New Year, but Not New Enough

With the start of the new year, stocks and bonds around the world experienced a decline in value. It was a grim beginning with the first two months being the worst performing January and February on record. The focus for the first quarter then became capital preservation. More recently, the markets have experienced a surge since the lows of March 9th. Even so, we still caution investors that the road to recovery is long and potentially bumpy. The stock market is likely to continue to struggle even as the Federal Reserve, Treasury and the Obama administration unveil unprecedented economic stimulus programs. Because of toxic assets and the ailing health of the largest financial institutions, our problems are far from over. The three trillion dollar stimulus might also have a negative impact on our standard of living, not to mention the effect it will have on future generations. Given our view of the economy and the policies coming from Washington, we will outline our investment strategy and highlight important events that will shape the future of the U.S. economy.

Here are the performance numbers for the major indices for the 1st quarter of 2009, 6 months and 12 months (as of 3/31/09), Total Return % Change.

Click here to view 1st Quarter 2009 Sector Performance.

Banks and the Obama Plan

The administration’s plan to get toxic assets off the banks’ balance sheets has been well received by Wall Street and investors. Keep in mind that spending trillions of dollars is a zero sum game and there will be economic ramifications. If it works, the program will remove one trillion dollars worth of toxic assets at prices not yet determined. It will leave an estimated $60 billion in excess assets on the banks’ balance sheets. This addresses the known toxic assets, but what about the future losses in commercial and residential mortgages, credit cards and other consumer credit? The answer may well lie in more programs and more of your money being spent. There are a few obstacles that must be overcome in order for the plan to work. Will the banks participate? Rumors abound that JP Morgan and Goldman Sachs want to give back the original TARP monies they received, claiming difficulties in running their businesses with government oversight. To further complicate matters, some of these toxic assets are still paying and are far from defunct. There is no guarantee banks are going to lend to credit worthy borrowers, and that is a concern. The best course to recovery might be to call it what it is; nationalize the banks, sell the bad assets, then sell the healthy banks back into the capital markets.

The Fed to the Rescue

The Federal Reserve took bold steps to stimulate credit markets. Their plan is to buy $300 billion in long term treasury bonds, up to $750 billion in mortgage backed securities, and $100 billion in other securities. The TALF (Term Asset backed security Loan Facility) is the name of the program to help Main Street. The Feds will lend against AAA rated asset backed securities and loans guaranteed by the Small Business Administration. They will collateralize credit card debt, student and auto loans. In effect, the Fed buys these loans and will eventually sell them, putting money back in the system to make loans. If this program works as planned, it will allow the financial institutions to make new consumer, business, and mortgage loans at lower interest rates. The good news is we are seeing mortgage rates and some consumer loan rates come down.

Housing – Did we Bottom?

Housing is stabilizing in the markets that have been hit the hardest, which is not the same as a recovery. Are buyers entering the market because of low prices and historically low interest rates? Or is it that sellers are forced to sell due to job losses and financial hardship? Half of the sales in February were distressed properties. The home inventory overhang is finally beginning to shrink. As job losses continue, home prices will continue to slide, but at a slower rate. This is a good time to buy a home as your primary residence if you have job security and a good credit score. On the investment side, we would buy homes in the best neighborhoods where the generated income from the property is in line with ownership expenses.

