Dowley & Company
 
 

3rd Quarter Newsletter

 

Greetings!

 

We usually like to think of the summer as a time of quiet reflection with a good book on a sunny beach.  Turmoil in Europe and the markets clearly had other things in mind.  This quarter's newsletter reflects on what we have seen and where we are going as well  

as a simple idea on savings.                            

 
As always, we encourage your feedback on issues  

you would like to see in this forum and feel free to along to your friends and family.

We thank you for your continued patronage to  

Dowley & Company.

   

Sincerely,

 

Chris

 

Chris Dowley

RLP, CLU, ChFC, CFS

Dowley & Company, Inc.

www.dowleyandco.com 

 

In This Issue
Market Upheavals: Summer of Our Discontent
Subprime Mortgage Revisited
The Pickle Jar




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Market Upheavals: Summer of Our Discontent  

Over the last two months, equity markets have once again delivered record-breaking volatility along with jaw-dropping declines. The down grade in US Treasury debt by Standard & Poor's and the turmoil in Europe surrounding Greek credit challenges are the primary culprits. Regardless of reason, fear seems to rule the day. At one point in early August, despite any real signs of recession, selling pressure resulted in a ratio of declining stocks to advancing over a day's trading of 77 to 1, a level not reached in the last 80 years! The result was a blood bath of short-term losses that rocked the investment world and shortened the vacations of nervous hedge fund managers and short term traders. The press, of course played its part suggesting comparisons with the 2008 debacle, creating the impression that the sky was indeed falling, and opening the door for emotions to overwhelm rational reason.

 

What, me worry?    

 

While we at Dowley & Company have been known to be optimists, I think we are well within the bounds of credibility and we seem to have lots of company. Yes, the economy is not exactly firing on all cylinders, while unemployment remains stubbornly fixed and seems content to remain so. And the EU? Well they seem to despair at the tough choices around Greece and how to handle it all. When you look at it, it does seem pretty ugly, doesn't it?

   

Not so fast

 

There is a big difference between economies and markets. Economies grow (or not) and change with the pace of a tortoise while markets leap about like so many hares on amphetamines. The US Economy is growing, despite all the evidence in the press to the contrary. One percent seems to be the annual estimate at last look. Growing slowly, but growing nonetheless. Consumer debt is shrinking, as indicated by the numbers of defaults on revolving credit. As of the end of the second quarter of this year, over 75% of the S&P 500 companies reported earnings that beat Wall Street estimates. They posted earnings growth of 18% and revenue growth of 13%. They also happen to be harboring a record amount of cash. If you exclude financial stocks from the mix, it is estimated they have approximately $1.75 trillion on the balance sheets. Even if they need to borrow the money for their expansion ideas, interest rates are at record lows and it costs them very little to do so. Access to capital does not seem to be a problem. In case they want to hire new employees, they have what appears to be the largest supply in half a century available at competitive wages given that most of the potential hires would be glad to take a pay cut just to get a job. Wage inflation doesn't seem to be a problem (or any inflation for that matter) nor does the supply of eligible hires.

 

So why aren't these businesses investing and spending and hiring? Businesses are concerned with return on equity. They want to know if they put their capital to work; it will give them a return that will accrete to the bottom line. The only reason they don't invest in new capital and hire employees is fear of not getting that return. So they do things like increase dividends and share buy backs to improve their stock's market price. Yes the economy may be slow, or slower than we would like. While markets may be depressed on the back of uncertainty in the news, they look like they have earned our optimism.

 

That leaves only one major unknown: government. I would like to think even politicians couldn't mess this one up. Yet they are so desperate to save their elected hides that they will do almost anything, which is where the problem comes in. I would like to think the legislative environment is accommodative to business, and it probably is right up to next year's election. After that, all bets are off.

 

So what do we like?   

 

Taking into account that volatility will be the order of the day, our investment team continues to favor equities over fixed income and large cap stocks over small. We like the emerging international markets and continue to allocate assets to that area. We have taken gains earlier this quarter and used the proceeds to reinvest opportunistically where we have found price declines have created value. While we still allocate assets to fixed income asset classes, our managers have tended towards a defensive posture in our core holdings and increased security selection at the fringe. Overall duration is shortened given concerns over rising interest rates. After all, we know they cannot go down forever. The question remains, when they do go up, how fast will it happen? The Federal Reserve may like to broadcast its intentions, but bond markets are not so generous.

