Roundtable Recap

 

We had nearly 70 clients of the firm at our Monday afternoon roundtable discussion and assessment of current market conditions and the Troubled Asset Relief Program (TARP).

 

What began as a 3 page proposal by Secretary Paulson evolved into a bill over 400 pages in length. The main purpose of the legislation is not to bail out Wall Street but rather a mechanism to inject liquidity into the banking system by providing a market for troubled assets allowing banks to again lend money so that short term credit markets can return to normal. Of course, the devil is always in the details and the details of how the plan will work are left largely up to the Secretary. Financial institutions can choose to sell troubled assets to the fund or participate in an insurance pool. Revenues from the subsequent sale of assets or insurance proceeds will be used for reduction of the public debt. Institutions who participate in the program and later profit will have a portion of those profits returned to the fund to offset the cost to taxpayers. Easily the most popular provision of the plan is a limit on executive compensation for the executives of companies who participate in the relief provisions.

 

Also included in the legislation is a temporary increase of the FDIC insurance limits to $250,000. The limit will return to $100,000 on November 1, 2009.

 

The meeting then turned to a detailed discussion of how consumer confidence (or lack thereof) has been an accurate predictor of changes in the S&P 500 (S&P 500 Index and Consumer Confidence).

When consumer confidence is at it’s lowest the stock market typically enjoys strong appreciation during the following 12 months. Investor confidence is currently at a 15 year low.

 

We then discussed a slide (S&P 500 Performance, Equity Mutual Fund Flows & Bull Market Headlines)

which illustrated that mutual funds investors historically chased performance by investing the most when prices were high and the least when prices were low. In other words, most mutual fund investors bought at the peak of the market and sold at the bottom which is why investors have historically done worse than the markets.

 

The next slide (Risks of Market Timing) illustrated how missing just a few of the top performing days in the market could dramatically reduce an investor’s total return. Historically, the stock market has led the overall economy out of a recession.

The last slide (Expansions and Stock Returns, 1948-1991) shows that during a typical recession, the trough in the stock market came an average of 5.1 months before the trough in the economy.

In that 5.1 month lag before the economy turns around, the stock market has an average gain of almost 24%. These slides show the danger in trying to time the market. Just missing a few days in the market can dramatically affect your returns.

 

Questions:
What about safety in the short-term? Are Schwab & Fidelity Safe?

 

The decline of the mortgage market and other credit markets in recent months has led to losses in certain types of fixed income securities and has contributed to the difficulties faced by some financial firms. In contrast to these firms, Schwab & Fidelity do not have an investment banking business or pursue their own trading strategies, such as taking a large position or maintaining large inventories of particular fixed income securities; rather, they execute trades at the direction of retail and institutional brokerage clients.

 

Additionally, each account at Schwab & Fidelity is protected up to $500,000 through SIPC. Schwab & Fidelity have taken steps beyond that to protect accounts beyond SIPC.

 

We feel very safe using Schwab & Fidelity as the custodian for your assets.

 

Have we hit the bottom yet?
The short answer is we don’t know. Nobody can predict if we’re currently at the bottom. The drama surrounding the TARP plan may be out of the way, but it has not been put into effect yet.

 

If no, why not sell everything and wait until the bottom?

We don’t know where we are in this down-turn. We hope (and think) that we are closer to the bottom than the top. If you were to sell out now and wait for the economy to turn around, history tells us you would miss an average return of 24%.

 

Who caused the sell-off on Monday?

If you had to point fingers at one group, our best guess is the hedge funds. The troubled credit market has wreaked havoc on the highly leveraged investment vehicles. De-leveraging has caused the hedge funds to dump assets regardless of price. As they sold off & filled the market with supply, asset prices were driven down even further. In addition, most hedge funds allow investors to withdrawal money quarterly. The end of the third quarter has seen a flood of withdrawal requests which as lead to more selling by the hedge funds.

 

Are there any federal regulations for hedge funds on the horizon?

There have already been some regulatory changes that have affected the hedge funds. Reinstating the up-tick rule, disallowing naked shorts (again), and the creation of a no-short list are at least partially aimed at hedge funds. Congress has talked of adding regulations to hedge funds for a few years without much action. That may change in light of the current market conditions.