Manchester's Musings

FICO: Is Your’s Fabulous or Fading?

2010-02-26T10:56:00.000-08:00

We all have credit and most of us use it daily. It has become ubiquitous in our society, but most users don’t fully understand how it is created and how it is best maintained.

Credit supports the foundation of our economy. The upheaval that we all lived through in 2008 was the unraveling of credit. Most people don’t realize that the credit markets are many times larger than the stock markets. Typically, we see stock market corrections every few years, but corrections in the credit markets are rare, more serious, and take much longer to repair. Healthy credit markets are important to us all.

Establishing and maintaining good credit is essential to creating and protecting your wealth. The process of consistently improving your credit or maintaining it at a superior level is one of the best financial disciplines you can develop. It requires balancing expenses with income and reward with risk.

Our largest purchases are typically made using credit. Your credit history will largely determine whether you qualify for a loan and what interest rate you will pay. Your credit history has two main components, the credit report and the credit score.

Your Credit Report

Your credit reports are created by the three main credit bureaus: Equifax, Experian, and TransUnion. Each credit bureau receives information about most of your credit uses. Generally, they have similar information, but there may be some lenders that report to just one or two of the bureaus. Since your FICO score is calculated using the data on your credit reports, in reality, you actually have three FICO scores – each one based on the reported information from one credit bureau.

Recent surveys show that nearly 80% of credit reports contain an error, and almost 30% contain a serious error. It is very important that your credit reports do not contain any errors that will damage your credit history, and errors will likely stay on your report until you fix them. To verify the accuracy of your reports you must obtain all three reports and carefully examine each one. Challenge any errors you find, first through the credit bureau and, if unsuccessful, through the lender. This often takes some hard work, but it is worth the battle.

Your Credit Score

It is critical to know how your score is calculated, how it is used by lenders, and how you can improve it. Your credit score (also known as your FICO score since it was developed by the Fair Isaac Corporation) is a number between 300 and 850. This number (higher is better) quantifies your credit risk to lenders. It is generally used along with a few other pieces of information, such as income and age, to determine the interest rate on a loan. A 100-point difference in your FICO can cost you $10,000 in interest per $100,000 of mortgage or $1,000 in interest per $10,000 of car loan over the lifetime of the loan.

Your goal is to get your credit score into the highest level, 760-850. Rumor has it that a 761 is just as good as an 849, so don’t go overboard trying to max it out. Fair Isaac Corporation sorts the information on your credit report into 5 categories with varying weights to calculate your score (see table). Hopefully, most of the work you’ll need to put into raising you score will likely be focused on debts other than your mortgage and car loans. Revolving debts such as credit cards and lines of credit are where most people, with a little management, can improve their FICO score. They are called revolving debts because you can run them up and then pay them down repeatedly.

Weightings	Factors
35% - Payments	Do you always pay on time?
30% - Balances	How much do you owe? - Utilization rate in total and by account
15% - Duration	How long have you had credit? - Longer is better
10% - Applications	Do you maintain accounts for a long time? - Older accounts are better
10% - Mix	What is the mixture of credit sources? - More are better

Your payment history counts for 35% of your score, so paying on time – all the time – really matters the most. Credit duration counts for 15% of your score, so the longer you have had credit the better. Thus, it can be a good idea to help your child establish credit as soon as they turn 18, and then teach them to manage it effectively. Your credit mix weighs in at 10% of your score. Your FICO score improves as you responsibly take on varying types of debt, such as car loans, lines of credit, and mortgages. The remaining two categories are more complicated, require some ongoing management, and will be the areas where most people can improve their FICO scores.

Your balances count for 30% of your score, and you must manage both your total credit lines and your “utilization rate.” First, your total credit lines must be reasonable, so be very discerning about the credit offers you accept. Generally, your credit card lines should not be more than 2-3 months of your gross salary. Second, your utilization rate is the amount of credit you’re using versus your total credit – in other words, your current balance divided by your credit line. Thus, your utilization rate is 25% with a credit card approved for $40,000 carrying a $10,000 balance. Lenders want to see a utilization rate below 50% on each card and in total. Thus, even though you might save money by transferring several balances onto one lower interest rate card, your FICO score will go down if your utilization rate on that new card is over 50%.

Last, but not least, credit applications impact 10% of your score. First, it is a good idea not to apply too often for credit as multiple applications or credit inquiries hitting your credit file lower your score for awhile. Second, the age of each account is also important as older credit is favorable. Thus, if you close an old card or open a new card, your FICO score will go down for awhile because the “average” age of your credit decreased. To protect your score when you no longer want a very old card, ask to decrease your credit line, but keep it open until you have had other cards open for many years.

Conclusion

For many families, this recession has caused some real belt tightening, or at least more thought is being given to debt than ever before. These adjustments can be painful, but they are healthier in the long-run for each of us and for our economy. While it has always been important to maintain the right amount of good credit, Americans are now more aware of what can happen when too much bad credit meets a serious recession. A healthy FICO score safeguards your wealth by protecting your available credit during recessions and improves your wealth by allowing you to access better loans in any environment. A few hours a year goes a long way to saving you money and protecting your wealth.

Helpful Sources

Obtain your credit score at myfico.com

Get a free annual credit report at annualcreditreport.com

Stop junk mail credit card offers at optoutscreen.com

Research competitive credit offers at bankrate.com

Compare your credit cards at mint.com

Analyze your credit score at creditkarma.com

Find help with credit problems at nfcc.org

For a Fabulous FICO

Pay on time

Keep utilization rates under 50%

Pay off monthly, if possible

Establish credit at age 18

Apply for new credit infrequently

Don’t close old accounts too often

Open varying types of credit over time

Get all 3 credit reports & correct errors

MARKET UPDATE -- Winter 2010

2010-01-15T09:34:00.000-08:00

We would like to tell you everything is fine and there’s nothing to worry about. However, we must accept the present reality which is not all that pretty. The housing bubble, which was created by an incompetent government and fueled by Wall Street greed, has led to hundreds of bank failures, real unemployment near 17%, and many cities and states near bankruptcy. So, what now? We can continue to debate whether all the government involvement was prudent or even necessary (mostly not), but this will not help in positioning your portfolio to take advantage of what has been created.

Knowing how we got here, and what constitutes a bubble, is important in order to know what to look for to avoid getting caught in the next one. Most bubbles are associated with strong growth in money and credit, but this time the opposite is true. Bank lending continues to contract as banks are very happy to maintain large cash reserves. With near-zero interest rates, the government is forcing money out of safer investments paying near nothing into riskier investments. Why would they do this? Because when we collectively decide not to take risks the economy grin to a halt. Our government, through the Fed, has adopted a strategy of making it so uncomfortable to play it safe that investors will move into riskier assets in order to obtain the returns that they need. Unfortunately, by doing this they increase the risk of fueling speculation somewhere else and creating a new bubble – especially with the Fed making it clear that rates will stay down for “an extended period.” Ultimately, the piper will need to get paid—this will lead to much higher interest rates and a drastic reduction in value of US Treasuries somewhere down the line.

Worldwide, the extreme policy actions of the past couple of years are creating all kinds of distortions. These pressures could be alleviated by a tightening in monetary conditions in China and other growing economies that are coming out of the recession in better shape. However, they currently have very little incentive to back off the throttle on their growth engine as they attempt to provide their citizens a greater standard of living. The seeds of prosperity that used to be the domain of the USA now have a passport full of overseas destinations.

Going forward, we believe this recovery will be meek. The Fed will be tolerant of further gains in all asset prices as long as inflation expectations are calm and US economic growth remains near zero. With such a weak recovery, we do not expect the Fed to raise rates until 2011. Early last year we stated our preference of corporate bonds to stocks for 2009, and we weighted portfolios quite heavily that direction. Despite what turned out to be a decent year for the stock market, the bond positions did substantially better for the year, some even doubling the stock market. We continue to see value in corporate bonds, several foreign markets and technology stocks. While not as cheap as they were a year ago, they still offer good yields or the prospect of further growth during 2010. As always, we are monitoring the changing economic landscape and will strategically adjust your portfolio as warranted.

To Roth, or Not to Roth: That is the Question

2009-11-23T06:10:00.000-08:00

The Beatles’ George Harrison wrote these famous lyrics in “The Taxman” when he realized his earnings were pushing him into the 95% tax bracket in England:

Should 5% appear too small, be thankful I don’t take it all,
‘Cause I’m the taxman, yeah, I’m the taxman.

It may sound far-fetched today, but it was not too long ago, and I believe much higher taxes are coming sooner than any of us wish to believe. During the “Roaring 20’s” taxes were in the 25% range for top earners. Due to lower tax receipts at the onset of the Great Depression, our Congress increased the tax rate in 1932 to 63%, and then steadily pushed it up to 91% by 1963. It was still has high as 70% in 1980, before President Reagan slashed it down to 28%. With today’s top tax rate near 40%, and government budget deficits soaring, we are likely to experience a wave of new taxes and deduction limits.

Over the past 40 years as tax rates have fallen, it has been better to stash money into a retirement account during high tax years, and then withdraw the money at lower tax rates many years later. This 40 year trend is about to swing in the opposite direction, making the misunderstood Roth IRA your best tax friend.

What we don’t Understand, we Avoid
Most articles written about Roth IRAs are filled with complicated tax jargon – sometimes trying to be technically precise, but more often in an attempt to impress the reader. Either way, the information is too complicated and boring, making it virtually useless. While the actual tax rules are complicated, and include many deadlines, amounts, limits, and exceptions, the essence of the rules are very simple. What you need to know is…if, why and how a Roth IRA is to your advantage.

Why Me?
1. Age: The younger you are, the more a Roth is a great retirement tool for you.
2. Wealth: The more likely you are to leave some of your IRA to your heirs, the more a Roth is a great estate planning tool for you and your heirs.

Why Now?
1. Never before available to those earning over $100,000
2. Pay the tax at today’s lower rate
3. Advantageous IRS rules only available for 2010

Why Care?
1. Tax-free withdrawals
2. Lower estate tax
3. More spendable income
4. Lower tax on Social Security
5. No required withdrawals

What’s an IRA?
I imagine you have heard the term, but what is it? It actually stands for Individual Retirement Arrangement, of which there are several types, but the Individual Retirement Account is the most common since its creation in 1975. Money contributed to an IRA is tax deductible, it grows inside the IRA over the years with no taxes due on the increasing value, and then tax is due on each withdrawal. To avoid confusion, many people now use the term “Traditional IRA” to avoid confusion with a Roth IRA. I should note that 401(k), 403(b), SEP, Simple IRA, Profit Sharing Plan, etc., all work similarly to an IRA.

What’s A Roth?
Created in 1997, the Roth IRA works differently than a Traditional IRA when money is contributed or withdrawn. Money contributed to a Roth is not tax deductible, it still grows inside the Roth with no taxes due on the increasing value, but no tax is ever due on withdrawals. In the long-run, Roths are better than IRAs in generating more spendable income, because the taxes are paid early and then never again. This allows the power of compounding returns to work their long-run magic for younger savers and older, wealthier investors leaving money to their younger heirs.

What’s A Conversion?
Roths can be very beneficial, and since so many people already had money in IRAs and the like, the IRS created a process to convert IRAs into Roths if desired. Thus, a Roth Conversion allows you to convert some or all of your IRA into a Roth and pay the tax on the converted amount now, resulting in no future taxes.

A Break for the Wealthy…Really?
Yes, but only because Uncle Sam is desperate! Prior to 2010, the only people who could have a Roth were those making under $100,000 per year. Why? Because the government realized that Roths allow you to pay some tax now, versus lots more tax over the decades ahead, which is better for you and worse for them. Therefore, Congress initially decided to limit the number of people who could have a Roth in order to maximize the amount of taxes paid over the years. However, with our government’s budget out of control, Congress has decided to let you win in the long-run. They are willing to take less of your money if they can have some of it right now. Furthermore, a Roth Conversion makes even more sense with current tax rates being relatively low and likely moving much higher – you will be paying at today’s lower rates, and never again!

