Saturday, October 18, 2008

Let’s Talk Turkey

From the Desk of Joe Rollins

I have never before seen U.S. stocks as cheap as they are today. This may be the greatest buying opportunity in our lifetime! I marvel at how far U.S. stocks have fallen, and now is the time for us to take advantage of these low prices.

I have never seen opportunities to purchase stocks so inexpensively with such incredibly high amounts of cash sitting on the sidelines. Interest rates on money market accounts are now paying somewhere in the 2% range, but you can buy the stocks of some of the titans of American industry with yields that are two to three times the amount that you would earn on cash. Furthermore, these dividend yields come with a favorable tax rate that is one-third that of the income tax on cash.

I feel like the proverbial fox in the henhouse when reviewing these stock buying opportunities. Just look at the following list of stocks that could be purchased on Friday morning and their dividends yields:

General Electric Company6.4%9.8
Merck & Company, Inc.5.7%12.4
Altria (Phlip Morris USA)7.1%4.9
Chevron Corporation4.3%6.7
United States Steel Corporation3.1%4.0
Exxon Mobil Corporation2.6%8.6
Johnson & Johnson3.0%14.0
AT&T, Inc.6.5%11.9

When you invest in cash, you will earn the stated rate of return. However, I think it’s almost a given that the interest rate earned on money market accounts is falling and will soon be in the 1% range. On the other hand, if you invest in the companies above, you not only get paid a significantly higher rate of return, you also receive the potential for the companies to appreciate through the years. In other words, you would be buying stocks of some of the greatest U.S. companies at bargain basement prices and with a dividend yield far in excess of anything you could earn on cash.

Do you know who else thinks that right now is a great opportunity for buying equities? Warren Buffett, who wrote a convincing Op-Ed in Friday’s edition of The New York Times. Click here to read Buffett’s "Buy American. I am." editorial column.

Warren Buffett is probably the most legendary investor of our lifetime, and he is actively buying American stocks in his personal account today. Buffett explains his thought process on why he’s so keen on United States equities right now: “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.” No other explanation is needed. With the extraordinary volatility in investing today, no one could argue that fear is quite widespread. Now is the time to buy!

Buffett also explains that, “Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.” You don’t need a higher endorsement to purchase stocks than one from the greatest investor in our lifetime.

I continue to be somewhat confused as exactly why there is such a high fear level surrounding the financial world today. Stocks prices have fallen dramatically, but that is part of investing – stocks go up and stocks go down, but over time it is proven that stocks are the best investment vehicle.

One potential fear was completely resolved on Thursday; the most recent inflation reading indicates that there is no inflation. A clear example of that is the dramatic fall-off in the price of energy. In addition to oil, nearly all commodities have realized 50% to 70% declines in value over the last six months. It is estimated that every penny that the price of gas goes down represents over $10 billion in reduced costs to Americans. While everyone sees the savings at the pump, most people don’t recognize how representative this is of savings across the board. For instance, transportation of food and other commodities are dramatically reduced when the price of oil decreases. Accordingly, the fear of inflation is not an impending issue right now.

Moreover, I see no reason for investors to be fearful of the banking industry anymore. The extraordinary actions of our Federal Reserve have resolved those issues. The Department of Treasury is scheduled to inject $125 billion in cash into our major banks; their futures are now secure. Additionally, the Treasury will soon deploy the remainder of the almost one-half of a trillion dollars to stabilize banking in America.

If you were concerned about your checking account, you should set your mind at ease. The FDIC has increased the insured account amount to $250,000, and there is currently a government guarantee on all non-interest bearing checking in the United States. Therefore, any checking account in any Federally-insured bank is absolutely secure. Other governments around the world have made similar banking guarantees.

