Jennifer Myers, President of Sage Financial Management Group, Inc., has issued the following 3rd Quarter Market Report.
MARKET OVERVIEW
History is in the making as our global financial markets stand in a state of disarray. Events that we had thought and hoped we would never see in our lifetimes coincided in one quarter. We witnessed the nationalization of Fannie Mae and Freddie Mac, the fall of Lehman Brothers, a duress sale of Merrill Lynch and the list goes on. Governments (notably ours) have enacted overwhelming intervention, including the recently passed $700 billion bailout package. Yet, investors and consumers remain in a state of panic - a phenomenon that gives us the greatest cause for concern.
We are in the midst of a harsh economic domino effect. The fall of the behemoth mortgage debt market has triggered a mass wave of destruction, leaving no place to hide. Every sector of the stock market is in negative territory. As of quarter end, every global equity market (with the exception of Venezuela) posted negative YTD returns with the 'best' at -15% (Canada) and the worst at -57% (China). Investor flight also extended to bonds, real estate and commodities. Not even cash soothed investors as they feared underlying short-term investments and began a true 'run on the money'. Large cash withdrawals instigated the ultimate decline of IndyMac Bank and Washington Mutual. Flight to ultra safe Treasuries pulled the 1 month Treasury yield down to 0.13% (where investors were practically paying the Treasury to hold their money!). Bottom line - we have left the realm of rationale investing.
Ironically, the credit markets that got us into this mess are what we need to pull us out. Liberal lending standards at dirt cheap rates fueled the housing boom and powered consumer spending. People pulled equity out of their houses thinking they had actually found the proverbial money tree planted in their backyards. Now, extremely conservative lending practices are virtually freezing our credit markets. Just like in politics, ultra liberalism and ultra conservatism are seldom healthy. Our financial markets need to find a healthy, happy medium. Unfortunately, there is nothing happy about the process of getting there.
Governments around the world have been trying to aide this effort by lowering lending rates and infusing mass liquidity into banking systems. They were hoping this extra financial security and flexibility would bring banks off the sidelines to once again shake friendly hands with businesses and consumers. Unfortunately, initial cash infusions generated little to no progress. Banks remained in a 'hunker down' mode, scared to lend money they might need or that others might not repay in this distressed financial environment.
As a result, individuals who could once tap up to 95% of their home equity, are now lucky if they can tap up to 70%. Students facing incredible tuition bills are unable to obtain student loans. Businesses that rely upon revolving credit lines and short-term commercial paper are being forced to borrow at much higher rates, or worse yet, unable to borrow at all. We will utilize Caterpillar, one of the highest quality companies, to illustrate current conditions. Caterpillar recently had to pay 3.25% over the 10 year Treasury as compared to 1.3% the year prior - representing a 150% increase in borrowing costs!
These lending chokeholds incited by banking fear, combined with an avalanche of negative news stories, only serve to spread angst among investors and consumers - creating the ultimate self-feeding downward spiral.
Let us be clear - Wall Street has already impacted Main Street. This is seen everywhere. Companies can't support ongoing expenses. Unemployment is rising. Manufacturing activity is declining. Corporate earnings are disappointing. Auto sales are dismal. Home prices continue to contract.
People are pulling money out of banks and out of the markets, and are commiserating over concerns of another Great Depression. Which brings us to the questions of: Is it really that bad? We will be honest. Yes, it could be if panic continues to spread like wildfire. It doesn't matter how strong a bank is, if depositors flee by withdrawing their savings, crisis ensues. This impacts businesses, consumers and all assets - stocks, bonds, homes, etc.