Beginning in 2010, two things change. First, everyone can now convert. Second, to sweeten the deal and entice more people to convert in 2010, you can elect to pay the tax due in 2011 and 2012. If you believe your tax rates will be higher in those years, you can still pay all the tax in 2010.

What’s A Recharacterization?
Sorry! I hate to bring up another term (especially this ominous sounding one), but it is important since it provides you an easy out and some great tax and investment planning opportunities. Put simply, a recharacterization reverses a conversion. Thus, if you convert your IRA to a Roth, and later need or want to move some or all of the money back to your IRA, you perform a recharacterization.

One useful strategy for recharacterization is if you convert and the Roth later drops in value. Unfortunately, you paid tax on the higher converted amount. Amazingly, the IRS allows you to pretend that you never converted. By recharacterizing your Roth back to an IRA, you get your taxes back. Then, if desired, you can again convert to a Roth, but at the lower value and pay less tax, keeping the difference. This is just one of many great strategies that use this tax provision to your advantage.

Conclusion
The IRA & Roth pool of required knowledge is deep and wide with new rules being added almost weekly. A great resource is www.irahelp.com. There are so many great planning opportunities, but an advisor must expertly apply the rules to benefit your personal situation.

1. 2010’s new Roth rules provide a unique planning opportunity that should not be ignored.
2. If your retirement account values are lower now than they were last year, then conversion or recharacterization strategies could improve your long-term results.
3. Roth Conversion or Recharacterization strategies involve investment, tax and estate planning considerations. It is important to work with an advisor that understands the interplay of these three areas and who will concisely analyze and simply explain to you how you would benefit.

The bottom line is…IRAs are tax deductible, then merely tax deferred, whereas Roths are not tax deductible, but tax-free for you and your heirs. Roth IRAs are a very powerful retirement and estate planning tool and 2010’s new tax rules are exciting. With increasing income tax rates on the horizon, it’s time to seriously consider a Roth Conversion.

NOTE: This material provided for general and educational purposes only, and is not legal, tax or investment advice. For each strategy or option mentioned, there are detailed tax rules that must be followed.

This Article appeared in the Jan/Feb 2010 issue of Westlake Malibu Magazine

Insuring Yourselves Before Disaster Strikes

2009-10-22T07:52:00.000-07:00

There have always been risks, and Lloyd’s of London began insuring them in 1688. They’ll provide coverage for just about anything under the sun from body parts, to voices, natural disasters, and even kidnappings by aliens. Celebrity leg insurance is one of the more well-known policies, starting in 1940 with Betty Grable purchasing $1 million of coverage to our modern day David Beckham, with a reported $70 million policy.

Most people, however, lead much more normal lives and merely carry homeowners and auto policies. These types of insurance are package policies, meaning that they cover both damage to your property and your liability should you or members of your family injure or cause property damage to someone else. The next most common type of insurance for Southern California residents is earthquake. This insurance is easily available and regulated by the state of California. Another common form of insurance coverage is an umbrella policy. This coverage is often overlooked, because it requires that you maximize your home and auto coverage before it can be purchased. It is quite inexpensive, however, and I highly recommend that you talk to your insurance agent about its benefits.

Most people’s awareness and exposure to insurance ends right there. However, there is a nearly endless array of specialty policies available. Let’s look at a few that are typical for this local area and its demographics.

Wildfire

While insurance policies are known for the clever exclusions, fire is one of the most basic areas of coverage and included in most standard home, renter, business and auto policies. Where people come up short on their coverage is failing to account for code changes, your renovations or add-ons, or today’s higher building costs. It is also important to have coverage for the contents of your home at replacement value. For example, if your old computer is worth $100, your current policy might not cover the $1,000 to replace it, but merely cover the $100 current value. Also, make sure your policy covers your landscaping and the extra cost of living in an hotel and eating out while your house is being rebuilt. One of the areas not covered is the land value. If a neighborhood is ravaged by a fire and the property values drop because of the extensive damage, homeowners are not covered for this loss in value. To secure the highest reimbursement, it is a good idea to video-record your home and all its internal contents. Store this in your safe deposit box or remote office (not at a neighbor's) in case you need to prove your claim.

Mudslides

While most Americans only read about mudslides, we Californians need to seriously consider them. With homes often built on, or near, hillsides and the combination of wildfires and El Nino, we need to be mindful of the risk. The standard homeowners policy does not cover flood, mudslides and landslides. If you desire such insurance you generally must purchase it through the federal government’s FEMA program. Further, you can’t just pick up the phone and secure the coverage. It takes time to purchase, and there is usually a waiting period until the coverage begins – so plan ahead.

Vintage Wines

If your wine is covered solely by a traditional homeowners policy, you may be surprised by the meager coverage. Further, if your wine is stored away from your home, your coverage may be even more limited. To obtain full value coverage for fire, theft, earthquake, breakage, water damage, and more, you generally need a special policy. Many specialty policies even cover accidental dropage or unauthorized consumption.

Aviation

Owners and operators of an aircraft both share liability. It is generally the aircraft operator that obtains the insurance policy. Most owners require that the insurer have an “A” rating or better from A.M. Best. Further, the owner should review the policy, making certain that it covers their key areas of liability. A last important step for the owner is to make sure to periodically request a certificate of insurance to make certain insurance is in place and evidencing that the necessary protections are in place.

Bloodstock

High value horses have problems all their own and specialized insurance is available to cover their risks. The main risk is generally mortality – the animal dies due to accident, illness, or disease. However, theft and loss of use are also typical. Since many of these animals are transported around the world for shows, races, or breeding, transportation coverage is also common. Additional coverage can be purchased for stallion infertility, broodmare barrenness, and even the unborn foal.

Directors

Most businesses and non-profits have insurance that covers their risks, but many fail to provide adequate coverage to those who serve on their boards. While most companies do provide traditional Directors & Officers insurance, it may not be enough in today’s litigious world. Independent directors and board members should consider additional personal coverage designed specifically to protect their personal assets.

Fine Art

Collections can range from paintings to antique weapons to taxidermy. Specialty insurance can be obtained to cover your personal fine art or collectibles. Additional coverage is available for any portion of your collection that may be part of an exhibition or on loan to a museum. Many insurance companies are even happy to send a specialist to evaluate and suggest better ways to protect your fine art from theft, fire, water or light damage.

Kidnap and Ransom

The U.S. Department of Justice states that there are over 1 million cases of forcible entry of residences, almost 1.5 million stalking cases, over 50,000 carjackings, and between 3,000 and 5,000 cases of non-family-related abductions that take place annually. The average cost of a carjacking, stalking or home invasion is $38,000, yet ransom demands can run into the millions. Several insurance companies offer policies that address all of these threats. Kidnapping is a billion-dollar industry around the world, frequently run by well-trained teams. Some policies not only cover the ransom cost, but also provide an experienced response team to work with you for the safe return of your loved one. Americans traveling overseas, especially in eastern Europe and Latin America, are often preferred targets. Demands as high as $20 million are not uncommon, but ransom settlements are often 10-20% of the demand.

So while you may not be one of the 40,000 people who have purchased alien abduction insurance (you’ll need to pass a polygraph, have photographic evidence, and a witness to collect the money), I’m sure there are areas of risk exposure in your life for which you should consider additional or specialty coverage.

Robert J. Katch is the founder of Manchester Financial, an Investment Counsel/Wealth Management firm located in Westlake Village. For more information call 805 495 4405

This Article appeared in the Nov/Dec 2009 issue of Westlake Malibu Magazine.

Client Update -- September 30, 2009

2009-09-30T09:11:00.000-07:00

The New Gold Rush!

California was the home of the original gold rush in 1849 and Wall Street is now the cause for the new gold rush in 2009. The first rush was fueled by greed after the discovery of gold, providing opportunity to improve one’s lot in life. This new gold rush is being fueled by fear that our lot in life will diminish unless we own gold. This fear is rooted in the hundreds of billions of dollars being printed by our treasury and thereby putting our currency at risk.

How did we get into this mess? Contrary to media reports, capitalism has not failed us. No other political/economic system has ever produced so much freedom and opportunity while improving the standard of living for so many people. The terrible economic crisis that hit us in 2008 has crippled the reputation of capitalism, even though the crisis was caused by our government’s actions. We all know that printing too much money is not a good thing, but our government did it anyway starting at Y2K with concerns about our economy and the new century. This led to the tech stock boom, and during the subsequent bust our government created even more money to save us again. This led to the housing boom (the money has to go somewhere!), and now we’ve just gone through our second bust this decade. How has our government decided to fix this one? By giving the addict more drugs!

History does not repeat itself, but it rhymes. Had the Federal Reserve not created so much money and kept interest rates so low twice this decade, this current crisis would not have been able to develop. All that money needed a home, and it eventually found one in home prices. For capitalism, this is merely the failure to handle all the money that government recklessly created. The three largest economic disasters—the 1930’s Great Depression, the 1970’s Great Inflation, and the 2000’s Great Recession—were all caused by government economic policy mistakes, but played out in the capital markets, and thus capitalism undeservedly received the media’s blame and the public’s scorn.

All of this begs the question, what works well in a world of falling dollar value and uncertain economic times? First and foremost is protection in the form of assets that should retain their value and even profit in this environment: foreign government bonds, commodities such as gold along with other natural resources, and higher growth areas like technology. Areas that may seem safe but could lose value include US treasuries and utilities. Second is vigilance. Most advisors won’t admit it, but the days of buy and hold are over. As we’ve always done for you, we will constantly watch over your portfolios, making strategic changes in investments as conditions warrant. Opportunities present themselves every day, but so do threats. It is just as irrational to believe that every investment opportunity is bad, as it is impractical to think that there is not risk in them.

We will continue to find investments where we can reasonably assess the risks in this dynamic and ever changing environment. Please call if you have any questions about your portfolio.

Market Update

2009-08-22T12:21:00.000-07:00

Stock markets around the world have rallied strong from their March lows, retracing about one-half of their losses. While this is better than the alternative, it is also very typical of a bear market rally, so it does not necessarily mean we're out of the woods.

One year ago, the most adamant bears were predicting the S&P would sink to 1,000 and it dipped into the 600's. Six months ago, the most adamant bulls were predicting a rally to 1,000, and now we're there! Just as it overshot on the downside, it may overshoot to the upside, with the reasonable answer somewhere in between.

Looking in the rear-view mirror, let's assume first that the March lows were too low and merely the final panic sell-off created by the economic meltdown last year, and second that the market is now fairly priced for our current economic circumstances. If this is the case, then the market will only make progress from here if our economy makes true progress going forward. However, since our economy is at the epicenter of the world's troubles, it has many more economic issues to work through before solid results are consistently achieved.

Thus we are also looking elsewhere for opportunities. While other stock markets around the world sold off along with us during the panic stages, they do not face our troubles going forward and may offer better returns. Economies such as India, Brazil and Turkey to name a few, are experiencing internal growth and favorable economic and demographic trends that will allow them to prosper even as America suffers through some tough times. We expect to add incremental exposure to such overseas markets as their conditions continue to improve.

Overall, we would continue to characterize our outlook not as optimistic or pessimistic, but merely opportunistic. Our economy is in uncharted territory. While we hope for the good times to return, we must be ready for some difficult times as well and try to take advantage of what develops along the way. Thus far, our theme of getting paid (i.e. owning more bonds than usual) while we wait for the recovery is working quite nicely, and we do not expect substantial changes in the near term. In fact, several bond market indices have more than doubled the stock market indices this year.

We continue to monitor the economic landscape to assess a prudent path through these difficult times.

Client Update – July 15, 2009

2009-07-15T14:45:00.000-07:00

Our current view is more cautious than optimistic. Because the drop-off was so severe, there is certainly a likely case for a short-term recovery. However, the unwillingness of lenders to take on even typical risks will throw a road block in front of any potential recovery. So, where does that leave us? Probably with an economic and financial roller coaster for the next several years! A sustained vibrant economic expansion needs free-flowing credit. Until that occurs, the odds favor a sub-par recovery. The massive amount of credit taken on by consumers this decade needs to be unwound at the very time that banks already have too many loans on their books and are in no hurry to boost lending – especially given the rising trend in delinquency rates. The Fed has boosted excess reserves in the banking system, but banks are not using this to increase lending – they would rather hoard the cash and safely make money for themselves and not take the risk of lending it to others.

