4th Quarter 2009 Newsletter
Dear Valued Client:
How many of us would have predicted at the end of 2008, or even at the end of the first quarter of 2009, that we would end the year with virtually all of the various investment markets in double digit returns. In many ways it has been a gratifying year, watching as the market confirmed the value of a disciplined investment approach. One of the big questions lingering from 2008 was whether or not Asset Allocation as an investment approach was proven ineffective in the market meltdown. After this year, the answer is a resounding ‘no!’ Using a disciplined, rational investment approach slowed the loss in the down market, and is now reaping the reward in the recovery.
Long-term investing is difficult. It requires that we overlook the volatility in the short-term for the prospect of higher returns in the long-term: Higher returns that may not materialize or may take far longer than we anticipate to be realized. To be a truly successful long-term investor we must be patient, disciplined, and unwavering. Those who are the least successful are those who lack commitment, continually following after the latest trends or reacting to short-term events. Unless they are exceedingly lucky, or gifted with second sight, they invariably end up buying at high points and selling at low points, thus reaping lower returns than if they had just stayed invested the whole way through. Study after study confirms this, and yet many still have a strong inclination to follow the herd. This is no better displayed than in a broad market panic, like we saw in first quarter of 2009, where many investors sold everything and anything they could regardless of price or value.
What we need to continually keep in mind is that investing is not a contest of who can post better numbers than whom; it is about you reaching your goals. The problem is most investors have never really considered or quantified their goals, so they have no idea what it will take to get them there. For lack of knowing what they are striving for, they focus on what is readily available: short-term performance. It is similar to driving to an unknown destination. If you know the road you are on will take you where you need to go, you will not immediately change course if it veers in an opposite direction for a time. You might stop and review your map, but you will trust that it will eventually turn back toward the direction you need to go. Without that map you will likely make the next turn to get you going back in the right direction, without knowing what consequences that has to reaching your destination. A sound financial plan, periodically reviewed and updated, is that map for your financial life, and provides you with the confidence to ride through the twists and turns that come with long-term investing.
Year in Review
In acknowledging the importance of having a plan to help you navigate the investment markets, we made some significant internal changes in 2009 to allow us to more thoroughly focus on helping you develop a plan. Our investment guidelines have always been driven by our Investment Advisory Committee, but previously it fell to the individual planners and relationship managers to implement those guidelines. This meant that a majority of their time was spent on investment issues. We saw an opportunity to free up their time to focus on your broader financial planning needs by centralizing the investment management process within the firm. This allows for a more consistent application of the committee’s guidelines and it creates a management position whose main responsibility is the ongoing review of both current and proposed investment vehicles and strategies. We feel this will bring a new dimension to our investment management, and will broaden the scope of your relationship with your current advisor, and our experience in 2009 has borne this out.
On the investment side, we made 2 tactical shifts in 2009, the first to overweighting High Yield Bonds earlier in the year when we felt that they offered a compelling way to capitalize on the potential market recovery coupled with a high double digit interest rate that would mitigate downside risk. Later in the year we then to began underweighting them, when we felt that the majority of the returns had been made and that the risk was building in that part of the market.
We also were able to employ some new investment products for certain clients this year in the form of structured notes. In the first quarter we used notes that provided enhanced exposure to the returns of the S&P 500 and provided limited downside protection. We employed these during the worst period of the market panic as a way to help some of our investors feel more comfortable in investing in the market. In the middle of the year we used a similar note to gain exposure to a compelling commodity strategy managed by one of the world’s largest commodities investors that offered the ability to benefit from both positive and negative movements in the commodities markets. To date these products have performed as expected and we continue to look for compelling opportunities like these to enhance your portfolios.
On the financial planning side, debt restructuring has been a big theme for the year, as we have helped a number of clients to examine their mortgage options and refinance where appropriate. With a combination of falling interest rates and tightening cash flows, a tactical refinancing of debt had the opportunity to provide significant and timely value. In at least two situations we were able to offer a non-mortgage solution to assist in real estate transactions using the investment portfolio as collateral for a short-term loan.
Another area we have emphasized in our client discussions is estate planning. As estate planning grows more complex, we stand in a unique position to be an advocate for our clients to help them navigate the various and often competing issues involved in the estate plan. In one instance we were able to review an overall plan and see how a perfectly reasonable approach to avoiding estate taxes resulted in creating unforeseen creditor risk for an ‘at risk’ professional. In another, we are working with a client to determine how best to structure a trust to leave potentially substantial retirement assets to a child, where the current arrangement may be too liberal and could result in thousands of dollars in unnecessary taxes.
Looking Ahead
In 2010, we want to continue to work with you to bring better clarity to your financial goals and to continue to build a framework for making sound financial decisions. Mortgages will continue to be a source of fertile conversation as long as rates remain low. Two major planning issues facing us in 2010 is Roth Conversions and the Estate Tax: In 2010 the income limits for Roth Conversions are repealed, expanding the opportunity to make use of this potentially powerful estate and tax planning tool to everyone. However, as with all financial decisions, determining if it is relevant to you requires a careful examination of your goals and current financial situation. Also in 2010, the Federal Estate Tax is repealed, but only for 1 year. Without legislative action, the law reverts back to 2001 levels in 2011. Action is expected, and everyone is anxiously awaiting it to see what changes they need to make to their existing plans to remain current. Once this occurs this will be a good time to review the entire estate plan to make sure that it accurately reflects your legacy goals.
