Issue #28

Summer Recap
Well the Olympics are over, the Yankees are out of the pennant race, the lending markets are barely functioning, and the mortgage lenders are close to failing. Oh, this just in, the Commerce Department has determined a recession will begin by Christmas.

Let’s start with the facts. Last issue we were fairly obsessed with inflation ($90.21 fill-ups). Then we went to Italy and paid $150 for a smaller tank (14 gallons). Maybe it’s time to get serious about building an Energy-Star economy? If we can spend a $1 Trillion trying in insure cheap oil in the Middle East, imagine what $1 Trillion of government support for developing alternative/renewable energy industries in our own terra firma could achieve.

With a global economic slowdown in process, inflation fears are declining. Some continue to speak of deflation. And the deleveraging going on it credit markets supports this. With less lending occurring, assets have little ability to appreciate. Since June 30th Commodities retreated 10%–22%, while Equity Markets were flat. While commodities were declining and the equities were volatile but trendless, all hell broke loose in parts of the fixed income market.

The ongoing saga of the impending insolvency of Fannie Mae and Freddie Mac, crashed parts of the Fixed Income Credit markets in the 2nd and 3rd weeks of July. Reminiscent of other crashes (1987), many bond trading desks failed to answer their phones on July 15. Hopefully you weren’t watching while this was happening. Some bonds fell 20% while others fell more than 40%. A semblance of normalcy returned over the last 6 weeks but the widespread uncertainty due to the absence of a Fannie/Freddie solution remains. This is affecting every company that needs to raise capital. Last week, Wells Fargo, the only AAA-rated money center bank in the country needed to offer 8 5/8% interest on its new preferred stock issue.

The Greenback
A big surprise this summer was the strengthening of the U.S. Dollar. Just when every smart person thought the dollar is doomed, the greenback rallied hard, rising 10% against world currencies. Hint, when every person you meet says they want to be short the dollar, a reversal is in order. Remember 2006? After the dollar collapsed 15% in 2005, it rallied for nearly 15 months through 2006 and into 2007 before resuming its precipitous decline In any case, the easy money betting against the dollar has already been made (the Dollar Index has declined from 120 in 1999 to 77 today).

Real Estate
Housing prices nationwide continued to move lower as supply (sellers) gradually comes to accept lower price levels. The current situation is more normal than the bubble of 2004-2006 real estate prices. Buyers are discerning today. In time, sellers will accept lower prices and transaction activity will rise to “normal” again. Price levels will fall another 3% to 10% in many markets and then stabilize for several years before a new up cycle begins.

Real Estate follows a predictable 20-year pattern, 10 up years followed by 3 down years and then 7 flat years (adjusted for inflation, i.e. 3%-4% annual gains), and then the cycle repeats. The next 6-12 months will likely represent the end of the 3 down years, and then we will be in store for 5-7 flat years. That’s the likely scenario as we see it. If you are holding on to extra real estate properties, keep your expectations low between now and 2015.

Net Worth
Back in earlier issues we discussed GaveKal’s research that shows that asset growth has risen nearly 6% annually since 1945. The great anomaly of 2008 is that asset growth is likely to be negative for only the 3rd time since 1945. When the value of all assets is declining, the “haves” (Issue #27-those who own lots of assets) feel poorer. But it’s not all about the “haves”. Part of the hope of the American experiment is the promise of the “have-nots’ faith” in their own eventual material/financial success. This is why the aspiring middle class, those making ($30,000-$70,000 in annual household income), are not especially supportive of transfer wealth programs. They understand that a leveling of the economic pyramid reduces their upward mobility.

What to Do
It’s going to be okay. A bad market in stocks and real estate isn’t the end of the world. A real estate investor asked an old-timer when the real estate market would normalize. The wise old-timer replied–“this is normal”.
Make sure you are in a position to buy a house in the next 5-7 years; you don’t want to miss the next up cycle. For now, don’t be leveraged and reduce your expectations for asset growth. In a time of global deleveraging, assets don’t appreciate much. This is a period of low returns for nearly all asset classes including alternatives like private equity and venture capital.

Strategies
Recently we’ve been implementing income strategies for clients who need to generate significant annual income. Despite our long-term fears of rising interest rates, long-dated municipal bonds are trading at the top of their yield range of the last 20 years. So while they may not be dirt cheap, they do offer solid returns for investors in high marginal tax brackets who seek to minimize risk. Remember Issue #14, for many investors, “staying even” is half the battle. Municipal bonds can provide a partial solution to “staying even” during tough economic times.

We are sticking with our tangible asset theme, believing that the commodity bull market is not over – just experiencing a major correction. The consumption of raw materials by Asia and Latin America is likely to continue. Preferred stock issues offer good value. High quality issues (like Well Fargo and Prudential) are yielding nearly 9% and while lower quality issues like REITs and some less strong financial 12%. Since we don’t expect equities to average 10% annual returns anytime soon, these are attractive, particularly for retirement accounts.

In Conclusion
Excellent investment counsel minimizes fees and delivers wise counsel. Perhaps more importantly, the best investment counsel creates a safe environment in which clients can dream, think and share the hopes, fears, aspirations and doubts. Be discerning in your choices of who to work for, bank with, and invest in. Don’t just settle.
So what’s this mean for your portfolios? Equities and real estate continue to face heavy headwinds and are unlikely to produce consistent double digit returns anytime soon. However, the next bull-market may not be as far off as we think. Perhaps a bit of productive investment, rather than Middle East occupations, would increase equity returns? As we circle the wagons, we continue to find value in pockets of the fixed income market, gold and some equities. We are producing income with covered call strategies and biding time, in this “normal” market.

At Barnes Capital our approach is to protect and grow our client’s wealth with less risk while providing exceptional client service. This combination of benefits is uncommon amongst financial services companies. If you know someone we may be able to help, please let us know.

Barnes Capital is a Registered Investment Advisor located at in downtown Lafayette. With RB Capital Management, Barnes Capital develops custom tailored portfolios for its clients. Specialized in retirement income portfolios, financial planning in an integral part of our process. Call 925-284-3503.

This entry was posted on Sunday, August 31st, 2008 at 2:23 pm and is filed under Insight Newsletter. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.