The initial stock market enthusiasm this Spring seems to be giving way to more realism. Historically, deep recessions are followed by strong recoveries. The thought is that with higher corporate growth rates, both profits and equity prices will rise. However, this financial crisis is far from typical, and we can not safely rely on past cycles to predict how this will turn out. Could stocks surprise on the upside in the coming year? Of course they could! Since there is still a lot of cash on the sidelines, earning virtually nothing, those investors are under the pressure to raise their stock exposure. Further, the economy could rebound more strongly than generally expected. Although these outcomes are all possible, we give them a lower probability and are staying with a strategy that places a higher weight on capital preservation than normal.

The viciousness of this economic and financial meltdown has frayed nerves, and left many investors deeply skeptical about the timing, strength and sustainability of a recovery. These concerns are justified since lurking just over the horizon is the threat of another economic/financial crisis—inflation. We do not believe the government will be able to remove the current extreme stimulus (see chart) in a timely and controlled manner without creating a devaluation of the dollar and consequentially higher inflation. The market dysfunction has, and will continue to create opportunities at the stock- and bond-picking level. This has helped many of our active equity and fixed income managers generate high levels of outperformance during this recent period.

As is often the case, thoughtful, active management is experiencing a period of outperformance. What is encouraging is the evidence that these periods can last several years when following a time of market dysfunction. Data and manager feedback suggests that valuation discrepancies still remain and that it should continue to be a good environment for our management philosophy for some time.

To conclude, the financial nature of this cycle will have lasting repercussions and it will be a difficult climb back to any semblance of normality. The outlook is highly uncertain, and that argues against taking on too much exposure to stocks. Therefore, our preference is to remain focused on the varied opportunities we continue to find in the fixed-income markets around the world. We are working diligently to continue to find great opportunities amongst the markets’ wreckage.

Real Estate Moves

2009-06-10T13:42:00.000-07:00

Six months ago, the real estate market appeared mortally wounded. Today, however, many sellers are receiving multiple offers on their homes; lower prices make this a great time to be a buyer or get your property taxes reduced; and low interest rates make this an ideal time to lock into a great long-term mortgage. Whether you’re an owner, buyer or seller, there are several factors to keep tabs on in today’s rapidly changing local real estate market.

Property Tax Reduction
If you own real estate, this may be the easiest time ever to obtain a property tax reduction. If the market value of your property (residential or commercial) is less than the property tax assessment value, then you may be able to reduce your property taxes. The closer to the top of the market you purchased, the greater your savings could be. Properties are valued by the county assessor every January 1 and the reduction filing period runs from July 2 to November 30 based on that value. You will need evidence to support your proposed valuation, but you may only use sales price data prior to March 31 to refute the Assessor’s January 1 value.

Your appeal can be submitted in two ways: via an application for a formal hearing or via a mail-in appeal. If you live in a neighborhood with similar homes, the sales price data is usually easy to compute and a mail-in appeal is generally sufficient. However, the more custom your home or location, or if the property is commercial, a successful appeal can be more difficult, but also more significant. Currently, due to the large number of appeals, it may take 6 or more months to secure a hearing date, and you’d better come prepared. At the hearing, you’ll be up against the Assessor’s office, and it will be your data versus their data. In this type of situation, I highly recommend using a professional service to represent you. However, be wary of the many scams that are surfacing requiring upfront payments followed by little or no work to obtain your property tax reduction.

It’s a Lender’s Market
Most real estate cycles are described as either being a “seller’s” or “buyer’s” market depending on whether prices are rising or falling and who is in control of the transaction. Today’s environment, however, is neither…it’s a lender’s market, because more than at any time in the past 50 years, it’s tough to get a mortgage. It’s more difficult to secure a mortgage now because of all of the cumulative abuses of recent years. The pendulum has swung the other direction—likely too far—and it will eventually swing back. However, most all the current problems would have been avoided had we just honored some simple lending requirements: Everybody should have to put 20% down and use either a 15- or 30-year fixed mortgage with reasonable and verified debt-to-income ratios. To secure any other type of alternative mortgage, the buyer should have a higher credit score and better debt-to-income ratios than those necessary for a traditional mortgage. But this is not the world we live in so many mortgage options are available, even to those who shouldn’t use them.

George Savile, a 17th century English statesman, once said “A prince who will not undergo the difficulty of understanding must undergo the danger of trusting.” Americans have become too trusting of their mortgages. To understand the various types of mortgages and when to use them is not rocket science, but it takes some time and is best done in context with your own personal situation. What tends to happen is the buyer goes out and finds a house they want. They then use a lender (who is generally not financially savvy and does not know enough about the buyer’s personal financial situation and goals) to find a loan that allows them to qualify to purchase the house. However, just because the buyer can “qualify” doesn’t mean it’s the wise thing to do! Caveat Emptor—this famous Latin phrase meaning buyer beware—applies all too well to mortgages. What has generally been necessary to make the numbers work are alternative mortgage products such as ARMs, Convertible ARMs, Option ARMs, Interest-Only, etc. While these alternative mortgages often make it easier to qualify for a loan, they can lead to unaffordably high future payments.

Fixed or Adjustable?
I must admit that I’ve never been a fan of adjustable mortgages. My business partner, on the other hand, has been very successful over the years just using adjustables, but he works at it and his timing has been good. However, we have been in a period of generally falling interest rates for the past 25 years so it has been easier to refinance at better rates every few years. While this has worked for both fixed and adjustable mortgages, it has been really good for adjustables. At some point the trend will reverse and it will be difficult to impossible to pull off what has been so easy in the past. Going forward, fixed rate mortgages may well be the better way to go.

If you already own your home, now is a great time to refinance and get rid of that adjustable loan and lock into great long-term fixed financing. If you are looking to buy, begin working with a lender before making an offer so that you understand your financing options. Currently, the fixed mortgage market is split into two camps. First, for larger loans over $1,000,000 your best place to start is a large institutional lender where jumbo, fixed rate loans are available. Second, for loans under $750,000, a good place to start is with an independent mortgage broker. If your loan amount is in between, you may need shop between the two in order to determine the best source.

Time to Buy?
History doesn’t repeat itself, but it does rhyme. So, I believe it will be helpful to look at the last LA/Ventura County housing bubble to gain some insight on the current situation. The last bubble started in 1985 and ended in 1989, with prices rising about 40% over 4 years. It then took almost 6 years (1995) to bottom at 1985 prices and another 3 years (1998) before it began to move back up. That’s 9 years from the market top to the point where we could feel the market moving up again. This current bubble started in 1998 and rose steadily through 2001, where it reached the previous 1989 peak, and then rose very sharply through 2005, with prices going up 125% over 7 years. Prices have been much quicker to drop this time, already falling back to 2001 levels in many areas by December 2008. Prices would still need to fall another 25% to reach the previous lows of 1985 and 1995.

Recent data still shows home prices continuing to decline, but the volume of home sales is finally on the upswing. A stabilizing of consumer confidence; government programs slowing foreclosures, providing tax credits, and modifying loans; along with record low interest rates (with government help) have all worked together to bring buyers back to the market. However, given the strength of this recession, and the fact that real estate markets don’t turn on a dime, we’re still likely to see more price declines, mixed in with several years of leveling off before prices eventually gain traction and begin to rise again. Further, all of the current government programs will be hard to sustain, creating more downward pressure on prices as these programs are terminated or modified. It may be 3-5 years before we see a more normal real estate market.

So, is it time to buy? In my opinion, only if you plan to keep the house for 5 or more years and you can get a 15- or 30-year fixed mortgage, then it may be a good time to buy. Interest rates will likely be higher in the future, so now is not a great time to use adjustable mortgages hoping to refinance at better rates in the future. A year from now, prices may be lower, but rates may be higher, and we could easily find ourselves just half way through a long, drawn-out recovery period. You won’t miss a big recovery by waiting a year or two, but you might miss out on an incredible foreclosure deal, your perfect dream home at a reasonable price, or historically low mortgage rates. So, be a selective buyer and use a traditional fixed mortgage to protect yourself.

Next Steps
Now is a great time to lock in great long-term financing or reduce your property taxes. Given current lending conditions, certain lenders are better for jumbo loans and others for conforming loans. My office maintains a list of trustworthy and skilled professionals who have been successful in helping our clients in today’s real estate environment. Please call if you would like a confidential referral.

Seven Steps to an Affordable College Experience

2009-05-24T16:10:00.000-07:00

Find the school that’s truly a “best fit” for you, and the school will find more ways to make it affordable. Most students, however, go about the process backwards. With all the focus on getting in, few focus on getting out without significant debt. First, they find the school they want to attend, and then their parents scramble to find a way to pay once they’re admitted and offered limited financial help.

The good news for affluent and middle-class families, especially those that have not set aside enough money for college, is that those who receive the most financial aid are not always the ones that need it. Even if you have a large income, or have significant assets, there are many ways to cut college costs if you know the steps to take.

Qualify for Quality Aid
There are two types of financial aid: need-based and non-need-based. Even if you do not qualify for need-based aid at a less expensive school, you may qualify for it at a more expensive school. For example, if you’re expected to pay $20,000, and a state school costs $15,000, you might be expected to foot the entire bill. However, at a private school costing $45,000, you might qualify for $25,000 in need-based aid.

Furthermore, even if you don’t qualify for any need-based aid, many schools offer great non-need-based aid including grants, scholarships, tuition discounts, and merit money. To keep things simple, we’ll call all of these forms of free money “grants.” However, regardless of your financial situation, every student needs to complete a FAFSA (Free Application for Federal Student Aid) to be considered for both need- and non-need-based aid.

Step 1: Go to FAFSA4caster.ed.gov and click on “Begin Now” in the “Use the FAFSA4caster B” box to estimate your Expected Family Contribution (EFC).

Begin with the End in Mind
A successful approach is to target schools where you will be a best-fit student. To be a best-fit student, you should be in the top one-third of their freshman class, possess the characteristics and qualifications that make you the type of student they are looking for, and exemplify the school’s mission. A little known bonanza of detailed information known as the Common Data Set is a goldmine of admission and financial aid information.

Step 2: Using Google, type in the college name and “common data set” and find Part C to analyze the school’s stated admission criteria, including GPA and SAT statistics. Also, view Part F2 to locate programs and activities in which you participate. Finally, review the school’s mission statement. Does it resonate with you? Focus on those schools that are a best fit for you.

Four on the Floor
One of the biggest ways to cut the total cost of a college education is to graduate in 4 years. You’d be surprised at how difficult that can be at many schools. Few schools advertise their 4-year graduation rates, and many schools’ published rates are actually 6-year numbers. The average 4-year graduation rate for all colleges and universities is only 40%, versus 60% in 6 years. Private universities’ average 4-year graduation rates are 70%, versus 30% for public universities.

Step 3: Go to www.CollegeResults.org/search_basic.aspx and select the school, then click on the “vital statistics” link to see 4 to 6 year graduation rates for your best-fit schools.

Get the Grant
For most students, admission to a respectable college where they will thrive both academically and personally is not the real problem, it’s affordability. Many schools tout that they meet 75-100% of students’ financial need, but when you dig deeper you’ll often find that the need is met with loans. This could leave a graduating student saddled with significant debt. Therefore, your search should focus on schools that provide the largest portion of their financial aid in grants, not loans. You also want to verify that the school does a good job in continuing to provide grants during years 2-4.

Step 4: Use the Common Data Set, Part H, for each of your best-fit schools to analyze its total financial aid package. To find the average grant dollars go to Part H2 line (k) for need-based or line (o) for non-need-based students. Further, line (e) and line (n) tell how many need- or non-need-based students received grants, respectively. With a little basic math, you can glean valuable insight into how each school awards financial aid. Then, further focus on those best-fit schools that offer the amount and type of aid you’ll need.

