This note is a simple heads up to prepare you for your September statements. They are going to look terrible. It wasn't just stocks that had poor performance during the month, everything did! Bonds in every category, natural resources, and international equities . . . you name it, it was down. It is rare, but not unprecedented, when panic strikes, diversification does not always help. The same thing happened in 2002 when for a short while nothing seemed to be working. Fortunately, such conditions are usually very temporary.

So the natural question is, what do we do? The short answer is, don't panic. Our friend Dave Ramsey gave some great advice on Fox News' The O'Reilly Factor last Tuesday we he said, "we are on a rollercoaster, you know what is liable to happen if you try and jump off a rollercoaster?" Bear Markets are scary, especially near the bottom because that is when the news is the worst. We believe we are close to the bottom for several reasons: According to Jack Schannep's book, Dow Theory for the 21st Century:

"The average Bear Market drop since WWII is -27.3% as measured by the Dow Jones Industrial Average." We are currently down -26.8% from the market highs on October 9, 2007.

"The average Bear Market during that same time period lasts 13.9 months." It has been about 12 months since the market high on October 9, 2007.

"Most Bear Markets give back about 50% of the prior Bull Market gains." The Dow Jones average went up about 6,800 points during the last bull market and has given back 3,400 since last October's high. (We didn't make these numbers up; the current drop is down almost exactly 50% from the high.)

"25% of all Bear Markets have ended in October."

"The average Bull Market will double off the bottom." The last one went from about 7,000 to about 14,000. So, if this Bear Market bottoms around 10,000 on the Dow, it is not a stretch to imagine a new Bull Market rising to about 20,000! That's why we own stocks for the long term.

We believe the credit crisis is real but it will be solved and the banks will start lending again. We hope this helps.          10/03/08
 

 

A Perspective on Recent Market Activity From Advanced Equities Asset Management
Craig Columbus, President & Chief Marketing Strategist Advanced Equities Asset Management, Inc.

Events remain highly fluid as we wind down what has likely been the most disruptive and transformative period in the history of American financial markets. Critics have pointed out that the flurry of government intervention risks establishing a system that privatizes profits and socializes losses. Restrictions on legal short selling could also damage market liquidity and undermine the long-term price discovery process. But as investment professionals, it is our job to adapt to whatever regulatory and macro environment is presented - no matter how foreign. While the events of the last two weeks have likely forever changed the fabric of American capitalism, the magnitude of the risks justified much of the unprecedented action, in our view.

With the collapse of the venerable Lehman Brothers, government officials attempted to at least re-introduce the notion of moral hazard - the age-old law of the jungle that requires greed be tempered by fear. Unfortunately, the excesses of the housing bubble can be found in far more corners of America than in the halls of a single fallen Wall Street firm. For several years, housing-related spending, in all its forms, was the engine of U.S. economic growth.

Economist Robert Shiller, writing in 2005, captured the mood in the country:

"Once stocks fell, real estate became the primary outlet for the speculative frenzy that the stock market had unleashed. Where else could plungers apply their newly acquired trading talents? The materialistic display of the big house also has become a salve to bruised egos of disappointed stock investors. These days, the only thing that comes close to real estate as a national obsession is poker. "

Excess supply of housing still rests at the heart of the country's economic turmoil. In short, housing must stabilize for the economy to fully recover. For several years, housing prices rose significantly faster than the rate of inflation (nearly doubling from 1998 to 2006), breaking a well-established near hundred-year relationship. And this occurred at a time when the median income in the United States was actually falling! Spurred on by an overly easy monetary regime, extremely poor lending oversight and an explosion in exotic, ill-fated mortgage engineering, we have arrived at the September crisis - merely a symptom of the era's broader borrowing disease.

However, now it is time to look ahead. Will this week's housing data show some sign of stabilization after the Treasury Department's rescue of Fannie Mae and Freddie Mac? Secretary Paulson has said that five million homeowners are behind on their mortgage payments or are in foreclosure. Mortgage rates have fallen and the spread between mortgage-backed securities and Treasuries have narrowed (a positive for the broader economy) since the announcement of the government's unprecedented Government Sponsored Enterprise (GSE) intervention less than two weeks ago. Data also reveals that foreign buyers have returned to the agency paper market. But, now we need to see some improvement in the housing data coming out of Main Street.