The U.S. Treasury is creating a market in loaning to banks. They have guaranteed inter-bank loans effective this past week, and they are now providing direct financing to corporations in the commercial paper market. In fact, the Federal government appears to be guaranteeing anything that resembles cash. Frankly, I believe that they probably have an indirect guarantee on your Sears & Roebuck credit card…

If you are an avid reader of my posts, you know that I’m an ardent supporter of capitalism. In spite of my strong beliefs, the government’s intervention in the banking system was mandatory this time. As I listened to Congress debate regarding the bill to save the banks, I was stunned at the complete ineptitude of our elected officials. Those members of Congress who believe it would’ve been okay for banks and companies to fail just don’t get it! There’s nothing wrong with our government assisting businesses through a rough patch. While nationalization is never pretty, the human suffering and the damage to our economy due to massive unemployment would be a lot less attractive. I think we will see that the money used in this transaction will be quickly repaid and the government will no longer have an ownership interest in our businesses. In this particular case, it was a win-win for all parties.

When listening to the news this morning, I heard several analysts comment that the economy had yet to start recovering. Considering that not one single check was been written by the government yet, these comments were bewildering. It would be astonishing if things started getting better before the money supply was actually funded. However, next week – once this money starts flowing through the system – you will see immediate and significant improvements in liquidity, creditworthiness and, eventually, the economy.

Perhaps you’re assuming from the foregoing that I’m oblivious to the elephant in the room – the upcoming recession. Almost assuredly, there will be some sort of economic slowdown soon. We may already be in a mild recession, but if not, it’s certainly a possibility to happen sometime during this quarter. However, any discussion that it will be a devastating and prolonged recession is just not supported by the facts.

The U.S. Treasury is currently pushing close to $1 trillion through the American banking system. Milton Friedman, the American Nobel Laureate economist, made it very clear: If you want to avoid recessions, you must liquefy America by flooding the cash accounts. Never in the history of American finance has there been such a rush to put liquidity into the system.

Moreover, there is an absolutely unprecedented worldwide coordination going on with the major banks in Asia, Europe, the Americas and others, including interbank guarantees and checking account guarantees. There have been coordinated interest rate cuts around the world, and this enormous and swift international cooperation in resolving a potential economic disaster will prove to be effective.

The only way to assume that the potential recession will be devastating is to first assume that the most basic economic principals no longer work. I am not one who believes that the end of the world is near – the fundamental economic theories of monetary policy are well-proven, and the fact that we have never seen such a coordinated global effort to create positive monetary flow further supports my position.

According to the principal well-respected economists, any forthcoming recession should be short and swift. In fact, most economists are saying that we will only have three negative quarters. The third and fourth quarters of 2008 and the first quarter of 2009 could potentially be negative, but the general consensus among these economists is that the second quarter of 2009 will start to provide a positive economic upturn. If I’m not mistaken, that’s only five months away. I continue to wonder why fear is gripping investors when we are only a short period of time away from potential recovery.

So that you don’t start to think that my ramblings are strictly hyperbole, the following are some supporting facts:

I have previously written on the Federal Reserve’s IBES valuation model. This model was introduced to Congress by former Federal Reserve Chairman Alan Greenspan on July 22, 1997. Essentially, it defined the interaction of common stock equities and risk-free Treasury bonds. Its formula is the current estimate for the 12-month future earnings for the S&P 500 divided by the yield on the 10-year Treasury bond at any one point in time.

Assuming that economic fundamentals are currently working, this formula should give us some direction as to the fair value of stocks. According to the Standard & Poor’s projection of operating earnings from the issue I received on October 14, 2008, operating earnings for the S&P 500 for 2008 are at $76.73. For 2007, the confirmed numbers were at $82.54. In 2008, the banks and financial institutions – which are a large part of the S&P 500 composite – provided a significant draw-down in earnings. Without the banks, operating earnings would be significantly higher.

Today, the 10-year Treasury bond has an approximate interest rate of 4% (it’s actually slightly lower, but for illustration purposes I am using an approximated percentage). If you divide the current estimated earnings for 2008 of $76.73 by .04, the result is a fair value of the S&P at 1,919. The S&P today is at 946, so a move to this level would be over a 100% increase. While this is certainly desirable, it’s probably not realistic.

Cynics argue that earnings will be dramatically reduced by the upcoming recession, but frankly, I do not agree with that assessment. I do, however, understand their concerns, and while it’s perfectly possible that earnings will be reduced in 2009 for some industries in the United States, banks and financial institutions will still be dramatically higher. The corresponding net effect will likely change very little.

