1st Quarter 2009 Commentary

7/31/2019 1st Quarter 2009 Commentary

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ECONOMICS

Bailout-Version 2.0

Bailout! The markets abhor uncertainty. We were

reminded o this in spades when our new Secretary o

the Treasury, Timothy Geithner, frst spoke about the

bailout package on February 10th. From that day to

March 10 the Dow Jones ell about 2,000 points, or

21.6%. When we fnally got some details about the

plan on March 23rd, the market responded with a 500

point (6.8%) rise and has since climbed back to 7,609.

Will the plan work? Yes. Is it the best plan? No. It is

the most politically expedient plan that will quickly help

turn the economy around. However, it will come at a

large uture cost. Essentially, the Obama Administration,

Congress and the Federal Reserve have concluded that

the easiest way to solve the crisis is to reignite ination.This will eventually cause home prices to rise and thus

allow homeowners who are under water to pay o their

mortgages. The banks that hold these mortgages and

the investors who bought the bonds backed by these

mortgages will get paid and the loans and mortgage-

backed-securities (MBS) will rise in price.

Mr. Geithners plan, the PPIP (Public-Private Investment

Program) is a deal that Wall Street cannot pass up.

Some o the details are as ollows:

15%down. TheFedwillprovidequaliedprivateinvestorswith

cheap government fnancing.

Theseinvestorswillbuyupthetoxicmortgages

and MBS that are at the heart o the crisis.

Theprivateinvestorswillgettokeep50%ofthe

proft and the Government will keep the rest.

Who is likely to be deemed qualifed? It will be the

largest fnancial frms which have a cadre o sta

First QUARTER 2009QUARTERLYCommentary

Inside this Issue

ECONOMICS

: : Bailout-Version 2.0

ASSET MANAGEMENT

: : High Anxiety in theEquity Market

COMMENTARY

: : Are Bonds a

Sae Haven?

WEALTH MANAGEMENT

: : The Case or

Stocks and Against

Market Timing

www.nelsonroberts.com | 650.322.4

experienced in the mortgage securities business. But

arent these the same olks who created all these

securities and should have seriously known what

a mess they were creating in the frst place? As an

example, a group o ormer Countrywide Financial

executives has started a new frm that has been buyin

delinquent home mortgages that the government too

over rom ailed banks at steep discounts to their origin

value. Though the thought o this new frm profting

rom the very problem they helped to create is distaste

it is this activity that will ultimately lead to stable prici

o these toxic securities.

Once the toxic junk is o o the banks books, happy

days will be here again, right? The answer is yes,

at least or awhile. There are two risks to investing in

mortgages. First is the risk o deault, that is, will the

borrower remain current with payments and be able

to repay the loan when due? Deault risk is the curren

problem and stimulus and bailout unds are ocused o

addressing this. The second risk is the prepayment risk.

Will investors get their principal back when they expec

it? When rates all, borrowers re-fnance their loans,

i they can, and MBS investors get back their principa

sooner than they want it. Conversely, when rates rise,

borrowers postpone selling or refnancing and the MB

INDEX PERFORMANCE Q109 YTD

Dow Jones Industrials -12.48 -12.48

Standard & Poors 500 -10.98 -10.98

EAFE (international stocks) -13.95 -13.95

Russell 2000 (small stocks) -14.95 -14.95

Lehman Intermediate -0.04 -0.04

Lehman Municipal 4.21 4.21


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rs, a carefully selected equity

The most basic explanation or the stock market decline

is that more people are selling stocks than are buying

them. There are many reasons or selling, but unda-

mentally, as Mark Twain once said: The cat, having sat

on a hot stove lid, will not sit on a hot stove lid again.

But he wont sit on a cold stove lid, either.

