4th Quarter 2008 Commentary

7/31/2019 4th Quarter 2008 Commentary

1/6

ASSET MANAGEMENT

Good Riddance to 2008

Ugh, what a year. Our relie that its over is tempered

only by our ear o what might be ahead.

Just beore Christmas, the Bureau o Economic Analysis

announced that the economy declined in the quarter

ending in September. Everyone knows the 4th quarter

was even weaker, so soon they will declare we are

ocially in a recession, as i we didnt already know.

The banking system is in much better shape ater record

amounts o government stimulus, support and lending,

but still the banks are not lending money out. Prices or

energy, most visibly gasoline, industrial commodities,

grains, homes and cars are still declining. Market expec-

tations or the next 5 years are or prices, on average, to

decline by 0.1 to 0.2% per year.

Layos and unemployment are rising. The pace o job

losses is accelerating with 533,000 jobs lost in November.

Might we surpass the 602,000 jobs lost in December

1974? Comparisons to job losses in 1974 need to

consider that the labor orce is nearly twice as big today

so or job losses to be as bad as they were in late 74

Non Farm Payrolls would need to decline by over 1.0

million jobs.

How did we get here? There will be many books written

about this and we will be discussing it or the rest o

our lives. We have aptly described the markets this year

as a slow moving train wreck. The root cause o the

train wreck is the most signicant liquidity crunch that

we have seen in our lietimes, combined with near total

regulatory ailure. The markets orgot that the black

box models that calculate Value-At-Risk dont work

FOURTH QUARTER 2008QUARTERLYCommentary

Inside this Issue

ASSET MANAGEMENT

: : Good Riddance

to 2008

COMMENTARY: : Going Forward

WEALTH MANAGEMENT

: : Rule Changes That

May Aect You

www.nelsonroberts.com | 650.322.4

when normally liquid markets become illiquid. We hav

seen other liquidity crunches beore. In October 1987

the markets or stocks and options suered liquidity

problems as program trading related to Portolio

Insurance overwhelmed the markets. It took 6 mont

or this crisis to sort itsel out. In the all o 1998, Lon

Term Capital, a huge, highly leveraged hedge und,

ailed because o a liquidity crisis in oreign currency

and debt. Several months later this crisis too was over

and the markets were racing to the peak o the Dot

Com Boom.

The buildup to the current crisis has been much longe

the underlying problems are ar deeper and the resultin

time necessary to the complete workout will thereore

be much longer. The crisis has been exacerbated by th

ailure o regulators, especially the SEC, and as a resu

Wall Street has changed orever. Since May Day 1975

when stock brokerage commissions were deregulated,

the rules governing our nancial markets have becom

weaker and weaker. Normally, ater such a mess has

been created, as in the post Enron period, we would

see quickly passed and onerous new regulations. In th

INDEX PERFORMANCE Q409 YTD

Dow Jones Industrials -18.39 -31.92

Standard & Poors 500 -21.95 -36.99

EAFE (international stocks) -19.94 -43.07

Russell 2000 (small stocks) -26.14 -33.80

Lehman Intermediate 4.83 5.08

Lehman Municipal 0.74 -2.46


2/6

Every downturn sets the stage fomassive stimulus will work.

Largest

FiFteen equity

HoLdings

Chevron

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GenenteCh

iShareS S&P Small CaP index

intl BuSineSS maChineS

FaStenal

utilitieS SeCtor SPdr

oraCle

CoStCo

novartiS adr

Genzyme

emerSon eleCtriC

verizon

PePSiCo

Brown & Brown

present case, re-regulation has occurred overnight as

the major investment banks have unilaterally subjected

themselves to deeper regulation by ling to become or

selling out to commercial banks. Without the access to

the capital that these moves provided, Goldman Sachs,

Morgan Stanley, and Merrill would have ailed just as

Lehman and Bear Sterns did. The increased regulation

was the price they paid to survive.

Beore the mess is completely cleaned up, we expect

that there will be consolidation o the regulatory agencies

and greater oversight and restrictions placed on hedge

unds and over-the-counter derivative contracts, especially

credit deault swaps (CDS).

