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Greed is Good, or Is It?
The government bailout has finally passed after a stalemate. The agreed upon version provides greater detail and clarification on how the taxpayers’ funds would be used to solve the credit crisis and put us on the road to economic recovery. Despite this, confidence in the plan has been met with considerable skepticism by economists and the American people. To make matters worse, some of the oldest and most respected financial institutions have ceased to operate. The ramifications, however, don’t stop there. The stability of the money market industry has been called into question and a few money market funds broke the buck. Some well diversified growth indices are down 30% since October of last year. Investing in treasuries appeared to be the only shelter in the storm. Outside the financial markets, Main Street is having its own issues. New home sales hit a 17-year low, which exceeded even the most pessimistic expectations. This can’t help but make the consumer wonder, where is the bottom in the housing market? To further compound the problem, jobless claims hit a seven-year high. (view Weekly Unemployment Claims). The question on everyone’s mind is what should I do now? In this installment of the Karp Capital Focus we will attempt to answer that question and build an argument for the prospects of an economic recovery.Here are the performance numbers for the major indices as of 09/30/08 (total return).
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Housing – The Root of the Problem
Make no mistake; the rise in foreclosures is at the heart of the credit crisis and the economic recession. Sales of existing homes fell in August, down 2.2% from July and 10.7% from a year ago, according to the National Association of Realtors of Chicago. The median price of an existing home in August was $203,100, down 9.5% from a year ago. California home prices fell a record 41 percent year over year for August, and the California Association of Realtors expects prices to fall further. The Federal Reserve has responded by aggressively cutting interest rates and committing several hundred billion dollars in credit facilities for banks and brokers. In addition, the government took over mortgage giants Fannie Mae and Freddie Mac to increase the flow of capital to ease lending bottle-necks. Despite these measures, the tide of foreclosures has not been stemmed. There are simply not enough qualified buyers to take down the supply of available homes which is increasing by 10,000 per day. Perhaps the overriding question should be, how do we keep these people in their homes? There is a delicate balancing act if taxpayer money is to be used to reinforce poor investment decisions. Then there’s the other side of the coin. What about people who bought homes responsibly? What do they get? What happens to the people who have paid their bills on time, despite living paycheck to paycheck? Should they now be saddled with substantial increases in taxes to pay for this mess? Whatever the plan of action, we must halt the inventory of homes if we are to turn the economic corner toward recovery. What has Changed? Historically, Wall Street investment banks have facilitated transactions and helped maintain an orderly market. Given the lax regulations and the use of borrowing and leverage, the investment banks have created an environment of their own demise. As a result, the investment banks are edging toward extinction. We are now down to two major investment banks- Goldman Sachs and Morgan Stanley. In order to survive and raise capital, an historic decision was made by the government; they were both given permission to become banks. Now Goldman Sachs and Morgan Stanley will be able to take direct deposits that are insured by the FDIC, but neither will be able to leverage themselves like they used to. As such, margins and profits at both companies will shrink considerably. With this change, the face of Wall Street will never again be the same. In light of this, the investment community is likely to clean up its act over the short term. Over the long haul, markets might return to strategies that delivered great returns with little regard for risk. The focus seems to be return, return, return with little concern for risk. There’s not much reason to believe politicians will get this right, either -- the government invests in plenty of things for the public good without a chance of generating a financial return. There needs to be a shift in how we view capitalism. There needs to be a focus on balance between savings, investing and spending. The government is in a unique position to shape the habits of Americans by increasing the limits on retirement savings and tax credits for investments and energy conservation. This crisis developed over time, and all parties share the blame: Republicans, Democrats, Wall Street and Main Street.Big Bailout? Even though the bailout has been approved, credit markets continue to tighten as banks hold onto cash and liquidity dries up with end of quarter demands. Banks around the world have had some temporary success bringing down the overnight lending rates with sustained injections of cash, but banks have been unable to have an impact on the three-month Libor rate, which continues to climb. This makes lending for business more expensive. The rate is nearly 1% above the level it stood before the latest