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
7/31/2019 4th Quarter 2008 Commentary
2/6
Every downturn sets the stage fomassive stimulus will work.
Largest
FiFteen equity
HoLdings
Chevron
iShareS eaFe index Fund
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.
7/31/2019 4th Quarter 2008 Commentary
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
7/31/2019 4th Quarter 2008 Commentary
4/6
www.nelsonroberts.com | 650.322.4000
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
7/31/2019 4th Quarter 2008 Commentary
5/6
www.nelsonroberts.com | 650.322.4000
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
7/31/2019 4th Quarter 2008 Commentary
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