Is It Soup Yet?
Have we bottomed? Is the worst over? Has the bull market started yet? No matter how you say it,
many investors are thinking, or at least hoping, that the market will go no lower than it did in mid
November. The above chart shows the S&P 500 Index from its high in October 2007 until the end of
2008. We can see that there have been five distinct "bottoms" or new lows, since peaking in late
2007. Notice that some of the bottoms are literally single day events, while others are double or
triple bottoms that take several weeks or months to occur. With each new low, the market has
bounced back up, with gains of 10-20% or more, only to come down and make a new low.
The point of this graph is not to bring back miserable memories. Rather, it is to show the difficulty in
"calling" market bottoms. We may not know for several more months whether the November 2008
low is in fact the bottom or not. If it turns out that November was the low, then chances are, by the
time we realize this fact, the market will have already regained a meaningful amount of its losses.
And forget about reading the paper or watching TV to get information about when the bottom will
occur. Stock markets always bottom before the economy does, which means that the news will
always be worse after the bottom is already in place. If you wait for good news to occur before
getting (back) into the market, the bottom will be long gone.
That is precisely why we advise our clients to stay invested and patient. By the time everyone
"knows" the market has bottomed, the market will have already rewarded investors who have stayed
the course. By owning portfolios that are well diversified, we will be assured of owning portions of
the best performing asset classes in the new bull market, even if we currently do not know exactly
which ones they will be. Needless to say, when the soup is finally done, we are all looking forward
to a hearty bowlful.
That's the feeling that most of Bernard Madoff's investors are experiencing right now. They put their
full trust into this financial icon, only to find out that he was running the grandest of all Ponzi
schemes. Here is some advice for those who don't want to end up in similar circumstances:
Invest in assets that you can see, otherwise known as "transparency". Many hedge funds
and other "opaque" vehicles such as private Collective Trusts or Unit Investment Trusts
simply don't allow an investor to know exactly what is going on with their money. Madoff's
investors are finding out that not seeing what you own can lead to disaster.
House your assets at a reputable, third party custodian. Madoff's clients kept their assets at
Madoff's own securities firm. So Bernard could literally print anything he wanted on "his"
Dixon Hughes Wealth Advisors has been following the above advice from our first day of business.
Our investment vehicles are totally transparent, institutional, pure no-load asset class mutual funds.
In addition, we hold all client assets at TD Ameritrade Institutional Services - one of the largest and
most reputable institutional custodial firms in the world. Your DHWA advisor never has possession
of your assets; we only instruct your custodian when to buy and sell. Only you have access to your
Trust is a great thing. But without the precautions of transparency and independent custody, trust
doesn't mean much. Just ask those angry Madoff investors.
Active Management Bites the Dust...Again
Active investment management is defined as buying low and selling high in an attempt to beat your
benchmark. Historically, during bull markets, the majority of active managers have under performed
their benchmarks. Passive managers simply own a group of securities that replicate a benchmark
index, or asset class. Active managers claim one of the reasons for this under performance in good
times is that passive management is virtually always fully invested, and don't have much cash in the
portfolio to drag down performance. Many active managers claim that they will out perform passive
management in bear markets, when their ability to raise cash will help soften the blow. That makes
good sense. Unfortunately for them, that reasoning has proved false
According to Morningstar Inc.,* over 70% of the largest 100 actively managed mutual funds
underperformed the S&P 500 Index in 2008 through October 28 (date of study). That means that
during the worst bear market in recent memory, the majority of the largest active mutual fund
managers have done worse than their passive benchmark counterparts. This is true even though
the active managers had the ability to raise as much cash or use other hedging techniques if they
desired. The moral of this story is that active management finds it difficult to beat passive, even
when the odds appear to favor it (like a bear market). Passive management is predictable, more tax
efficient and much cheaper....in good times, and bad.
*InvestmentNews "Big mutual funds stumble in market collapse" 11/08
Fourth Quarter 2008 Asset Class Returns
With all the television and press coverage and your monthly brokerage statements, it is probably
needless to say that the fourth quarter had some of the most negative quarterly returns in history.
And as the chart at the beginning of this letter shows, this is after a decent bounce from the
November lows. The severe fourth quarter only punctuated horrible yearly figures, which showed
reductions in equity asset class values from 1/3 to 1/2 and more. Most Domestic and International
stock returns were quite similar, which underscored that even with excellent diversification among
nations, company size (Large and Small), and company style (Growth and Value), with the panic
selling that occurred during October and November, no amount of diversification lessened the blow.
Bonds appeared to have good quarterly and year to date returns, but that was actually a deception.
Government bonds posted excellent returns, but all other type of bonds were pounded down, with
some of their worst quarterly returns on record. In many cases, investment grade bonds lost 15% to
25% of their value. Municipal bonds were also hammered, often hampered by the fact that many
insuring companies (such as MBIA and AMBAC), which municipalities use to establish AAA ratings,
were hurt by the mortgage collateralized bond market, and consequently the ratings of huge
amounts of municipal debt were decreased - sometimes twice or three times during the quarter.
High yield corporate (junk) bonds had equity like losses. Lastly, mortgage-backed bonds, as you
may have guessed, had some of the poorest returns of all. So, unless your income vehicles were
strictly guaranteed by the US Treasury, most investors' bond returns were meaningfully negative.
Since the third week of November, both stock and bond markets have begun to slowly repair
themselves. Most equity asset classes have moved up 15% or more from their lows. As mentioned
earlier in this letter, whether this was a bottom, or the bottom, won't be known for a few more
months. Regardless, market valuations continue to be at multi-decade lows, which suggests very
generous multiyear returns for the patient, long term, investor. After the drubbing the market has
taken over the past year, it only makes sense to stay the course and potentially receive the upside
rewards that volatile equity markets can produce.
As we say goodbye to all things relating to 2008, it reminds us of a joke. A concerned client asks his
advisor how he's holding up under all the tough market conditions. The advisor replies, "No
problem, I'm sleeping like a baby -- up every two hours crying and screaming for my mother!"
We hope 2009 will give us all reasons for much better sleep. The New Year is sure to have some
exciting times -- hopefully pleasant ones. All of us here are Dixon Hughes Wealth Advisors wish you
a very healthy and prosperous New Year.
Frederick F. Kramer IV, JD
Chief Investment Officer
DIXON HUGHES WEALTH ADVISORS LLC