was a token compared to BSC's high of $172 per share in January of 2007.
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Treasury Secretary Paulson announced his "Blueprint for Monetary Reform" on March 31st. This proposal for financial regulatory reform is long overdue because time, market developments, globalization and technology have long since by-passed the Depression-era legislation under which many of the regulatory authorities (such as the SEC) operate. Sadly, because of the "lame-duck" status of the current Administration, and the very powerful constituencies who benefit from the status quo, implementation will probably be measured in months, if not years.
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To place the current data in perspective, the table below compares key indicators at year-end 2006, before "sub-prime" was a household word, and at 3/31/08. As you will note, equities are little changed, Treasury rates are down sharply (but mortgage rates are not). The U.S. dollar is much lower versus the Euro, and thus oil and gold are sharply higher.
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Please feel free to contact us with any questions you may have on this or any other topic.