Trade Wars

In order for the U.S. economy to climb out of this recession we need to support global trade and eliminate protectionism. Our relationship with China is a perfect example. We need China to buy our debt to finance the deficit. China has become the largest holder of U.S. currency in the world. In fact, China is the only major economy that continues to grow throughout this current global downturn. The ramifications of closing our markets would be devastating. China’s top foreign exchange official said that China will continue to buy U.S. treasuries and endorses the dollar’s role as the world’s reserve currency. Two weeks earlier, Chinese premier Wen Jiabao said he was worried about the safety of treasuries. U.S. Secretary of State, Hillary Clinton has urged China to keep buying U.S. debt. At the beginning of January, the U.S. iron and steel industry was lobbying for a Buy American provision in the stimulus package. Congress is signaling to the rest of the world that the U.S. supports protectionism. Forcing U.S. contractors to buy domestic goods instead of shopping for the best price available world wide means that taxpayers risk overpaying for their roads and bridges. This means capital will be misallocated and hardly makes for good economics. Other countries, including China might lock American companies out of the bidding on their projects. In what could be interpreted as retaliation, the Chinese government blocked Coca-Cola’s $2.3 billion bid for China Huiyuan Juice Group Ltd. It would have been the biggest foreign takeover of a Chinese company. Protectionism has never stimulated the U.S. economy. Free trade and open markets create jobs. We believe the U.S. dollar will weaken if this policy continues. We still want to buy U.S. multinational companies with sustainable dividends.

The Market Environment

There is a saying on Wall Street, Don’t Fight the Fed. Since they are printing money at an alarming rate we believe we will have inflation in the near future. We live in a global community and compete with the world for goods and services. More than 80 percent of the world’s commodities are priced and traded in dollars. Inflation will cause these prices to increase. In addition, our dollar is starting to drop. It will cost us more than the major countries of the world to compete for these commodities. Who will buy our government debt? As soon as foreigners buy it, it is worth less than their local currency. Keep in mind we are currently experiencing deflation, but the markets are forward looking. In order to best position our clients we must invest in emerging themes. This re-inflation theme can be addressed by buying commodities, oil, and the indices of the BRIC countries (Brazil, India and China.) These investments will benefit from inflation and a weak dollar. When positioning assets, we want to focus on true long term risk-return fundamentals and results. Even though investing in the stock market carries some degree of risk, we believe you should think twice before giving up on stocks. Given the uncertain market environment, we are buying and hedging portfolios at the same time. We want to see the market stabilize and price volatility subside before actively adding to our favorite sectors. The lows in the market have been tested and we want to see them hold in order to feel confident that we are starting the new up-tick in the market. Call us to review how your portfolio is positioned for the current market environment.

Looking for Income

We continue to focus on high quality bonds as our core fixed income position. The recession and the Fed have painted bond holders into a corner. The Fed has pushed the Fed funds rate close to zero. It is hard to get excited with historically low treasury rates and cash yielding nearly zero. High yield bonds and preferred stocks force the investor to take on credit risk from issuers where credit quality could be a concern. The issuance of $68 billion worth of investment grade corporate debt in February was a positive sign for the fixed income market. This compares with $35 billion issued in February 2008. As we wrote in the 2008 year-end edition of Karp Capital Focus, we like general obligation municipal bonds. In addition, given our outlook on rising inflation, we embrace the defensive nature of the yield advantage of high grade corporate bonds and the inflation hedge of treasury inflation notes (TIPS). It’s our belief treasury prices will plummet and yields will rise. The massive fiscal and monetary stimulus introduced by the U.S. Treasury and the Obama administration is bound to cause a rise in inflation. Even though we have concerns about inflation, we are suggesting 1-3 year treasuries for our risk adverse investors.

All that Glitters

While equity markets have plummeted around the globe, gold has shown price stability. Gold is viewed as a hedge during geo-political instability, inflationary times, and economic uncertainty. Though we are currently in a deflationary environment, the gold market has been rallying on fear that the trillions of dollars printed by Washington will not be removed in a timely manner once the economy shows signs of recovery. As we know from economic experiments around the world, printing money is an inflationary monetary policy. We view gold as a hedge in our portfolios and are bullish on the precious metal. In the future we expect to see hyper-inflation and rising unemployment. Gold could come in handy as a predictable global currency. The more dollars that are printed, the less they are worth as they enter circulation. As the dollar drifts lower, gold becomes more attractive. Determining when to add to our gold position is the challenge at hand. We generally like to add to our market hedges when prices are strong, not weak. We participate in the gold market by buying the exchange traded fund, symbol GLD. Over the last five years, gold has been a lousy investment on a risk/return basis. Even at its current price per ounce (low $900s) gold is only 12 percent higher than its price on January 21, 1980, when it hit its former high of $840 per ounce, adjusted for inflation.