Dollars for Diversity
Admissions officers are all striving for diversity. The term means something slightly different to each college, but regardless, it can be used to your advantage. For example, most engineering and technical colleges are male dominated, so they are looking for more female students; and most schools are filled with in-state students, so they are looking for students from far-away states. Find the schools that want, but lack students like you, and they’ll find you more grant money.

Step 5: Use the application, admission, and enrollment numbers found in the Common Data Set, Part B2, C1, C7, and F2 to your favor by applying to schools that are looking for students like you. Further, apply to distant schools (Common Data Set, Part F1) who will be excited to receive an application from outside their region.

Application Angles
Aside from the proper completion of the application, it is helpful to apply early, visit the schools if possible, and stay politely in contact with them so they know you’re interested. In addition, there are a few more subtle steps that can increase your financial aid. If you are truly a best-fit for the school, they will not want to lose you to a competitor, especially one in their region. Therefore, consider applying to a known rival school where you’d also be a best fit, and to a reputable, in-state public school where they know you could attend for less. How will they know where else you applied? You filled out the FAFSA in Step 1 and listed the schools you wanted it sent to!

Step 6: Go to CollegeBoard.com, select your best-fit schools and use the “Find Similar” tab to locate at least one nearby rival school for each of your best-fit schools and apply to them as well. Respectfully mention the competing schools when discussing your financial aid package with your preferred schools.

Funding Fears
Most parents overestimate how savings, retirement, and 529 accounts will cost them financial aid. FAFSA doesn’t even ask about home equity, retirement accounts, or a non-custodial parent’s assets to determine need-based aid. Parental assets, including 529 accounts, only reduce need-based aid by 6% of their value. Parents also underestimate how much flexibility many schools have in awarding grants to their best-fit students, especially if the family’s financial situation has changed. Admissions officers can be very accommodating when they feel they are dealing with reasonable people.

Step 7: Use 529 plans to save for college and convert traditional custodial accounts (UGMA & UTMA) to 529s. Calmly appeal the financial aid package you’ve been awarded. Don’t treat the discussion as a heated negotiation and don’t oversell the student – admissions officers have seen and heard it all before. Be specific as to the number you’d need to make it work, mention any situation they could empathize with, and offer documentation to support your case.

Competition among students and schools has created a focus on admission to schools with big brand names and impressive rankings. However, if you’re not a best fit for one of these schools, your financial aid package will likely be miserly. Instead, increase your odds of receiving the financial aid you need by following these seven steps to an affordable college experience.

Client Update – April 15, 2009

2009-04-15T11:42:00.000-07:00

Cashing In on Closed-Ends: The first three months of this year saw the seventh consecutive quarterly loss for the major stock market averages. From 2009’s peak to trough (January 6 to March 9), the stock market dropped nearly 30%. However, amidst the continued carnage, there exist some very interesting securities. These securities are very misunderstood and this allows a patient and careful investor to take advantage of the current environment. What makes them a real value is that their higher volatility is due to other peoples’ fear and panic and not reality. When you understand how they work you will be more comfortable with the volatility and realize how profitable these securities can be, when purchased as others panic.

They are unusual, so stick with me and I believe I can explain them. First, on Monday, March 9, 2008, the stock market was down nearly 4%. One of these misunderstood securities, Eaton Vance Limited Duration Income (symbol EVV), was also down 3% in price. However the actual value of this security increased by 0.2%. Further, from February 1 to March 9, EVV’s price fell 20%, but its value fell only 4%. So, while the stock market may move its price around, its true value is much more stable. How can this be?

A little history is in order! At this point my kid’s eyes usually glaze over, but please stick with me. This type of security is called a closed-end company and there are many hundreds of them. They’ve been around since 1822 when King William I of the Netherlands first authorized and used the concept. They are the predecessor to today’s mutual fund, which were created in 1924 in response to a “flaw” these securities have; a “flaw” that can be exploited. Where mutual funds only price at the end of the day and everybody gets in and out at the same price, closed-end companies are traded all day long at varying prices. So they are basically mutual funds that trade on the stock market, or to think of it in other terms, a stock/company whose sole business is managing a portfolio for its shareholders. There is an important difference (as noted above): Closed-end company stock prices can move differently than the true value of the portfolio they manage for you. This perceived “flaw” led to the creation and popularity of mutual funds and their pricing fairness. However, the “flaw” can be used to your advantage when there is sufficient fear in the market.

Both mutual funds and closed-end companies have a Net Asset Value (NAV) which is their true value and a market price they trade at. The NAV is the value of the stocks or bonds that the fund holds. Where a mutual fund’s NAV (value) and price are always the same, only a closed-end company has a price that can be different from its NAV (value). Thus, while EVV’s portfolio of notes and bonds fell only 4% (from $11.77 to $11.30 due to panic and mass selling around the world in early March), your fellow investors were in full panic mode and selling everything they could, driving its price down 20% in a few short weeks.

So, while most investors were reacting to its 20% price drop, we were comfortable with EVV’s 4% value drop and felt certain it would correct quickly. By March 31, EVV’s value was up 5% (from $11.30 to $11.87), recouping all its drop incurred during the 30% market sell off, and its price was up 17%, almost recouping all its 20% drop. But, we care more about its value for gauging safety and real progress. For the first quarter of 2009, EVV’s value was up 7% while the stock market was down about 15%. Did I mention that it pays 1% per month in dividends? So, EVV’s year to date return was actually 10%, based on value. Based on price, the return was about 9%, but with more volatility, which I’m suggesting you ignore as long as the value is holding up.

I have attached a chart that shows its movements since December 31, 2008. Please use the left scale in dollars for Value and Price and the right scale in percent for the Discount. You can see the green Value line has remained quite steady. If EVV were a mutual fund, its NAV (the green Value line) would have made it a steady performer in the recent 30% sell-off. In contrast, the blue Price line has moved quite a lot. The yellow Discount line tracks the difference between the Value and Price. For example, at March 9, EVV’s value was $11.30 per share, but you could buy it for $8.89 per share, a 21% discount. That’s nothing but fear!

On top of that, I should explain how we can find a bond portfolio yielding over 12% per year. Well, it was a bond portfolio yielding about 8% last August that has fallen 25% in value from roughly $16.00 to $11.87 and its price dropped even further to $10.51, causing its yield to go from 8% to 12%. Thus, EVV’s income producing securities are trading at a 25% discount to their maturity value, and you are able to buy the fund itself at a discount. A discount on a discount and 12% per year in dividends while waiting for it to go back up could be a good thing. We just need to tolerate the price volatility (while we closely monitor the value) to be sure this gem continues making real progress.

EVV is just one example and over the coming months we plan to continue researching and acquiring other deeply discounted closed-end securities as opportunities arise. Thank you for your patience and I hope this helps you understand more about the unusual opportunities available in this confusing market environment.

Client Update – April 2, 2009

2009-04-02T13:09:00.000-07:00

Why today may have been significant to our economic future! We would like to share with you an article written by Steve Forbes, Editor and Chief of Forbes magazine. Mr. Forbes writes about the unnecessary regulations and new accounting rules that have brought on many of the problems surrounding our financial crisis: In particular he discusses the so called “mark-to-market” accounting rules that make companies and banks recognize prices for assets that are not realistic but have a profound impact on our financial system. This rule has forced many whose operations are profitable to appear as if they are losing money or insolvent. To the credit of this administration, this rule was greatly changed yesterday, and the stock markets around the world have reacted by going up significantly.

Although many good financial lessons were learned during the Great Depression, unfortunately many of the laws passed at the time to stabilize our financial system have been undone in the past few years: mark-to-market accounting, short sale uptick rule, naked shorting, and the Glass-Stegall Act to name just a few. This article was written about a month ago and he clearly lays out the problems being caused by mark-to-market accounting. Our hope is that it will help you understand the benefits of changing the rules back to where they had been. We don’t need more regulation, we just need to go back to what has worked fairly well for the last 70 years. Here’s the article:

By STEVE FORBES
What is most astounding about President Barack Obama's radical economic recovery program isn't its breadth, but its continuation of the most destructive policies of the Bush administration. These Bush policies were in themselves repudiations of Franklin Delano Roosevelt, Mr. Obama's hero.
The most disastrous Bush policy that Mr. Obama is perpetuating is mark-to-market or "fair value" accounting for banks, insurance companies and other financial institutions. The idea seems harmless: Financial institutions should adjust their balance sheets and their capital accounts when the market value of the financial assets they hold goes up or down.
That works when you have very liquid securities, such as Treasury bonds, or the common stock of IBM or GE. But when the credit crisis hit in 2007, there was no market for subprime securities and other suspect assets. Yet regulators and auditors kept pressing banks and other financial firms to knock down the book value of this paper, even in cases where these obligations were being fully serviced in the payment of principal and interest. Thus, under mark-to-market, even non-suspect assets are being artificially knocked down in value for regulatory capital (the amount of capital required by regulators for industries like banks and life insurance).
Banks and life insurance companies that have positive cash flows now find themselves in a death spiral. Of the more than $700 billion that financial institutions have written off, almost all of it has been book write-downs, not actual cash losses. When banks or insurers write down the value of their assets they have to get new capital. And the need for new capital is a signal to ratings agencies that these outfits might deserve a credit-rating reduction.
So although banks have twice the amount of cash on hand that they did a year ago, they lend only under duress, or apply onerous conditions that would warm Tony Soprano's heart. This is because they know that every time they make a loan or an investment there is a risk of a book write-down, even if the loan is unimpaired.
If this rigid mark-to-market accounting had been in effect during the banking trouble in the early 1990s, almost every major commercial bank in the U.S. would have collapsed because of shaky Latin American and commercial real estate loans. We would have had a second Great Depression.
But put aside for a moment the absurdity of trying to price assets in a disrupted or non-existent market, of not distinguishing between distress prices and "normal" prices. Regulatory capital by its definition should take the long view when it comes to valuation; day-to-day fluctuations shouldn't matter. Assets should be kept on the books at the price they were obtained, as long as the assets haven't actually been impaired.
Mark-to-market accounting does just the opposite. When times are good, it artificially boosts banks' capital, thereby encouraging more investing and lending. In a downturn it sets off a devastating deflation.
Mark-to-market accounting is the principal reason why our financial system is in a meltdown. The destructiveness of mark-to-market -- which was in force before the Great Depression -- is why FDR suspended it in 1938. It was unnecessarily destroying banks.
But bad ideas never die. Mark-to-market was resurrected by the Financial Accounting Standards Board and became effective in the fall of 2007 (FASB rule 157) to the approval of the Bush administration, its Treasury Department, and the Securities and Exchange Commission. Even as FASB 157 began to take its toll on financial institutions last year, Mr. Bush refused to kill or suspend it. When Congress voiced displeasure last fall, the administration and regulatory authorities made some cosmetic changes, but the poisonous essence remained.
If the president really takes Roosevelt's legacy seriously, he should suspend mark-to-market accounting rules, restore the uptick rule, and enforce the prohibition against naked short selling. If he doesn't, historians will look back in utter amazement at Mr. Obama's preservation of Mr. Bush's worst economic policies.

Client Update – December 31, 2008

2008-12-31T13:39:00.000-08:00

2008 will likely be the worst investment year that any of us will experience in our lifetime. Stocks had their worst calendar year since 1931. Almost every asset class was in the red for the year, with many deeply underwater, giving investors almost no place to hide. Clearly we are now in the midst of a severe recession with higher unemployment and other discouraging economic news over the next few quarters. Consumers are being forced to adjust to a new reality in which they finally have to pay down debt, increase savings and thus spend less than before.

While it may be that we have seen the market bottom, we can’t be sure. We are prepared for volatile markets and expect that the stock market will continue to experience strong rallies and subsequent sell-offs. These rallies could last for months with sizable returns, followed by sharp pullbacks. We have already seen a stock market rally of 18%, followed by a 25% decline, and a 21% rebound within the last few months. We don’t know if this is what the next few months will look like, but we believe this to be a likely scenario – this is how other severe bear markets have petered out over time. Unfortunately, this grinding process is what keeps most investors’ fear level up and their money on the sidelines and they miss the final real rally when it comes.

