3rd Quarter 2008 Commentary

7/31/2019 3rd Quarter 2008 Commentary

1/6

ASSET MANAGEMENT

A Destructive Financial Hurricane

A nancial hurricane has struck Wall Street. The storms

intensity has been building or many months and has

now come ashore. Though the worst o the destruction

has been borne by the nancial sector, the entire market

has also suered. From 9/30/2007 through 9/30/2008,

the S&P 500 has declined -21.8%. The nancial sector

has plummeted nearly twice that amount in the same

time period: -38.7%.

Now that the roo has blown o and the basement is

fooded, Congress and the Administration are trying

to plug the leaks. O course, they have conveniently

ignored the evidence that it was lax nancial building

codes and poor preparation that unleashed the ull

destructive power o the hurricane in the rst place.

For the past year at Nelson Roberts, we have aggressively

managed and signicantly decreased our nancial sector

exposure. While our stock portolios have suered

along with the rest o the market, we have successully

minimized losses.

Preparation

Within the equity portion o our portolio, we have

taken several key actions on behal o our clients. Ratherthan detail every transaction we have made, we have

highlighted those that are most relevant to the nancial

sector crisis.

July 2007 We sold a protable position in Goldman

Sachs (Sale price ~211.00/share). Nelson Roberts ana-

lysts, while reviewing the consumer discretionary sector,

THIRD QUARTER 2008QUARTERLYCommentary

Inside this Issue

ASSET MANAGEMENT

: : A Destructive

Financial Hurricane

COMMENTARY

: : The Fall Election

WEALTH MANAGEMENT

: : Saving Money During

the Credit Crisis

www.nelsonroberts.com | 650.322.4

were surprised that a high yield bond nancing the

Dollar General leveraged buyout was selling poorly in

the public market. This less-publicized news item, mo

than the ailing o two subprime mortgage hedge un

run by Bear Stearns, caused us to begin a thorough

evaluation o the risks that nancial stocks had on the

balance sheets.

October 2007 We exited our position in Citigroup

(sale price $48.37/share) on concerns that the liquidity ri

o esoteric nancial instruments were not being appr

priately valued on the balance sheets o major Wall Stre

banks. Citigroup was our largest exposure to this risk

March 2008 We sold AIG (sale price $43.00/share).

Earlier, we had valued the company based on the

unique strength o their international insurance porto-

lio. We lost aith in AIGs management ater multiple

restatements between spring 2007 and spring 2008

regarding their exposure to credit related investments

and exited the position. AIG has since received suppo

rom an $85 billion loan rom the U.S. Government,

mostly wiping out preexisting shareholders.

INDEX PERFORMANCE Q308 YTD

Dow Jones Industrials -3.71 -16.57

Standard & Poors 500 -8.36 -19.27

EAFE (international stocks) -20.57 -28.92

Russell 2000 (small stocks) -1.11 -10.37

Lehman Intermediate -1.18 .22

Lehman Municipal -3.20 -3.19


2/6

Though the effortswe have putinto signicant, we have still been sur

Largest

FiFteen equity

HoLdings

Procter & Gamble

iShareS eaFe index Fund

matthewS PaciFic tiGer Fund

intl buSineSS machineS

FaStenal

chevron corP

SchlumberGer

maSterS Select intl

Genentech

coStco

thermo FiSher ScientiFic

utilitieS Sector SPdr

weStern union

walGreen

PePSico

August 2008 We trimmed our position in General

Electric (sale price $29.90/share). The business lines o

General Electric are in solid shape; however, GEs Financial

division is both a big portion o their revenue stream

and their balance sheet.

September 2008 We sold our position in Target

Corporation (sale price $54.47). While we believe Target

is well positioned among its retailing peers or the long-

term, in the short term, the company is reliant on the

near term nancings o their customers purchases to

maximize sales. That, coupled with the yet-to-be-deter-

mined but likely negative eect o the nancial crisis on

the American consumer, led us to sell our position at a

gain or the year.

