“The more things change, the more they remain the same”
Jean-Baptiste Alphonse Karr, French journalist
The investment markets are finishing the third quarter of 2009 in fine form. For the quarter the S&P 500 returned about 15% leaving it up about 20% for 2009 and down about 6% since September 30, 2008 (all returns as of September 28, 2009 close).
It is instructive to look back a year. Let’s recap some of the timeline highlights (lowlights?) of September 2008:
September 1, 2008 - Dow Jones Industrials Average (DJIA) begins the month at 11,543
September 7, 2008 - Fannie Mae and Freddie Mac are placed in conservatorship.
September 15, 2008 - Lehman Brothers declares bankruptcy. DJIA drops 504 points.
September 16, 2008 - Reserve Primary Fund (large money market fund) who owned Lehman Brothers commercial paper reduces it share price below $1 and investors worldwide begin to redeem money markets. American International Group (AIG) receives downgrade in credit rating, suffers liquidity crisis and receives an $85 billion credit facility from the Federal Reserve to avoid bankruptcy.
September 17, 2008 - DJIA drops 450 points.
September 18, 2008 - The SEC suspends short selling of financial stocks.
September 19, 2008 - U.S. Treasury guarantees money markets under temporary program and the administration proposes Troubled Assets Relief Program (TARP) to purchase illiquid assets of troubled financial institutions.
September 21, 2008 - Goldman Sachs and Morgan Stanley convert from investment bank to bank holding companies with approval of Federal Reserve to permit better access to capital.
September 25, 2008 - Washington Mutual, nations largest savings and loan, seized by FDIC. Most of its assets transferred to JPMorgan Chase. Wachovia in sales negotiations.
September 29, 2008 - Vote on TARP in House of Representatives failed to pass. DJIA drops 778 points.
September 30, 2008 - DJIA closes at 10,850 about 6% loss for the month.
October 31, 2008 - DJIA closes at 9,325 for a loss of about 20% since beginning of September.
The events of a year ago rocked the world. Many experts have described what they believe was the cause of the financial upheaval. Our view is that the world, led by the U.S., became much too comfortable with high levels of debt and the high asset prices and high consumption that such debt supported.
Although asset prices have recovered significantly, there are still concerns. The U.S. and most developed countries of the world have sizeable budget deficits and see public debt as a percentage of GDP growing to levels many of these countries have never experienced. This debt is financed by investors at presently low rates (the 10-year U.S. Treasury bond rate is about 3.3%), but the declining quality of the balance sheet of the borrower countries (including the U.S.) would seem to indicate higher interest rates in the future. The currency of countries with such increasing debt like the U.S. should experience decreases in future value.
The high levels of debt that companies employed in the past led to higher profits to owners. Lower levels of corporate debt in the future should lead to lower profits. Consumers will purchase less as they reduce spending and increase savings to pay down debt and replace lost wealth. This also will lead to lower profits.
Governments worldwide have provided huge levels of support to cushion the economy of their nations. This support is still almost entirely in place. At some point this government help will be withdrawn and the private sector will need to exist on its own. Given the large amount of government support, one can expect such withdrawal will certainly be felt by the markets.
We are saying that the concerns that led to last September’s historic events still exist in significant part, or have been replaced with new and equally important concerns. Investors need to stay in the game (or they wouldn’t have experienced the stock market gains of 2009), but we all need to be attentive to many factors, including government policy, economic indicators and the level of security prices. To control risk in the present environment we have the stock portion of client accounts near the low end of our target ranges.
It should be noted that interest rates have changed significantly from the extremes reached over the past year. High yield bonds show this most clearly. On March 27 of this year the high yield bonds average rate was 18.09% for a spread of 15.33% over the 10-year Treasury rate of 2.76%. As of September 25th high yield rates were 10.29% for a spread of 6.96 over the 10-year Treasury rate of 3.33%. During the intervening period, high yield investors received significant gains in the prices of bonds. At Payne Wealth Partners we have targeted a present 7% of client portfolios into high yield bonds, however we expect to see this position reduced or eliminated in the near term as a result of the rate declines.
Our firm continues to advocate for investing in emerging markets. The economic growth rate of those economies should be higher than developed markets and their currencies should perform better. We may very well target future increases in the portion of our portfolios that is invested in emerging markets.
Please read this quick planning note regarding Roth IRAs. Fidelity Investments just released a survey where 83% of investors questioned were not aware that starting in 2010 the income limits for Roth conversions will be removed. We want to make sure each of our clients is in the small 17% minority that understand the potential opportunity this rule change will provide. In the past Roth IRA conversion has been limited to those with income below $100,000. Roth IRAs grow tax-free and all distributions come out tax-free. The Roth IRA account owner is never required to take minimum distributions (unlike a traditional IRA where taxable required minimum distributions must start at age 70 ½). Roth IRAs inherited by children and other heirs are income tax-free to them and they are allowed to take the money out very slowly (over their single life expectancy). We have discussed Roth IRA conversion with many of our clients for whom we manage IRA money and provide planning services. If you have any questions about this please ask!