In order to satisfy the cynics, I will reduce corporate earnings in my example above by a full 30%. At this level, estimated corporate earnings would be $53.71, which would yield a fair market value of the S&P at 1,343, or a 42% increase from the current level.

As I’ve often said, no one can adequately time the market. In fact, the market may go even lower from where it is right now. Whether the trend is up or down, you can expect extraordinary volatility that will delight you some days and frustrate you others. Don’t misunderstand what I’m saying to mean that we’ve reached the bottom of the market; I’m simply saying that stocks by any measure are extraordinarily cheap – perhaps even legendarily cheap – from an investment standpoint.

It’s time for Americans to step up and support the U.S. financial system. Stocks are cheap and there is a significant investment opportunity available to us all. I can’t predict when stocks will go up, but I am certain that they most assuredly will. Many years from now, we will reflect on these days and realize that it was the greatest stock buying opportunity of our lifetime.

When one of the greatest investors of all time says stocks are looking cheap, it’s time to really reassess the market. Buffett isn’t calling a “bottom,” but he is looking forward one, three, five and 10 years out. If he is investing with his personal money, then shouldn’t we start looking for investments, too?

Friday, October 10, 2008

Current Status of the Markets

From the Desk of Joe Rollins

I took a few days off from posting to the Rollins Financial blog since my “Third Quarter Analysis” post because I have been waiting for more pronounced news regarding the stock market. There’s no question that the markets have been frightful over the last six or seven trading days, and that’s undoubtedly due to nothing other than panic. As the front page of the New York Times indicated on Wednesday – “Forget Logic; Fear Appears to Have Edge.” I think you’ll find the article to be very interesting.

In my last post, I referred to Rip Van Winkle’s 20-year sleep when discussing how I felt after the complete upheaval of the markets – it felt like the financial world as I knew it had completely changed. I decided to review all of the financial news as of late to figure out where the market really should be based upon the facts. Looking at only the facts and excluding all of the emotions, I would have assumed that the stock market would have been up several thousand points. The fact that it has been down several thousand points only reflects that fear – not investing fundamentals – is controlling this market.

Let’s take a look at the movements by our government and the Federal Reserve over the last four days:

  1. On Friday, the U.S. Congress passed and President Bush signed an historic $700 billion bill to buy distressed assets from banks and other companies. It also allows the government to make direct investments in banks, and it authorizes the Treasury Secretary to purchase troubled mortgage loans from individuals.

  2. The Federal Reserve and the Treasury moved quickly to stabilize from the fallout caused by average citizens who were removing their money from banks to buy Treasury bills. The FDIC guarantee on bank accounts was moved up temporarily from $100,000 to $250,000 (higher FDIC limits apply to retirement accounts). Additionally, the government guaranteed all commercial money market accounts to essentially make all of them risk-free.

    By taking these extraordinary actions, they saved smaller banks from runs on their accounts. Now, local and small regional banks have the same government protection as many bigger and much more financially sound financial institutions. Due to the flight to safety, U.S. government guarantee bonds are paying almost no interest. For a time, the one-month Treasury actually had a negative rate of return. As I write this post today, the one-year Treasury is paying an annualized rate of 0.15%.

  3. On Monday, the Federal Reserve doubled the allotment of money they would sell into the banking system. This enables commercial banks to take assets to the Federal Reserve and obtain direct loans to supplement their daily operations.

  4. On Tuesday, the Federal Reserve notified their member banks that they would pay interest on their excess cash reserves held at the Federal Reserve. This step had never been used by the Federal Reserve before. By agreeing to pay interest to the member banks, the Fed allowed the member banks to use their excess cash to put it back in the system and not purchase Treasury bills. This action creates significant cash assets for banks to loan.

