Quarterly Commentary: April 2008

First Quarter in Review

It was the worst quarter in five years.  The S&P 500 declined 9.65%; global equity markets fell by 14.9%.  Not only did every sector decline; they all declined by more than 10%.  Energy was actually the second worst performing sector, with a decline of 17.6%.

I ran large cash balances and ended the quarter pretty flat.  I am now almost fully invested, largely in energy and Asian exchange-traded funds.

Strategy for the Second Quarter

Market conditions strike me as rather obvious.

• The credit crises already well surpasses the savings & loan debacle, and is approaching great depression proportions.  The fact that the Wall Street firms are allowing the auction rate securities auctions to fail is just one suggestion that they are in much bigger trouble than may be publicized.
• The Federal Reserve will continue to lower interest rates and pour massive amounts of money into the markets to bail out residential housing – and fail.  Residential housing cannot be bailed out, even if mortgage rates were zero.
• However, all that Fed bailout money will have unintended consequences.  The dollar will continue to collapse, and the next bubble will form in commodities.
• A falling dollar and higher inflation will create much greater market risks, but simultaneously require greater returns to maintain purchasing power.  

The bull markets will be in foreign markets, precious and industrial metals, energy and agriculture.  The bear markets will be in consumer related investments, bonds, financials, real estate, anything leveraged.  The markets will ebb and flow, and there will be counter-rallies.  But the trend is pretty clear.

Tactics

Given the market risk and volatility, short-term treasuries and certificates of deposit are actually great parking places for the lay investor.  However, while market risk is mitigated, purchasing power risk is increased, since rising inflation and a falling dollar will require higher investment returns just to keep pace.  As our clients hope to minimize both market and inflation risk, I will continue to actively manage the portfolio in what I define as bull market securities.

I still suspect that most market sectors are in a big, volatile trading range.  I have larger positions in oil, natural gas, and copper that pay high dividends and have appreciation potential.  The markets have been so negative, and the Federal Reserve has supplied such massive stimulus, that I anticipate a second-quarter counter rally of some duration.   As such, I have a few positions in the S&P 500, the dollar, etc. that I think might pop a bit here.

The new trades to watch are unfamiliar to most investors.  The yen, the swiss frank, silver, gold and oil, are all investments from the history books of the 1970’s.  One of the hardest emotional aspects of investing is to recognize when one party has ended and another has started.  The Federal Reserve could not re-inflate the dot.com bubble, and cannot re-inflate real estate.  But all that money has to show up somewhere.  The market reaction of the dollar, gold, and oil has been unambiguous.