Government actions become the only viable answer to stem a frenetic 'run on the money'. The recent flight to Treasuries proves that Americans still trust the faith of the U.S. government. Likewise, a flurry of interventions proves the U.S. government's commitment to preventing a depression, if possible. The most recent and significant of these interventions include:
1) Nationalization of Fannie Mae & Freddie Mac - to stabilize the housing markets
2) $85 Million loan to AIG - to prevent a 'disorderly' failure in the insurance and financial markets
3) Increased FDIC Coverage (from $100,000 to $250,000) - to stop money flight from banks
4) Corporate Commercial Paper Purchases - to help ensure liquidity for continuation of corporate day-to-day operations
5) $700 Billion 'Bailout' Package - creating a Troubled Asset Protection Program (TARP) to remove toxic mortgage debt from bank and financial institution balance sheets to quell lending fears and revive lending activity.
We believe the government actions have merit, but it has yet to be seen if they can 'do the trick'. The answer largely hinges on the $700 Billion Bailout Package (the only action that goes directly to the root of the problem). It remains to be seen how quickly the program can be put into effect and at what price it will be able to purchase mortgage debt - points that require review and approval. Unfortunately, this likely means more political bickering and more 'grim reaper' news reports are just around the corner, ready to rattle confidence yet again.
Hence, we continue to face overwhelming levels of uncertainty, where everything is fluid (with the notable exception of market liquidity).
It is impossible to chart a fail-safe course of action in such a dynamic and fast changing environment. This is particularly true when investor psychology and fear are just as pivotal as basic market fundamentals. Thus, our recommendations are as follows:
1) Don't expect a miracle quick-fix recovery. The problems that we face are deeply entrenched and will take time to cleanse.
2) Prepare yourself for continued volatility. The markets are testing for a bottom, but we may not be there yet.
3) Ensure sufficient liquidity is in place to allow you to 'ride out the market'. This is a fundamental practice in our investment management approach.
4) Diversify! This is our mantra, and we believe that it has never been more important.
We have taken a number of actions to trim equity positions where we saw appropriate - both last year at much higher market levels and more recently as risks began to escalate. At this juncture, we are remaining defensive and cautious.
It is difficult to estimate exactly when or exactly where, but opportunity will arise from this market. We are therefore committed to holding a mixture of investments that could participate in a variety of economic scenarios. Some of these include:
Bonds - We are evaluating a wider offering of bonds which are not void of risk, but inherently have far less risk. Yields are becoming increasingly attractive after investor flight from all asset classes.
Commodities - After a long-standing run, the steam is letting out of commodities. We're still holding positions on concerns of possible inflationary pressure resulting from mounting government debt (which could require printing lots of new money).
Gold - Within commodities, we have added a pure gold position which has long been regarded as the ultra defensive play, and as a hedge against a possible retrenchment in the US Dollar.
Energy - In a time when Russia's actions are resurrecting cold war discussions, and as we approach colder months, we are committed to retaining this defensive position.
Health Care - Another defensive area of interest among equities is health care, where we see demand based upon demographics and growth among biopharmaceuticals.
Emerging Markets - Emerging markets have experienced some of the most dire YTD returns, but they also offer inexpensive, and now more highly trained labor markets without massive, tag-on social obligations (Medicare, Social Security, etc.).
Cash - It doesn't earn you a lot of money, but it is king when you enter a buyer's market.
In desperate need of some positive news, we invite you to consider the following recent developments.
We are finally seeing interest in 'bottom fishing' buying. On the street, buyers jumped in after each of the massive point declines. On Sept 30th, the market recovered 485 points after a 777 point prior day decline, and on Oct 6th the market erased 452 points of decline after extending as low as 819 points! We're also seeing buying on the corporate and private side. Warren Buffet is exercising his clout as a buyer, negotiating a $3 Billion investment in Goldman Sacs and a $5 Billion investment in General Electric. Perhaps more importantly, we are even seeing two financial firms, Citigroup and Wells Fargo (yes, financial firms!) fighting over who will acquire Wachovia.
Sage Financial Management Group, Inc
The information contained herein is obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed. This newsletter is for informational purposes only. The views expressed are those of Sage Financial Management Group and should not be construed as investment advice. All expressions of opinions are subject to change and past performance is no guarantee of future results.