  5. Also on Tuesday, the Federal Reserve exercised its right to lend cash directly to corporations to fund their commercial paper needs. This action by the Federal Reserve had not been utilized since the 1930’s – almost 80 years. Since the commercial credit markets had seized up in the United States, banks weren’t loaning to each other. Therefore, companies that fund their operations based on short-term commercial paper were unable to borrow needed cash for their operations. But on Tuesday, the Federal Reserve changed all of that. By putting money directly into the economy, the Fed circumvents the need to force banks to make loans that they are either unprepared or unwilling to make.

  6. Early on Wednesday morning, there was a coordinated global interest rate cut. Nearly all of the major economies in the world simultaneously cut their interest rates by at least one-half of a point. Even though there had been coordinated cuts in prior years for minor amounts, such a large cut had never been accomplished in the history of modern finance. Additionally on Wednesday, Great Britain indicated that they would inject capital directly into their national banks. By depositing £50 billion ($88 billion U.S. dollars), the British government secured their national banks and created liquidity and working capital for their operations.

  7. Additionally, while all of the above was occurring, the Federal Reserve and the archaic accounting profession has proposed a major change to the ridiculous and totally unwarranted “mark to market” accounting rules, which I have discussed before. By the SEC’s insistence that assets be marked down to a market value that doesn’t exist in the current environment, this governmental agency has destroyed over $500 billion in bank equity and reduced lending capacity by almost $5 trillion. These actions have hurt America by creating a risk to our financial system for no good reason. The President should immediately repeal these provisions.
If I had pulled a Rip Van Winkle and woken up to the events described above, I would have thought that the stock market would have reacted very positively. Unfortunately, that is not the case. To continue to watch the market trade in wild swings of 200 points in either direction is very discouraging. Once again, the market is trading strictly on fear and not on financial fundamentals.

The most fundamental aspect of stock market investing analysis is evaluating the effect that the Federal Reserve System has on corporate profitability. The adage that I’ve used time and time again, “Don’t Fight the Fed,” is particularly meaningful in this regard. As illustrated above, the actions of Federal Reserve Chairman Dr. Ben Bernanke have been extraordinary over the last several weeks. In fact, his actions are so decisive that all Americans should feel comfortable with his job performance.

Dr. Bernanke is reportedly the world’s leading expert and academic on the Great Depression, on which he has written extensively. The Great Depression primarily had more to do with the actions of the government than with the actions of investors and companies. As you know, the 1920’s are often referred to as “The Roaring Twenties.” The economy was hot and the government was loose (with the exception of the Prohibition on alcohol); money was seemingly everywhere and prosperity was growing at an accelerated pace. In spite of Prohibition, alcohol, flappers and good times ruled the economy. Of course, the party came to an abrupt halt in 1929 when the stock market crashed due to its own excesses.

The actions taken by the Federal Reserve during the Great Depression are vastly different from what Dr. Bernanke is doing now. In 1930, the Federal Reserve began draining the cash flow from the banking system. Their perception was that, due to inflation, they needed to slow down the economy and squeeze out all the excesses that had occurred during the 1920’s. In doing so, they basically forced 25% of the banks in the United States out of business and reduced credit to companies, causing many of them to fail or to lay off employees. Virtually everything they did was wrong.

It should never be forgotten that during the 1930’s, unemployment in the United States was over 25%. Today, even with all the negative talk regarding the economy, unemployment continues to be at a very controlled level of 6.1%.

All of the examples itemized above illustrate that the Federal Reserve is taking a completely different approach today than during the 1930’s. It is clear that the Fed is flooding the U.S. economy with money. Everyone is now flush with cash; this includes the banks, corporations and even – due to the financial effect of the Fed’s actions – investors. There is currently over $3.5 trillion sitting in commercial money market accounts, which doesn’t even include bank CD’s, checking accounts and other types of investments that are in near liquid form.

What we have today with all the uninvested cash is exactly the fuel for a stock market rally. However, what the markets are experiencing is truly due to a lack of investor confidence. There is more than adequate cash on the sidelines waiting for an opportunity to invest. It’s only a matter of time until that money works its way back into the markets.