crisis began. This is a signal that banks are growing increasingly uneasy about lending and tensions in the short-term credit markets are high. The underlying reason of the bailout was to build investor confidence. This, however, didn’t happen as the bill wasn’t passed on the first go round. Following the announcement of the vote, the Dow fell a record 777.68, or 6.98%, to 10,365.45. The NASDAQ Composite Index dropped 199.61, or 9.14%, to 1,983.73. The S&P 500 slid 106.59, or 8.79%, to 1,106.42. This showed that our legislators didn’t understand how important it was to address the problem. The confidence was already broken. It will take more than the passage of this bill to restore confidence. One of the best things that could come out of Paulson’s plan is that the illiquid assets would have a price again, and investors would have a much clearer understanding of the condition of balance sheets at the banks. At the moment, banks do not have to place a value on these assets because the market is frozen. This might help stabilize the price of bank shares which became an issue when Washington Mutual tanked and depositors withdrew billions of dollars. The Washington Mutual bank seizure by the FDIC was the largest bank failure in U.S. history. Whatever side of the bill you are on, the consensus is something needs to be done to avert a prolonged recession.What's Next – What is Our Strategy? We believe we are close to reaching the bottom in the markets. (View the S&P Worst Single-Day Returns (1962-2008) Here at Karp Capital, we are buying our focus sectors on dips and raising cash given the extreme market volatility. In addition we are continuing to hedge our portfolios by adding securities that increase in value as the markets fall. This allows us to increase performance for our client’s accounts in the short term, while having an eye for positioning our accounts for long term investment objectives. The last 3 months have been a difficult market for investors. The extreme market volatility and rotation into and out of sectors has hurt our near term performance. I urge clients to have a longer term perspective as we position our portfolios in accordance with the markets turning the corner. All the variables that we normally look for in identifying a bottom— volume, panic, pessimism, new lows, and market breadth– were satisfied over the course of the market’s downturn at the end of September and beginning of October. However, it is the federal government’s rescue plan that has cracked open the door for investing new monies. The short term solutions are over. A plan of action is being crafted. In addition, there are sectors and companies that have been unfairly punished in the current environment. One example is Microsoft Corp., which announced a $40 billion share repurchase program over a five-year period and increased its quarterly dividend. The government's budget deficit will rise substantially under the proposed bailout. The thought of this will eventually punish the dollar's value against other currencies. We still suggest overweighting commodities. Prices have been volatile over the last two months since most are traded in dollars. Oil spiked, at the end of September having the biggest one-day dollar gain in history on September 23rd. We still believe the underlying reason for high oil prices is the disparity between supply and demand due to growth in China, India and other emerging markets. Our over weight in commodities is regaining traction. We are also adding to our healthcare, consumer staples (everyday household product companies) and utility holdings. Those are sectors of the economy that tend to weather the storm. Bonds – Looking for Income Looking for a place to hide? Treasuries were the top performing investment over the last three months. Treasuries outperformed the S&P 500 over the past 1, 3, 6 and 12 months. This fact has been overlooked by most investors. We continue to believe that clients should invest in high quality, U.S. bonds. In the fixed income sector, now is the time to buy municipal bonds. Given the ballooning deficit, you can assume taxes will be raised. While this is a negative for some investments, higher taxes benefit municipals because it generates tax exempt income. This, in turn, should help munis to perform well, relative to other fixed income investments. Additionally, presidential candidate Barack Obama has called for increased infrastructure spending. The money for this would be generated through the issuance of tax exempt bonds. There are still concerns even with the recent positive developments. We continually monitor the fall out from the credit crunch. It is very difficult to invest when you are unsure about future company earnings. In addition, we don’t know how long there will be a continued strangle hold on growth and how different sectors will be effected. We fully expect the majority of investors to remain cautious and skeptical. It will take time to rebuild investor confidence. Between now and the election, we should be on the path of economic reform. I urge you to ignore the negative stories in the press and the sensationalism of the television financial evangelists. It might appeal to traders but it is a disservice to investors. Ignore them. Look to the future, not the past. It’s better to be somewhat of a contrarian in this market environment. Our continued philosophy will be to buy the dips, hedge portfolios and raise