Commentary and Articles
4th Quarter 2008 Quarterly Synopsis
“Back to the Basics”
When our Mid-4th Quarter Commentary was published, there seemed to be no shortage of concerns in the U.S. and Global economies with considerable unknowns and abundant risk. As 2008 came to a close, the unknowns began to clear and equity markets had a nice bounce to end an otherwise dismal year.
Conditions for the overall economic environment are no less shaky, but the unknowns have increasingly diminished making equity investors more sanguine about the opportunities in a market that may have overly discounted equity prices. Interbank lending rates have come down to the lowest levels since June of 2004, showing the effect of central bank monetary policy and giving investors hope that bank credit markets will normalize once again. Commercial bankers are already showing tighter lending standards in survey data, which may seem contrary to economic stimulus, but instead shows that banks and credit market investors are in fact going back to the more reasoned lending standards of the early 1990’s with an attitude of “let’s not go that far again,” which will make for more stable economic growth going forward.
Although the deflationary risks still exist in the recessionary climate, the latest readings from the Institute for Supply Management show the relative price index at its lowest level since 1949. Given the state of the current monetary stimulus and anticipated fiscal stimulus, it is unlikely that the deflationary risks continue much beyond this level. In fact, the recent sharp fall in wheat, corn and oil prices is already flattening out. The sharp fall in commodity prices over the last few months will act as its own economic stimulus helping to shorten the duration of the recession.
U.S. Equity markets have also flattened out over the last month of the quarter, but share price volatility has remained high. Interestingly, corporate insiders are buying shares of their companies at the fastest pace since 1975. In spite of the significant cuts in U.S. interest rates, the U.S. Dollar is strengthening versus other world currencies showing that the economic problems are worldwide and signaling that money is likely to flow to U.S. equity markets ahead of world markets that had previously seen higher money inflows. These factors indicate that there are positive feelings beginning among some equity investors despite the weak economy. One example of this is the loss of 533,000 jobs in November 2008, a drop of 1.35% year-over-year. Historically after a drop of greater than 0.9% in a year, the market rebounded by an average of 19.8% meaning that relatively large drops in employment signal a market bottom. Low relative valuations and the feeling that the risks may already be sufficiently discounted by the sharp downturn in the 4th Quarter also add to the sentiment. Even though we’ve been in recession for over 12 months and the average recession has lasted 10 months, we may have further to go to get back to a growth climate, but the signs of a market recovery in equities are beginning to show.
In fixed income markets, we may be nearing the top as yields on debt drop to extremely low levels. The one thing about bond market prices that makes them different from stock market prices is that the top is easier to call. Since rates can’t go below zero, the closer we get to zero the closer we get to the top of the bond market. Over the next 12 months, we are likely to see significant inflation return as a result of current policy decisions. Because of these factors the bond market is likely to have a rough time as the economy recovers, but Inflation-protected Treasuries will perform well. Also we would expect that as risk premiums return to normal levels that corporate and high-yield bonds will perform well.
In the 4th Quarter 2008, fixed income holdings performed positively, while equity results were disappointing. The Health Care sector outperformed the overall market for the quarter with United Health Care (UHC, NYSE) and Amgen (AMGN, NASDAQ) leading portfolio names in the sector. Energy and Natural Resources related investments performed poorly given the sharp drop in commodity prices. Our portfolios had a higher than normal allocation to cash which helped them weather the storm.
The downturn of 2008 makes us consider the definition of “long-term”. Passive returns in equity indexes over the last 10 years were negative as of the end of 2008. Historically, negative 10-year cycles have been followed by significantly positive 10-year cycles with an annualized return at 10.38%. Clearly, a well-constructed, systematically-rebalanced portfolio can help to outperform over this period. Whether the next 10 years will complete the historical long-term cycle in similar fashion is difficult to foresee.
WHM Capital Advisors, LLC is a financial advisory and wealth strategies firm headquartered in Columbia, South Carolina, which specializes in valuing companies, designing exit strategies and managing portfolios for business owners. In addition, WHM Capital Advisors manages a select number of portfolios for high-net worth individuals, trusts, and foundations. The firm uses a diversified equity and fixed income strategy designed to meet the individual objectives of each client.
Contact: William McAfee, Chief Investment Officer
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