 

A final thought   

 

One investment strategist was quoted recently saying, "When we're getting close to a market bottom, the phone starts ringing off the hook and our clients want us to sell everything. Market bottoms are less about an improvement in the fundamental situation and a lot more about getting rid of all the anxious investors"

 

No doubt the media will continue to translate the current volatile market conditions into dramatic headlines. No doubt this will continue to feed investors' fears. No doubt some of them will sell everything. Our job is to prevent the market swings from getting rid of the anxious investors, instead helping the investors get rid of their anxiety.

 

 

Chris Dowley   

September 2011

   

Chris Dowley has spent the last 25 years as a financial advisor helping individuals and their families organize themselves financially and realize dreams. He has spent the last 13 years as the managing principal of his firm Dowley & Company, Inc. in Marblehead, MA where he practices financial life planning and lives with his wife and son.

 

Subprime Mortgage Revisited

Recently, Bloomberg News reported (8/31/11) that Standard & Poor's, the New York based rating agency, was "poised" to provide a AAA grade (it's highest) to a mortgage trust comprising bonds totaling $497 million dollars lent to homeowners with "below average credit scores and almost no equity in their properties." The mortgage trust was put together by a lender who specializes in lending to borrowers with risky credit, and who also pays S&P to evaluate the deal for creditworthiness. This is the same S&P rating agency that recently downgraded the United States to AA+ (its second highest rating) because US politicians are becoming "less stable, less effective, and less predictable." As the Bloomberg article pointed out, debt issued by the United States is now comparable in risk of default to that of Belgium.

  

Deven Sharma, who has been S&P's president since 2007 and who is reportedly stepping down this month, defended the company's practice. He suggested its methodologies are "completely comparable" and consistent across all assets it reviews. These attempts to be consistent have seemingly met some snags. S&P apparently continues to assign its top grades to pieces of home-loan bonds which are packaged into securities called re-remics. Bloomberg reports that in May 2010, S&P was forced to lower the ratings on 308 classes of such deals. One deal worth a reported $10 million, created only nine months prior to the downgrade, went from a AAA rating to CCC, a slide of six ratings in one day! The reason was a higher-than-forecast number of mortgage defaults. In December 2010, S&P said it would need to review 1196 such re-remic securities because it had apparently "incorrectly analyzed" the debt structure of the underlying deals. Bloomberg also cited S&P's admission of mistakes in structured finance, ranging from misunderstanding of cash flows to inconsistent and sometimes conflicting methods of analysis.

  

Is S&P in this alone? Apparently not. According to Bloomberg, a former analyst from Moody's Investors Service, in a letter to the SEC, said that his group faced management pressure to issue higher grades in an effort to win business for the firm by implementing "a market friendly methodology." You might be tempted, as we are, to ask "Friendly to whom?" Enough people are asking that question to prompt the Justice Department, the Senate Banking Committee, and the Securities and Exchange Commission to investigate the role of the rating agencies in the original crisis of 2008 and in the downgrade of US Treasury debt last month. I would submit that you don't get that kind of broad-based attention unless things are seriously out of alignment. 

  

Credibility for Sale?

 

The credibility of S&P and its brethren is clearly on the wane. The Bloomberg article cites a number of money managers with significant doubts on rating agency reporting. This is quite understandable, given the capital they have at risk and the experience they have been through in the last three years. More importantly, the markets seem to be the ultimate voice of sanity. Rates on 10-year US treasuries have been consistently far lower than on comparable mortgage-backed offerings of similar maturity, even after the August 5 downgrade. This suggests that investors demand a far higher yield on the mortgage offerings, given the perceived risk involved. And the risk is considerable. It only takes a slight downturn in the economy to further depress home prices, which will encourage another wave of borrowers to walk away from their underwater homes and leave investors with a sea of worthless debt. Treasuries are still the safe haven for capital, no matter what S&P says. And why shouldn't it be? Unlike the mortgage deals mentioned, the US Government has the authority to adjust tax rates (and thus its income to repay the debt) as well as to print more money (despite the accompanying inflation). Just who is S&P trying to kid? 

  

The casualty in all this, once again, is the individual investor who at one time came to rely on the three major credit rating agencies (S&P, Moody's, and Fitch) for reliable credit reporting. Their reliability has seemingly been sold to the highest bidder in the name of corporate profits. In order to please Wall Street securities firms, the reporting agencies are slathering lipstick on so many pigs and selling them off as stallions. And apparently it is working. That $497 million in bonds for sale in the mortgage trust? According to the Bloomberg article, roughly half had been sold. Some lessons are just too difficult to learn, and some people never get it.

