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Good Bye 2008
In this installment of Karp Capital Focus, we will share our concerns and offer some sensible solutions to this market malaise as we begin an uncertain 2009. Here are the performance numbers for the major indices for the fourth quarter of 2008, 6 months and year to date (as of 12/31/08). (Total Return % Change)
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Our View We believe there is hope on the horizon in the form of cheaper credit, increased government backing of corporate debt, and the new administration’s economic stimulus plan. However, we suspect the economic downturn has not yet run its course. With unemployment accelerating and so much wealth lost, it will take some time before consumer, business and construction spending is revitalized. Given the massive amount of government stimulus, we should see the economy stabilize as we enter the second half of 2009. It also seems likely that a lot of the bad news has already been discounted in the markets. Now we have to ask ourselves, when will the private sector start participating in the recovery and what should we be looking for to signal a turn in the markets and the economy? Credit and Liquidity
Employment = Confidence Economic recovery will depend on job creation since employment is the centerpiece of establishing consumer confidence. If 70% of our gross domestic product is derived from consumer spending, cutting unemployment is paramount. If we see the unemployment rate continue to climb, it will have an adverse effect on consumer confidence. To further complicate matters, deflation will contribute to unemployment. As prices continue to fall, business and consumers move to the sideline and curtail spending. Change of Attitude
It’s also important to consider the effect of the alleged $50 billion Ponzi scheme by Bernie Madoff. This travesty only highlights the need for greater transparency in markets and legitimate businesses. We have been failed by our regulators in their lack of oversight and enforcement by the SEC. There was also a gross failure of investors in their due diligence. Transparency is key. Our clients can see what we are doing on line minute by minute. Additionally, our clients receive statements provided by a secure independent third party custodian. We have an investment strategy and process which is outlined for each client. Our goal is to be clear about how each client will reach their long term investment objectives. Our ultimate achievement is your trust in us. Desperate for change, America’s voters spoke loudly when Democrats and Republicans alike made history by electing our first black president. Barack Obama’s platform and persona showcased the qualities we want to see from our commander in chief, compassion and integrity. Even before his inauguration, the markets have responded well to Obama’s cabinet appointees. Investment Strategy Where do we begin? Being nimble wasn't enough to save our performance in 2008 given the dismal markets. In order to develop and refine our investment strategy, we need to clarify our view of the economy and have an understanding of the psychology of the markets. We cannot turn a blind eye from the massive intervention by the Federal Reserve and legislators in increasing the money supply. In time, this could result in inflationary pressures leading to possible interest rate increases. In 2008 there was no place to hide except in the low yielding treasury market. Government bonds have dramatically outperformed other investments, driven more by fear and a need to park monies rather than as a long term investment vehicle. We saw damage in the equity markets spread to all sectors. Despite the turmoil in the markets, we continue to buy our focus sectors. Our core stock strategy is based on analyzing sectors that comprise the S&P 500. In 2008 all ten sectors of the S&P 500 exhibited significantly negative returns leaving no place for investors to hide. Even though we are more constructive on the stock market, we think it is much better to be a little late than early with respect to timing the market recovery. We are starting to see some sectors stabilize without reacting to the announcement of bad news. This could be a sign of a bottoming process and a near term market rebound. As we mentioned in past installments of this newsletter, we want to own securities for our core portfolios that generate sustainable dividend yields and not the highest yields. Furthermore, dividend income still has tax advantages over interest income. Our focus sectors are healthcare, utilities, consumer staples and large cap technology. Given the uncertainty that has gripped investors, we want to use our cash position and trading flexibility to take advantage of sell offs. We want to start putting our large cash position to work to purchase sectors that have suffered over the last year. We sold most of our international and energy holdings at the end of the third quarter. Because of the extreme market volatility, we have been hedging our portfolios for unanticipated events. The hedge is used as we are repositioning holdings. This helps us enhance performance as the market tries to find a bottom. The market, as we know, has been driven by consumer confidence. We believe investors will start to focus on the new stimulus package. There is tremendous cash on the sidelines in the U.S. Investors are just waiting for some catalyst to put the money to work. This is not to say it will be a smooth ride. In the past, whenever there was “blood in the streets,” opportunities have arisen for long term investors. During the two most important lows in recent history (1974 and 1982) it was truly a good time to invest. Above all, it’s important to remain patient. Where is the Growth?
