October 2007

Portfolio Comments

Market View

Dorato Services

The Library: articles by Steve TeSelle

Portfolio Comments

I’ve mentioned fees more than once. I usually suggest that, given the choice, you should look for investment managers or mutual funds with low fees. After all, fees nibble away at your returns.

I’ve decided that I can do a little better to help you in that regard, and so am lowering my asset management fee from 1% to 0.8% per year. The lower rate will be effective on January 1, 2008. It’s not a huge drop, but every little bit helps.

Even though I’m reducing my fee, I understand that performance and service are important. Ultimately, those two factors, I think, will determine whether you stay with me or decide to look elsewhere. So fear not: I’m not adopting the deep-discount-with-shoddy-service business model. I’m just trying to provide the same service for a lower fee.

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 Market View

Stock markets got a lot more wobbly in the third quarter. One and two percent moves, both up and down, were not uncommon. In part, this was due to a part of the debt market most of us had never heard of before: sub-prime mortgages. But concerns quickly spread to other markets. I mentioned in the last newsletter that few of the financial institutions seemed to think they had to worry about risk. But suddenly, they’ve realized that the risk they thought they’d passed on to someone else could creep back to haunt them. The noise started with the sub-prime sector (which is a euphemism for stinky quality mortgages), but it’s moved on to other asset-backed debt and to high-yield bonds (another euphemism). And, in a whiff of panic, banks have even been reluctant to lend to each other.

Nobody really knows the extent of the mortgage problem. How many of us are under mortgages that are too expensive for our incomes or the value of our homes, or both? I’m taking the view that even if many recently issued mortgages are stinky, the vast majority of mortgages are in good shape. That means the mortgage industry will survive, but its growth should slow way down. So I expect to see many mortgage firms go out of business, the housing sector to stagnate, and some financial firms to take big write downs on the value of their investments. I also expect a hedge fund or two to close. While these will cause some pain, and might nudge us into a brief recession, I don’t think we need to worry about a major meltdown.

Junk bonds should also take a hit. Once people wake up to risk, they usually look around at what else they’ve been mispricing. Junk bonds were trading as though defaults were a distant memory. They’re now trading more closely to historical norms, but since markets have a tendency to overshoot, I expect junk bonds to fall a bit farther.

Since junk bonds are connected to the recent spate of company buy-outs, we should also see a drop-off in private-equity deals. While we’ve benefited from the buyout binge, a break in the action is probably a good thing. It should refocus investors on companies that have good businesses that are built to last.

In acknowledgment of the debt troubles, the Federal Reserve took several actions, including cutting short-term interest rates. Stocks jumped on the news. Even with smells from the debt markets, the major stock market indices are now only slightly below the highs we reached in July. After falling about ten percent between mid-July and mid-August, stocks have mostly recovered. I think investors’ confidence could be subject to change, so I expect a few more wobblies in the stock market in the next several months.

One potential thorn is the weak dollar. The dollar was falling before the Federal Reserve cut rates, and it continued to fall afterward. One danger is that a weak dollar could lead to inflation, which would cause the Federal Reserve to reverse course and raise interest rates.

The weaker dollar has been helping US investors in foreign stocks. Earnings in Euros and Yen look better when translated back to dollars. After five years of strong overseas stock markets, I don’t think anyone is getting great deals in foreign stocks, but they still offer good diversification.

My overall view is that the short-term risk of owning stocks has grown. I’d say you want to keep your allocation to stocks, but there is now a higher likelihood that investors will be disappointed by slower earnings growth, by bad news out of the financial sector, or by inflation that comes in higher than expected.

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.

Dorato Services:

• Separately managed stock portfolios
• Allocations for retirement accounts
• Small business retirement accounts
• Retirement planning
• Advice on stock options
• Assistance with tax questions
  

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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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"So for my last wish...I said to the genie, I don't ever want to pay taxes again."

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