Saturday, September 20, 2008

Holding Down the Fort When It's Raining Shoes

I started to write this update every day this week, and then another shoe or two would drop, so I keep starting over. Since this is a very fast-moving financial transition, I’ll strip this to the important details. Pam is also composing another email to all clients with a more general review of the situation.

Dangers: The biggest danger to clients individually is to panic. Mistakes of the past are unraveling, but this downturn is actually normal for a functioning economy with global growth. On average we have a recession every 5.5 years. We went through this in the 70’s with the S&L crisis, the market fell 25% in one day in the 1987, there was a real estate and international meltdown in 1992, then the dot-com bust in 2000-2002. Now, 5-6 years later, it’s time for another one. We have successfully survived financial upheaval before and we will survive this one.

For Wealth Management Clients, we are monitoring specific risks to your portfolio and acting when necessary. For example, when financial stocks are on the brink of collapse, we take discretionary action to sell them before they stop trading to assure that you will have a tax loss (if the bank goes into bankruptcy, you can’t take the loss until the stock is totally worthless which may be a couple of years). We have sold Fannie Mae stock, Lehman and Merrill Lynch in the past week in clients’ portfolios accordingly.

Other stocks, such as AIG and various money market funds, are being analyzed to determine what action is called for. At the current time, we are keeping Fannie and Freddie bonds in portfolios, as will as annuities, insurance, etc. held by AIG, and money market funds as it appears the feds are taking action to support these securities.

We are ‘watching your back’ continually, so you don’t have to worry about this, and we will continue to update you as needed.

Opportunities: We are generally recommending that clients with extra cash start Dollar-Cost-Averaging into the market. While we don’t know how low the market will drop, most assuredly we will look back in five years and recognize that today’s market was a terrific buying opportunity. It is not appropriate for all clients to be buying stocks now as individual situations may call for more liquidity (see below). Dollar-Cost-Averaging is overwhelmingly more profitable than trying to do market timing.

While US markets are down ~17% this year, international markets are down 25-30%, with virtually every country down over 25%. The Cambridge Global Growth Portfolio by comparison (down 18% YTD) demonstrates the advantages offered by FIM money management. The Cambridge Index Portfolio is tracking the US large-cap markets (such as the S&P 500) as they were designed to do. Unless there is a substantial market turnaround, we will likely have losses to reap which will carryover to future years

We are also cautioning clients in general to maintain liquidity by avoiding illiquid investments (e.g. real estate, partnerships, paying off mortgages, etc.). Because of the credit crisis, some banks are cancelling lines of credit and credit cards, not because the customer has been at fault, but because financial institutions themselves are having difficulty raising capital. We expect this will continue for the next 6-18 months and will advise clients on this individually.

Strengths: U.S. financial and economic foundations are strong, despite what the press says. Foreign markets in general have dropped twice as fast as ours as their economies adjust to new global realities. As Americans, we have unparalleled strengths in terms of education, innovation, and perhaps most importantly = experience. We have been through these crises before and have the leadership in economic matters (e.g. Paulsen, Bernanke, etc.) to respond appropriately. The solutions they have been implementing will not bankrupt the US – keep in mind we have had government intervention in the financial markets before, e.g. during the Great Depression, the RTC to buy assets of S&L’s in the 80’s, the loan to Chrysler in the past decade.

Of course it is a political football, which heightens public paranoia to attract votes. I don’t think that the politicians have a clue about these economic matters = interesting that no one on either side of the aisle saw this trainwreck coming a year ago! While our financial and economic leaders aren’t elected, they aren’t totally immune from political pressure. One of our society’s strengths is that we have very capable people in these key positions who are generally supported by both parties.

As your fee-only financial advisors, we are experience and knowledgeable, and know your personal situations. We have been planning for this possibility all along, which is why virtually all of our clients have US Treasuries in their portfolios to assure them of ample cash flow for 15 years. Interestingly, Treasuries have increased in value by a staggering 15.7% year to date during this market chaos as investors worldwide flock to them as the ultimate in safety. Yes, they have very low yields, but for this part of your portfolio, “Safety Trumps Yeild!”

Using Functional Asset Allocation concepts, you will also be in good shape to profit from the rebound. We do not sell off equity positions during market downturns, so when the market turns around, you will be poised to participate in the following prospertity. It is important to realize that market turn-arounds typically are leading indicators and begin 9-18 months before the economy starts to recover. Thus it is folly to try to guess when the market will shift: by the time you see the change in economic measures the market will have already bolted ahead.

We hope this update is helpful and comforting for you. If you have any questions please call us…we sell sleep, and if you’re losing sleep over this, we’re not doing our job!

Bert Whitehead, MBA, JD

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