September 2008 We sold a protable position in

Fiserv (sale price: $49.39). Fiserv is a sotware and

services rm that sells directly to small and medium-

sized banks. We anticipate continued consolidation in

the banking industry with the biggest rms such as JP

Morgan and Citigroup acquiring more, smaller rms,

thereby decreasing Fiservs customer base dramatically

As o September 30, 2007, our weighting in the nan

sector was 8.5% relative to the S&P 500s weighting

o 19.7%. As o September 30, 2008, our weighting

even lower, at 6.8% relative to the S&P 500 o 16.1%

Weathering the Storm

Though the eorts we have put into our client portol

to prepare have been signicant, we have still been

surprised by the magnitude o the crisis. The demise o

Countrywide, Bear Stearns, IndyMac Bank, Fannie Ma

Freddie Mac, AIG, Merrill Lynch, Wachovia Bank, Was

ington Mutual and Lehman Brothers were all impossib

to predict a year ago. For each o these companies, th

dramatic decline in the liquidity (see Nelson Roberts 1

2008 Quarterly Commentary, A Crisis in Liquidity) o

their balance sheets precipitated an accelerating need

Featured Equity: Ritchie Brothers Auctioneers Inc. (RBA)

When we rst purchased Ritchie Brothers Auctioneers, we had several phone calls rom clients asking

about the company, because it is not well known. It is one o those small gems which excels in its busi-

ness yet gets little attention rom mainstream analysts. The company is the largest auctioneer o industrial

and agricultural equipment in the world, generating gross auction proceeds o over $3 billion in 2007

at almost 300 auctions. Auctions are conducted worldwide (in 27 countries at 110 dierent locations),

with 60% o revenue coming rom the U.S., 20% rom Canada and the rest rom Europe and Asia. RBA

dierentiates itsel rom other auction companies by conducting unreserved auctions, that is, auctions

with no minimum price or the equipment items being sold. Buyers love this approach because it means

that prices are not infated by seller foors. As a result, buyers fock to RBAs auctions, which in turn

attract more sellers. Sellers also like the act that most buyers are end-users and are pre-qualied by the

company. Gross auction proceeds have grown 14% annually or the last 25 years, an impressive record.

RBA launched its Internet auction site six years ago and has an astounding 89,000 registered users. At

some auctions, up to 50% o buyers participate via real-time internet. In these uncertain economic times,

we like this company because it makes most o its money rom pre-negotiated xed commission rates,

provides excellent service and is continuing to grow its business.


3/6

client portfolios to preparehave beendby themagnitudeof thecrisis.

or assistance. This in turn led to their inability to obtain

short-term nancing rom traditional sources, resulting

in bankruptcy, an acquisition, or intervention by the

Federal Government.

In addition to the underweighting o nance in client

portolios, we have also ocused strongly on liquidity.

Nelson Roberts has been willing to exchange short-

term return or a higher level o condence in liquidity.

Specically, we have:

Raised Cash Our cash positions are near historical highs

in our portolios.

Bought short- term Treasury bonds The debt o the

U.S. Government is still viewed as the highest credit

quality instrument in the world. As the crisis has inten-

sied, so has the demand or US Treasury instruments,

resulting in a declining yield. We have resisted the urge to

chase yields rom less liquid securities and have concentrated

instead on the short end o the very liquid Treasury market.

Reviewed the near term liquidity needs of

our equity holdings In addition to analyzing our

client liquidity needs, we have also been reviewing the

requirements o companies in which we own stock. I

short-term nancing is dicult or nancial institutions

to obtain, we have to assume that other sectors are

experiencing the same constraints. This led to the sale

o Target Corp and the trim o General Electric.

Surveying the Destruction

The nancial hurricane has let signicant carnage in

its wake. Amongst the tombstones already in place are

those o Wall Street t itans like 94 year-old Merrill Lynch,

Lehman Brothers, and Bear Stearns. The banking industry

has seen the ailure o Washington Mutual, Wachovia

Bank, and Indy Mac. The competitive landscape has

changed in a dramatic way or both o those industries.

Change will create opportunity or the companies that

have not just survived but have been strengthened by a

greater breadth o geographic ootprint and products.

