April 2008

Portfolio Comments

Market View

Dorato Services

The Library: articles by Steve TeSelle

Portfolio Comments

People sometimes ask if I know when the market will go up or down. The short answer is no.

The long answer is also no, but I’ll give a little more detail. I may have a sense that stocks are priced too high or too low, in general, but I wouldn’t want to try to translate that into saying when the market will go up or down. And I certainly wouldn’t want to try to predict the market on a daily basis. There are too many variables, too much that I don’t know. Who knew that US stocks would rise 4% on March 11, and again a week later? Not I.

In a recent article (The Wisdom and Whims of the Collective), Michael Mauboussin, Chief Investment Strategist at Legg Mason, pointed out that if you had invested in a stock index fund from January 1978 through March 2007, you would have earned about 9% per year. But suppose you had tried to time the market. If you missed out on the 50 worst days, your return would have doubled to 18% per year. As tantalizing as Eve’s apple. On the other hand, if your timing was off, and you missed the 50 best days rather than the 50 worst days, your return would have slumped to 1% per year. That’s 50 days out of about 7000.

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 Market View

I have written before that markets tend to overshoot, both to the upside and to the downside. When all is well, people expect the sun to shine indefinitely; and when all is bad, it seems the clouds will never leave.

The press now peppers articles with ‘recession,’ as though they’ve rediscovered a favorite word. They include phrases such as ‘ominous cracks in the job market.’ I’ve even seen the word depression flung about. Very scary. Very cloudy. I understand that they need to sell papers, but really.

A recession is not a happy event, but, if politicians and policymakers avoid disastrous solutions, it is a temporary phenomenon, not a permanent one. Even if company earnings suffer for a short time, they will recover. Because I don’t see our current troubles as permanent, I think stock prices are at attractive levels.

Other markets only confirm my optimism. In the bond market, the yield curve is now steeply sloped – about a three percent differential between short-term and long-term rates. In addition, the extra yield that investors are requiring on junk bonds is above the long term average. The stock market has generally performed well when the yield curve has been this steep, and when junk bond premiums have been this high.

And consumer confidence, depending on who’s doing the measuring, is as low as it’s been in nearly twenty years. I admit that I haven’t been friendly with too many trends, so you can rightly accuse me of a contrary disposition. Still, it has usually been a good time to buy stocks when consumers have less confidence than the average teenager.

All those factors together get me quite excited about the future return for US stocks. I can’t say with absolute certainty that this is a great time to invest, in part because one can never be sure what colorful ideas lawmakers might hatch. Import restrictions, price controls, and poorly directed government spending (think Japan in the 1990s) are just a few of the possibilities. I don’t think we’re likely to get those policies; I like to think we’ve learned from the past. But you never know.

The US stock market isn’t the only place where we’re getting some overshooting. The dollar has resumed its droop against the Euro and Yen. This is due to the Federal Reserve lowering short-term interest rates, and to concern about the economic health of the US. This puts the Euro well above a fair value, based on what currencies can buy. My advice: don’t load up on Euros.

And commodities have continued their climb. They, like the Euro, are overshooting to the upside. Gold, oil, wheat – have all risen to record prices. A lot of money is flowing into funds that are buying futures on these things. But beware, those prices can turn faster than you can say ‘Whoops.’

The collapse of Bear Stearns, an investment bank that survived the Great Depression, is a reminder about risk. They didn’t think so many of their investments would go against them at the same time, but they did. There were investors who bought the stock in the last year, as it dropped from $170 per share to $4, thinking that it was a good value. It wasn’t. In the end, Bear Stearns was doomed by an old-fashioned run on the bank, as rumors swirled about their solvency; not by people with savings accounts, but by other banks and financial institutions that pulled assets and refused to do business with them for fear they wouldn’t be able to make good on their obligations. Investing involves risk. It always will.

As always, I recommend investors stick to their long-term asset allocation strategies and retain a diversified stock portfolio.

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To provide separate account management that meets the needs of each investor, and to educate and inform both clients and the general public about investment and financial issues.

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• Separately managed stock portfolios
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The Library: articles by Steve TeSelle:

• College Savings Options
• Retirement: What's the Target?
• Fun Facts About Taxes
• Understanding Your Finances
• Risk, Anyone?
• A Primer on Asset Allocation
• Debt, Friend or Foe?
• Life Insurance Basics
• Calculating a Return
• Estate Planning
• Index Investing
• Financial Checklist

To read them online, simply click on the title. To obtain a printed copy, please call us at 303-733-4999, or e-mail me at steselle@doratocapital.com.

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