Letter to Our Clients - December 5, 2008

December 5, 2008


Dear Clients and Friends:

Recently my family and I were watching on cable TV an old episode of Mork & Mindy. It was fun, watching the antics of a young Robin Williams as Mork. I will explain in a minute why it is pertinent to this letter.

If you open your monthly statements, you are not likely to see any improvement over last month’s reports. Behavioral analysis has demonstrated that most people think the future will be like the immediate past. This is why when the markets are going up, everyone is comfortable with investing. Likewise, now that the markets are dropping, the sense is that this will go on forever. However, the question is not “will this end,” but, “when will it end?”

Every period of excess sows the seeds of a counter-trend. Outsized market returns have led to outsized market downturns. Too much debt has led to too little lending. Too much confidence led to too much pessimism. In my opinion, it is approaching the time where the pendulum should begin to swing back toward profitability, liquidity and confidence. “Black Friday’s” shopping is proof that the US economy, even in recession, continues to function.

We may not be at or near the bottom. Even if this is close to the bottom, it may be some time before we see a long-term upward trend. Nevertheless, this is an excellent time to be investing in the stock, bond and real estate markets, and for those already invested it only makes sense to maintain your existing investment strategy. Think of it this way: every time someone sells a stock, someone else is buying. Right now, who is smarter? The sellers, or the buyers? Which will we be?

One justification for this optimistic outlook is the enormous amount of cash now on the sidelines. Investors all over the world have been buying US Treasury obligations as a short-term holding. Banks are full of depositor money. Institutional money managers are building huge cash reserves, at least those not having to liquidate for margin calls or shareholder redemptions. And, the nation’s money market accounts are at all-time highs.

I read the Wall Street Journal daily, and I don’t know why I remember this statistic, but in 1994 I noticed that there was $600 billion in money market accounts. I meant to call attention to the increases when that number hit $1.6 trillion, but missed it, and again at $2.6 trillion. However, this last month the Journal reported that there is $3.6 trillion in money market accounts. This is a staggering amount, especially when added to the other liquid reserves available throughout the world.

Added to all this, the US Treasury, in its infinite wisdom, is flooding the markets with cash. Sooner or later commerce will begin moving again. Sooner or later investors will begin again to buy into the value currently available in the stock and bond markets.

However, I doubt we will return to the 20% per year returns of the 1980’s and 1990’s. What were known as “investment banks,” with huge appetites for risk and lax regulation, have now become commercial banks. They will now be governed by different rules, which will remove much of the froth from the markets. Also, while the current concern is deflation, longer-term there is a real risk of inflation, perhaps even outsized inflation. Hopefully it will not be as bad as 1977 to 1982, but it will take very wise fiscal policy to avoid the worst inflation since the early 1980’s.

And then there are taxes. How can taxes not rise when we are throwing money at our problems? In addition, the Boomer generation is now a) qualifying for Social Security, Medicare and Medicaid, and b) as soon as they stop working, these citizens will no longer be paying Social Security taxes.

So, we face opportunities, and risks. The three greatest risks for those approaching or in retirement are: 1) Longevity (you do not want to outlive your money), 2) Medical Expenses, and 3) Inflation.

Which brings me to Mork & Mindy. In the episode I was watching, Mindy’s father was excited because he had finally saved up $2400. He wanted to demonstrate that he was a success when he went to the upcoming high school reunion. The $2400 was enough for him to buy a brand new Cadillac. Imagine what kind of automobile $2400 would buy today!

In 1978 a first class stamp cost $0.13. Today it is $0.42. My math says this is a loss of purchasing power over the last 30 years of almost 70%.

So, if we look at “risk management,” it may be tempting to reduce volatility risk by purchasing “fixed income” investments. For example, an immediate annuity might guarantee a payment of $1000 a month for life, yet you surrender any rights to your principal. A bond might guarantee $12,000 a year for 30 years, and then give back to you the principal – but the $12,000 annual income never goes up. If your plan is to use the monthly income for transportation, utilities, and groceries, where will you get the dollars to cover the increases in costs over the years? When the bond matures, the principal returning to you may be able to purchase only 30% of your first investment.

The stock market may offer an attractive alternative. Profitable companies that pay dividends generally increase their dividends over time, which provides increased cash-flow to help maintain purchasing power. Historically, stocks appreciate over time, even though the last 8 years is not good evidence of it. Thus, the potential for rising dividends and share price appreciation make stocks one of the few investments which can generate cash flow that can keep pace with inflation. Too little stock market exposure puts you at risk of outliving your money. Too much stock market exposure may make it difficult to sleep in times like this. We need to always be mindful of the need to balance long-term strategies against the risks and fear of down markets such as this.

On the flight home from San Francisco I read an interview with a famous portfolio manager. When asked what he would have liked to have done differently in 2008, his answer was “the entire year.” But, when asked the best advice he could give to those suffering through this market turmoil, he responded: “Things can change quickly, but your investment philosophy should not.” We agree with him and strongly support this as a general principle.

However, it is not our intention to impose on anyone our world view. Our job is to help you develop and operate a financial plan and an investment strategy that meets your specific needs, concerns and situation. If you are worried about your financial health, please contact us to schedule an appointment.

If I do not see you before the New Year, I hope you have a wonderful Holiday Season. Thank you again for the opportunity to work with you.

Best wishes,

Robert K. Haley, JD, CFP®, AIF®