For years, economists and government gurus have

bemoaned the minuscule amount o money that most

Americans were putting into savings. Now the savings

rate has climbed dramatically to about 5%, as individuals

have pulled money out o the stock market and put it

into money market accounts or even tucked it under

their mattresses. Companies are ocusing on strength-

ening their balance sheets, which requires cash. This

means that they are cutting dividends and decreasing

stock buybacks. Optimists believe that people and

institutions will soon tire o receiving virtually zero

return on their money, but we are not so sure. There is

very little appetite or risk right now. It may be a long,

slow recovery rom the shock most people have experi-

enced as they have watched their assets decline.

A ew statistics rom a recent Wall Street Journal article

entitled Will Queasy Money Return?:

Holdingsincash(moneymarketfunds)haveincreased

rom 43% to 84% o the value o the U.S. stock

market. This is due to both cash increases and

declines in the value o stocks.

Thehistoricalaverageis66%.

AsofDecember2008,therewas$3.8trillionin

money market accounts.

Investorssaytheircashholdingsare30%,up

rom 23%.

Investors are looking or lower-risk investments and

the stock market certainly does not appear to all into

that category.

In sum, equity investments are now a source o huge

anxiety and most investors have either sold signifcant

portions o their portolios or are hunkered down

trying to wait out the economic turmoil. As a result,

people are paying little attention to company unda-

mentals (particularly companies in non-fnancial sectors)

while a great deal o attention is centered on the latest

government actions.

We analyze our portolio o stocks and candidates or

addition to the Nelson Roberts portolio based on a

companys historic perormance combined with our

rationale or why uture perormance will exceed current

market expectations. Outperormance could come as a

result o improved internal efciencies, growth in the

industry, or market share gains due to superior products

or pricing. For example, we can think o no reason that

an excellent company like Dynamic Materials (Tkr: BOOM)

should be trading at three times earnings. It is a good

business, there is demand or its products by fnancially

healthy end-users and the company is vigorously paying

down long-term debt to less than 25% o capital.

The equity market is unpredictable thereore we should

not expect it to be predictable. As difcult as it is to

ignore the cacophony o prognosticators, we believe

the best strategy continues to be careully researching

companies, and buying those that are fnancially strong,

well-managed and make things that people need or

want. Then, we diversiy our selections across sectors. In

the long run, this is the strategy that will be successul.

ASSET MANAGEMENT

High Anxiety in the Equity Market


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www.nelsonroberts.com | 650.322.4000

Equity markets have been hit hard by the recent economic

downturn, and investors have been drawn to the bond

market in search o guaranteed income streams, principal

protection and decreased volatility. Though the fxed

income market is generally viewed as a sae haven,

investors should be aware that the bond market is not

void o risk and actions taken by the government in the

orm o monetary stimulus and running large defcits

will result in ination. Higher ination means higher

interest rates and tough times ahead or the bond market.

Fixed income and bonds are terms oten used

interchangeably. The return on these instruments can

be counterintuitive. A bond is essentially a loan an

investor makes to the entity issuing the bond. Issuing

entities include:

TheFederalGovernmentandAgencies

StateGovernmentsandMunicipalities

Publicandprivatecorporations

These obligations can be secured by:

Thefullfaithandcreditoftheissuer

Aspecicproject

Adivisionoftheissuer

Acollectionofassets

Todays fnancial crisis started when

the value o the assets securing many

Mortgage Backed Securities declined.

The buyer o these bonds typically

receives fxed interest payments

based on the coupon rate, until the

bond matures, at which time the issuer returns the

principal amount o the loan to the investor. For the

owner o the bond, the higher the coupon rate, the

higher the interest payments the owner receives. This

coupon rate is set at the time the bond is issued and

does not change. Due to the fxed nature o the pay-

ment stream, the value o the bond holding moves in

the opposite direction o interest rates. When interest

rates rise, bond prices all because the buyer o a new

bond is able to obtain a stream o fxed payments that

is higher than existing ones. In an environment in which

interest rates are changing dramatically, the value o

a bond holding will also experience wide price swings.