Gold and the Dollar
It’s also worth noting that gold has been climbing as the dollar has been falling. It’s hard not to wonder if there is any correlation. We believe foreign monies are looking for a safe haven and an alternative to the dollar as the uncertainty of the global recession plays out. We use gold only as a hedge and do not believe in its long term investment merits. We will be taking profits in our gold position as the price approaches $1,000 an ounce. We would rather own gold, the commodity, as opposed to the companies responsible for its mining and refinement. Real Estate – From Bad to Worse
Bailout Hits Main Street The Federal Reserve is finally implementing a program that directly helps homeowners. In an effort to help lower home loan rates, the Fed said they will be purchasing as much as $600 billion of debt issued or guaranteed by Fannie Mae, Freddie Mac and other government backed mortgage companies. Fed rate cuts typically lead to inflation – the enemy of bonds and home loan availability. This time, the Fed stated that inflation pressures have diminished appreciably and it expects inflation to moderate further in coming quarters. This comment rings true after viewing the inflation measuring Consumer Price Index Report. It showed that consumer prices dropped more in November than any other month since record-keeping began in 1947. Lower interest rates on home loans will help reduce excess home inventories and qualify more people for loans. Greater affordability is needed, given rising unemployment and home foreclosure rates. There is talk that Uncle Sam is about to enact a housing stimulus program. These programs will probably not help borrowers who subscribed to the option arm loan. During 2005-2007 many consumers strived for the lowest possible payment. Bonds – The Opportunity We all know that 2008 was a rough year for virtually all investors. The fixed income market was no exception. To be on the defensive, good quality fixed income investments should be added to a portfolio. For equities to perform, some appetite for risk is necessary. In the corporate bond market, you need companies to remain current on their obligations and able to make interest payments. Some of the drop in the corporate bond market was due to a lack of liquidity as opposed to real economic issues. Additionally, the yield differentials between corporate and treasury bonds have never been wider. Eventually these spreads will narrow. There is an opportunity to lock in some attractive yields never before seen for investment grade bonds. Call us if you have questions on how to generate sustainable income. To further shore up your portfolios, we still want to add municipals. In the fixed income arena, they have weathered the storm better than most asset classes. This chart shows the relative risk and after tax performance of major equity and fixed income asset classes. Tax-exempt municipals have provided higher levels of after-tax returns than treasuries or corporate bonds over the past 10 years. These returns have come with lower volatility, as measured by the annual standard deviation of returns. The current market environment has witnessed numerous market mispricings. These have led to extreme moves due to fear and greed and resulted in forced selling. This environment has produced both opportunity and real concerns. We believe the market has factored in most of the bad news for the municipal market. Please keep in mind the municipal market is diverse and is state specific. Each bond must be analyzed on its own investment merits and income to cover the bond interest payout. Ten year municipals are currently trading at roughly double the yields that can be found in 10 year treasuries. At the end of December, 10 year municipals were yielding 4.27 percent, compared to 2.13 percent for the equivalent treasury. On a tax equivalent basis, the municipal yield is comparable to a taxable bond yield of 6.57 percent for investors in the highest tax bracket. With the opportunities come risks in this fixed income sector. An example of this is the dire financial predicament of the State of California. California's estimated budget gap through June now stands at nearly $15 billion. Gov. Arnold Schwarzenegger has written letters to congress and stated his case on 60 Minutes. The news is out. Many states are in trouble. We believe the next bailout could be a lending facility on the state level. Projects such as building and improving roads and schools could be in jeopardy. This flies in the face of one of Obama’s main initiatives, infrastructure spending. Right Now The innovative strategy by the Fed and the Treasury to purchase mortgage backed securities has caused fixed rate loan interest rates to plummet. Home owners are not just refinancing their existing mortgages, but first time home buyers should be getting off the fence and making the purchase. The savings are tremendous given the historic low fixed rates. The time to act is now. Rates on 30 year fixed rate mortgages are the lowest in nearly four decades. If you're a potential investor holding out on hopes that the U.S. Treasury Department will follow through on a proposal to push rates down as low as 4.5% for purchase mortgages, that could be a mistake. Rates climb more quickly than they come down. Please keep in mind, these rates are not available to everyone. It can be somewhat misleading if you listen to the media. Also, if you are looking to pull cash out of your home, the process is more involved and the rate could be affected. These loans are available for specific borrowers who meet certain qualifications and requirements. The conforming loan limit in 2009 is $417,000 for most areas of the U.S. In designated high cost markets, the limit rises to $625,500. Rates on jumbo mortgages have not come down. Any loan over $625,500 is considered a jumbo. If you would like a mortgage analysis please download our form and fax us your request. Financial Planning Now