Our biggest ear is that the longer the economy resist

stimulation eorts, the greater the chance that consum

truly expect lower prices in the uture. For almost all o

the last 60 years, our economy has experienced infatio

The expectation that prices will be higher in the utur

is deeply ingrained in our systems. When in doubt,

consumers have generally purchased items to store o

a uture rainy day, and why not? Its cheaper today thit will likely be tomorrow. I however, consumers truly

believe that items will be cheaper tomorrow, then the

will begin to think do I really need this item today?

And many buying decisions would be postponed on t

expectation that one can always buy it or less tomorro

Featured Stock: Volcano Corporation

Stenting a coronary artery involves placing a tiny, permanent mesh device inside in order to keep the

artery open, thereby preventing heart attacks. In the last couple o years, scientic studies have demon-strated that there can be problems with both stent placement and late blood clots on the stent itsel.

Volcano Corporation manuactures and sells devices which provide much clearer and more detailed

imaging o the inside o coronary arteries than the traditional coronary angiography test. Intravascular

ultrasound, or IVUS, is the companys key product line. Specialized catheters are used to both image the

arterys interior and document blood fow across a particular area. The companys ultrasound consoles

can be integrated into any cardiac catheterization lab built by companies such as GE, Toshiba and Phillips.

Volcano is expanding its capabilities and is now developing optical coherence tomography products,

which give even greater resolution and allow cardiologists to see downstream rom a lesion as well.

The companys revenues come rom both new installations o its console systems and repeat sales o its

specialized catheters. Volcano currently has over 3,700 systems in cath labs around the world. About

50% o revenues come rom outside the United States, particularly rom Japan, whose physicians wereearly adopters o IVUS technology. U.S. cardiologists are now quickly adopting this technology, as studies

have demonstrated that stents placed using IVUS have ewer complications down the road. In particular,

cardiologists are able to determine whether the stent is completely expanded and snugged tight against

the arterial wall.

Volcano is actively gaining market share. The company estimates that there are now over 6,000 cath labs

world-wide. Between ongoing revenues rom new installations, catheter sales and continued development

o additional imaging technologies, Volcano is well-positioned to continue its growth, even in the ace o

the challenging economic environment today.


3/6

overy and we are optimistic that the

A recent Wall Street Journal article pointed out that,

historically, it takes years or badly-burned investors to

re-enter the market. And in this case, there have been

two bear markets (2001 and 2008) in less than a decade.

Individual investors own more than 50% o U.S. stock

holdings. Or at least they did, beore the massive sell-o

that has occurred over the last ew months. In October,

individuals took $72 billion out o stock unds. Addition-

ally, big hedge unds and private equity rms are also

abandoning the stock market or alternative invest-

ments such as real estate and art. Leuthold Group

reports that 71% o the value o the US equity markets

is held in zero maturity unds (i.e. money market unds

today or cash balances and very short term securities in

the 70s). At the bottom in 1982, this measure reached

95% and in 1974 it reached 121%. At both o these

bottoms we could earn much, much more on our cash

reserves (6-7% in 74 and 12% in 82). Today these

unds, mostly in Treasuries, are earning less than 1%.

US Treasury Bills, Notes and Bonds are severely over-

valued and we think that sometime in 2009, investors

will wake up to the act that their cash balances are

utterly unproductive and the search or yield will begin.

This should lead to lower US Treasury prices, much

improved liquidity and higher prices in other markets,

especially in the more risky corporate and municipal

bonds and common stocks.

On the positive side, stock valuations are attractive and

the government is coming to the rescue. Ater brutal

declines in the market last year, many stocks look very

inexpensive on a price to earnings (P/E) or price to book

value (P/B). But no one seems to care, probably because

there is little aith in the denominators.

TED Spread

Sept30

Oct1

6Oct3

1No

v11

Nov2

9

Dec1

6De

c31

5.0%

4.5%

4.0%

3.5%

3.0%

2.5%

2.0%

1.5%

Indicates liquidity is improving

Sept. 15. 2008 - Dec. 31, 2008


4/6


What is money?