MARKET OVERVIEW
History is in the making as our global financial markets stand in a state of disarray. Events that we had thought and hoped we would never see in our lifetimes coincided in one quarter. We witnessed the nationalization of Fannie Mae and Freddie Mac, the fall of Lehman Brothers, a duress sale of Merrill Lynch and the list goes on. Governments (notably ours) have enacted overwhelming intervention, including the recently passed $700 billion bailout package. Yet, investors and consumers remain in a state of panic - a phenomenon that gives us the greatest cause for concern.
The Global Domino Effect, Leaving No Place To Hide
We are in the midst of a harsh economic domino effect. The fall of the behemoth mortgage debt market has triggered a mass wave of destruction, leaving no place to hide. Every sector of the stock market is in negative territory. As of quarter end, every global equity market (with the exception of Venezuela) posted negative YTD returns with the 'best' at -15% (Canada) and the worst at -57% (China). Investor flight also extended to bonds, real estate and commodities. Not even cash soothed investors as they feared underlying short-term investments and began a true 'run on the money'. Large cash withdrawals instigated the ultimate decline of IndyMac Bank and Washington Mutual. Flight to ultra safe Treasuries pulled the 1 month Treasury yield down to 0.13% (where investors were practically paying the Treasury to hold their money!). Bottom line - we have left the realm of rationale investing.
Credit - Our Friend and Our Foe
Ironically, the credit markets that got us into this mess are what we need to pull us out. Liberal lending standards at dirt cheap rates fueled the housing boom and powered consumer spending. People pulled equity out of their houses thinking they had actually found the proverbial money tree planted in their backyards. Now, extremely conservative lending practices are virtually freezing our credit markets. Just like in politics, ultra liberalism and ultra conservatism are seldom healthy. Our financial markets need to find a healthy, happy medium. Unfortunately, there is nothing happy about the process of getting there.
Governments around the world have been trying to aide this effort by lowering lending rates and infusing mass liquidity into banking systems. They were hoping this extra financial security and flexibility would bring banks off the sidelines to once again shake friendly hands with businesses and consumers. Unfortunately, initial cash infusions generated little to no progress. Banks remained in a 'hunker down' mode, scared to lend money they might need or that others might not repay in this distressed financial environment.
As a result, individuals who could once tap up to 95% of their home equity, are now lucky if they can tap up to 70%. Students facing incredible tuition bills are unable to obtain student loans. Businesses that rely upon revolving credit lines and short-term commercial paper are being forced to borrow at much higher rates, or worse yet, unable to borrow at all. We will utilize Caterpillar, one of the highest quality companies, to illustrate current conditions. Caterpillar recently had to pay 3.25% over the 10 year Treasury as compared to 1.3% the year prior - representing a 150% increase in borrowing costs!
These lending chokeholds incited by banking fear, combined with an avalanche of negative news stories, only serve to spread angst among investors and consumers - creating the ultimate self-feeding downward spiral.
Wall Street to Main Street
Let us be clear - Wall Street has already impacted Main Street. This is seen everywhere. Companies can't support ongoing expenses. Unemployment is rising. Manufacturing activity is declining. Corporate earnings are disappointing. Auto sales are dismal. Home prices continue to contract.
People are pulling money out of banks and out of the markets, and are commiserating over concerns of another Great Depression. Which brings us to the questions of: Is it really that bad? We will be honest. Yes, it could be if panic continues to spread like wildfire. It doesn't matter how strong a bank is, if depositors flee by withdrawing their savings, crisis ensues. This impacts businesses, consumers and all assets - stocks, bonds, homes, etc.
