2nd Quarter 2008 Commentary

7/31/2019 2nd Quarter 2008 Commentary

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ll continue unabated until the Fed

INDEX PERFORMANCE Q208 YTD

Dow Jones Industrials -6.79 -13.36

Standard & Poors 500 -2.69 -11.90

EAFE (international stocks) -1.80 -10.50

Russell 2000 (small stocks) 0.60 -9.37

Lehman Intermediate -1.52 1.43

Lehman Municipal 0.63 0.01

also driven by the aging population (see summary

o our eatured equity: Genzyme.) We sold Johnson

& Johnson due to its slowing sales. In other actions,

we trimmed Schlumberger, which had grown signi-

cantly as the price o crude oil rose, and sold the tiny

Verizon spin-os Idearc and Fairpoint. Buys included

Dynamic Materials, which makes corrosion-resistant

metal containers or the oil and chemical industries;

Ritchie Brothers, the worlds largest auctioneer o

heavy machinery like tractors and loaders; and Disney,

which has cleverly positioned itsel to benet rom the

dramatic changes in how entertainment is delivered

to consumers.

Looking Ahead

Following a grueling primary process, the Democrats

nally settled on Barack Obama as their presidential

candidate. The next our months will be lled with the

usual pre-election speculation. History tells us that

government bodies, such as the Fed, are reluctant to

interere with the political process by taking actions

that could unduly hurt or help one partys chances.

We thereore do not anticipate any dramatic action on

interest rates prior to the election. However, once the

election is over, the Fed will have to turn its attention

to deteriorating indicators and raise rates in order to

get the lid back on infation. Foreign central banks have

already begun to raise their benchmark rates.

Next quarters Commentarywill ocus on the impact o

the presidential election and the outlook or tax and

spending policies. We will also bring you an update on

the credit crisis and infation.

The Trillion Dollar Meltdown

Our research team recently reviewed and discussed Charles

R. Morris book The Trillion Dollar Meltdown. Writers o

business books are driven by the need to create interest

and urgency in order to sell their wares, just as newspapers

eel compelled to ocus on murder and mayhem in order

to entice readers. That said, Mr. Morris points out that the

global inancial boom o the last ive years has indeed

been a bubble. According to his statistics, global nan-

cial assets as a multiple o global gross domestic product

have risen rom a historical norm o parity to our times

global GDP. Many o these assets are not attached to

real, measurable items or obligations. He argues that this is

in part due to the ree-wheeling, unregulated environment

that promoted the creation o new nancial instruments

and a tower o unsecured debt. As a long-time observer

o both political and economic cycles, he pithily observes

that liberal cycles end in an excess o power; conservative

cycles end in an excess o money. Are we approaching the

end o a conservative cycle? We think the answer is yes.


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Finance sector equities are not out o the woods yet.

Thereore, we continue to maintain our underweighted

position in the Nelson Roberts portolio. Over the last

twelve months, Wall Street rms and other banks have

taken nearly $400 billion in write-downs; many analysts

believe this gure represents less than hal o the even-

tual total. Assuming the process o re-valuing assets

will be relatively orderly and ecient, by the time the

credit market nishes unwinding, deaults and write-

downs will likely total $1 trillion.

While the sector briefy rallied 6.6% in April ollowing

the Fed-orchestrated buyout o Bear Stearns, the next

two months were lled with reports o earnings declines,

more write-downs and somber, cautionary statements

by bank and investment house CEOs. Collectively, thenance sector declined 16.2% rom May to June, vali-

dating our cautious approach. These companies were

either not initially orthcoming about their potential

liabilities or they were ignorant to the magnitude o

their possible losses. Neither explanation oers us much

comort. We have ocused recent research in this sector

on local and regional banks which were less involved in

the subprime business; however, we have been dismayed

by how rothy this market became. Even sensible bankers

threw caution to the wind and jumped on the easy

credit bandwagon. This leads us to believe that the

credit crisis will continue to play out over at least

the next year. Our timely sales o Goldman, Citigroup,

McGraw-Hill, Moodys, and AIG over the last twelve

months helped us to mitigate the downdrat rom the

nance sector.

Unortunately, the thunderclouds have not entirely

dissipated. Should uture write-downs cause corporate

deaults to increase, this could wreak havoc on a large

but lesser-known derivative market that deals in credit

www.nelsonroberts.com | 650.322.4000

deault swaps (CDS). When the Fed engineered the buy-

out o Bear Stearns by J.P. Morgan, one motivation was

to prevent a cascading o contract deaults in the CDS

market. CDS are derivatives used mostly by large invest-ment banks, brokerage rms and hedge unds. They are

either bets on the deault risk o various debt issues

or insurance against deault protection. I this sounds

complicated, it is. These derivatives were invented in the

mid-90s, but the market has exploded rom $1 trillion to

$62 trillion in just over six years. Unlike the Treasury

market where bonds are traded requently and prices are

readily available, the CDS market has no orum or pricing

and is dependent upon unregulated counterparties ul-

lling obligations o payment i a borrower (bond issuer)

does indeed deault. According to a February 2007report by Bank o America, 31% o all CDS contracts

have been written by hedge unds. No one knows how

much leverage these unds employ. We assume, on

average, it is signicant. A large number o bond deaults,

coupled with counterparties ailing to make good on

the credit swaps, could have a devastating eect on

those nancial institutions involved, leading to a nega-

tive eect rippling into the underlying bond market. For

the time being, we are quite comortable in our seats

on the sidelines o the nance sector.

