Letter to Our Clients - April 2008

April 2008


Several months ago I said in one of my letters that it had been a long time since the stock market had dropped 10%, and I added that a 20% drop was a possibility. While the news media generally talk about how the Dow Jones Average has done, most professionals pay more attention to the S&P 500. This is an index that tracks the stock prices of the 500 largest US companies, and when I made my comments, a 20% drop in the S&P 500 would have put it at or near 1250. During this last quarter the S&P dropped to 1278, and I hope that is as low as it goes.

Some investment professionals wonder why stocks have not dropped more. The financial markets have been facing their most serious set of crises since the Depression, and yet the stock market drop is still fairly muted. When headlines scream bad news every day, we often quit paying attention. I think you should be aware that the Fed’s actions in “saving” Bear Stearns from bankruptcy was historic. It was the first time since the Depression that the Fed stepped in to save a non-bank institution from collapse, and it really is not one of the Fed’s listed responsibilities to do so. I predict there will be lawsuits challenging the legality of the Fed’s actions in this matter.

I returned last week from a Symposium in New York on “Investing for Income in Retirement,” where several stock market gurus were featured. The week before that I was on a conference call with a bond manager. As usual there is no agreement about where the financial markets are headed or about the most profitable strategy to use going forward.

There was one thing everyone seemed to agree upon – that taxes will go up. One speaker said that the Comptroller of the United States (like the CFO of the US) has refused to sign the year-end financial statements for the US Government for the last 11 years. We were told the Comptroller has said that the financial records as written bear so little resemblance to reality that he will not allow his name to be attached to them. The present and future costs of Social Security, Medicare, Medicaid and the wars in Iraq and Afghanistan are not being paid out of current revenues, and the spending for these and other “essential” programs can only increase. One of my worries is that we are going so much in debt for these items that we are seriously underfunding government spending on infrastructure and education, the two things that can most help us stay competitive in the global marketplace.

Inflation also seems to be running higher in real life than government statistics would indicate. Medical costs, for example, seem to be going up at twice the rate of the Consumer Price Index. So, if things are going to cost more, and if we are going to keep less of what we make, what are we to do?

People often say they do not want any investment risk, so they will leave their money in bank savings or CD’s. This can be described as the safest way to lose money. If the CD pays 3.5% and inflation is at 4%, and if you must pay tax on the 3.5%, then your “real rate of return” is much less than your “nominal rate of return.”

One potentially can only obtain a positive real rate of return on a long-term basis by diversifying among different investment opportunities, and being neither too aggressive nor too conservative in doing so. (Diversification does not assure a profit or protect against a loss in declining markets.) Occasionally prospective clients ask me if I consider myself to be aggressive or conservative. I answer that my aggressive clients generally say I am more conservative than they are, and my conservative clients say I am more aggressive than they are. I would be curious to learn how you would answer this question.

To the best of our ability and consistent with what we know about you, we believe your accounts are structured as prudently as we can make them at this time. I want to stress, though, that times and things change. This is why it is important that we meet or talk at least annually. I need you to contact me if you have concerns or questions which have arisen since we last talked. Please also contact me if there has been a significant event in your life, as it might be relevant to your financial health in a way you might not predict.

On a personal note, I want to let you know that in addition to all the “normal” activity this quarter I had the opportunity to spend a little over a week in Spain with my oldest son, Ted. I clearly had a wonderful time as a tourist, but he and I also worked on developing a plan for bringing him into the business. While traveling I was paying close attention to the economies and lifestyles in Spain, Portugal and Morocco. During that week I read in the Financial Times that the European Union (EU) now has a larger market capitalization than the US. When I started in financial services in 1982 the United States had 60%+ of the world stock market value. Now we are less than 40% and no longer the largest single market segment. This is an example of why we believe your investment accounts need to maintain a significant percentage of international exposure.

Overall it seems clear to me that Europe does some things better than we do, and I am sure other places in the world also have their own competitive advantages. However, I am very grateful I live in this country, and in my particular corner of it.

Thank you again for the opportunity to work with you, and I hope to see or talk to you soon.

Best wishes,

Robert K. Haley, JD, CFP®, AIF®