Government Actions
Government actions become the only viable answer to stem a frenetic 'run on the money'. The recent flight to Treasuries proves that Americans still trust the faith of the U.S. government. Likewise, a flurry of interventions proves the U.S. government's commitment to preventing a depression, if possible. The most recent and significant of these interventions include:
1) Nationalization of Fannie Mae & Freddie Mac - to stabilize the housing markets
2) $85 Million loan to AIG - to prevent a 'disorderly' failure in the insurance and financial markets
3) Increased FDIC Coverage (from $100,000 to $250,000) - to stop money flight from banks
4) Corporate Commercial Paper Purchases - to help ensure liquidity for continuation of corporate day-to-day operations
5) $700 Billion 'Bailout' Package - creating a Troubled Asset Protection Program (TARP) to remove toxic mortgage debt from bank and financial institution balance sheets to quell lending fears and revive lending activity.
What to Expect?
We believe the government actions have merit, but it has yet to be seen if they can 'do the trick'. The answer largely hinges on the $700 Billion Bailout Package (the only action that goes directly to the root of the problem). It remains to be seen how quickly the program can be put into effect and at what price it will be able to purchase mortgage debt - points that require review and approval. Unfortunately, this likely means more political bickering and more 'grim reaper' news reports are just around the corner, ready to rattle confidence yet again.
Hence, we continue to face overwhelming levels of uncertainty, where everything is fluid (with the notable exception of market liquidity).
It is impossible to chart a fail-safe course of action in such a dynamic and fast changing environment. This is particularly true when investor psychology and fear are just as pivotal as basic market fundamentals. Thus, our recommendations are as follows:
1) Don't expect a miracle quick-fix recovery. The problems that we face are deeply entrenched and will take time to cleanse.
2) Prepare yourself for continued volatility. The markets are testing for a bottom, but we may not be there yet.
3) Ensure sufficient liquidity is in place to allow you to 'ride out the market'. This is a fundamental practice in our investment management approach.
4) Diversify! This is our mantra, and we believe that it has never been more important.
We have taken a number of actions to trim equity positions where we saw appropriate - both last year at much higher market levels and more recently as risks began to escalate. At this juncture, we are remaining defensive and cautious.
It is difficult to estimate exactly when or exactly where, but opportunity will arise from this market. We are therefore committed to holding a mixture of investments that could participate in a variety of economic scenarios. Some of these include:
Bonds - We are evaluating a wider offering of bonds which are not void of risk, but inherently have far less risk. Yields are becoming increasingly attractive after investor flight from all asset classes.
Commodities - After a long-standing run, the steam is letting out of commodities. We're still holding positions on concerns of possible inflationary pressure resulting from mounting government debt (which could require printing lots of new money).
Gold - Within commodities, we have added a pure gold position which has long been regarded as the ultra defensive play, and as a hedge against a possible retrenchment in the US Dollar.
Energy - In a time when Russia's actions are resurrecting cold war discussions, and as we approach colder months, we are committed to retaining this defensive position.
Health Care - Another defensive area of interest among equities is health care, where we see demand based upon demographics and growth among biopharmaceuticals.
Emerging Markets - Emerging markets have experienced some of the most dire YTD returns, but they also offer inexpensive, and now more highly trained labor markets without massive, tag-on social obligations (Medicare, Social Security, etc.).
Cash - It doesn't earn you a lot of money, but it is king when you enter a buyer's market.
In desperate need of some positive news, we invite you to consider the following recent developments.
We are finally seeing interest in 'bottom fishing' buying. On the street, buyers jumped in after each of the massive point declines. On Sept 30th, the market recovered 485 points after a 777 point prior day decline, and on Oct 6th the market erased 452 points of decline after extending as low as 819 points! We're also seeing buying on the corporate and private side. Warren Buffet is exercising his clout as a buyer, negotiating a $3 Billion investment in Goldman Sacs and a $5 Billion investment in General Electric. Perhaps more importantly, we are even seeing two financial firms, Citigroup and Wells Fargo (yes, financial firms!) fighting over who will acquire Wachovia.
Sage Financial Management Group, Inc
The information contained herein is obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed. This newsletter is for informational purposes only. The views expressed are those of Sage Financial Management Group and should not be construed as investment advice. All expressions of opinions are subject to change and past performance is no guarantee of future results.
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