Yields on bonds can vary markedly based on several

variables, but two important determinants are deault

risk and interest rate risk. Deault risk is the risk thatthe issuer o the bond becomes unable to pay back

Vv a l u e

How do we measure value?

By producing it in the growth o assets, in how our clients view us,

in how we create partnership.

[val yoo] n. a quality having intrinsic worth

COMMENTARY

Are Bonds a Sae Haven?

How a bond performs can be counterintuitive.

Here are some guiding principles:

Bondreturniscomprisedoftwocomponents,interest

income and the change in price

Theinterestearnedonabondisaxedamount

Thepriceofabonductuateswithchangesininterestrates

Wheninterestratesgohigher,bondpricesgolower

Wheninterestratesgolower,bondpricesgohigher

Thelongerthetimeuntilthebondmaturesthemoresensitive

the price is to a change in interest rates

Expectationsofhigherinationwillresultinhigherinterestrates


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1950 Un vers ty Avenue, Su te 202

East Palo Alto, CA 94303

tel 650-322-4000

web www.ne sonro erts.com

email [email protected]

Past perormance is not necessarily a guide to uture perormance. There are risks involved in investing,

including possible loss o principal. This inormation is provided or inormational purposes only and does

not constitute a recommendation or any investment strategy, security or product described herein. Please

contact us or a complete list o portolio holdings.

For additional inormation on the services o Nelson Roberts Investment Advisors, or to receive our

Newsletters via e-mail or be removed rom our mailing list, please contact us at 650-322-4000.

2009 Nelson Roberts Investment Advisors

Despite the high anxiety in the equity market and the

whipsawing o fnancial stocks as the government

nnounces each new phase o the bailout, we believe

hat or long-term investors, a careully selected equity

portolio is essential.

Stock prices reect the aggregate expectations o market

investors and stocks appreciate most signifcantly when

hese expectations are exceeded. Thereore, the best

ime to be a buyer o stocks is when the expectations o

market investors are most easily exceeded. In the current

conomic environment there are low expectations or

ompanies to perorm and their stock prices reect this.

Many investors ear that the potential downside o

odays market could rival that o the Great Depression.

As o the end o January 2009, the rolling 10-year real

verage return was at the lowest level in history. The

market declined on an annual basis at a real rate onear y - . over t ose years. e mar ets rea

return during the 20 years that began with the market

rash o the Great Depression was 0.0%. For todays

market to match that same 0.0% return over the 20

year period that includes the last 10 years as well as

he next 10 years, the market would have to go UP at

real rate o return o 6.5% annually or the next decade1

I we are truly in a stock market environment that

matches the returns experienced during the Great

Depression, now is a good time or long term investors

o be buying stocks and holding them or the next

years.

When market participants think that current expectations

re too negative, the market rallies dramatically. From

he lows o early March to today, we have experienced

single session rally o nearly 500 points and an over

1,100 point rally in less than three weeks. A market rally

an be swit even i the economic recovery is measured.

The ollowing chart rom the State o Wisconsin Invest-

ment Board shows the dangers o being out o the

tock market during these good days. Perormance

an be dramatically aected by missing the best days o

market returns. We continue to believe that the stock

market will provide superior long term returns or our

investors and are committed to fnding the companies

hat will help us get there.

EALTH MANAGEMENT

The Case or Stocks and Against Market Timing

1 im OShaugnessy, OShaughnessy Asset Management presentation.

February 2009.

$0 $2,000 $4,000 $6,000 $8,000 $10,000

Investing $1,000 in S&P 500 Index

1988-2007

Continually invested

inus 40 b st daysst days

inus 30 best days0 best days

st daysMinus 20 bMinus 20 b

inus 10 best daysst days

Investment Team

Brooks Nelson, CFA

Brian Roberts, CFA, MBA

Steve Philpott, MBA

Dennistoun Brown, MD

Ann Oglesby, MD, MBA

Documents

1st Quarter 2009 Commentary