The timing of the recent sell-off is somewhat coincidental. At the beginning of almost every quarter, investors typically have reservations about taking positions. The end of September through the first two weeks of October is historically a blackout time for corporate news. Since almost all corporations report their earnings on a quarterly basis, they are not allowed to make any comments regarding their expected results during the first two weeks of a quarter. It’s fairly clear that the economy has shifted from a robust GDP growth of 2.9% in the second quarter to a projected negative GDP for the third quarter, and that explains the hesitation regarding the expected earnings of the corporations.

It is unknown to nearly everyone how good or bad the earnings will be for the third quarter and how the negative economy will affect those earnings. However, IBM’s early earnings report released on Wednesday night was a good sign, especially since they beat their estimates. As a general rule, if earnings were going to be terrible across the board, we would have already heard many announcements to that effect.

The very positive actions taken by Dr. Bernanke are directly opposite of the actions taken by former Federal Reserve Chairman Dr. Alan Greenspan when he was in office. I think you would be interested in reading the lead article in Thursday’s edition of the New York Times, “Taking Hard New Look at a Greenspan Legacy.” The article raises many concerns regarding the actions and inactions of the former Fed Chairman. Those of you who have read my work in the past know that I have been very critical of Dr. Greenspan over the years. I actually wrote a similar article well over five years ago; I guess the New York Times is finally catching on.

The other major event that occurred during the third quarter was the significant liquidation of positions by the hedge fund industry. During 2007, the new hot purchase was commodities. It was reported that many endowments and pension plans were establishing an asset class in commodities equal to 5% or 10% of their total assets or higher. Many thought of commodities as a true asset class as important as cash, bonds and equities, and that commodity prices would rise forever and would never significantly decline. I guess they were wrong about that!

Now that the price of oil is falling from $148 a barrel to $84, it is obvious to see why hedge funds are being liquidated. The cost of almost every commodity has been cut by 50% or more. Some of the losses in these commodity-driven stocks are absolutely staggering. Share price reductions of 75% to 80% are the norm. Obviously, the fundamentals do not support this level of decline. However, in a liquidation mode the baby is always thrown out with the bath water.

Hedge funds were facing serious and material liquidations, which generally only occur in hedge funds at the end of a quarter. There was a massive deleveraging and liquidation of these positions over the last few weeks, but all of this selling should be wrapped up within the next week. Perhaps that is when we’ll get back to a normal trading environment.

When it comes to stock market evaluation, the fundamentals have almost never been stronger. While it’s true that we’re facing a decline in earnings due to a recessionary economy, the decline is certainly not severe. No one is forecasting a deep recession; it’s negative – but not severe. Interest rates are extremely low, giving rise to a definite preference for equities over fixed-income investments. CD and money market rates are low and going lower. Mortgage rates are incredibly low and it appears that they will continue to be low for some time. Cash is abundant and becoming even more available to virtually every corporation. If you evaluate stock market valuations based upon fundamentals alone, the market should be 30% to 40% higher today – even with lower earnings.

I don’t know exactly when we’ll experience a snap-back rally – it could be any day now. The traders on Wall Street couldn’t care less about the direction of the market. They can make money on both the upside and the downside. Volatility must exist in order for them to benefit from the market. On Wednesday, the market swung up 200 pointS and then down 200 points in a matter of minutes. That is reflective of professional stock trading activity, not the general public…

We will continue to see massive volatility until some sort of stabilization occurs. When the new buying occurs, it will be explosive and dynamic. The only way to participate in that upward movement is to be invested in advance. You will never be able to move quickly enough to participate if you are in cash. There have been exhaustive studies done on market timing, and each and every one comes to the same conclusion: market timing for professionals is impossible, and for the public, it is inconceivable.

I’m often asked why I do not sell during these types of declines. Whether you realize it or not, watching the market decline on an almost daily basis is excruciating for me and my staff. The easiest things for us to do would be to sell the portfolios to cash, which would alleviate the pressure and minimize the risk. However, if we did that, we would be doing a disservice to our clients. We must invest based on fundamentals; we cannot invest based upon external events that no one could have predicted.

