Apparently, the markets are attempting to prepare me for the upcoming birth of my first child, giving me many sleepless nights. It would be extremely naïve, if not downright ignorant, not to be concerned with the state of things. Oil is near 150.00 a barrel, housing prices continue to fall it seems with no foreseeable bottom in sight, Indy Mac Bank being taken over by the government, and people even casting aspersions on the viability of the GSE’s (Fannie Mae and Freddie Mac). Every one of these is worrisome, some very much so, but let me try to give a little perspective and maybe a more positive analysis.
Let me start by saying, I am in no way an expert on Oil, or an Oil analyst, and I’ll be honest I’m not sure even Oil experts could give a plausible explanation for the severe run up in price. Of course on a base level it is extremely simple, more buyers than sellers. Now are there more buyers because global demand has increased (domestic demand is dropping); there are more speculators; China is consuming more; all of which I have heard, in addition to countless more explanations. It is my belief that oil at these levels is overpriced, taking into account demand, supply, alternatives, the dollar, geopolitical risk, and a myriad of other factors. As far as a target price goes, those “are like opinions” and we all know that saying, but seeing as how everybody does have one I throw a dart and say mine is $85.00 a barrel 18-24 months out. Unfortunately, you will see $175.00 before that. Why? Because bubbles (yeah I said it) always last way longer than anyone expects, and people believe the price will go there (NASDAQ 5000????). Oil will come down in price, we will adjust to consuming less of it, and companies and the markets will “get over it”.
Housing is a little different, but much much simpler. A piece of dirt on this planet is worth money. Throw some bricks, lumber, and glass on it and its worth a little more. Is it worth 20% more than you paid for it? Is it worth 20% LESS, who knows? Residential real estate has a very emotional component to it. It is one of the only investments that I can think of that people utterly refuse believe is worth less than they paid for it. We got away from the “your house is your home” mentality in this country and went to the "my house is my biggest investment and my piggy bank." Housing will bottom when people realize they aren’t necessarily entitled to a 20% annual return on a house. I know there are mortgages, debts, etc and it will be extremely painful, but unfortunately its stage that needs to be gone thru.
The GSEs. Hmmmmmmm. Government Sponsored Entity. The only way these agencies have been able to operate and fulfill there mandate is/was the implicit backing of the US Government. Without it they would be just like any other mortgage company, and at the size they are probably would have a bleak future. The Chicken Littles, Short Sellers, and all around Negative Nancys can point out all they want that it’s an implicit not EXPLICIT Gvt guarantee. So as we have seen from the rather unusual (like there hasn’t been a Sunday treasury announcement since Eisenhower was president!) Sunday statement from the Treasury Secretary, Uncle Sam will make sure its kids continue to operate.
You may think I’m insane, but the most positive news to me this weekend was the Government takeover of Indy Mac Bank. What?!!!!!! Let me explain. We have seen this situation before (S&L crisis), and we built a system to deal with it. THE SYSTEM WORKED. The Office of Thrift Supervision came in, took over and is now cleaning it up. It’s terrible if a person had more than 100,000 dollars in the bank, no system is perfect and can guarantee against all lose. If a building catches fire and the sprinkler systems goes off and contains the fire, there is always damage, when the system works the damage is minimized. In this case the system worked, we know it still works after all these years and can move on. Imagine if it didn’t, Yikes!
All that verbiage may not make you feel any better, maybe nothing will; but I’ve been doing this a long time, and studying it even longer. The one thing I can say with 100% certainty is our investment philosophy works. If you invested $100,000 in the S&P 500 on September 30, 1973, on June 30, 2008 it was worth……..$3,565,612, an average annual return of 10.83%. That return includes the Crash of 1987, the recession of the 70’s the tech bubble, 09/11, and you name it. Although that result may not meet everyone’s return expectations, I dare say the majority of investors would be very happy with it.
Guess how much that same $100,000 was worth on September 30, 1974?...$61,007.00. A -38.99% annual return. How about September 30, 1975?...$84,266.00. Two years later you were still down 15.73%. My point is (as it always is) we invest for the long term. Short term market moves can be extremely distasteful, they can make you want to run and hide under your bed (or at least put your money there). But we will continue to look long term and stay the course. Regards.
Brad Reynolds, CFA