Speaking of Main Street, Wall Street's crisis will likely impact the broader economy, the tail wagging the proverbial dog in an unusual way. Household debt growth has fallen to its slowest rate since the first quarter of 1983 (source: Ned Davis Research). Ultimately, repair of the consumer's untenable balance sheet will be a positive for the long-term structural soundness of America's economy. However, in the short-run, there will be a profound economic impact. The odds of recession are increasing, and employment will have to be carefully monitored. Of concern to us are the rising delinquency rates on exotic option adjustable rate mortgages (ARMs), particularly those that are prone to large rate increases from artificially low teaser rates.

We believe that the seeds of the next great public policy are now being sown by a variety of economic experts, lawyers and academics. A growing chorus is calling for an overhaul of bankruptcy law that would allow judges to slash what debtors owe on their mortgages to the value of the property. It also appears to us that many financial institutions will not only seek government relief for their non-performing residential loan exposure but also things like commercial real estate, auto and credit card loans.

Markets cheered last week's announcement that the U.S. government intends to create some type of entity, similar to the Resolution Trust Corporation of the 1990s, to buy up toxic bonds that are backed by delinquent and foreclosed properties. Like all the recent initiatives before it, it is unclear how the federal government intends to pay for these massive undertakings. U.S. government debt (federal, state and local) as a percentage of the Gross Domestic Product (GDP) was already pushing record levels - before this month's unprecedented expansion. We would simply remind people the purchase of "bad" assets by the government does not suddenly make them "good." Unless the government is willing to purchase these real estate backed bonds for more than they are currently worth, it does not represent a recapitalization of troubled banks (but it does provide them with valuable liquidity).

We believe that success of the plan and the large expansion of the Federal Reserve's balance sheet, hinges in large part on the stability of the U.S. dollar, which had broken an important downtrend. Resumption in the decline of the dollar will bring back the commodity brushfire of inflation expectations that appeared to have finally subsided in recent months.

Regardless of one's view of the plan, the implementation of the so-called Congressional Superfund plan is potentially a very important equity market catalyst. Markets will likely hold their breath as lawmakers debate passage of the bill with an eye on a variety of potential hang-ups, including provisions regarding executive compensation and whether the Treasury will receive equity warrants in any financial company that sells troubled assets into the fund.

Many markets have traded in recent days with wild, bordering sometimes on irrational, un-orderly volatility. Last week's rally occurred at technical levels we have previously mentioned, testing an important technical support level of 1140 on the S&P 500. The reversal had many of the hallmarks of a classic selling climax: four days with 9 times the volume to the down side as the up side, followed by a 10-to-1 up-volume day, accompanied by a large spike in volatility measures. While often ultimately retested, it appears to us that last week's lows represented an important market inflection point. Some of our metrics also reveal that liquidity and bank-to-bank lending have receded from crisis levels. Normalization of other credit markets, such as the corporate, municipal, and high yield markets, would be other important signposts.

According to our research, summarized in the table below, the average bear market decline since VWVII has amounted to a 27 percent sell-off with a duration of just under a year. Through Thursday's low, the market had declined 28 percent in about 50 weeks. Thus, if this is the garden-variety bear market, we are approaching the zone, with respect to magnitude and duration, where risk/reward for equities is getting more attractive.

	Peak-to-Trough	Subsequent
Recession	S &P 500	12 month	Decline
Year	Decline	Return	Duration (wks)
1947	-14%	23%	51
1949	-21%	42%	51
1953	-15%	37%	37
1957	-22%	32%	16
1960	-14%	31%	43
1969	-36%	51%	67
1974	-48%	54%	89
1980	-27%	68%	89
1990	-20%	35%	13
2002*	-50%	36%
Average	-27%	41%	51
2007-2008 (Peek to 9/18/08 low)	-28%	?	50

Source: Bloomberg (Past Performance is not a indicator of future results.)

As a result, last week, in an internal conference call, we discussed our belief that the risk/reward for equities was getting favorable - especially in the light of a negative real return in alternatives like treasury bonds.

It is our hope that this 1 DO-year storm produces meaningful reforms including forcing financial institutions to finally disclose their troubled, and ultimately toxic, Level 3 assets in a transparent way. We want banks to become boring again with a return to back-to-basics lending. With Washington's new-found role as both referee and player in the private markets, we want an end to the political partisanship that has paralyzed the country. Given the stakes, we hope that lawmakers and candidates devote themselves to dramatically improving their financial literacy and sharpening their awareness to systemic risks rather than searching for selective scapegoats. From great crisis often comes great opportunity. We are looking for those opportunities on behalf of our clients - albeit within a modified market structure.

Obviously, events are tremendously fluid and reflect the crisis atmosphere in which policies are often quickly implemented with little time for public debate or comment. We pride ourselves on access and transparency, so if you have any questions or concerns, please feel free to contact us.                        09/23/08