I believe the market is dramatically undervalued at this point and that a major rally will occur sometime soon. I don’t know how long the rally will last or what levels it will reach. In any event, fundamentals today do not warrant the current low levels of the market. I highly recommend that if you have money to invest, now is the time to get positioned for this rally. If you don’t have additional money to invest but you are invested right now, I highly recommend you be patient and let the professionals do what they do on a daily basis until fundamentals once again dominate equity investing.

I’m often asked why we do not move the investments to more conservative and safer accounts. The investing environment during 2008 has been strange, to say the least. During the sell-off that occurred from 2000 through 2002, the market bifurcated into two separate investment worlds. Anything related to technology was sold-off dramatically; however, other funds invested in traditional businesses did very well during that period of time.

In 2008, there’s not a single asset class that has made money except government guaranteed bonds. Even so-called “conservative bond funds” are down double-digits in 2008. In all honesty, there’s been nowhere to hide in the investment world. This is unusual, unprecedented and not reflective of investing fundamentals.

It’s also interesting to see projections of the economy going forward. Never in the history of America have we seen such a massive injection of cash into the economy over such a short period of time. On almost a daily basis I hear commentators say that the $700 billion to buy distressed assets is not working. I guess they haven’t quite figured out that it was only approved last week and not one asset has been purchased at this point. Everything we know about economics dictates that when you flood the U.S. economy with such a massive amount of cash, you will receive an enormous stimulus which should prevent a deep recession, or hopefully, a snap-back in early 2009.

Another interesting aspect of this tremendous sell-off has been the incredible strength of the U.S. dollar. The Federal Reserve System had to provide U.S. dollars to other banks around the world. Even though all of these economies enjoy criticizing the U.S. and our way of doing things, isn’t it interesting that the currency preferred by the entire world in a time of crisis is the U.S. dollar? For that reason, international investing has lost a lot of its luster and cannot be counted on for consistent returns until the dollar begins to weaken again.

As information, we have sold out of some of our international positions and created cash for virtually all of our clients. This provides some safety and takes some of the volatility out of the accounts. Our intent is to reinvest when it is appropriate so that you benefit from the expected rally.

- An Aside Regarding Tuesday’s Presidential Debate –

It was kind of the Presidential candidates to mention both the Manhattan Project and John F. Kennedy’s “Man on the Moon” pledge in Tuesday night’s debate. You may recall that I mentioned both of these initiatives in my “Energy Crisis Resolved!” post on August 15th. It’s good to know that my posts are widely circulated – even to the politicians I so often criticize. While they didn’t directly plagiarize my posts, I still found it humorous that these two projects were brought up. I’ll just give myself a pat on the back for bringing those things to their attention. Maybe I should tell them how to balance the Federal budget…

Saturday, October 4, 2008

Third Quarter Analysis

From the Desk of Joe Rollins

Coming out of the third quarter, I feel sort of like Rip Van Winkle waking from his 20-year sleep and discovering that his life and the world as he knows it have completely changed. The only difference is that it only took 90 days for such confusing, profound changes to happen in our financial system. When we reflect on the third quarter of 2008 in future years, I am sure we will all realize that it was one for the ages. So much happened during this quarter that I am certain entire textbooks will be dedicated to the subject.

If I had been told on Friday, September 26th that Wachovia Bank – with a market capitalization close to $30 billion and its book value at $29 per share as of that date – would essentially be worthless on Monday, September 29th, I would never have believed it. Today – only four days later – it was sold to another bank. Geez! Likewise, if I had been told that the infamous 150-year old Wall Street brokerage house, Lehman Brothers – which made $7 billion in the previous fiscal year – would file for bankruptcy only 60 days later, I would have scoffed in disbelief. Similarly, if I had been told that AIG – one of the most legendary and financially strong insurance companies – would be brought to its knees by stock speculators, I would have found that be equally inconceivable. I would have found it even more outrageous that the U.S. government would make an $85 billion loan to a private enterprise in order to keep them from bankruptcy. The fact that these events (and many more) actually occurred during the third quarter is stranger than fiction!

