April 15, 2008
“Our best defense is the same offense we’ve used for years: diversification, a long-term perspective, and a reluctance to try and time this market.” – Dan Weiner. I believe this statement does a good job of summarizing what I believe in and strive for when I invest your hard earned money. When the stock market turns rocky like it did this past quarter, we need to remind ourselves that as long as we stick with these three pillars of investing, our portfolio will be fine.
The first quarter of 2008 was the worst quarter the stock market has experienced since 2002. During the quarter, the stock market digested the news coming from major financial companies and banks around the country stating that the subprime mess was worse than first realized. Christopher Davis, co-manager of Selected American Shares fund, said four to six weeks ago that he believes that we are halfway through the housing debacle. There are many more mortgages that are due to reset this summer. Let us hope that the worst of the subprime fiasco is behind us.
Bear Stearns was one of the bigger stories this past quarter due to the “run on the bank” and the subsequent buyout by J.P. Morgan. Bear Stearns was one of the companies mentioned above that was caught up in the subprime mess. They held too many securities made up of mortgages that were going “belly-up” on a daily basis. Many in the financial community called the actions at Bear Stearns to be a classic “run on the bank” scenario. In other words, those firms or individuals that were lending or had their savings at Bear Stearns wanted to retrieve their money at the same time. As you and I know, banks are not required to keep large cash reserves on hand to meet every single payback/withdrawal need. When Bear Stearns could not find anyone to lend to them to meet these needs and when there were no buyers for these mortgage-backed securities, they turned to the Federal Reserve and the Fed brought their trusted, strong-balance-sheet friend J.P. Morgan in to help with the situation. Again, the theory is that they did not want a large bank in the United States to go bankrupt in the middle of a credit crunch. If they did not take action, foreign banks or foreign governments would most likely start pulling money out of U.S. securities.
To entice J.P. Morgan, the Federal Reserve said that J.P. Morgan was responsible for the first $1 billion while the Fed would pick up the next $29 billion in Bear Stearns’ loan defaults. They also worked out the purchase price of $2 per share and then upped it to $10 after initial complaints from Bear Stearns stockholders. What can we learn from this story? The shareholders of Bear Stearns were lucky. They received $10 per share when their stock was essentially worthless (the other option was bankruptcy). Once again, it pays to be diversified!
The dollar continues to fall as the Federal Reserve lowers the federal funds and discount rates. The Fed is doing this for two reasons: First, the Fed would like to stave off a further decline in the banking and housing industries. Second, The Fed wants to stimulate the economy with lower rates which would enable corporations to borrow and, thus, spend on capital goods and services. This cheap money policy has had its share of critics. Some investors feel that the rate cuts are feeding the flames of inflation and increasing the price of a barrel of oil. After all, a barrel of oil is sold in U.S. dollars and if the dollar is worth less, suppliers are going to demand more dollars for the same product. Others believe that the Fed needed to react or face a global financial crisis. I have a feeling that students will be studying this financial situation and the Federal Reserve’s reaction to it well into the future.
I realize that this letter and your returns may not be the most uplifting news at the present time. We all know that when we invest in the stock market, we are taking on risk. With this risk comes a reward – as long as you are willing to stay invested for the long-term. While I do not know what will transpire with the economy and stock market in the next few months, I do know that if you use history as a guide, the stock market has always recovered after times of turmoil. It is not a question of if, but when.
Enclosed, you will find your Portfolio Holdings statement as of March 31, Portfolio Performance summaries, a quarterly Account Management Fee Statement, and a Notice Regarding Treatment of Confidential Information. Please call us should you desire the most recent copy of our Form ADV, Part II. In addition, do not forget to notify us should your investment objectives or personal financial situation change.
Sincerely,
William A. Bullock
P.S. On a personal note, on Saturday, April 12th at 1:10 in the morning, my wife, Karla, and I welcomed Patrick William Bullock into this world. Patrick and Mom are doing quite well and big sister Bridget adores Patrick by routinely calling him “baby.”