October 14, 2009
What a difference a year makes. On October 1, 2009, the Wall Street Journal reported that the Dow Jones Industrial Average had its best third quarter since 1939. That is not a typo. It went on to report that the S&P 500 is “up 56% from its March low but off 32% from its October 2007 high.” In other words, we have come a long way, but we still have a ways to go. This is going to take time – something I know all of you understand.
During this past quarter I thought it was interesting when Harvard announced that their endowment performance dropped 27% and Yale’s fell 30% for the last twelve months ending June 30, 2009. For many years, the money managers of these prestigious institutions’ endowments were considered to be the “elite of the elite” of all investment professionals. These professionals made their handsome returns by investing in assets that the common investor had little or no access to (e.g. private-equity partnerships and real assets such as timber, commodities and real estate). The trouble is the market for these assets shrank as the economy faltered last year. It turned out that the endowments relied too heavily on these illiquid assets for their gains – they could not sell them when they wanted to late last fall. With most, if not all of you, substantially beating the returns I listed above, I believe we can learn something from all of this. When it comes to our investments, “liquidity” has a value. Liquid investments like open-ended mutual funds have advantages over illiquid securities like real estate and timber when things become difficult. I would bet that you will see more liquid investments appear in these endowments in the months and years to come.
I have always thought of myself as a “buy and hold” kind of investor. In other words, I am reluctant to try to time the rise and falls of the stock market. But if you really think about it, no individual is actually a “buy and hold forever” investor. Even Warren Buffet and his holding company, Berkshire Hathaway, will liquidate a stock here and there. You and I need to dip into our portfolios to pay for various expenses such as an education or maybe a house improvement or two. The endowments mentioned above believed that they had an advantage over common investors since their portfolios never had an end-date – they could conceivably go on forever. As we found out, there are times that you have to sell. Value investors would argue that once a stock that was purchased at a discount reaches its intrinsic value (what the company is truly worth – investors use different means to calculate intrinsic value), a sale of that stock would be prudent. All of our equity funds except for our index funds practice this approach – they try to purchase stocks well below their intrinsic value and sell them once they reach the intrinsic value. So even though it might look like we are holding on to the same boring, old mutual funds forever, do not forget about our mutual fund managers buying and selling underneath the mutual fund name. That is not to say that our mutual fund managers are churning their accounts. Many of our mutual funds have a turnover rate of 30% or below, which is considered extremely low turnover by Morningstar.
Our country is in a precarious time. We are in a recession that is being labeled as the “Great Recession” by the popular press. It is the worst economic downturn since the Great Depression. We are experiencing close to 10% unemployment at present – the highest it has been since the early 1980’s. Our government has responded with extremely low interest rates, an economic stimulus package and the promise of higher taxes and tighter regulation going forward. All of these things or some of these things will be credited or discredited with improving our economy in the future. I will leave that to the historians. My main concern at the present time is regarding the U.S. dollar. Will the debt that our country has taken on become a ball and chain for us during the global recovery? Will our dollar begin to fall as our nation’s debt continues to rise? Where is inflation in all of this?
The stock market has rallied to date based on economic numbers that are showing signs that are not as bad as they once were and by positive news on the corporate earnings side of things – something we knew we would need to see before the market would turn around. I still think there is a probability that the economy could slow down and “absorb” inflation in the near-term, but I believe the odds are in favor of higher inflation in the years to come. As we approach the year 2010, I will be looking to investments that have a history of doing well in a declining dollar environment and may be making some changes in your portfolio to reflect this thesis.
Best regards,
Bill