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Financial Markets Hate Uncertainty!
As I write this the DJIA is trading at about 6,550 having declined over 50% from its peak of 14,164 in October of 2007. The credit markets remain frozen for the most part, unemployment is continuing to grow, and the economy continues to slow.
What the financial markets do from here is unknowable but we are confident that our Managed Portfolios, with about 80% invested in short-term US Treasury securities, are well positioned for the worst-case scenario.
We have identified what we think are some great long-term opportunities selling for bargain prices but we feel there is too much uncertainty in too many areas for us to sensibly commit more money to the equity markets at this time. We accept that we may "miss the bottom" and hope you will forgive us for that, but it is one of our maxims not to be the last one to leave the party, nor the first one to arrive at a new party.
In reviewing our holdings in the two Managed Portfolios (Income & Growth) we do not believe we have suffered any permanent loss of capital, and remain confident that we will be able to regain what we have given back in relatively short order when this storm clears.
We believe that this recession is likely to be deeper, longer and more global in nature than past recessions, and for the time being we intend to remain patient and open to see what develops in the months ahead.
The graph below shows the dollar value performance of our two Managed Portfolios versus the S&P 500 index since their inception of March 31, 2006.
The Big Picture
WHAT IS HAPPENING TO THE ECONOMY AND FINANCIAL MARKETS?
The fundamental forces of "global de-leveraging" continue to push asset prices lower, unemployment and bankruptcies higher, and have the US Government issuing debt in frightening amounts. As difficult as things are getting here in the US, many countries, such as Japan, are suffering even nastier recessions, caught in the backwash of the collapse of world trade. Others, such as the U.K. and Eastern Europe, are sinking under even worse financial crises, threatening widespread bank nationalization.
WHAT CAN WE DO TO MAKE IT THROUGH THIS CRISIS?
Dig in for the long haul and try not to panic or extrapolate. De-leverage where it makes sense. Reduce discretionary spending, pay off or pay down debt, and increase your emergency savings.
On the investment side, if we are managing your investments in our discretionary Managed Accounts Program then you should be aware and hopefully comfortable with how your money is allocated. If you have other investments that we are not managing for you, it may make sense to fax us those statements at (858)350-1044 so we can review them with you.
If you are currently contributing to a retirement plan we suggest you continue to do so but perhaps consider for the time being allocating your new contributions into a money market fund.
I HAVE ACCOUNTS AT ANOTHER INVESTMENT FIRM THAT ARE DOWN A LOT. AT THIS POINT SHOULD I JUST HOLD ON AND RIDE THIS OUT?
Not necessarily. Each investment, strategy, philosophy and/or plan should be reviewed to determine if it still holds water today. This time IS different and applying old mantras (buy & hold forever, buy on the dips, broad diversification protects against declines, it always comes back) could be dangerous. If you are unsure or uncomfortable with an investment or philosophy (or have a friend or family member who is) CALL US!
HOW COULD A CATASTROPHE LIKE THIS HAPPEN AND WHAT CAN BE DONE TO PREVENT IT?
There is no short answer to this question.
Most major catastrophes can't be reduced to a simple cause and effect explanation. They are the result of a complex confluence of events that line up over time to create a "Perfect Storm".
The roots of today's Perfect Storm are financial, political, emotional, legal, and societal and date back decades. How each of these dominoes played a part and lined up to tumble at once will make for a great book some day.
How to prevent the next Perfect Storm will be debated for years to come. I will leave the discussion on the political, emotional, legal and societal dominos to someone more qualified, but when looking at the part the global financial industry played, I believe the discussion needs to start with regulations and supervision that make common sense.
The United States was founded under a system of checks and balances to guard against extremes and encourage moderation. Slowly over the past few decades, Wall Street lost sight of these checks and balances and came to believe it could self-regulate; effectively manage complex and highly leveraged risk with minimal oversight; and not be corrupted by the possibility of limitless profits. This idealistic school of thought assured us that we could avoid financial panics and economic depressions and was similar to the conviction in the 1920's that we could outlaw war.
The global financial industry has made tremendous advances in the past few decades, but ironically these advances also made it extremely vulnerable. I don't believe this vulnerability can ever be completely eliminated but it can be mitigated by better oversight and a more realistic understanding of human behavior.
WILL THE GOVERNMENT'S VARIOUS STIMULUS PLANS HELP US OUT OF THIS?
Given our situation, I think that radical government policies should be considered if they promise to lower the probability and likely size of a depression. However, many governmental actions -- including several pursued by Franklin Roosevelt during the Great Depression -- can make things worse.
I wish I could be confident that the array of U.S. policies already in place and those likely forthcoming will be helpful. But I think it more likely that the economy will eventually recover despite these policies, rather than because of them.
WILL THERE BE NEW OPPORTUNITES CREATED BY THIS MESS?
YES. Absolutely! By definition change always creates opportunity, and the change we are seeing on all fronts today will create an abundance of new opportunities.
What is happening today economically is like a 100 year flood. It hadn't rained heavily for so long that we convinced ourselves that weather patterns had permanently changed. We disregarded our own rules and ignored the warnings of our grandparents and built in the flood plain anyway.
It can be hard to see opportunity now because it is still raining hard and structures continue to be washed away, but NOW is the time to start looking for where the best opportunities to re-build will be and how to sensibly capitalize on them.
Exactly how or when the markets and economy will stabilize is unknowable, but we believe they will. At some point the de-leveraging process will end, the uncertainty and panic will subside, credit instruments will be re-designed and the global financial markets and economy will start to grow again.
The opportunities of tomorrow are already starting to emerge today. Behind the headlines, capital is flowing in new directions seeding entirely new industries, and many established, well managed companies with great products and healthy finances are selling for bargain prices.
We will continue to be patient and sensibly opportunistic moving forward and thank you for your continued trust.
If you have any questions regarding your accounts please call us at (858)350-1010.
Sincerely,
Craig P. Kelley Sean P. O'Hara
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* Performance information stated above is for the one year time period, January 1, 2008 through December 31, 2008, from December 31, 2008 through January 31, 2009, and from inception, March 31, 2006 through January 31, 2009, as is indicated. Performance information is for Kelley Investments Managed Accounts Program where client accounts are managed on a discretionary basis. Not all accounts managed by Kelley Investments are part of the discretionary Managed Accounts Program. Performance information stated above does not pertain to any accounts that are not part of the Managed Accounts Program. Performance results for accounts that are not part of the Managed Accounts Program may differ significantly. Performance information quoted above represents past performance and is not a guarantee of future results. Performance information is quoted on a Gross basis and does not include deductions for management fees or trading expenses. If these fees and expenses were taken into account, performance would be lower. The investment return and principal value of investments in the Managed Income & Growth or Managed Growth Portfolios will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost.
**For illustrative purposes only. It is not possible to invest directly in an index. Comparisons with the S&P 500® Index are not meant to be indicative of any of Kelley Investments Managed Portfolio strategies, asset composition or volatility. Given the wide scope of securities held by S&P 500, it should be inherently less volatile. Our results may differ markedly from those of the S&P 500 in either up or down market trends. The performance of the S&P 500 is shown with all dividends reinvested into the index and does not reflect any reduction in performance for the effects of transaction cost or management fees.
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Conference Call
To listen to a replay
of our
January 12, 2008 Conference Call, dial (877)471-6587
and enter Program ID 1038358075004#
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Craig P. Kelley offers Investment Advisory Services through Kelley Investments, A Registered Investment Advisor. Client assets are held in custody at Fidelity Investments clearing firm, National Financial Services LLC (NFS).
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