Good News for Seniors Every demographic has been hit by the recession and market downturn. Seniors are no exception. President Bush signed the Worker, Retiree, and Employer Recovery Act of 2008 into law on December 23, 2008. This emergency package provides much needed relief from required minimum distributions (RMDs) in 2009. The legislation waives RMDs for 401(k) 403(b), IRA and other "qualified" retirement accounts in 2009 for taxpayers who are 70 ½ or older. Because RMDs are determined based on the account balance as of the previous year (on December 31st), this means Americans over 70 ½ can avoid taking a distribution in 2009 when the value of their retirement account is down. This is smart legislation that affects many Americans directly. For more information about how the new legislation affects your plan distributions and requirements, please contact us. As we begin the new year there is a risk of not having enough money to reach your goals because of recent losses in the market. In addition, cash and low yielding treasuries do not allow for any future growth potential. Everyone wants to buy low and sell high, but with the current market, many investors are inclined to panic and abandon their investment strategy. Now is the time to make adjustments and be realistic. Call us to create or review your road map to financial success.
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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Perhaps the best thing that can be said about 2008 is that it’s finally over. It was a year tarnished by rising unemployment, corporate bankruptcies and corporate fire sales, the credit freeze, unprecedented market volatility, and plunging portfolio values. Add to the mix soaring energy prices for the first half of the year followed by their crash in the ensuing months and you have a year that most people would like to forget. As if all of this wasn’t enough, we’ve had a Federal Reserve that was ineffective for much of the year. The Fed opted to print dollars in unlimited volume and trim rates almost to zero. Economic pundits praised the central bank’s determination to fight deflation by supporting inflationary measures. Savers were punished at the expense of speculators. The Dow Jones Industrial Average lost nearly 34% for the year, its worst performance since 1931 when the benchmark stock index lost more than half of its value. The Standard & Poor's 500 Index lost 38.5%, its worst year since 1937. 
The price movements of the dollar vs other currencies will be a main focus of ours in 2009. We witnessed renewed weakness in the dollar at the end of 2008. As foreign governments continue to lower interest rates and stimulate their economies, the dollar should continue to slide. To have a strong dollar, we must have a sound economy that includes manufacturing, tax cuts, and an incentive to save. If weakness continues, it could be a sign that risk taking is coming back into the markets. This would be positive for stocks yet negative for U.S. treasuries. In the second half of 2008, the fear trade was to rush to treasuries and the dollar. So much of the leverage that had to be unwound in the deleveraging process was based in dollars. If the retreat takes hold, it may mean that we are far enough through the deleveraging process; a process that was destructive for both the markets and the economy.
Excess home inventories are a major problem at this point in the real estate cycle. As long as there is excess inventory (more homes for sale vs. qualified buyers) there will be downward pressure on housing prices. This puts more homeowners at risk, where their loan amount is above the home value. It makes it impossible to refinance and perpetuates the downward spiral in prices. Since real estate markets are local, some areas have been devastated while other areas with little supply have remained relatively unscathed. Home prices are back to their March 2004 levels, having dropped in 20 major U.S. cities by 2.2% in October and by a record 18% from the previous year, according to the Case-Shiller price index. The latest data from the National Association of Realtors in Washington showed that sales of single family homes, townhouses, condominiums and co-ops fell to a seasonally adjusted rate of 4.49 million units in November, down 8.6% from October and 10.6% from a year ago. At the same time, median home prices fell 13.2% to $181,300 in November from the same month a year earlier.
This is the time to evaluate whether you need to adjust your finances or make a lifestyle change in order to accommodate your cash flow needs. The first step is defining your financial goals and needs. If you feel these might have changed over the last year, we’re always available for a one on one consultation. Our job is to help clients make decisions on how to invest their monies and evaluate financial goals. Call us if you have questions on the process or (