2009 Report to Clients*
About this report…
Our friend and noted economist, Woody Brock, PhD, likes to quote poet T.S. Elliot’s “Where is the wisdom we have lost in knowledge? Where is the knowledge we have lost in information?”
How prescient. T.S. Elliot could not have been writing about the
difference between hard copy and the digital age, since there was little
concept of the digital age during his lifetime (1888-1965). Yet digital
communication has exponentially increased the data at our fingertips,
both in quantity and timeliness. To the extent this data is
“information,” it would be impossible for it to be conveyed via hard
copy; it is outdated the instant it materializes in cyberspace. In like
vein, there is no “information” in this report.
Because of the digital age, there exist many rich data sources that
can be accessed by almost anyone. We try to interpret these data with
economic and financial analysis to pick out investments for your
This report depicts how we find the markets we work in to find
investments. Not necessarily a forecast of future prices, but what are
the conditions (safety, danger, etc) of the markets. Where might there
Note that even more pages are devoted to Level I, Conservative Income.
As we wrote last year at this time, these markets were dysfunctional:
for all intents and purposes, the only liquid instrument was a U.S.
Government bond. There were no markets for high-quality residential
mortgage-backed securities, commercial real estate pools or even
corporate bonds. Without primary and secondary markets for these
instruments, commerce grinds to a halt, and this was happening at the
time. Reflecting these conditions, equities were in free fall.
In last year’s Annual Report, we noted that opportunities in Level I
investments would need to be realized before investors would be willing
to venture out on the risk curve to Levels II, III and IV, Aggressive
Income, Conservative Growth and Aggressive Growth, respectively. In
other words, as long as the bond market wasn’t working, neither would the stock market or the economy.
Our analysis was correct. Yield spreads collapsed from record levels,
over $1.0 trillion of new corporate debt came to market as interest
rates fell, and equities soared. But our time frame could never have
comprehended the speed with which this recovery took place. As will be
said again in this report, what we thought would take years happened in just a few short months.
Capital poured into bonds and overflowed into stocks. By yearend, not
only were equities higher, but the riskiest, most unhealthy companies
saw their stock prices soaring.
But how healthy is the bond market? Will secondary mortgages continue
to be traded after the Federal Reserve discontinues its acquisition
program? Have equities gotten ahead of economic reality? A return
to conditions present a year ago (or even a whiff of them) could result
in a lot of damage to stocks whose prices contain much-raised
expectations. Level I is still the most important investment category, and there are strong forces buffeting this market segment.
Here’s something else we’d like you to know. In response to the crash
of 2008-Q1, 2009, it appears that investors and managers are taking one
of three courses of action.
- Some in the investment community continue to practice denial. Whatever happened, happened to
them. They were, and are, correct. Sooner or later, their investment
strategies and tactics will deliver superior results; and their accounts
will get back to where they were at the end of 2007. These are the
mutual funds that remain fully invested, in their respective style
boxes, regardless of market conditions and ignorant of fundamentals in
other markets. These are some of the nation’s large college endowment
funds, pension funds and local government benefit funds who support
their—incorrect—decisions to own “alternative investments” and esoteric
holdings that lack a mechanism for price discovery.
- Other participants, having provided some degree of protection from the market crash (better relative returns) with diversification, are redoubling their efforts to make their pie charts more effective. In this endeavor, they are trying to do a better job of preparing for what they don’t know: the cause of the next storm.
- Finally, there are a few who are looking outside the box.
This is the category we belong to. Yes, in relative terms, your
diversified portfolios may have delivered better returns (less losses)
than a host of indices; but we understand you live in the real (not
relative) world, can stand some volatility, but are not in the position
to live another 100 years to overcome a 37% whack out of your investment
capital. As a result, we identified four specific areas in last year’s
Annual Report that needed to change. We are happy to report that we
believe our efforts in this regard are bearing fruit. They are
continuing, and we will have more to report in future periods.
Entering the second half of 2008, we began to think about some type of activity to celebrate the firm’s 15th
year in business, which landmark we passed in September 2009. As the
remainder of 2008 unfolded, and the markets crashed, it became apparent
that it would be an accomplishment just to survive the period. The objective was to get to 16.
This year, we will achieve that goal in September, and we like to think
the services we provide to you are partially responsible. However, unequivocally, we know that we survived because of you. Tom, Louise and I want to thank you for being our clients. Rest assured that we will be here for you in the future.
*Complete reports available to clients and subscribers in Client Area.