On the Investment front, we are continuing to watch for signs that the economic recovery is on track. Two areas of particular concern are employment and mortgage foreclosures. Both are currently riding at historic highs of near 10%, and could weigh heavily on the pace of the economic recovery if they do not abate. Given this risk, we are still somewhat conservatively positioned, underweighting some of the riskier areas of the market and holding more cash than usual. We are also continuing to encourage clients to have a healthy cash reserve to help them through short-term fluctuations.
Another area of concern is inflation. Given the unprecedented government stimulus applied in 2008 and 2009 and the resulting expansion of the Federal Reserve’s balance sheet, there is a risk of elevated inflation if not handled properly. Already in 2009 we saw a significant weakening of the dollar. For the most part this was simply a reversion to pre-crisis level, but if this continues, higher prices for imported goods, which represents the majority of things that we buy, will be the result. Higher inflation is of particular concern for our investors drawing living expenses from their portfolios, as it results in a faster liquidation than expected if investment returns do not keep pace. We have already had many internal conversations regarding this issue, and are looking for the most appropriate way to hedge this risk in your portfolio.
As we look back over the last two years, we are extremely grateful for your confidence in us, and trusting us to get you through these difficult times. For those of you who have been clients long enough, this is the second major correction you have been through with us and you have seen how our approach can weather even historically volatile markets. For those of you who are newer, this will likely not be the last time we go through this together, although we hope future corrections will be less extreme. However, we will remain committed to managing your investments in a prudent, disciplined, risk conscious manner that we are confident will take us through whatever the future may hold. We will also continue to improve our service offerings, both investment and non-investment related, to provide you with the highest possible value for your time and money. Again we thank you, and look forward to working with you in the years ahead.
Sincerely,
Thomas N. Alvaré, CPA/PFS
President
Robert M Vogel, CFP®
Chair, Investment Advisory Committee
Ryan Barrett, CFP® William T. Reynard, CFP® Robert G. Heitsenrether
Financial Advisors
2009 Market Data Highlight
Equities
The broad US Equity Market, as measured by the Dow Jones US Aggregate Index, added another 5.5% in the 4th quarter and finished the year up just shy of 26%. Technology stocks led for both the quarter and the year, up 10.5% and 62.8% respectively, with Basic Material stock not far behind, up 9.5% for the quarter and 61.9% for the year. The laggard for the quarter was Financials, which gave back 1.8%, the only negative return for the quarter. For the year Telecom stock trailed, up only 3.7%, less than half of the nearest performer, Utilities, up 7.6%. Financial stocks do win for the best comeback in 2009, having risen 116.6% from the March 9th low.
In a complete reversal from 2008, International Equity Markets posted the best returns in 2009. The MSCI All Country World Index ex US ended the year up 37.4%. The weakening dollar helped considerably adding more than 9% over local currencies. Digging deeper, it was the Emerging Markets which led the year, up an eye-popping 74.5%, compared to the Developed Markets, represented by the MSCI World ex US, up 29.7%. The Pacific Rim brought up the rear, weighed down heavily by Japan which posted only a 4.4% return for the year.
Fixed Income
The broad-based BarCap US Aggregate Bond Index was up 5.93% for 2009, close to the 5.24% return of 2008. Digging deeper, however, we again see a reversal from last year. Whereas Long-Term US Treasuries were the only bright spot in 2008, maturities over 20 years lost more than 21% in 2009. In 2008 the premium in yield over Treasury Bonds soared to all time highs in the credit markets; in 2009 they returned to normal ranges driving the BarCap US Credit Index to post a 16% return for the year.
In the riskier High Yield Market, we saw a similar reversal. On December 31, 2008 the bonds in the BofA Merrill Lynch US High Yield Index were paying in excess of 18% over comparable US Treasuries. On December 31, 2009 that premium had declined to within historic norms at 6.4%, resulting in a 12 month return of 57.5%.
Similar to Equities, the weakening dollar lifted foreign Fixed Income investments returns for US investors. The BofA Merrill Lynch Global Broad Market Index ex US returned 7.8% in US dollars in 2009. In local currencies it rose just 4.68%.
Real Estate
One unexpected bright spot in 2009 was the Global Real Estate Investment Trust (REIT) Markets. After an abysmal 2008 and losing more than 26% in the first quarter of 2009, the Dow Jones Global Select REIT Index jumped over 79% in the next 3 quarters to finish the year up 32.2%. In the latter half of 2007 and first half of 2008, non-publically traded real estate investments outperformed their publically traded counterparts by a wide margin, as investors anticipated the credit slowdown and sold off their public holdings early. We are now seeing that reverse itself as publically traded REITs are anticipating a recovery and non-public real estate remains mired in the middle of a credit crunch that has still not abated in those markets.
Commodities
The broad Commodities Markets also bounced back in 2009, but with mixed results in the components. The DJ UBS Commodity Index finished the year up 18.9%, fueled mainly by Industrial and Precious Metals, up 80% and 29% respectively. The Energy components, which made up almost 33% of the index at the beginning of the year, continued to weigh on the index performance, closing the year down 5.3%. Livestock, a relatively small component, was the worst performer down more than 15% on the year. The big story this year in Commodities, and the Industrial Metals Market in particular, was the demand from China, which essentially drove market prices while the rest of the world recovered from the economic downturn. Much attention is fixed on how commodity prices will react when the rest of the world returns to normalized growth.