Credit Woes

As the recession deepens, people are looking for relief from financial pressures. Housing costs are the largest expense for most Americans. The media is feeding the refinance frenzy by telling home owners rates are at historic lows. It is critical to have your credit in good standing. When you request your credit report, the major credit agencies (Experian, Trans Union, Equifax) can sell your name to the highest bidder. You may then receive a call, convincing you to divulge personal information with the assumption it’s part of the credit updating process. For the last six years, identity theft has been the number one fraud complaint filed with the Federal Trade Commission. Given the ease of the crime, identity theft and misinformation on credit reports are connected. So much of what affects us financially stems from our credit report and its corresponding score. After a credit report is run for a re-finance or home purchase, clients have reported receiving suspicious calls. The credit agency states they are performing a service by having other financial or lending companies contact the client. This is an invasion of your privacy and an opportunity for identity theft. Furthermore, if your credit is compromised, it is difficult to repair your score. The major agencies are not interested in insuring accuracy or responding to the consumer. There is no financial incentive to provide assistance. They are paid for running the reports and selling information. Why should you care? Credit reports contain personal information about how you pay your bills, your address, whether you have been sued, or filed for bankruptcies. The Federal Trade Commission recommends consumers dispute errors and report unauthorized credit report access as soon as possible. This process takes time, money and diligence to be affective. Do not disclose personal information over the phone to people you do not know. Request any inquiry be sent to you in writing. If you'd like to learn more about protecting yourself from identity theft, call us today.

The Big Question

When Wayne Gretzky was asked what made him the Great One, he replied, “I skate to where the puck is going to be, not where it has been.” A solid financial plan is similar in that it provides the road map that will get you to where you want to be. It helps you look beyond the day to day, gut wrenching volatility and focuses on why we invest. People panic, become irrational and make things worse. They tend to sell out at the worst time. Fear is a disruptive force in making long term decisions. Focusing on your daily account balance is counter productive. A plan that’s well executed allows you to relax, secure in the knowledge that there is a formulated, mutually agreed upon strategy in place. Click here to start the financial planning process.

We will make the necessary changes to portfolios, adjust financial plans and listen to your concerns to put you closer to obtaining your financial goals. We continually strive to add value to the relationships we have with our clients. How can we help you during these down markets and troubled economic times? What services and activities do you value? In the next few weeks we will be sending out a brief survey. To further strengthen our relationship and be even more responsive to your needs, it’s important that you respond.

These are challenging times, to be sure, but you don’t have to face them alone. There are still many investment opportunities on the horizon and we look forward to taking this journey together.

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 portfolio's performance, please call me at 877 900 Karp. Working with Karp Capital, there is only one boss, YOU!

Peter Karp Karp Capital Management Corporation Registered Investment Advisor 2269 Chestnut St #308 San Francisco, CA 94123 P: (415) 345-8185 (F:(415) 869-2832 peter@karpcapital.com karpcapital.com

If you no longer wish to receive the Karp Capital Management Focus newsletter, please contact us to be removed from our mailing list . Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. All opinions and estimates herein, including forecast returns, reflect our judgment on the date of this report and are subject to change without notice. Such options and estimates, including forecast returns involve a number of assumptions that may not prove valid. Further, investments in international markets can be affected by a host of factors, including political or social conditions, diplomatic relations, limitations or removal of funds or assets or imposition of (or change in) exchange control or tax regulation in such markets. The past performance of securities or other investments does not necessarily indicate or predict future performance, and the value of investments and income arising there from can fall as well as rise; the investor may get back less than what was invested; and no assurance can be given that any portfolio or investment described herein would yield favorable investment results. We or our associated persons may act upon or use material in this report prior to publication. This document may not be reproduced or circulated without our written authority.