COMMENTARY - 4TH QUARTER 2008

“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”
                  - Charles Mackay (1841)

Was 2008 an “unprecedented” year?  Not exactly.

The term “unprecedented” as it has been used so frequently to describe either failures by our leaders or the current economic downturn is an overused cliché that is simply not true.  It is true that recently the world’s economies and financial markets have registered very large declines. We will look back on this period and say that we witnessed one of the most dramatic parts of our economic history, whether it was the collapse of the housing market, emerging markets and commodities bubbles, the demise of once-respected Wall Street firms such as Merrill Lynch and Lehman Brothers, or the hospital bed-side bailout of the Big Three automakers.  But, to say that this past year’s events were unprecedented is to neglect economic history and the lessons (including investment lessons) which should have been learned from that history.

A closer examination reveals that economic cycles – expansions, contractions, and their more notorious cousins, bubbles and panics – have regularly occurred throughout history and one must conclude are rooted in the nature of capitalism itself.  Charles Mackay (the author quoted above) was the first to document early historical booms, busts, and manias in his famous treatise, “Extraordinary Popular Delusions and the Madness of Crowds.”  First published back in 1841, Mackay’s work detailed historic economic booms, busts, and crashes – the most noteworthy of which was the infamous 17th century tulip mania.  His book is generally considered required reading for investment professionals, and his timeless lessons regarding mass human behavior and the creation and destruction of speculative bubbles still apply today as evidence that this time it’s not different.

Our country’s economic roadside is littered with booms, busts, bubbles, and crashes spanning the past two centuries. The 19th century alone witnessed five panics (1819, 1837, 1857, 1873 and 1893) including a global depression (1873). The 20th century again experienced five financial panics (1907, 1929, 1937, 1973, and 1987); most notable (and painful) was the Great Depression (1929). All of these crises shared the same characteristics in that each owed its existence to some form of speculation – fueled by easy credit – which gave rise first to excess speculation and risk-taking, resulting in an asset bubble which later popped.  After the bursting of the bubble, crisis ensued including mass panic and freezing of credit. This has always been followed by policy response from our government as a last resort.  Each past economic crisis has resulted in new rules, regulations, and safeguards allowing both recovery and a better foundation for the future.  This is exactly what we are experiencing at the present time.

We are positioning your portfolios to take advantage of the recovery as it unfolds and have reason to be optimistic as we look forward to the new year.  By many measures valuations for blue-chip stocks are as low as they ever have been and dividend yields are high. Oil prices, which have acted as a headwind for corporations and consumers alike, have fallen dramatically. Inflation is low and the Fed has reduced short-term interest rates to almost zero. A new U.S. administration is ramping up a massive stimulus package and global governments are taking coordinated action to spur economic activity. As confidence returns, the nearly $8.85 trillion in cash, bank deposits, and money market funds sitting on the sidelines waiting to be invested, will be drawn into the market (especially into high-dividend-paying blue chip stocks) as this money is currently earning unacceptable returns.  This mountain of cash equals almost 75 percent of the stock market value of U.S. companies – one of the highest such levels in history. 

Going forward, the economy will continue to face challenges. However, the stock market typically anticipates an economic recovery well in advance of the actual economic data. In fact, looking at the past ten recessions, dating back to 1949, the S&P 500 has returned an average 32.4% in the 12 months following the market lows of the recession.

We thank you for your trust and your support during this difficult period.  We have included with this commentary your quarterly performance figures, management fee invoices, and a copy of your portfolio allocation as of 12/31/08.  Please also be advised that for those of you with taxable accounts, we have enclosed your 2008 Realized Gains & Losses. These reports should be given to your accountant, along with the IRS Form 1099 that you will be receiving from Schwab or your other custodians in early February.  Note that if there is a “0” in the cost basis column, it is because we do not have the cost basis information for these securities.  If you have this information and would like us to update the report, please give us a call.

With best regards,

Disclaimer: All opinions presented in this commentary are strictly those of the Golub Group.  You should not construe any implied or expressed conclusions presented as a promise of future returns.