October 2008

Portfolio Comments

Market View

Dorato Services

The Library: articles by Steve TeSelle

Portfolio Comments

It’s at times like this that you’ll see a lot of articles about investments that don’t lose money – or at least that didn’t lose money in the last year. That can sound appealing when the stock markets are down more than 20%. But those same investments lag far behind when markets rise.

I was recently in a meeting with a group of stockbrokers. They lamented that no one wanted to buy into this stock market. To be fair, they didn’t think that was right; they were simply commenting about what they were hearing from investors. The only investment they could sell was one that had returned about 1% this year. It didn’t matter what the investment was, just that it hadn’t lost money. The time to buy that investment was 12-15 months ago; not today. But that’s what these young men could sell, so that’s what they were selling.

People will happily sell you whatever they can get you to buy. Those young brokers aren’t bad people, but they get paid for selling you something, not for encouraging you to stick to your long-term investment goals.

Investing is a curious business. It’s the only one I know of in which a sale causes people to run away. If there’s a sale at a clothing store, you need to strap on a helmet to wade in among the elbows. If the stock market falls, the aisles echo with your footsteps. Remarkable.

[top]

 Market View

Optimism in the stock markets appears to be in short supply. As September comes to an end, the US market is down about 20% in 2008, though that figure can vary dramatically by the day, and even by the hour. The return may seem dismal, but it is one of the best showings around the world. China is down 60%; European markets have fallen 30-35%; only Japan is down about the same as the US.

There are certainly reasons to worry. The US government now owns Fannie Mae and Freddie Mac, as well as most of American International Group. Investment banks, such as Lehman and Merrill Lynch, are either bankrupt or no longer independent. The US economy is limping along, and unemployment has jumped above 6%. Economies around the world are slowing, too. Who can be optimistic in the face of all that?

Me, for one. I tend to be an optimistic fellow. But even discounting my sunny nature, there are a number of indications that stock markets will soon improve.

Ten-year US Treasury bonds now yield about 3.5%. Over long periods, inflation has averaged about 3% -- and recently it’s been even higher. Either investors think a return of half a percent per year above inflation, for ten years, is quite good, or people are so fearful of investing in anything but Treasury bonds that they’re willing to accept miniscule returns. My guess is the latter.

Another fear gauge is also at high levels. A volatility index, the VIX to those in the know, measures, you guessed it, volatility in the stock market. In times of fear (1991, 1998, 2002) this measure rose sharply. We are now at levels seen in those prior fearful times.

Finally, we typically see heavy share volume toward the end of a nasty market, as people give up and decide to sell. At the end of September, we saw record numbers of trades.

All those measures of fear point toward a better future for US stocks. Every time in the past that there have been high levels of fear, stocks have subsequently provided above-average returns. In addition, measures of value, such as PE, price to book value, and price to cash flow, show that a lot of good companies are selling for attractive prices.

You might be thinking that my optimism has gotten the better of me; that indeed things are as bad as the stock markets are telling us. Perhaps, you say, we will even careen into a Depression. I cannot guarantee that we won’t. But I can tell you that the Federal Reserve and Treasury are not making the same policy mistakes that the US made in the 1930s and that Japan made in the 1990s. As I write this, plans are afoot for a taxpayer-funded plan to buy the nasty bits off of financial companies at discounted prices. This should go a long way toward resolving the current crisis.

I have been right about a number of things, but I have been terribly wrong about American International Group. This was a company with worldwide operations, a long history of earnings growth, a supposedly good balance sheet, and a strong brand name. It is now a company in tatters, eighty percent owned by the US government. As the stock price dropped, I kept thinking that the market was over-reacting, that AIG still had a strong franchise. After all, insurance operations are highly regulated. What I didn’t count on was that a relatively small part of the company, not part of the normal insurance operations, could make so many large and bad bets in such a short time, and lose so much money. For me, the lesson is that even good companies can be run into the ground by a bout of disastrous management. And, of course, it serves as a reminder to be diversified. A diversified portfolio can withstand the losses from an AIG.

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

[top]

Dorato Mission Statement:

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
  

[Top]
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.

[Top]

"It's time to clean up, young man. This place looks like Wall Street."

[Top]

© Dorato Capital Management, LLC. All rights reserved.