3rd Quarter in Review

Phil Diamond, CFA | Sept. 30, 2009

"Seize opportunity by the beard, for it is bald behind."- Bulgarian Proverb

3rd Quarter Results -- S&P 500, +15% for the quarter, +3.6% for September, +17% year-to-date; Dow Jones Industrial Average, +15% for the quarter, +2.3% for September, +11% year-to-date; Nasdaq Composite, +15.7% for the quarter, +5.6% for the month, +33% year-to-date.

What an extraordinary year it has been thus far! Much has been and will be written about the events of the last 12 months and it is certainly one for the history books. It's worth taking a look back to see where we've been because the lessons we've learned (or relearned as the case may be) are many. It was a year ago that Lehman Brothers went into bankruptcy and the government saved Freddie Mac and Fannie Mae. We saw the collapse of Washington Mutual and Wachovia Bank along with the forced sales of both. American International Group was on the brink of failure due to its holdings of credit default swaps, so the Treasury stepped in and saved them, too. What a considerable difference between then and now.

Things are different today than they were a year ago. Then, we were in the midst of a financial panic that rivaled anything in eighty years. Now, we have significantly rebuilt the financial landscape with the help of government guarantees and with increased government oversight to help prevent the sort of speculative excess that led us to the trouble. Last year we were looking at an economy that was stumbling backwards, today we have gotten our footing. The world seemed a very dangerous place then, and now we are feeling a lot more normal (though we aren't quite there yet). The future from the vantage point of one year ago was terrifying to many. Today it's a whole lot better and getting better every day.

It’s refreshing to see the beginnings of optimism again. Most everybody agrees that the recession is ending or soon will. The markets; stock, bond and commodity have anticipated the recession’s end long before now of course. We just witnessed one of the shortest and steepest recoveries in the market ever. One of the precipitators of the crisis, housing, may have bottomed-out in many parts of the country. Though there may still be weakness in some of the most over-priced areas, on the whole the real estate bear market appears to be winding down.

Despite the advances already behind us, we still see opportunity in many parts of the market. With a new economic recovery right in front of us, we see significant potential improvement in corporate earnings and cash flows. Better earnings and cash flow means an increase in both stocks and bond valuations as investors return to a more normal assessment of growth and value. We see improvement in most of the rest of the world as well, so nearly everything we say applies to international markets too.

There are still a significant number of former investors, driven out of the markets during the dark year that have yet to return. There are literally trillions of dollars still waiting on the sidelines until the market is more attractive. We have heard time and again that folks are waiting for a pull-back before committing to the market. Whether there is a pull-back or not, sooner or later those dollars will return and that will create substantial new demand for investment products and subsequent higher prices. As we have learned once again, the time to worry is when everyone else is confident and the time to be confident is when everyone else is worried.

Of course markets don’t deliver their returns evenly year over year, and while we see significant recovery and opportunity over the medium and long term there are bound to be setbacks along the way.  Last June we had a period of falling prices as investors worried about the “sticking power” of the recovery and took profits. These setbacks are a very normal part of the way markets behave, and tend to happen within the framework of a larger bull market. These sell-offs within a broader recovery help investors get comfortable with market increases, allowing some to take their profits and others to step in during the pullback in prices. Since the new bull market began back in March, we have already had one retreat that measured 7.5% or so. More such "wiggles" are likely in the months and years ahead. The stock market is back above where it started the year, but is still a long way from the highs reached in late 2007. It is certain that eventually we will eclipse those old highs, even if there are slips along the way.

Fortunately there are still things to worry about. The old adage “Wall Street climbs a wall of worry” is as true today as it ever was. The unemployment rate is expected to continue rising in the months ahead as managers and business leaders wait for ample confirmation of recovery before adding to their payrolls. People can’t spend until they have those paychecks, and so consumer spending will rise very slowly. The economic recovery won’t be nearly as robust as some would like, and that will continue to provide fodder for pessimistic viewpoints. Those pessimistic viewpoints are actually a good thing. It’s only when everyone agrees that stocks will continue to rise that another bear market is in the offing.

Last quarter we wrote about the opportunities that the sell-off in stocks and bonds afforded us. We’re happy to report that you are still benefiting from the bargains in bonds and high quality growth stocks. These sorts of trends very often take some time to fully mature, and we have positioned your portfolio to take advantage of them.

Clients will notice some changes in the coming months in regards to their positions in international stocks. We are increasing the weighting of international equities in client portfolios to take advantage of the continuing higher growth rates expected for many of the world’s economies. We feel that increased exposure here will help to offset the expected slower growth of our own economy as many nations benefit from increased stability, sophistication and the development of their own domestic economy. In addition to the positions in foreign companies the emphasis on high quality US growth companies will help clients share in the growth overseas as the profits of many of these firms have a significant international component as America’s strong brands are valued and desired outside our borders.

You should congratulate yourselves for staying the course during this terrifying time. While bear markets are inevitable, and happen rather more often than we would like, they are simply part of the process and cycle of investing. Over time patient investors are rewarded, and history affirms the triumph of the optimists.

I would like to thank our colleagues and business partners at FocusPoint Solutions for their contribution to our Commentary. Particular thanks go to Phil Diamond, CFA; Ryan Long, CFA and all within their research staff. We look forward to their on-going  Commentary contributions.

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