At its simplest, it remains a orm o barter, an exchange o energy or goods.

At its most complex, its a symbol o mastery, a measure o power. At its center

are people with vision, talent, skill, amilies, children, hope and dreams.

Our hopes or an economic recovery are riding on the

back o the bailout, not just by the U.S. but by govern-

ments around the world. The magnitude o the US bailout

is mind boggling. As lender, investor or insurer, various

ederal agencies have promised a total o at least $7.8

trillion dollars. Through late November approximately

17% o these unds had been expended. The incoming

Obama Administration has already been discussing anadditional stimulus package. Spending largely on inra-

structure, much like the New Deal programs o Franklin

Delano Roosevelt, estimates o the potential size o the

program run up to $1 trillion. (See right column).

Every downturn sets the stage or recovery and we

are optimistic that the massive stimulus will work. We

are optimistic, but not certain and so we continue to

monitor the indicators that measure defation expecta-

tions and demand. See the chart on the TED spread,

which is generally recognized as a measure o creditavailability. The 5 year TIP/Note index measures market

expectations or uture price changes and is rustratingly

just below 0%. In the past 5 years this has ranged

between 150 and 200 basis points. This infation

expectation index needs to start improving soon or

all bets are o.

I the TED and TIP/Note indices continue to improve,

it will be due to bankers actually doing their jobs by

lending to consumers and businesses. As we become

more condent that lenders are behaving as i were in

the money, you will see us deploying the better than

20% equity cash reserves we now hold and swapping

US Treasury issues or much higher yielding corporate or

municipal debt.

The Incredible Size o the Bailout

$1.7 Trillion as a Lender:

$900BillionTAF(TermAuctionFacility)lendstonancial

institutions or 28 to 84 days using asset backed

securities as collateral.

$200BillionTALF(TermAsset-backedsecuritiesLoan

Facility) lends to investors using car and small business

loans as collateral. $550BillionOtherLoansfromtheFederalReserves

discount window.

$3.0 Trillion as an Investor:

$1,600BillionCommercialPaper.TheFedisnow

the buyer o last resort in an eort to unreeze

this important market.

$700BillionTARP(TroubledAssetReliefProgram).

This is the most covered program. Initially proposed by

Paulson as a program to buy assets rom banks and

brokers, this has instead been used as a source o US

unds or direct investment in banks equity.

$600BillionFHLB(TheFederalHomeLoanBank)is

using these unds to buy mortgage backed securities

rom Fannie Mae, Freddy Mack and Ginny Mae.

$53BillioninloanstoAIG.

$3.1 Trillion as an Insurer:

$1,500Billionbackingseniorsubordinateddebentures

issued rom now to June 2009.

$600BillioninguaranteesofMoneyMarketFunds.

$500BillionincreaseinFDICinsuranceonnon-interest

bearing accounts.

$487Billionofotherpromisesincludingcostsincurred

bailing out Citigroup, Fannie Mae, Freddie Mack,

Bear Sterns, and Morgan Stanley.

As o late November 2008, $1.363 Trillion as been

expended or about 17% o the total.

Source: New York Times 11/26/08

Vv i s i o n

[vizh en] n. the ability to perceive or foresee through mental acuteness


5/6


Firm Updates: : Congratulations to Terrence and Vanisha Boyd who were married on

October 26, 2008.

January 1st marks not only the beginning o a new calendar year, but also puts into eect a number o

changes that may be signicant to our clients. We have highlighted some o these changes below.

Conorming Loan Adjustment. The San Francisco Bay Area qualies as an area o high cost housing and

will see an increase in the conorming loan amounts. Starting in January, conorming loans will be those that

total up to $625,000. Home owners with mortgages outstanding near this value should consider renancing

to take advantage o the lower rates available on conorming loans. With the FOMC recent reduction o

the Fed Funds rate to 0.00-0.25% conorming mortgage rates have declined to levels not experienced

in decades.

