November 10, 2008
Greetings,
Now Comes the Difficult Part
Finally, the election is behind us! U.S. equity markets reacted with the biggest two day decline since October 20, 1987. The economic news continues dismal. The tax-loss selling season is upon us. Hedge funds are preparing for heavy year-end withdrawals; many will fold as margin loan calls force the liquidation of whatever marketable collateral remains in their portfolios, and since they are so far away from their performance fee benchmarks the incentive to continue has disappeared.
Endowments, pension funds and other investors loaded with non-marketable alternative investments continue to be concerned about the liquidity of their holdings. Harvard's endowment (35% in alternatives) made it known last week it will seek to sell $1.5 billion in private equity investments. Yale's endowment (in excess of 60% alternatives!) and many others, must be considering similar moves to cover current cash flow needs. An abundance of cash in the hands of investors sits on the sidelines, but earning less than 1% pre-tax! So the big question remains, who has the confidence to step up and buy, and at what price?
The News from Omaha
In the past year, the focus has been on the various "rescue" investments and pronouncements of the Sage of Omaha, Warren Buffett. Perhaps suffering recently from a bout of media over-exposure, he has become the latest all-purpose poster person, sometimes seemingly verging on a cult status. Buffett's bellweather Berkshire Hathaway Corporation last week reported September 30th quarter results indicating the company has also been affected by the turmoil of the last few months in the financial markets. Berkshire's net income for the September quarter was down 77% from the year-ago result, confirming that weakness amongst all financial services companies has spread to even Buffett's fortress-like insurance conglomerate. However, the equity markets seemed to take it all in stride; Berkshire's stock rose on the announcement.
U.S. Politics and the Global Economic Outlook
Until late last summer, equity markets around the world appeared, as is usually the case, to be focused on and tied to global economic (i.e., Gross Domestic Product, or GDP) growth prospects. Since September, this relationship seems to have been turned on its head; that is, the financial markets have been driving the world's economies. Some economists estimate that in the U.S. roughly $7.0 trillion (of $17 trillion total at the beginning of 2008) of stock market wealth has disappeared in this bear market. The diminished wealth effect on U.S. consumers has begun to reflect itself in our domestic economy's vital signs. Elsewhere, outside the U.S. our trading partners have been similarly impacted, and this will filter back as lessening demand for our exports. The Chinese stimulus package announced over the weekend gives further indication of the coordinated nature of global central bank policies attempting to reverse these trends. Clearly, a world-wide recession (probably dating from late 2007) is underway. The questions investors and the investment markets are now grappling with have to do with how deep and how long will the GDP downturn be?
If the new administration's transition to power can proceed apace, and important political appointments work their way through the Senate confirmation process without too much controversary, the reformation of the U.S. credit and equity markets can get underway. Given the extent of the carnage in the U.S. these past few months, the post-election shift in the balance of power in Washington, and the extent of damage to financial markets elsewhere, the potential for politically motivated intervention at this delicate moment needs to be understood by all parties. Statesmanship must prevail over partisanship.
For our clients and U.S. equity investors today, the issue remains how much of all this has been already discounted in the 43% decline in stock prices during the past 12 months? The news ahead will continue depressing, but perhaps as in the instance of last week's stock market reaction to Berkshire Hathaway's earnings announcement this is priced into today's valuations. Depressing though the news may be during the next few quarters, the equity markets may soon begin to look across the chasm and begin to focus on a turnaround. During this interim period, we will be implementing the tax loss realization transactions in taxable accounts discussed in recent e-mails and carrying out rebalancing programs as market circumstances allow.
As always, your thoughts, comments and questions are most welcome. Please contact us via email at tfc@tfcfinancial.com or call us at 617-210-6700.
Sincerely,
James L. Joslin
Chairman & CEO