cash for buying opportunities. Take Action Now Debt—the new four letter word. It’s time to get back to basics. People are growing more and more in debt without realizing the consequences. Debt is equally affecting the wealthy and the middle class. There is good debt and bad debt. Call us if you would like to review your current liabilities. There are several immediate steps you can take to reign in your debt. The first hurdle is to admit there is a problem. Most Americans live in debt denial until their backs are against the wall and by then it’s usually too late. Instead, do yourself a favor. Sit down and take inventory of what you owe. List all your debts, starting with credit cards. List the minimum monthly payment and the interest rate on that card. Then do the same thing for everything else you owe. Next, prioritize your debt. If possible, get rid of any small balances right away before dealing with the larger ones. Do not rollover balances from card to card. Don’t rely on equity lines of credit. Banks are cancelling or reducing most lines of credit- secured and unsecured. Just continue to pay the minimum amounts on the big ones until you reduce the number of cards and then start paying off the card with the highest rate of interest. The best way to do that is by doubling the minimum payment each month without charging anything else on that card. As you pay off each card, call up the company and cancel it. If you need to have a card, use debit cards instead. While you are doing that, try to obtain a copy of your credit report and credit score. The Fair and Accurate Credit Transaction Act gives you the right to a free credit report every year from the three major credit bureaus Equifax, Experian and TransUnion. If you would like, we will run an expanded credit report for you. You may not like what you see, but at least you are no longer living in denial and you can begin to repair the damage. Who knows, there may actually be errors in the report that you can correct by contacting the merchants. We have run credit reports on our top clients and often find egregious entries in need of correction. Next, figure out how much you are bringing in. Break it down into monthly and then weekly numbers. Do you make enough to break even or is there a short-fall and if so, how much? Can you change your spending patterns or is it already beyond that?THE SAFETY OF YOUR ASSETS
Only over the last month (and only after the insistence of New York’s Attorney General, Andrew Cuomo) did the likes of Merrill Lynch, Citigroup, investment banks UBS and Morgan Stanley finally agree to return billions to well-heeled, individual investors hurt in the auction rate securities markets. Although that was a welcome development, the money won’t be returned anytime soon. It may take up to two years before these investors receive their money. Barron’s, the weekly investment paper, noted that the large brokerage firms are seeing some asset outflow with both Citigroup and Merrill Lynch experiencing the largest decline while naming Charles Schwab and Fidelity Investments as two companies that are seeing net inflows as a result of their healthy operations. Investments with nearly all big investment houses and brokers are protected by the Securities Investor Protection Corporation. It covers stocks, bonds and other assets (but not futures or commodity contracts) held at a brokerage and covers up to $500,000 per account including a $100,000 limit on cash. Investors have another layer of protection in the event a broker goes bankrupt. The Securities and Exchange Commission (SEC) has stringent rules about segregating the broker’s money from the customer’s investments. If the broker fails, the first thing the SPIC will try to do, is transfer your securities to another firm. Is Your Annuity Safe? That question should be first answered by determining the asset and credit quality of your annuity company. Your vulnerability also depends on the type of annuity you own. If you own a fixed annuity -- essentially, an investment much like a certificate of deposit -- then your money has become part of the insurer's general account. This means its main asset base is linked directly to the insurer's financial health. If, on the other hand, you own a variable annuity -- an annuity that allows you to invest in mutual fund-like accounts called sub accounts -- your money is largely immune to an insurer's financial problems. If the insurance company fails, a safety net kicks in. Each state has a guaranty association which steps in to cover policyholders. The coverage varies by state, but generally it's limited to $100,000 in cash value for annuities and life insurance policies and $300,000 for life insurance death benefits. "Normally, there are enough assets in the failed company that the new company will take it over with the same benefits and the same premium” as reported by the director of the National Organization of Life and Health Insurance Guaranty Associations. All consumers should check the stability of their insurance company. If it is low-rated, consider switching. A.M. Best, rates insurance companies, or you can check them out at www.naic.org. If you are looking to purchase an annuity or would like us to review your annuities, call us. Before we purchase an annuity on behalf of a client, we look at a variety of factors. First we must uncover what the client’s goals are. Is it growth or income? Then we look at