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Will My Portfolio Recover?

Investment Policy Committee
November 4, 2008

It really isn’t hard these days to figure out what questions are foremost on the minds of investors.  I think David Letterman would have enjoyed suggesting answers to the above two questions with his famous list of ten on any recent night.  But while these questions might provide a good segue to some humor, they are no laughing matter.  They are of the greatest concern to all investors and understandably so.


In September, the S&P 500 Index lost 8.7%, one of the largest September declines on record.  On September 30, the YTD decline in the S&P 500 was 19.2%.  It was good to have September behind us!  But, we found out in early October that the “proverbial fat lady” had yet to sing.


In October the S&P 500 Index lost 16.8% bringing its YTD decline as of October 31 to 32.8%.  During the month we also learned that the third quarter registered a GDP decline of 0.3%.   A negative GDP in this quarter (resulting in two consecutive negative quarters) would put us officially in recession.  Of course, we already know we are in recession, but I guess it’s nice to have statistical confirmation.


Toward the end of October, however, the market signaled a change as we experienced an unsettling period of extreme volatility.  Between October 22 and October 31 there were more buyers than sellers in the market.  The S&P 500 Index closed at 896 on October 22.  It closed at 968 on October 31 .

The so-called “Vix Index of Volatility” during this period was in the 80’s.  This is unprecedented.  This measure of market volatility usually resides in a range of 20 to 30.  As I write this on Election Day evening, November 4, the Vix Index has dropped below 50.  A high Vix Index is a sign of fear and panic.  As the Index trends down the other market driver, greed, often sets in replacing sellers with buyers.


As investors we have troubled personalities.  We are at all times both sellers and buyers.  During the past several months we have all experienced the making of market history.  In attempting to stabilize world markets, the actions of government leaders around the globe have been unprecedented in their direction and scope.


I know of no previous market situation where the problem being addressed is so obtuse.  I remember when we used to fight inflation or unemployment.  Instead, we’re trying to get

a handle on preventing losses in the trillions of dollars in default credit swaps.  At least we can understand why hopeful home owners bought sub-prime mortgages.  Why these mortgages ended up in the portfolios of financial institutions around the world is not so clear. Remember, these are the smart financial folks who really know how things work.  Right!  And that brings us back to our questions.  Will my portfolio recover?  If I have cash, when should I get into the market?  It also brings us back to fundamentals.


Investing still involves taking a position in firms with the capacity to produce earnings.  The financial world has recently undergone and continues to undergo uncharted changes.  But, in the midst of this turmoil, thousands of businesses continue to produce goods and services that are in demand.  Yet, we have learned that segments of the financial sector have used smoke and mirrors to generate earnings.  Enron was the ultimate master of earnings deception.  We must avoid such companies.


What is now beginning to attract buyers back into the market are the many solid companies that have been undersold and are trading at exceptional valuations.  To name just a couple, Textron (TXT) is down 75% YTD, announced earnings per share of $3.77 in October, pays a 5.2% dividend, and is trading at 4.7 times earnings.  Cummins (CMI) is down over 50% YTD, announced earnings per share of $4.38 in October, pays a 2.7% dividend, and is trading at 6 times earnings.


Now, companies don’t necessarily come down in value solely due to market overreaction (TXT and CMI included).  But, there is tremendous value out there and a sea of liquidity that will at some point finally forsake fear for greed.  Many of the companies that will be the objects of this greed are already in your portfolios.


We are in the early stages of what promises to be a painful recession.  But, historically, the markets as leading indicators recover well before a recession is over.  This is the time to take advantage of value in sound, transparent companies.  Action now may not produce results for many months.  There will undoubtedly be a lower level to take advantage of opportunities.


Here in greater Boston we all learned this drill from Filene’s Basement.  It may be marked down lower but, then again, it may be gone!  If exceptional value is available at a cheap price, we are looking at the essential ingredients of a sound purchase.


If you are still fearful of the market and extremely worried about the recovery of your portfolio, you have every reason to harbor such feelings.  There are few superlatives that could describe what we’ve all experienced over the last few months.  It is the nature of the markets to always climb a wall of worry.  But it is also the nature of the markets to provide great opportunity in the midst of that worry.