However, with a great deal of negativity already priced in the markets, the longer-term return outlook is decent. We believe we will continue to see numerous opportunities created in this highly dislocated environment. There is a mountain of cash sitting on the sidelines. In fact, since the advent of money market funds more than 30 years ago, money market assets relative to total stock market capitalization has never been higher. Some of that cash will find its way back into stocks and bonds soon, especially with returns on CDs and cash so low. Thus, despite the near-term caution, we think the weight of the evidence overwhelmingly suggests that investors, over the next few years, are likely to reap at least satisfactory returns much higher than the 0% to 3% currently offered on money market funds and CDs. Moreover, periods of extreme dislocation usually create opportunities for significant value-added from active management. While the entire stock market does not have to do well, there will be sectors that will do very well. Based on our read of history, as well as data that indicates extensive valuation discrepancies in current stock and bond markets, we believe that the next few years are likely to be good ones for active managers relative to the indexes, such as the S&P 500 or Dow, and certainly superior to CDs or money market funds.

As we look forward from here, starting with beaten-down financial markets and an economy on the ropes, we ask the question we always ask: What expectations are currently reflected in asset class prices? Historical comparisons are sometimes helpful. There have been two extreme economic and investment environments in the last 80 years—the 1930s, and the 1970s/early 1980s. In both periods investor confidence was crushed after lengthy periods during which returns were dismal and because of a continuation of negative headlines. But as it turned out, both periods presented a great opportunity. This may be a similar time. These experiences reflect the tension that investors face—when risk seems greatest it is usually a good time to invest.

Market Update

2008-11-12T06:53:00.000-08:00

Markets are once again testing their lows and every investor’s resolve and patience. Economic conditions in some areas have improved, but in most areas continue to decline. The deterioration in the economy will be increasingly evident over the next few quarters in the unemployment numbers as consumers spend less and corporations lay off workers to offset their lower sales. Last year, unemployment was under 6%, it is currently at 6.5% and continues to rise. We expect it to top 8% before the economy turns around next year.

The massive government stimulus packages will top $1 trillion and likely take 2-3 quarters before the full impact of their economic benefit is felt. However, there are already some signs of improvement. The bond and credit markets have seen the beginning of a reduction in numerous risk spreads. This is an indication that money is beginning to circulate through the economy.

Usually during stock market declines bond prices move higher. However, from the middle of September to the middle of October this was not the case and many investment grade corporate bonds also lost 10% to 30% of their value during the panic selling. In the last several weeks as risk spreads have reduced, the normal relationship is being reestablished and bond prices are holding steady or moving higher even while the stock market declines.

As the overall political, economic and market conditions remain unclear and unstable, we understand that stability is at a premium. Thus, we continue to review the vast securities world for positions that will benefit your portfolio. Our approach is three fold:
1. Hold a majority of the portfolio in very safe securities where the yield is moderate (4% to 6%) and the risk to principal and volatility are very low.
2. Continue to hold only a small portion of the portfolio in the stock market.
3. Staying vigilant by watching the markets and looking for opportunities. We have found many securities that will add great value to the portfolios once the markets are more stable.

Market Update

2008-11-03T14:26:00.000-08:00

There are three problems currently facing the economy and markets. First, too much credit was created for individuals, corporations, and government and it needs to be unwound. Individuals and corporations have begun that process and it will continue for several years. Second, the U.S. economy’s recession began near the start of 2008. Even though government statistics masked its existence, it was evident through common sense observation. Recessions are a natural part of the business cycle and need not be feared. They generally last 12-16 months, causing stock markets returns to be low or slightly negative for a few months and bond prices to rise, offsetting some of the stock market’s return. However, the third factor, the recent credit freeze, has caused a powerful flight from risk pushing virtually all security prices much lower. This, in turn, makes the first two problems worse.

The credit freeze is much like a financial heart attack. It does not matter what other illnesses the patient may have, because they become irrelevant if the heart cannot be restarted. If credit does not flow through the economy’s veins, then business will come to a halt. Every week that conditions were frozen will likely add one month to the patient’s recovery. Thus, we expect that the four weeks from mid-September to mid-October will add four months to our recession, taking us out to mid-2009 before conditions begin to look better. The stock market, however, will anticipate the recovery and begin to move higher before the news media can report improving conditions.

Client Update - October 24, 2008

2008-10-24T17:01:00.000-07:00

Today we are seeing all the markets around the world sell off in historic proportions. Before the US markets even began trading this morning, orders to sell so overwhelmed the New York Stock Exchange that they halted additional sell orders from coming in until the markets opened at 6:30 am. This market activity is being caused by two very different but related events. The primary cause is the worldwide slowdown in economic activity. Secondarily, and more importantly for the next few trading days, forced selling of billions of dollars of assets by hedge funds will whipsaw the markets.

What does this mean? In the near term, the volatility in the markets will continue. We will see more days like this in the future, both on the upside and downside. Critically, the entire stimulus that world governments have put in place has not yet had a chance to work. Starting next week the Fed should begin to deploy the assets authorized through the historic bailout vote. As these assets are actually deployed, and similar stimulus plans are implemented, they will begin to more greatly influence the markets and more importantly the economies of the world.

In addition, we believe there will be an interest rate cut both here and in Europe next week. The world is no longer worried about inflation with oil dropping below $65 a barrel and home prices falling over 30% in many areas. No, the world is worried about deflation -- falling prices, earnings and economic activity. Governments around the world will throw all the money (ours and theirs) at this problem to try to head off a more serious recession than the one that is here now. These steps are in stark contrast to the actions leading to the Great Depression of the 1930’s. At that time, governments raised interest rates and cut off access to credit -- just the opposite of what policy makers are doing today. This printing and spending of money will eventually lead to much higher rates of inflation, but should help prevent a reoccurrence of that time in our history.

We have no doubt that we are in a severe economic slowdown. However, the markets will and are already overshooting to the downside just like they overshot on the upside in 1999-2000. There are many great values and opportunities being established both inside and outside the stock market. As an example, after the market crash of 2002 the bond market had returns of over 10% the next year and high yield bonds returned over 30%, which was more than the S&P 500.

Although we cannot dismiss the significant damage that has been done to markets, economies, and most importantly households, it is most important now not to panic, but instead seek information and make rational, reasonable decisions. We are carefully monitoring the economic and financial situation and will continue to strive to act in your best interest at every turn. Please contact us if you have any questions.

Client Update – October 10, 2008

2008-10-10T14:37:00.000-07:00

A fundamental change to the financial system and the economy took hold in September. First, the bond/credit markets went into cardiac arrest during the month, intensifying mid-month, with limited trading going on, and a near run on money market funds. Bond prices on everything but Treasury securities suffered unusually sizable declines--corporate bonds and municipals were particularly poor performers. The stock market began to realize the impact of the deterioration in the already stressed credit markets and moved sharply lower. Days of wild swings followed as a rescue package was proposed, then stunningly defeated by the House, then resurrected as conditions continued to deteriorate. Even when finally passed, the markets were not impressed.

For awhile now, a capital infusion into the banking system has been needed so that financial institutions can take their losses (there are many more loan losses to come) and recapitalize. It is important that it be a system-wide solution. Action is needed both to address the underlying fundamental problem and to help bring confidence back to the market. A continuation of the extreme dysfunction in the credit markets will further damage the economy, with potentially long-lasting effects, including more financial institution failures and a deep economic downturn. In our view, coordinated action from governments around the globe is the best chance to begin to bring confidence back to the credit markets. Risks would still remain, but those risks would be significantly reduced. It is the credit market not the stock market that is the cornerstone of our economy.

Usually pessimism creates good buying opportunities because psychology comes into play and fear drives prices lower than what the long-term fundamentals suggest is reasonable. Longer term, there are some asset classes that are beginning to intrigue us. Driven by the sell-off in everything but Treasury securities, high-quality mortgage-backed security yields and corporate bond yields now suggest returns in the 6-10% range over the next few years once the credit markets return to normal. These are attractive returns--especially for tax-exempt accounts. High-yield bonds are looking more interesting, but default rates are likely to be very high for some time so investment there is still premature. But that could change quickly as this market is also getting hit hard.

Our current large position in U.S. Treasury Bills is transitional. Once conditions truly improve, we expect to deploy assets quickly into areas of the market offering higher yields and potential appreciation. We see many opportunities but, as of now, it is too early to move. For now, we are holding more in safe U.S. Treasury money market funds than ever before and a drastically reduced exposure to equities.

We would like to leave you with some thoughts that might be helpful in coping with this very challenging time. It’s important to remember that the more dysfunctional the markets get, the more opportunities we’ll have to add value with tactical moves. We are optimistic that the returns we will capture with our disciplined, valuation-driven approach could be quite good, as they were after the last bear market. Finally, know that our only incentive is to try to do what is in your best interest. Your needs, trust and confidence are most important to us and are the primary driver of what we do.

Client Update - September 22, 2008

2008-09-22T15:32:00.000-07:00

In the past several weeks we have had many questions about market conditions and the safety of the money market accounts at the custodians we use. In order to update you, we have enclosed a market update and a report from the custodian for your assets detailing the protection afforded their accounts and money market funds.

To further protect the assets placed under our care, we have substantially all of our clients’ cash in U.S. Treasury money market funds which are the safest available. In contrast, Certificates of Deposit (CDs), that in the past have seemed so safe, are now causing investors much worry as they contemplate the fact that not only may their interest be at risk, their principal might also be in jeopardy if the issuing institution declares bankruptcy.

During the late 1980s and early 1990s almost 1,500 banks across the country went bankrupt. So far this year, only a few dozen banks have followed suit. We expect many more to follow, especially the small to mid-size banks. However, the banking industry will continue to play a vital part in the economic well-being of our country. Many banks are in very good condition, and the banking sector will offer some great investment opportunities going forward. This was confirmed by this morning’s news that Goldman Sachs and Morgan Stanley have applied to the government to become bank holding companies.

In summary, the custodians we use for your accounts are among the very safest in the world (safer than banks, savings & loans, and credit unions). Additionally, the money market funds we use are safer than other financial institutions, their CDs, or savings accounts. By design, we chose to place your funds only with custodians of the highest caliber in preparation for the remote possibility of the events we’ve all seen in recent weeks.

Client Update - September 21, 2008

2008-09-21T09:35:00.000-07:00

While the past year has been full of major-headline financial news, we have experienced a lifetime of it recently and the past week alone has been nothing short of historic:

Sunday – Lehman Brothers, a 158 year old investment bank, declared bankruptcy after being unable to find any other firm around the world to merge with and the U.S. Government declined to help. Seeing the writing on the wall, 94-year-old Merrill Lynch agreed to be purchased by Bank of America for $50 billion (one-half of the company’s market value six months earlier).

Monday – Over the weekend AIG, the largest U.S. based insurance company, had gone to the U.S. Government and requested $20 billion to protect its credit rating, but was denied on Monday. The stock market was down 5%.

Tuesday – AIG was downgraded by credit rating agencies because of its weakening financial condition and plummeting stock price. The fear permeating the stock market now began to spread into the safer areas of the bond market. Usually a safe haven, most areas of the bond market began to drop as investors panic-sold bonds to (1) cover margin calls on their falling stock portfolios, and (2) move their funds into money market accounts. Late in the evening, AIG announced that the Government had provided the $85 billion necessary to boost its credit rating back up to where it had been on Monday prior to the downgrading. Yes, that’s right, what cost $85 billion on Tuesday would have cost $20 billion on Monday! The stock market was up 2%.

Wednesday – The fear permeating the stock and bond markets now began to spread into the very safest and most critical area of our financial system. Several well respected money market accounts announced that they were in jeopardy of principal losses and not being able to guarantee full return of the investors’ money. This caused further panic and selling in both the stock and bond markets. Financial system and economic problems appeared to be worsening and spreading. The stock market was down 5%.

Thursday – Realizing that a Depression-era run on the bank and a complete financial meltdown was at hand, the U.S. Government, after the stock market closed, announced that it would protect $3 trillion in money market accounts using the Exchange Stabilization Fund created in 1934. A mid-day rumor that this might occur and another that a bank bailout package was being discussed caused the stock market to rally late in the day from being down 2% to closing up 4% for the day.