J.P. Morgan has the major task o absorbing its acquisitions

Mutual Fund Categories: 1 Year Returns

0.0%

LargeCapGrowth

LargeCapValue

MidCapCore

SmallCapCore

International

EmergingMarkets

GoldOriented

RealEstate

NaturalResources

-5.0%

-10.0%

-15.0%

-20.0%

-25.0%

-30.0%

-35.0%

-40.0%

-14.5% -14.5%

-21.4%

-33.8%

-30.5%

-18.7%

-20.7%

-23.8%-23.0%

Source: Lipper WALL STREET JOURNAL


4/6


i

n t e g r i t y

Where do you nd integrity?

It emanates rom tradition, endures market cycles, and sustains long-

term partnerships. Trust lies at the heart o what we do, how we serve

and whom we employ.

[in tegr te] n. honesty, sincerity, completeness

o Bear Stearns and Washington Mutual. Bank o

America will broaden its oerings with the acquisitions

o Countrywide and Merrill Lynch. Though it is possible

or these companies to emerge stronger ater this crisis

ends, both banks have taken on substantial new risks

with these acquisitions.

Predicting when the current nancial crisis will end is

like predicting where a hurricane will make landall.

However, there are three major upcoming events that

may give us some clues:

1. The bailout package. We will learn the details o

ongoing discussions in Congress about a $700 billion

package that would add liquidity to the most illiquid

markets. This is a necessary step to enable institutions

to stabilize their own balance sheets and return to

the business o banking rather than ocusing on their

short-term survival. At press time, the House version

o the bill had ailed to pass, ater both Republicans

and Democrats again embarrassed themselves with

unseemly partisan wrangling. We hope that the

Senate will rise to the occasion.

2. The Presidential Election. We discuss more

thoroughly the political environment later in this

commentary. By the rst week in November we will

know the answer to the question o Who will be

the next President o the United States?

3. Third quarter earnings. Market participants arecurrently let to speculate on the wider economic

impact o the last ew weeks o turmoil in the nan-

cial sector. Publicly traded companies will announce

their third quarter earnings, adding a data point to

gauge how the non-nancial sectors are doing. We

think that earnings are likely to disappoint, indica-

ting that the U.S. could be headed into a prolonged

recession.

Beyond Investment Risk

In the Nelson Roberts Investment Advisors First Quarter

2008 Quarterly Commentary we discussed The Risks

o Street Name. Given the large number o custodial

institution ailures in the last ew weeks, we thought it

is appropriate to reprint that piece.

The Risks of Street Name

Brokerage accounts today are almost always held in

street name. This means that the assets in the customer

accounts are held in the name o the brokerage rm and

on the brokers books they are held or the benet o

the customer. In the event o a huge, expanding crisis,

where brokerages went bankrupt, their creditors could

come ater customer assets. We believe this is HIGHLY

unlikely, but have to acknowledge that it could happen inextreme circumstances. Holding your assets in an agency

account within a trust company is a way to insure against

this risk. We would be happy to go over the costs, issues

and appropriateness o this strategy with you individually

upon request.


5/6


Firm Updates: : We want to thank Liz Fannon or her contributions to the rm and wish her

the best o luck in her new endeavor. Liz and her husband will be moving to

Park City, Utah where they recently purchased a business.

: : We welcome the newest member to our rm, Tien Tran Her responsibilities

will include portolio accounting and oce administrator.

As long-term participants in and observers o the economy, we are condent that the credit crisis and its

associated ripple eects will resolve over time. However, both the degree and complexity o what we are

seeing argue in avor o the duration being longer (years) rather than shorter (months). Some clients have

asked us what advice we have or trimming expenditures during this uncertain period. We have put together

a list o suggestions in response. Obviously, these ideas will not apply to everyone and we are not recom-mending that our clients start clipping coupons. However, even or high net worth individuals, certain types

o expenses can add up in a hurry. You may be surprised what you nd out as you look at your own personal

situation in light o the ollowing ideas:

1. Conorming loan limits have changed. Depending on your geography, loans below $429K are standard

conorming and below $729K are super conorming. Rates on these types o mortgages have been

declining. You might wish to consider paying down your mortgage to get below one o these levels or

more attractive pricing or renancing your existing balance. Both will improve your cash fow by lowering

monthly payments.