ASSET MANAGEMENT

Still in the Woods: Finance Sector Woes ContinueV

v 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

FINANCE SECTOR VS. S&P 500 INDEX

JUN 05 DEC 05 JUN 06 JUN 0DEC 07JUN 07DEC 06

-4

-2

20

40

0

S&P 500 FINANCIALS INDEX

S&P 500 INDEX


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www.nelsonroberts.com | 650.322.4000

Weve Moved: : As a result o our continued success and growth o the rm, Nelson Roberts

has relocated.

1950 University Avenue, Suite 202

East Palo Alto, CA 94303

Brooks Nelson, one o the principals o Nelson Roberts Investment Advisors, is no stranger to advising and

supporting clients through the process o setting up and carrying out an estate plan. However, it is always

dierent when the proessional goes through the process on a personal level. His mothers death last all has

caused Brooks to refect on his own experience as he went through the process o settling his mothers aairs.

Lucy Ann Moore died in September o 2007, a day beore her 78th birthday. She had suered rom chronic

obstructive pulmonary disease or many years, the result o being a lielong smoker. She had become increas-

ingly immobile, wheelchair-bound and tethered to oxygen, and required ull-time in-home care or the two

and a hal years beore her death. Her husband, and Brooks stepather, had died in August o 2006.

Brooks and his two younger sisters had always understood that he would be the primary manager o their

mothers personal care and nancial situation. In act, he had been in charge o his mothers asset manage-

ment or many years. Unlike most people, I had detailed knowledge o everything about my moms nancial

situation. I dont know how I could have done the job without that level o understanding.

As difcult as it can be to talk about nances, Brooks believes that aging parents

should bring at least one adult child up to speed.

This person should have intimate and complete knowledge o all parental assets. Even parents in their ties

with adult children (older than thirty) should take the time to at least write a letter o instructions, giving

detailed inormation about bank accounts, investments holdings, etc. Adult children should not have to ear

that they missed something. Brooks observes that even long-term clients o Nelson Roberts have some-

times ailed to disclose all o their assets to their advisor, let alone their children, which puts everyone in a

dicult position.

In Brooks experience, he sees parents wanting to be scrupulously equal in the way they treat their children.

This oten plays out by naming multiple children as co-executors o the estate. He strongly advises parents

against this type o equality. It is a one person job. The executor or trustee has set duties and responsibilities

and needs to be able to make decisions and implement them eciently. The job is a lot o work and theindividual should be compensated accordingly by the estate. This is all straightorward i parents discuss

their decision regarding who is to be executor with all o their ospring and explain the rationale or their

choice. The executor should anticipate that it will take 12-18 months to wind up the estate and as many as

5-15 hours per week. The timerame or completion can depend on the size o the estate, the date o the

parents death and the liquidity o the assets. It was a great relie to Brooks and his sisters that long beore

their mother became seriously ill, she divided up her personal property and documented who was getting

what among her children. Lucy wisely grouped items together and made sure that the total monetary value

was about the same or each adult child. Beyond these special items however, Brooks observes that when the

second parent dies and a house must be closed up and sold, going through the accumulated lietime posses-

sions o someone is a tedious process or heirs.

WEALTH MANAGEMENT

A Personal Perspective on Settling an Estate


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INVESTMENT ADVISORY TEAM

Brooks Nelson, CFA Brian Roberts, CFA Stephen Philpott

Our team o partners provides nancial

peace o mind to our clients, a select group

o individuals and amilies.

1950 University Avenue, Suite 202

East Palo Alto, CA 94303

tel 650-322-4000

web www.nelsonroberts.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 Elizabeth Fannon at 650-322-4000

or [email protected].

2008 Nelson Roberts Investment Advisors

Questions to ask yoursel1. Who is my point person to settle the estate ater I am gone?

2. Have I given this person suciently detailed inormation so he/she can do the job competently?

3. Have I explained my choice to my other children?

4. Have I clearly communicated my wishes regarding special personal property?

5. Have I taken advantage o wealth transer mechanisms to minimize estate taxes (or example,generation-skipping trusts)?

6. Do I have all o my estate documents in order, up-to-date and easily accessible?

7. Do I have a relationship established with an estate planning attorney?

The nal comment Brooks oered was to ensure that all the proper documents have been created and

are readily available in order to settle the estate. In his mothers case, or example, the estate attorney had

Brooks position as successor trustee recorded on the house title. Without this, selling the house would have

been a bigger hassle. Brooks advises clients to have periodic reviews with their estate planning attorney.

The larger the estate, the more requent they should be meeting.

Most clients with signicant assets benet enormously rom having a team o advisors, including their

wealth/asset manager rom Nelson Roberts, an estate attorney and a CPA. These proessionals work together

to ensure that:

the client has sufcient assets and liquidity to live the way he or she wants to in later years

tax obligations are minimized

proper documents are drated and current.

I have worked with many amilies during my proessional lietime and sometimes two or three generations

within a amily, said Brooks. Too oten the ailure to communicate and the ailure to plan lead to unintended

outcomes, both emotional and nancial. While dealing with my mothers passing was not easy, it went as

smoothly as it could have, because we had planned ahead.

Documents

2nd Quarter 2008 Commentary