Friday – The Government announced that a broad plan of policies and $700 billion in bailout programs are in the works to shore up our failing financial system. This news and the suspension of short-selling on 799 financial stocks pushed the market up 5% at Friday morning’s open before closing up only 4% for the day.

We have been exceedingly busy over the past weeks and months monitoring the financial markets and your portfolio. We will remain diligent in staying on top of the fast changing events. Thursday, when even money market accounts were in jeopardy, we came very close to moving all accounts substantially to the sidelines. However, due to various government bailout programs, we do not believe that it is best to be all out at this point in time. Nonetheless, we believe a more conservative stance is warranted. When the market recovery occurs there will be plenty of opportunities.

Client Update – July 15, 2008

2008-07-15T13:30:00.000-07:00

The first half of 2008 dramatically reinforced the idea that over the short term the stock market is predictably unpredictable. A sharply negative first quarter was followed by two months of positive returns, but the selloff resumed with a vengeance in June, with the market dropping 8.4% for the month and almost 3% in the second quarter. The phrase "June gloom" is used by residents of the Southern California coast to describe the cold and fog that persists this time of year, and it could also be used to describe investors’ moods as the quarter came to an end. The S&P is now down 12% for the first half of this year, and is about 18% below its October 2007 high. The market offered few places to hide. Mid- and smaller-cap stocks fared better than large in the second quarter, but still got slammed in June and now have high single-digit losses for the first half of 2008. Vanguard’s Total International Stock Index also had a rough month, losing 9% in June and 2.2% in the second quarter. Foreign stocks are now down 10.9% through the first half. REITs were hit hard, dropping 11% for the month. Domestic high-quality bonds were flat in June and down just over 1% for the second quarter and up 1.1% for the year.

As always happens in an environment of fear, we are asking a lot of questions. What is going on, and how bad could it get? What else should we be doing in your portfolios? This environment is in many ways unique and presents its own set of challenges, which we’ll address more specifically in a moment. But more generally, we want to start by saying that we’ve been through a number of crises over more than two decades of managing portfolios, and while each of these periods presented its own particular challenges, one thing that is common to them all is that a sense of accelerating bad news, escalating risk, fear, and panic were almost always present.

Looking back to March, the Federal Reserve’s unprecedented actions to shore up credit markets and create liquidity led many to hope that we were past the worst of the financial crisis and that the stock market had hit bottom. Today it seems that while the Fed’s actions may have significantly reduced the risk and fear of a full-scale financial meltdown, the losses from bad loans are not only continuing, but are continuing to be worse than expected.

The positive impact of soaring home prices and easy credit is now gone, and with it has gone a major source of consumer spending. Add in the impacts of high levels of household debt, higher gas and food prices, a weakening labor market, and, by one measure, consumer confidence at a 28-year low, and it seems increasingly likely that consumer spending will continue to deteriorate. The damaging combination of a slowing economy and higher inflation has also led to questions about the ability of the Fed to support economic growth and employment without stoking fears that it has gone soft on inflation. At their latest meeting in June, the Fed held rates steady and expectations of higher rates later this year has also hurt stock prices. What it all means is that risks to the economy remain high, and the financial markets are now more fully discounting this risk, which is an unemotional way of describing the battering taken by stocks in recent weeks.

As always, there are positives. Outside the financial sector, corporate balance sheets remain generally healthy and earnings have been okay. One source of strength has been exports, which have managed to offset much of the impact of the housing decline on GDP. But this could diminish if our slowing economy means we also export economic weakness to the rest of the globe.

"History is merely a list of surprises. It can only prepare us to be surprised yet again." —Kurt Vonnegut

One possibility is that things will get worse before they get better. Even without a bad recession, fear and pessimism can take hold of investor psychology and send the market down further than what would be justified by long-term economic fundamentals. Though it is easy to put too much weight on negative scenarios when bad news dominates the daily headlines, our economy and financial markets generally find a way to work through all the problems and heal themselves. History is full of awful events if you look back over the years, but the economy is bigger and stronger and the markets are higher.

In this type of environment, a sense of perspective and a reliance on our investment discipline helps us avoid becoming panicked by short-term concerns and paralyzed by longer-term uncertainty. Like it or not, we are always faced with making decisions in an uncertain world and this will not change. However, our experience in past market cycles and our analysis of the current market environment leads us to two important conclusions.

First, as we have written in previous commentaries, we know that we can’t avoid all losses, but we do understand that it is our job to protect your portfolio from the full impact of a bear market. As such, we have adjusted most portfolios several times and significantly reduced stock market exposure. We know that it is prudent to be more defensive when little else is working. In due time, we’ll have the opportunities we need to produce the returns you need.

Second, big market downturns invariably present opportunities, and without them, we would not have had the chance to identify some of the tactical allocations that have added value to your portfolios over the last 18 years. Bubbles lead investors to make errors in judgment and misprice assets on the way up. On the way down, assets often fall to bargain prices when investors are in the grip of fear. Our investment discipline (and our focus on what is knowable) can help us identify those asset classes where investor panic has led to excessive undervaluation. Once again, there are several that may be headed in this direction that we are monitoring carefully.

For the 10 years through the end of June, the S&P 500 has compounded at just under 3% annually. From June 1988 to June 1998 the S&P 500 returned a whopping 18.6% annually. During this time interest rates fell, the growth rate for corporate earnings climbed, investors took their enthusiasm too far, stocks became overvalued, setting up the market decline from 2000 to 2002. So in a sense, the low returns of the past 10 years have forced investors to give back some of the excess earned in the previous decade. When both periods are combined, stocks have returned a little more than 10% annually in the 20 years through June 2008. That’s in line with their very long-term average.

Market conditions may continue to be challenging. However, we believe we can add value from both our tactical asset allocation and security selection decisions. In terms of our current portfolios, we continue to hold lots of extra cash as a margin of safety and to allow us to quickly deploy it back into the market to take advantage of the inevitable market upturn or any intermediate trading opportunities. Once the market begins its "real" upward movement we think an overweighting of large-cap growth stocks, foreign markets and high-yield bonds will add great value much like they did in 2003-2004.

We remain confident that our investments will beat their benchmarks over the long term. Many of the managers we use and respect tell us they are buying shares of high-quality companies at bargain-basement prices. Consequently, even though the overall market does not look compelling, the current economic and market turmoil is creating significant return opportunities at the bottom-up individual stock level. Indeed, it is often when the overall trend is negative that disciplined investors can build a portfolio for long-term outperformance by carefully taking advantage of the opportunities created by these dislocations. It requires patience and the ability to weight long-term analysis above short-term fear, but it is what distinguishes successful investors. At market tops and bottoms, what feels right isn’t. The proverbial mattress, or a CD may feel like the right thing today, but the odds are great that one year from now it will be obvious why they weren’t.

Irrational Exuberance

2007-01-10T08:27:00.000-08:00

Just like the masses that arrive in Vegas daily hoping to win quick and leave before the odds catch up with them, today’s market speculators are playing a losing game. Speculators’ appetite for risk seems insatiable and in contrast to current economic and political conditions. The stock markets have hit new highs and money is flowing into increasingly risky investments. The billion dollar question is whether this speculation will be justified or will end badly.

It is the nature of the market (investors & speculators) to extrapolate both the good times and the bad times into the future. Twice in just the past six years the general public has been dead wrong and paid a dear price. They expected markets to continue to rise in early 2000 and to continue falling in late 2002. The current environment is closer to 1996-1997 where the market was slightly over priced but continued to rise for several more years. From here, if the stock market rises too fast relative to corporate earnings growth (as it did from 1997 to 2000), then it will again end badly. However, if it rises more in line with future earnings growth, then all will be well.

At this point, we do not believe this will end like the market crash of 2000-2002 when the S&P 500 was down almost 50%. Currently, we still see some upside in the U.S. stock market, however, many are clearly betting on the past winners and fail to see the changes ahead. This is as dangerous as driving looking only in your rearview mirror. Housing, energy, value stocks, and junk bonds are yesterday’s winners.

Going forward the U.S. economy faces a prolonged period of slower growth. Such an environment requires a different type of portfolio than has worked over the past 4 years. We contemplate several adjustments over the next few quarters to minimize risks and continue to find opportunities for good returns.

The environment where good economic conditions excessively rewarded risk taking is over.

Client Update – April 2006

2006-04-15T15:25:00.000-07:00

Rising interest rates, fear that the housing market may be starting to roll over, a growing current-account deficit, volatile commodity prices, ongoing turmoil in the Middle East—all of these concerns have been on investors’ minds lately. Looking past short-term noise is important in making good investment decisions; but many of these issues are more than noise, and require that we evaluate and try to put them in an investment context.

Given an almost endless list of positives and negatives to consider, our goal is to make a realistic assessment that weighs optimism and pessimism fairly. We give more weight to factors that are material and knowable, and then try to evaluate how they might relate to a clear argument for making a move in your portfolio. Therefore, over the past several years we have made many strategic changes to portfolios due to opportunities and threats created by ever-changing geopolitical and economic events.

There are problems on the horizon. The current-account deficit, the impact of a slowdown in housing prices, and other macro-level risks could all create scenarios where earnings could decline significantly (e.g., a weak dollar would lead to higher interest rates and a recession; lower housing prices could hurt consumer spending, etc.). Earnings growth is still quite good at the moment, but profit margins are near all-time highs, which leaves little room for improvement. All these variables—as well as others—contribute to our belief that the market is fairly valued at this time.

Though there are still plenty of risks in the outlook, and the U.S. and global economies remain volatile, we continue to find opportunities to take advantage of the market and its volatility. We seek opportunities where others see problems. For example, as the dollar falls in value, foreign stocks and bonds reap the benefit. Thus we are inclined to stay with a positive view and will continue to find investments that add value and minimize risk.

Client Update – June 2005

2005-06-10T16:20:00.000-07:00

As of this writing, we believe the S&P 500 is roughly 10% below fair value. This surely doesn’t qualify the market as vastly undervalued, especially in light of the significant risks that are out there, but it does provide some cushion.

For us, our analysis always comes back to valuations. There is never a shortage of things to worry about (see our “media” article on the back), but understanding the extent to which those risks are already being reflected in market prices is the key to making good investment decisions.

A very simplistic analysis of return expectations goes something like this: assuming that valuations return to “fair,” that we collect about 2% per year in dividends, and that earnings grow at 3% on average (a conservative number, which is about half their long-term average growth rate), we’d be looking at returns of roughly 7% for the S&P. These valuations also tell us that some level of pessimism is already priced into stocks, so the market is discounting a less-than-rosy outcome. And even if returns end up being only modest, we’d expect our investments to be able to add a bit of extra return above what the market provides.

What’s an investor to do in such an environment? As our natural bias is to err on the side of conservatism rather than exuberance, we are, for the time being, content to hold slightly below-average positions in high-quality bonds and neutral weightings in stocks. This is not exactly an exciting strategy but we are not inclined to take on more portfolio risk until the Fed’s monetary tightening cycle (raising interest rates) is closer to a peak.

Our obligation to you, as always, is to understand the risks associated with your portfolio, and select the investments that best reflect your tolerance for risk and the realities of your financial situation. Further, due to the ever-changing nature of world economic conditions and political events, we continue to do this on an ongoing basis.

Client Update – June 2004

2004-06-10T12:21:00.000-07:00

What Should I Do Now?

2004-03-30T11:35:00.000-08:00

Taking Control of Your Investments in Turbulent Times

As the investment markets have dropped significantly from their March 2000 highs, you most likely have watched your portfolio value drop unnecessarily. But at the same time a more worrisome drop may have occurred—a drop in your confidence as an investor, a drop caused by both the severity of the declines and a lack of guidance and direction regarding how best to get back on track toward your long-term goals.

Investor “Red Flags”
If that’s your situation, you should know that the key to regaining control over your investing future lies in asking yourself some basic questions:

Has it been a while since you and your advisor reviewed your strategy?
Are you paying large tax bills, even though your investment portfolio has dropped in value?
Most importantly, are you not getting sufficient advice and guidance from your financial advisor on reducing losses and enhancing your chances of regaining lost ground?