 

 

Chris Dowley   

September 2011

   

Chris Dowley has spent the last 25 years as a financial advisor helping individuals and their families organize themselves financially and realize dreams. He has spent the last 13 years as the managing principal of his firm Dowley & Company, Inc. in Marblehead, MA where he practices financial life planning and lives with his wife and son.

 

The Pickle Jar 

The pickle jar as far back as I can remember sat on  

the floor beside the dresser in my parents' bedroom.

When he got ready for bed, Dad would empty
his pockets and toss his coins into the jar.
As a small boy, I was always fascinated at the sounds the coins made
as they were dropped into the jar.
 
They landed with a merry jingle when the jar was almost empty. Then
the tones gradually muted to a dull thud as the jar was filled.
 
I used to squat on the floor in front of the jar to admire
the copper and silver circles that glinted like a pirate's
treasure when the sun poured through the bedroom window. When the 
jar was filled, Dad would sit at the kitchen table and roll the
coins before taking them to the bank.
 
Taking the coins to the bank was always a big production.
Stacked neatly in a small cardboard box, the coins were
placed between Dad and me on the seat of his old truck.
 
Each and every time, as we drove to the bank, Dad would
look at me hopefully. 'Those coins are going to keep you
out of the textile mill, son. You're going to do better than
me. This old mill town's not going to hold you back.'
 
Also, each and every time, as he slid the box of rolled
coins across the counter at the bank toward the cashier,
he would grin proudly. 'These are for my son's college
fund. He'll never work at the mill all his life like me.'

We would always celebrate each deposit by stopping
for an ice cream cone. I always got chocolate. Dad
always got vanilla. When the clerk at the ice cream
parlor handed Dad his change, he would show me the
few coins nestled in his palm. 'When we get home,
we'll start filling the jar again.' He always let me drop
the first coins into the empty jar. As they rattled around
with a brief, happy jingle, we grinned at each other.
'You'll get to college on pennies, nickels, dimes and
quarters,' he said. 'But you'll get there; I'll see to that.'
 
No matter how rough things got at home, Dad continued
to doggedly drop his coins into the jar. Even the summer
when Dad got laid off from the mill, and Mama had to
serve dried beans several times a week, not a single
dime was taken from the jar.
 
To the contrary, as Dad looked across the table at me,
pouring catsup over my beans to make them more
palatable, he became more determined than ever to
make a way out for me 'When you finish college, Son,'
he told me, his eyes glistening, 'You'll never have to
eat beans again - unless you want to.'
 
The years passed, and I finished college and took a
job in another town. Once, while visiting my parents,
I used the phone in their bedroom, and noticed that
the pickle jar was gone. It had served its purpose
and had been removed.
 
A lump rose in my throat as I stared at the spot beside
the dresser where the jar had always stood. My dad
was a man of few words: he never lectured me on the
values of determination, perseverance, and faith. The
pickle jar had taught me all these virtues far more
eloquently than the most flowery of words could have
done. When I married, I told my wife Susan about the
significant part the lowly pickle jar had played in my
life as a boy. In my mind, it defined, more than
anything else, how much my dad had loved me.
 
The first Christmas after our daughter Jessica was born,
we spent the holiday with my parents. After dinner, Mom
and Dad sat next to each other on the sofa, taking turns
cuddling their first grandchild. Jessica began to whimper
softly, and Susan took her from Dad's arms. 'She probably
needs to be changed,' she said, carrying the baby into my
parents' bedroom to diaper her. When Susan came back
into the living room, there was a strange mist in her eyes.
 
She handed Jessica back to Dad before taking my hand
and leading me into the room. 'Look,' she said softly, her
eyes directing me to a spot on the floor beside the dresser.
To my amazement, there, as if it had never been removed,
stood the old pickle jar, the bottom already covered with
coins. I walked over to the pickle jar, dug down into my
pocket, and pulled out a fistful of coins. With a gamut of
emotions choking me, I dropped the coins into the jar. I
looked up and saw that Dad, carrying Jessica, had slipped
quietly into the room. Our eyes locked, and I knew he was
feeling the same emotions I felt. Neither one of us could
speak.

 

 

Author Unknown

 


About Us

Dowley & Company is an independent Financial Advisory Firm started in 1997 motivated by the idea of making full service financial planning available to individuals and families.

 

We pride ourselves in helping independent minded clients break through limitations and get to a place of greater affluence they might not achieve on their own.

 

Dowley & Company, Inc.

22 School Street

Marblehead, MA 01945

781-631-4100

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www.dowleyandco.com

 

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