It seems that fundamental investment analysis meant nothing during the third quarter. By all measurable standards, stock market investing is cheaper today than it has ever been during my investing life. It was also a quarter where asset class made no difference. Other than U.S. government bond funds, every asset class lost money during the quarter. Bond funds protected investments only marginally better than stock funds. As we discovered, even cash wasn’t safe during the quarter. There was such a rush by the investing public to invest in Treasury bonds that at one point during the quarter, Treasury bonds had a negative rate of return. This means that some investors were willing to incur a loss only for the certainty that their money would eventually be returned. It was, by all standards, an extraordinarily difficult quarter – and it was certainly one for the ages.

There’s no way to sugarcoat the performance for the third quarter and for the year-to-date; it was terrible. Even a broadly-diversified portfolio would have returned significantly negative results. However, performance has not been based on fundamentals or profitability lately; rather, the losses were caused by fear, misinformation and governmental intervention. It is impossible to evaluate the losses based upon the fundamentals, as earnings continue to be good and interest rates are low. These factors mean that the stock market should be bursting higher, not lower! Did I mention that fundamental analysis meant nothing during this eventful quarter?!?!

For the nine-month period ended September 30, 2008, the Dow Jones Industrial Average was down 16.5%, and for the one-year period, it is at negative 19.8%. The Standard & Poor’s Index of 500 Stocks is down 19.3% in 2008 and down 22% for the one-year period. The NASDAQ Composite was down 21% for the first nine months of 2008 and down 22.3% for the one-year period. I understand that these are awful percentages and that they are very disappointing to investors.

During the quarter, we worked diligently to stave off the losses. Since the U.S. dollar was appreciating (making foreign investments less secure), we rotated out of nearly our entire international portfolio. We sold all of our emerging market funds and moved the money back to the United States. Even though the companies that base their profits on oil are by all standards the cheapest of any securities, the international emerging market funds got crushed during the quarter since many of these countries are oil rich.

Finally, during the quarter – once the SEC intervened to reduce short-selling in financials – we liquidated all of our convertible securities. In only a short, one-week period, these securities lost 15% in value. This was a quarter where typical investing took a back seat to fear, speculative buying and sector rotation on almost a weekly basis.

After reading the above, you might think that I’m discouraged, but that is not the case. In fact, I cannot remember a better opportunity for positive investing that is as pronounced as it is today. I am amazed that such overwhelmingly good opportunities continue to be sold off on a daily basis. It is very common today to invest in Blue Chip stocks earning dividend yields in excess of 4% and, in many cases, greater than 5%. However, many investors seem to prefer to be in cash earning less than 2%. Stocks of almost all of the big industrial companies are excellent investment opportunities, but the public fears investing right now. Therefore, these buying opportunities are not being seized.

There’s no question that the economy has slowed. It is likely that we will now have two back-to-back negative quarters – the third and fourth quarters of 2008. In spite of that possibility, I believe they will only be moderately negative and that we are not facing a serious recession.

I’ve often said that, “You can’t fight the Fed.” Our Federal Reserve and the Bush Administration have pumped literally trillions of dollars into the U.S. economy to free-up credit. There are not less dollars today than there were one year ago; in fact, I rather suspect that there are billions more. This is a unique time where no one seems to trust anyone. Banks are hoarding money as they fear customers will withdraw their cash and hide it under their mattresses. Banks will not even lend to other banks, much less to customers. However, the Federal Reserve is changing all of that.

As I have said before, the “cavalry” is on its way. The banks are being injected with billions and billions of new cash. The money they are going to receive from the government cannot be invested and must be loaned soon. As the banks start to put their cash to work and lend to each other, the economy will improve. I believe that we are within a short six months of the economy getting better. To give up the investment opportunity of a lifetime for only six more difficult months seems ill advised.

The stock market’s performance is a future indicator, as it typically experiences a turnaround and gets better before the wider economy. I am not certain when that day will come, but I believe it is very close. I recognize that this has been a difficult quarter, but I assure you that we are working hard to protect your investments. During this quarter, survival mode far exceeded investing fundamentals.

As the markets stabilize, we have the opportunity to move forward; I sincerely hope that investors will remain patient and wait for the good days to return. Best regards.