Back to the Basics
If you are experiencing any of these “Red Flags,” then this could be an indication that your investment strategy doesn’t accurately reflect your current personal situation. For example, your portfolio now could:

Have become too concentrated in certain industries or types of securities (such as technology stocks) in an attempt to capitalize on short-term market trends;
Contain more risk than you may find comfortable in today’s environment;
Be poorly designed—or not at all designed—to consider after-tax returns;
Be generating significant costs and expenses without providing personalized service and guidance in return.

The best way to correct this situation and take back control of your investing process is a thorough, objective analysis of your portfolio and strategy. This “financial checkup” is one way to ensure that your portfolio is properly managed and your strategy still suitable. A comprehensive portfolio assessment should include not only your individual securities holdings, but also an assessment of your goals and risk tolerance, your tax status and potential liabilities, and a cost/benefit analysis of the fees and expenses you are paying.

Next Steps
If you want to take back control of your investments then you should get this financial review. This checkup could simply reconfirm that you should “stay the course” with your current strategy. More likely, it will help identify if changes are necessary to better reflect your current concerns and needs. A “financial checkup” can help you regain control of your investment strategy and provide a lifetime of benefits for you and your family. What should you do now? Please take the time now to find the right answer for you.

Published in Westlake Magazine – April 2004

Market Update

2003-08-11T17:51:00.000-07:00

Carpe Annum

2003-01-24T14:41:00.000-08:00

As you read the newspaper or listen to the evening news, you hear a litany of reasons explaining our turbulent stock market: the economic recovery has stalled; earnings have disappointed; oil prices are high; deflation seems just around the corner. And to further complicate our nation’s economic situation, the threat of war with Iraq looms on the horizon. It makes a certain amount of sense that the market should be encountering instability as a result of these concerns. But they don’t adequately explain the sharp deterioration in confidence that has gripped not just our nation, but countries around the globe.

It is the combination of all of these factors which has led U.S. investors to what has become a crisis of confidence. Confidence is indeed depressed but the question is why has the result been so unusually harsh? Though our situation seems grim, we must remember that oil prices have been high in the past; the pace of economic growth, while somewhat disappointing, is still positive; deflation is under the control of the Fed; and earnings are up. But upon further inspection, one can see that our market seems to be falling into a cycle. The economy is weak because the market has drained consumer confidence. This crisis of confidence leads to lower market growth and this lower growth means fewer profits. This further drains consumer confidence, the economy weakens further and thus the cycle continues…

There is, however, a light at the end of this tunnel. The cycle can be broken when investors examine the facts and focus on the reality that the U.S. economy, for all the disappointments it’s delivered, is not in bad shape. GDP growth is positive and productivity is rising sharply. The unemployment rate remains near 6%; job growth is positive, if slow; consumer durables and housing are strong; and inflation and interest rates are low. It’s easy for us to lose sight of these fundamental supports when growth doesn’t necessarily meet expectations.

In the short-term, stray factors can influence stock prices and cause valuations to deviate from fair value. Sometimes these deviations can be rather large and last for quite some time, as we saw in the late ‘90s. But eventually the fundamental principles of capitalism will overcome, and the market will reflect a fair price that’s based on real earnings growth. In every market environment, good or bad, there are always opportunities and risks. A good investor will find some of the opportunities and avoid most of the risks. In 2003, most investors will once again be surprised by the market - missing the best opportunities. What will you do?

Published in Westlake Magazine – February 2003

Client Update – January 10, 2003

2003-01-10T09:18:00.000-08:00

While the fourth quarter was strong for stocks and high-yield bonds, it was small consolation in a tough year. For the year, every S&P industry sector was down and eight of the ten experienced double-digit loss. It has been sixty years since the market has fallen three straight years, and 2002 was the worst single year since 1974.

In our opinion, there are a number of factors that contributed to the bear market, but without question the biggest was the stock market’s tech bubble. Terrorism and war fears didn’t help, but these only contributed at the margin to the magnitude and length of the bear market. Corporate shenanigans also hurt, but were not the driver—just another outgrowth of the environment of bubble-driven greed.

It is almost a tradition for investment professionals and the media to issue a forecast at the beginning of each year. But in any particular year there are many factors that play out differently than expected (e.g. Enron & Worldcom), and other potential issues that simply can’t be foreseen (e.g. 9/11). This makes accurate forecasting very difficult. Instead, to achieve long-term investment success we believe it is essential that we base our strategies only on analysis that we are highly confident in, not hope or speculation. This necessitates a relatively long-term time horizon, since we have a much higher level of confidence in our ability to assess long-term factors.

As we look out over the next five years we are optimistic and believe financial markets are likely to deliver decent returns relative to inflation. There remains a lot of cash sitting on the sidelines waiting to enter, corporate valuations are moderate, and interest rates and inflation are low. While we won’t be seeing anything like the 1990’s Bull for many years, we don’t expect to be visited by the Bear anytime soon either.

Client Update – January 15, 2002

2002-01-15T14:35:00.000-08:00

While we generally look to financial and economic information to assess market conditions, we must never overlook the political forces. Nobel Prize winning economist Milton Friedman said that you cannot have individual liberty without economic freedom; politics and economics are in fact inseparable.

Our long-term positive outlook is attributable to the fact that our country is resilient. Our history has proven that we are able to overcome adversity once we have resolved to pursue a course of action. During most of our lifetimes, we have not seen periods of such patriotism. While the intellectual community likes to portray patriotism as naïve, that is not the case. America’s focus and commitment assures our success.

During the latter part of the summer, it appeared that the U.S. economy was on its way to a slight recovery. But that all changed on September 11. The economic and psychic blow was severe enough to keep the economy in a recession. Fear gripped the market and it dropped precipitously.

Since the attack, the Fed has helped tremendously by lowering short-term interest rates and increasing liquidity. This provided sufficient stimulus and support for the markets to rebound to their pre-attack levels. Anticipating these results, we added heavily to the market in late September and early October.

We believe that the economic recovery will come later this year, but will be quite moderate. At this point, money market and bond rates are unattractive and we do not expect that the stock market indexes will surge ahead since none of the major market indexes are cheap. There are, however, some investments where value is reasonable, such as smaller and mid-sized companies.

America will continue to exhibit the faith and unity required to overcome the obstacles we face. And from our perspective as investment managers, we know that capitalism is the natural partner of political freedom. We view the road ahead with optimism as our Country and its economy confronts its foes and moves ahead.

Back To Your Future

2001-11-28T13:01:00.000-08:00

Consider the past 18 months as your future. If your advisor has guided you through these rough times with little damage, you’re in good hands. However, if your feel your retirement has been jeopardized, your stock portfolio is down over 30%, or your balanced portfolio is off more than 10%, it’s time to seriously consider a change and seek out a few other advisors and their clients to see how they’ve done.

The stock and bond markets today face great opportunities and sizable threats. Your current portfolio should look different than it did a year ago. Much has changed and so should you. Has your advisor properly repositioned your portfolio, or are you still holding the same old stuff hoping it will come back?

The market’s roller-coaster ride has not only continued throughout 2001, but has turned into quite an “E” ticket over the past 6 months. Prior to the tragic events of September 11th, it had already been falling consistently for several weeks due to weakening economic conditions and falling corporate profits. As conditions deteriorated even more due to the tragedy, however, the probability of a sharp rebound in stock prices increased dramatically. While stocks were primed for a near-term rally, it was too early to be certain that a new bull phase was about to begin.

Late in the summer, it looked like companies were beginning to spend again and the leading economic indicator signaled a recovery, but the terrorist attacks changed both. In addition, consumers had the rug pulled out from under them by falling stock prices, layoffs, and a mood of uncertainty. This dramatic deterioration of events demanded action. The Federal Reserve and our Government are now both working overtime to stimulate the economy. No government will match the massive reflation effort now underway in the U.S. While the market will remain turbulent, it is only a matter of time before these actions take hold and our economy rebounds.

The past 20 years have witnessed the birth and death of a great bull market for stocks and bonds. Most advisors and their clients did well through 1999, but only a few have been successful since then. Markets will always be volatile, so your advisor must be willing and able to take action. The period from 1995 to 1999 was an exceptionally low volatility, high return stretch of years that made most advisors look smart. Since then, however, many market indexes have fallen 30% or more, and many advisors have severely damaged their clients’ future. This type of market activity will continue so you need to be able to trust your advisor to guide you through the next 20 years. As of today, you know all you need to know about your advisor. It’s time to fish or cut bait!

Published in Westlake Magazine – December 2001

Pinto or Porsche…What were you sold?

2001-09-24T15:29:00.000-07:00

Many people find that working with their investment advisor is as awkward as dealing with an auto mechanic. We’ve all had that uncomfortable feeling that we’re being taken advantage of, but have no ability to prove it. Just because they hand you back a bag of dirty parts doesn’t mean they really fixed anything or if they are really any good. These concerns relate directly to the quality of investment advice most people are receiving. All portfolios, like automobiles, are designed, built and then maintained. Your performance is dictated by the ability of the professionals doing the work.

Engineering: Who designed and built your portfolio? We all know that there is a large difference between a Pinto and a Porsche. Did your portfolio blowup when this bear market rear-ended you? Unfortunately, most investors’ portfolios suffered major damage because their advisor convinced them that they were driving a Porsche, when they really had a Pinto. If the firm that engineered your portfolio was any good, you should have avoided the damage.

Maintenance: Who takes care of your portfolio? Just like a high-performance automobile needs professional care and consistent maintenance, your portfolio requires attention as well. Portfolio maintenance is making adjustments as market conditions warrant. Most advisors lack the background to adequately build and maintain a portfolio. As such, they hang their hats with large firms that provide them marketing support to grow their client base, analysts to help them suggest investments to clients, and then legal support when things go wrong. Portfolio management is the primary skill that you desire them to have, yet it is precisely the area in which they have little or no real education or experience. Fancy certificates from 3-day seminars at Pebble Beach will not make them a portfolio manager.

Sales: It is through this well marketed business model that most investors have found their advisor and suffered steep investment loses in recent years. In reality, most of these advisors are merely “Used Stock Salesmen” acting as the marketing arm of large financial services firms. Though they are experts at describing features and making us feel comfortable with a purchase, none of us would ever consider taking our cars back to the salesman on the car lot for maintenance. Yet, these firms have convinced their clients that the salesman is really a mechanic as well. Just as selling hundreds of cars does not make the salesman a good mechanic or automotive engineer, convincing hundreds of investors to open accounts does not make the salesman a competent advisor.

While this market will eventually improve, it will not go back to the easy money of the 1995-1999 period. As always, investment skill and risk management will be needed. Consider the past 18 months as your future. If your advisor has guided you through these rough times with little or no damage, you are in good hands. If your advisor let your portfolio suffer during this downturn, then it is time to make a change.

Published in Westlake Magazine – October 2001

Mad Dow Disease

2001-05-24T18:21:00.000-07:00

Since December 31, 1999, the Dow has declined 7%. For many years, the only technology stock in the Dow was IBM. But, due to the great returns of technology stocks, there was great pressure to add more technology stocks to Dow so it would be more competitive with the S&P 500 index. So, Microsoft and Intel were added. Since then, they have proceeded to drop 40% and 60%, respectively from their highs, causing the Dow to drop further than it would have without them. While we agree that the Dow should have had more technology representation, it is interesting to note that even the “keepers” of market indexes were caught up in the hype.

Once again, the more things change, the more they stay the same. Over ten years ago, our country was obsessed with the growing budget deficit and the banking crisis. The media was busy whipping up the public into a fearful frenzy. It was the end of the financial world and everybody knew it. At the top of the best-seller list was Ravi Batra’s book The Great Depression of 1990. What followed, however, was a great decade of prosperity and economic strength.

