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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
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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
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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