Defned Contribution Deerral Limits Increase. The amount an employee can elect to deer to an employer

sponsored retirement plan (i.e. 401k) is increasing to $16,500. Employees 50 years o age and older can

make an additional catch-up contribution o $5,500 or a total deerral o $22,000.

Charitable Distributions direct rom an IRA. A provision that enables an IRA holder who has reached the

age o eligibility (59 ) to make a distribution rom an individual retirement account directly to a qualied

charity has been extended through 2009. Though there is no direct tax benet to utilizing this provision,

there is an incentive to do so. With an IRA git to a charity, the participants Adjusted Gross Income (AGI) isnot increased as it would be with a normal distribution. There are a number o tax deductions (i.e. medical

expenses) and qualications (i.e. ROTH IRA contributions) that phase out at higher AGI levels. By making

a contribution directly to a charity, the participant may be eligible to take advantage o items that would

have otherwise phased out.

Required Minimum Distribution Relaxed. On December 23, 2008, President Bush signed the Worker,

Retiree, and Employer Recovery Act o 2008. One o the main provisions o this act is to eliminate the required

minimum distribution (RMD) or the 2009 tax year. The RMD aects retirement account holders older than

70 years o age.

Annual Git Tax Exemption Increase. Any individual can make a tax ree git in the amount o $13,000

to another individual. This is an increase rom $12,000 in 2008.

Estate Tax Exemption Increase. The total amount o assets that an individual can pass upon death to a

non-spouse beneciary without paying estate and generation-skipping transer taxes will increase rom $2

million per taxpayer to $3.5 million per taxpayer.

Perhaps the biggest event this calendar year will be on January 20th when President-elect Barack Obama

takes the oath o oce. President elect Obama ran a campaign promising change and we anticipate the

new administration will hit the ground running.

WEALTH MANAGEMENT

Rule Changes That May Aect You


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.

2009 Nelson Roberts Investment Advisors

We will build our investment strategy in 2009 on

the ollowing oundation:

There is a song rom the Broadway musical Oliver

that begins Who will buy? This is the question wekeep asking ourselves as we discuss the appropriate

investment strategy or the gloomy economy. The central

assumption behind our purchase o any equity is that

other investors will careully analyze the company, as we

have, conclude that it will do well, and thereore also

buy the stock. However, we are not at all sure that the

usual buyers are going to be coming back into the stock

market any time soon, even to buy solid companies that

have been dragged down by the macroeconomic envi-

ronment. The one possible exception to this scenario

is sturdy, low-debt companies whose stocks oer high

dividend yields.

1. Focus predominantly on large, nancially strong, low

debt companies who make understandable products

that people need, even during a recession. Financial

reporting should be absolutely transparent. We will

be looking at companies who pay dividends o 3-7%,

with the goal o raising our overall dividend payout

percentage, as we believe stock price appreciation

over the next two years will be modest at best.

2. Begin to look more closely at opportunities in high-

quality corporate and municipal bonds. Again, this

comes back to transparent nancial reporting and

our condence in a companys or municipalitys ability

to pay both interest and principal over time.

3. Ater mostly avoiding the nance sector, especially

banks in 2007 and 2008, we will make a start at

re-investing in the nancial sector by choosing a

basket o banks and insurers who are getting

back to the basics o their businesses and appear

well-poised to earn money the old-ashioned way.

4. Consider the population o companies who will likely

be involved in major government inrastructure

projects. The disadvantage to these companies

is the lumpiness o their earnings. However,there are several that should do well who already

have major U.S. government projects underway.

5. Keep looking or small, interesting companies, where

we have the background and expertise, such as in

healthcare, to analyze the potential or uture growth.

Please do not hesitate to contact us i you would like

to discuss how the items highlighted above might be

signicant or you or your amily. We at Nelson Roberts

hope you enjoy a Happy New Year lled with health,

happiness, and prosperity.

COMMENTARY

Going Forward

Documents

4th Quarter 2008 Commentary