During the last few years of the 1990s, the U.S. economy was very strong and wealth creation seemed so easy. Dow 36,000 and The Roaring 2000’s hit the bookshelves and sold like crazy. Again, the general public was all worked up—but this time with greed. You couldn’t attend a social event or turn on the TV without being aware of how quick and easy money was being made in the stock market. Again, what has transpired in the past year was the opposite of what was expected by most investors. While the bull market may be dead and gone, the market in “bull” is still booming. Over the past 10 years, investors would have missed out or lost substantial wealth by following the crowds. In investing, the hype is always wrong.

Going forward, the erosion of stock market wealth will clearly affect spending in the months ahead, perhaps enough to cause a recession. Over the next few months, there will be more bleak earnings news so the stock market is not out of the woods yet. However, the Fed’s rate cutting has reaffirmed its determination to stabilize the economy and has likely put a floor under stock prices. Just as prices started falling last year before earnings dropped, they will begin to rise again before earnings improve. In the past nine bull/bear cycles, the S&P 500 rose 32% on average before earnings began to improve. However, we believe a more modest gain is likely this time.

While it would be great to know exactly which way the market was going to move next, it really doesn’t matter because it is possible to earn a good return on one’s money in most market cycles. Many advisors have failed their clients by having too much money in the wrong sectors of the market at the worst possible time. While these advisors will take credit for the money made during a rising market, they blame it on the market during tough times. As an investor, you need to question your advisor’s advice over the past year. First, did your advisor proactively adjust your portfolio to the changing conditions during 2000. Second, if you’re an aggressive investor you should be down no more than 15% and if you believe your account is conservative, you should actually be up a little. If you did worse than these, it is not the market’s that failed you, but your advisor. Only during tough times does skill, or lack thereof, make itself evident.

Whether you desire to grow your wealth conservatively or aggressively, our success comes from professionally managing your investment portfolio and working to align your financial decisions with your goals. Our goal is to grow what you have and protect what you’ve earned.

Published in Westlake Magazine – June 2001

Stocks: From Lemons to Lemonade

2001-03-25T15:23:00.000-08:00

You should not look at the stock market to make you wealthy. You should think of the stock market as a place where your wealth can be protected and grown if managed prudently. Over $1 trillion in value has been lost in Cisco Systems, Microsoft, and Intel. Very few people have actually created their personal wealth solely by investing in the stock market. Most people create their wealth through their personal initiative and hard work. No matter how you create your wealth, it is important to protect, grow, and manage it to meet your goals.

We have a unique mix of financial and estate planning services. Our goal is to identify and understand our client’s goals and assist them in protecting and growing their assets. Our emphasis is on formulating comprehensive family wealth and investment plans to avoid excessive market risks and the burden of taxes.

The following are just a few ideas to consider. Before implementing any strategy, you should check with your advisor.

Stock Losers
If you have substantial losses in any stock in a taxable account, you should consider selling it to “bank” the capital loss and put up to 50% of your loss back in your pocket. You can repurchase it 31 days later or immediately buy something similar to replicate the position.

Capital Gains
In this volatile market, many investors have tried to hold onto stocks for a few more months just to get the long-term capital gain tax rate. In so doing, they have often seen their stock price fall more than the tax savings would have been. Don’t let the “tax” tail wag the “investment” dog.

Re-pricing Stock Options
Many companies are considering re-pricing their stock options so that their employees are not so far out-of-the-money. While this may be great for the employees, it can really hurt the company’s P&L. Instead, consider canceling the options and issuing stock for notes.

Acquisition Bailout
Many key employees of companies with depressed valuations or cashflow concerns are hoping for a quick buyout to pop their stock price up. While this may appear to be a windfall, it often triggers costly “golden parachute” issues for key executives.

Covered Calls
Whether your large holdings are up and you’re worried they might go down, or they’re down and your not sure how quickly they’ll recover, consider writing covered calls on them to take in fat premiums. For example, January 65 2002 calls for Amgen currently at $63 will pay you $12 per share. This 19% current return caps your upside at $77 and protects you down to $51 per share.

Private Wealth Management takes control of your financial situation and creates a strategy to insure that your wealth is not squandered by taking speculative or unnecessary risks. We work with our clients to understand their goals and then create and manage a complete portfolio. We take care of business, which to us is protecting and growing your money. If you’d like to understand the difference that professional wealth management can make, please call 805-495-4405.

Published in Westlake Magazine – April 2001

Knowledge Is The Antidote To Fear - Ralph Waldo Emerson

2001-01-29T13:23:00.000-08:00

Most financial advisory businesses grew rapidly during the last decade. This was, however, the greatest bull market in history! For most of the past decade, simple investments in individual stocks, private accounts or even mutual funds have met investor’s expectations. But the 1990’s are over, and with it the realization that it’s not so easy. Financial advisory firms are laying-off thousands and investors are now wondering what to do.

Surveys performed during 1998 and 1999 showed investors expecting annual returns averaging 20% or more. Since the stock market’s return for the 1990s was about twice its average rate of return, any regression to the mean would lead to below average returns for the next 5 to 10 years, most likely in the 5% to 7% range. Since most investors have suffered significant losses over the past two years, they are now forced to rethink their approach to investing. Without much real analysis, many investors have already begun to reshape their portfolios by pulling money out of stocks and moving it into bonds and real estate. However, this is the exact same type of mistake that got them into technology in 1999, bonds in 1994, and real estate in 1989. It’s just not that easy!

In order to look credible after having done so poorly for their clients over the past two years, many financial advisors are finally suggesting that their clients move substantial portions of their portfolios into bonds. The advice appears reasonable because bonds have done well lately and are more conservative than stocks. However, the easy money in bonds has already been made and yields are at historic lows. So, let’s step back for a moment and see how much money you can make on bonds over the next 10 years. Currently a 10-year U.S. Treasury Bond will pay you about 5.2%. Now for the part that will trip-up most investors – interest rates will likely rise over the next few years from these low levels. If interest rates rise just 2%, up to only 7.2% over the next few years, today’s 10-year bonds will drop 12% in value. If you hold the bond until maturity, you will get your 5.2%, but if you need or want to sell it anytime in between, you are more likely to lose money as interest rates are more likely to rise over the next few years.

As has been the case over the past several years, only skilled advisors have been able to advance their clients’ portfolios. With both the stock and bond markets offering below average returns for the next few years, it will take a superior advisor to achieve above average returns. Using the past as prologue, your investing experience over the past two years indicates the competency of advice you will receive going forward. More than any time in the past 20 years, you will need a trusted advisor, with skill and experience, to manage your portfolio in the decade ahead.

Published in Westlake Magazine – February 2001

NASDAQ Math: 85 – 39 = 12.8

2001-01-25T13:18:00.000-08:00

In 1999 the NASDAQ went up an astonishing 85%, and then followed that feat with a stunning –39% drop. Most investors would assume that 85% - 39% would leave them with a return of 46% for the two years combined. Would you believe it is only 12.8%, which averages to only 6.2% per year. Let’s see how this works. If we assume you start with $1,000,000 and it grows 85%, you have $1,850,000 after one year. The following year, your $1,850,000 drops -39%, leaving you with $1,128,500. Your money grew by only $128,500 over two years, for a total return of 12.8%.

Even more disturbing is the fact that the typical investor lost more money because they were late to the party and then hung on too long to falling favorites once the party ended. If your financial advisor must call you before making any changes to your portfolio, they will be too slow to react to changing market conditions. If your advisor works for a brokerage firm, bank, or most independent financial planning firms, they are not allowed to manage your portfolio, but can only suggest securities and investment products to you. They must call each and every client, one at a time, in order to make a change. When opportunities or threats present themselves, they are unable to act in a timely manner for all their clients. Worst yet, when you’re ignored and must call your advisor to take action, you still pay them for implementing your idea.

The major brokerage and financial planning firms have seen this problem growing so they have instituted two programs to hide from this threat. First, some of their salesmen have reinvented themselves as “consultants” to sell clients to outside programs or wrap accounts. Second, they have instituted fee programs. Both of these schemes still have the same old flaw, making you pay high fees for low flexibility and marginal service. Because wealthy individuals have become more informed they have insisted on a better way – that way is wealth management.

True wealth management is gaining control of your financial situation and creating a strategy to insure that your wealth is not squandered by taking speculative or unnecessary risks. The key difference between us and “them” is that we manage our clients’ portfolios. We work with our clients to understand their goals and then create and manage a complete portfolio. We take care of business, which to us is protecting and growing your money. If you’d like to understand the difference that professional wealth management can make, please call 805-495-4405 to R.S.V.P for one of our upcoming events.

Portfolio Development Thursday, February 15 at 6pm
How to create, monitor, and maintain an all-weather portfolio

Retirement Planning Tuesday, February 27 at 6pm
Covering pension & 401(k) rollovers, early retirement, and IRAs

Stock Options Seminar Thursday, March 8 at 6pm
Covering ISO and NQSO employee stock options

This article appeared in Westlake Magazine – February 2001.

Client Update – January 10, 2001

2001-01-10T12:10:00.000-08:00

Most investors will be glad to say goodbye to the year 2000. The S&P 500 had its worst performance in over 10 years and the NASDAQ suffered its worst loss ever, down 39%. As expected, most Wall Street pundits predict a rising market in 2001 (as they did for 2000). The idea that the market could perform poorly two years in a row seems inconceivable. They will continue to predict the good times until they are wrong several times in a row and then they’ll switch to predicting bad times, but by then we’ll be back into good times.

There are still excesses in the technology sector despite the recent decline in the NASDAQ and tech stocks. Some tech stocks have fallen a lot, but the NASDAQ bubble is not fully deflated. The NASDAQ still sports a P/E ratio of 110, when its long-term average is around 40. That implies that some combination of prices falling over 50% or earnings doubling should take place.

The erosion of stock market wealth will clearly affect spending in the months ahead. Perhaps spending cutbacks will be severe enough to cause a recession instead of a soft landing. However, the Fed will keep lowering rates until it succeeds in stabilizing the economy.

The current shape of the yield curve suggests that the credit markets expect rate cuts of 100 basis points over the next 12 months. The Fed lowered the real fed funds rate to 0% in the early 1990s due to U.S. economic weakness. A similar move today would imply a fed funds rate of 2.5%, much lower than today’s 6.2%. This gives the Fed a rather large net to catch the economy should it fall.

On a more positive note, reasonable values are available in some sectors and many previously neglected stocks are now attracting interest. We will continue to prudently allocate money to those sectors that are the most reasonable and attractive.

While the stock market is no longer extremely overvalued, there are still dark clouds over upcoming earnings announcements. As far as the near term is concerned, we continue to advocate a conservative stance.

Client Update – January 15, 2000

2000-01-15T10:18:00.000-08:00

The stock market has begun the new millennium with more ups and downs than an elevator on the Empire State Building. Unfortunately, this will probably be the norm rather than the exception this year. Even with this volatility there is still good reason for optimism. The U.S. is enjoying the benefits of the technology-led economic expansion as we shift from the industrial age to the information age. The increased productivity that companies and individuals have seen in the past few years is truly amazing and will continue.

However, some sectors of our stock market are becoming increasingly overextended. Despite the many signs of investor mania for technology stocks, it is not accurate to label the overall market as too high given that a majority of stocks have actually declined over the past two years (see chart on page two for more details). Technology stocks are creating a classic investment “bubble” and the Internet sector is in a class of its own with prices soaring without any evidence that earnings will ever materialize.

All bubbles eventually burst and this one will be no different. What will trigger the burst? Our concern is whether the end of this technology bubble will cause a major decline in the rest of the stock market. Higher interest rates, foreign markets, and political developments all contain the ingredients to pop the bubble. The good news is that since a majority of stocks have languished in the past two years their valuations are reasonable and they should hold up well.

1999 was the worst year for bonds since before World War II with even the safest of U.S. Government bond funds losing money in 1999. In fact, anyone who owned a 30 Year Treasury bond in 1999 lost around 11%. Going into 1999, bonds were overvalued with interest rates under 5%. Now, bonds seem undervalued with yields over 6.5%. Although the FOMC has raised short-term rates by 75 basis points in the past five months, the domestic economy continues to grow faster than Fed Chairman Greenspan would like. Therefore, the FOMC will raise rates this year. The big question is how many times and by how much