Marketing Commentary- Q3 2008

What’s Been Happening?

Since we last wrote this piece three months ago the financial markets have been in turmoil. The problems in the credit markets have spilled over to the stock market and we have witnessed a crisis of confidence in the financial system not seen since the Great Depression.

Starting with subprime loans and most recently moving to “credit default swaps”, banks have been forced by accounting convention to write down these assets to fire sale prices. The ensuing losses caused some banks to fall below the minimum requirements for capital imposed by regulators. To remedy the situation, financial firms sold assets because selling their stock became more difficult. These sales fed into the downward spiral in asset values that weakened several well known firms such as Lehman Brothers, Merrill Lynch and Wachovia to the point where they had to be taken over by stronger competitors. Our custodian, Charles Schwab & Co. remains among the stronger financial firms due to the conservative management of their balance sheet and little trading in the exotic financial products that imploded.

We are witnessing the great de-leveraging [paying down of debt] of much of the financial services industry. Many firms were trading more than $30 for every $1 in capital [net worth]. The failures to date have been in the order of highest leverage on down starting with Bear Stearns. While the ultimate cost to taxpayers remains to be seen, the reduction of high leverage in our banking and brokerage firms will ultimately result in a stronger financial system.

The fallout from the crisis of confidence has been a lack of willingness of one bank to lend to the other for fear of not being repaid. This “interbank lending” is the grease that lubricates the economy and allows companies and individuals to borrow. The federal government has taken a number of significant steps to jump-start the lending process but so far with little progress.

Trends to be Aware of

We expect the government actions will eventually pry the credit spigot open and the credit markets will return to normal. We don’t expect another Great Depression; global regulators were much quicker to act this time with the intention of avoiding a repeat of the early 30s.

Market participants hate uncertainty so until: 1) we have functioning credit markets, 2) it appears that the significant bank write-downs are done and 3) elections are decided, we expect some more downside volatility. Once these issues are resolved, and they will be, we expect the stock market to resume its normal upward trajectory. The timing of the recovery will be determined by the length of the current recession but, as usual, the stock market should be a leading indicator.

We continue to find opportunities to rebalance and harvest tax losses to take advantage of the current volatility. Staying invested in globally diversified portfolios of funds with an appropriate stock/bond mix will position us to benefit from the anticipated eventual rebound.

Some Numbers for Comparison:

The following table compares some key indices against which fund performance is measured. All figures are for the periods ending 09/30/2008.

Chart Data Source:  Thomson Financial