Wednesday, October 22, 2008

I was taken to dinner by clients that had a decline in their accounts and they paid.

I had dinner with clients this weekend and they picked up the tab--perhaps they felt sorry for me. They had two questions that they wanted me to try and answer for them. The first question was, when will all of this turmoil be over and the second question was when would they see the values of our accounts start going up? On the surface, these seem like straightforward questions, but in reality, these are two questions that nobody has answers to now.

I told the clients that I do not have an exact answer because I am not sure that we have enough information to come up with an answer that can be supported by facts. I said that I felt that the greatest risk now is the unknown. It is what we do not know that could have the greatest impact on the eventual outcome of the challenges we are facing today.

There is no doubt that people just went crazy with some of the investment structures that are causing the problems we are dealing with today. I wanted to make my answers as simple as possible so that they could have a foundation of concepts. After you have built a foundation of information then you can begin to answer the questions. I do believe that one word sums up the extent of the problems, that word is transparency.

Clear glass in a window lets in more light than a stained glass window. If try to look through a stained glass window you cannot tell for sure what is on the other side. With a clear glass window, you can see everything. Many of the investment structures we have today have little or no transparency. By example: if you knew that the Reserve Fund had $750 million in Lehman Brothers commercial paper on the Friday before it closed, would you have deposited your money in the fund, probably not.

Under the structure of a mutual fund, you get detailed information every 90 days. What happens to the investments during the ensuring 90 days is not know to you until the next reporting period 90 days later. This is an example of a lack of transparency that exists today. I could give you many other examples, but time and space do not allow. Your understanding of the concept of transparency is most important. If you own a diversified portfolio of stocks then when you get your monthly statement you can see what you own and access the risk of what you own. You have total transparency.

Back to the two questions that need to be answered. I said in my last Blog to watch the movement of one month and three month LIBOR interest rates. (Go to for an excellent explanation of LIBOR.) If one and three month LIBOR interest rates start falling, the banks are beginning to lend money to each other. Since my last posting, three month LIBOR has fallen by about 1.5%. Currently one month and three month LIBOR are 3.28% and 3.54% respectively.
We need three month LIBOR to be within one quarter of one percent of 90-day T-bills. Right now, the difference is two-hundred and fifty basis points (250) or about 10 times higher that it should be normally. As the spread continues to narrow, we will see further rallies in the global stock markets. How long will it take to get the spread to return to a normal rage? My best guess is late this year, but more likely into first quarter 2009.

As a result, I think we are in for volatile time for the balance of the year and into first quarter 2009. Over time, the market swings will be dampened as more stability is added to the markets. As to the second question of recovering account values, my clients have already seen a significant recovery in their account values. The account values are not back to summer values, but have moved closer to the September month end values. As I indicated the things that will lead the market higher would be the assets classes that were the most beaten down in the bear markets.

Take a hard look at what you own and make decisions as to what you want to keep and what has to go. Set a realistic target for selling the ones that have to go and then sell them if they get to the target. If what you want to sell does not move up when the market rallies then sell out at the best price you can get.

The problems we are facing today have their origins way back to the Carter Administration and will take a long-time to rebuild. Return expectations are going to have to be reduced for many years to come. I think we may well see some recovery in account values in the second half of 2009 depending on what happens in the economy.

Dan Perkins

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