2. I you believe the value o your property has declined, have your home re-assessed in order to try to

lower your property tax.

3. Give your insurance agent a call and see i you might be eligible or lower premiums or property and

casualty insurance. Rates or both have generally been declining.

4. Cars, on average, are the second largest personal purchase one makes. I you drive a very thirsty car,

consider downsizing to a pre-owned vehicle with a warranty. Savings compared to new car purchases

are considerable. Have the kids let home but you havent gotten around to selling that extra car?

Maybe now would be a good time.

5. I you are considering purchasing a hybrid car, do the math rst. A Toyota Highlander hybrid costs

$10,000 more than a standard Highlander. At $4/gallon gas, you will have to drive 244,000 miles to

break even on the additional cost.

6. Consider where you vacation and where you stay. Room rates or superior hotels have gone through

the roo, as have airline ticket costs. You can save thousands o dollars by renting a house or an

apartment (see homeaway.com) and driving to your destination.

7. Look at how much you are spending on your hobbies. Race cars/motorcycles, horses, and boats,

or example, are all expensive to both purchase and maintain over time.

I you have questions about any o these items or need some assistance re-evaluating your cash fow, please

let us know. We would be happy to have urther discussions with you regarding your individual situation.

WEALTH MANAGEMENT

Saving Money During the Credit Crisis


6/6

INVESTMENT ADVISORY TEAM

Brooks Nelson, CFA Brian Roberts, CFA Stephen Philpott

Our team o partners provides nancialpeace 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 us at 650-322-4000.

2008 Nelson Roberts Investment Advisors

We are about to witness history. In just over one month,

our country will either have its rst black President or

its rst emale Vice President. 138 years ago the 15th

Amendment was passed guaranteeing that no man

would be denied the right to vote based on his race.88 years ago, the 19th Amendment to our Constitution

guaranteed women the right to vote. 45 years ago

Martin Luther King espoused his dream on the steps

o the Lincoln Memorial or a uture where people

will not be judged by the color o their skin, but by

the content o their character. One can decry the slow

pace o change, but we preer to recognize this as

evidence o the evolution o equality, or the better o

our country as a whole.

And yet, in the wake o the ailure o Congress rstattempt to pass legislation to rescue the banking system,

we empathize with the riend who sighed when asked

who he would vote or in the coming all election and

said I eel like I just read the menu in a restaurant and

am thinking theres got to be a better place to eat than

this. The shrieking, shrill invective coming rom the

media and both campaigns reminds one o the Hatelds

vs. the McCoys. One can only conclude that democracy

is a terrible way to pick a countrys leaders except, o

course, or all other systems which are worse.

Our lament is that the political process has polarized

both candidates away rom the moderate center.

Republicans rant that Barack Obama is a traditionally

liberal tax and spend Democrat. Democrats rant that

John McCain chose Sara Pallin as a running mate toplacate the radical religious Republican right, a major

source o campaign unding. We surmise that theyre

both probably right.

We hope that the winner o this Presidential contest

is the one to convince the voters that hell be scally

responsible, while leaving us each to live our private

lives in private. And then we will hope that he perorms

accordingly. Realistically, i the Democrats win, taxes on

our clients and us will very likely go up, some sort o

universal healthcare program will ensue and well exitIraq as soon as possible. I the Republicans win, well

see bigger decits, a smaller healthcare band-aid, and

political gridlock with the Democratically controlled

congress. Neither o these are upliting scenarios.

The Bush Administration will be leaving behind quite a

mess. Record high budget decits, a two ront war on

terrorism that has no end in sight, and the worst nancial

crisis in a generation. This reminds us o Lyndon Johnsons

one term Presidency. One is a Republican, one was a

Democrat, but both leave us with Texas-sized problems.

COMMENTARY

The Fall Election

Documents

3rd Quarter 2008 Commentary