highly rated insurers and the options under the annuity contract. (Read The Value of Annuities.) Bank Deposits- All banks and savings and loans fall under the regulatory body of the Federal Deposit Insurance Corporation. The FDIC is an independent agency of the United States government. The FDIC was created by Congress in 1933 to secure the savings of millions of Americans. The FDIC protects depositors against the loss of their insured deposits if an FDIC-insured bank or savings association fails. FDIC insurance is backed by the full faith and credit of the United States government. The basic insurance amount was raised to $250,000 per depositor, per insured bank after the passage of the bailout bill. Certain entitlements and different types of accounts may be insured for more than the $250,000 limits. To check whether your bank or savings association is insured by FDIC, call toll-free 1-877-275-3342, use "Bank Find" at www.fdic.gov/deposit. Money Market Funds- This long-safe corner of financial markets, home to some $3.5 trillion of deposits, has increasingly appeared at risk of falling victim to the year-old credit crunch. As jittery investors pulled money out money market funds, assets dropped by a record $169.03 billion in the week ended September 17. The Treasury said it would back money market funds whose asset values fall below $1 a share. Separately, the Fed said it would lend money to banks to finance purchases of certain assets from money market funds.When Times Get Tough, The Tough Get Going
A Debt Free Alternative to Reverse Mortgages While reverse mortgages have been around for decades, only in the last couple of years have there been alternatives that allow retired people to unlock their equity without tying up their present and future equity in a reverse mortgage. Now there is an option that allows a property owner (residential, land, investment and commercial) to own and control all their existing equity and obtain cash today in exchange for a percentage of future appreciation. Like a reverse mortgage there are no monthly payments, but this is where the similarities end. We use this program in accordance with income strategies to supplement retirement income and bolster investment savings. It could also assist you in restructuring your debt to lower your monthly payments. This form of equity access can be extremely valuable as an estate and tax planning tool. (Read A Debt Free Alternative to Reverse Mortgages.)At Karp Capital we’re here to listen to the concerns of our clients, give sound advice, and execute their financial plan. If you appreciate this style of financial management and would like to work with an advisor who can satisfy your investment concerns, you have found a home at Karp Capital. Please remember that we appreciate your support and we’re flattered when you refer your family and friends. If you know someone that would enjoy our commentary on the market, please share the newsletter with them. If they would like to receive our quarterly commentary please direct them to sign up for the email edition at www.karpcapital.com. If you have any questions on the analysis above, or would like to review your portfolio¹s performance, please call me at 877 900 Karp. Working with Karp Capital, there is only one boss, YOU!
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The third quarter of 2008 is one for the history books. The ongoing turmoil in the financial markets continues to dampen investor confidence and raise fears of a runaway financial crisis. AIG’s meltdown and the quickly arranged marriage of Merrill Lynch to Bank of America have raised concerns, too, especially about the fate of the remaining independent investment banks on Wall Street. Broader stresses in the banking industry are also contributing to the pressure on the stock market. 
Burned by brokers and banks… We have met a handful of people over the last few quarters that have been led astray by their financial advisors who have sold them “money market alternatives.” These alternatives included auction rate preferred, commercial paper, floating rate and notes backed by their financial institution. 
Don’t put your head in the sand now that the president and the administration have admitted there is a financial problem. When the economy is challenging, when people sense trouble, there's a tendency to look the other way or trust the first thing they hear if it's what they want to hear. Start by taking an inventory of where you are financially. Since it’s the end of the quarter, all your bank, credit, investment and retirement statements will be delivered in the next two weeks. Start by asking your financial advisor questions and monitor industry news and sources. We view today’s environment as an opportunity to upgrade your investments and determine your true risk tolerance. These are times that test how committed you are to your goals. We believe that a standard buy and hold portfolio is not the best strategy as your goals change and the fundamentals of the financial markets evolve. There are ways to transfer and reduce risk that are fairly new concepts to most investors. As you approach retirement, it is prudent to look not only at portfolio diversification (stocks, bonds, commodities, currencies and real estate) but also investment product diversification. Don't hide -- take an interest…. It is your money. Call us to review your portfolio or to address your financial concerns.
