2008 Year End Review

Did Anyone Make Money?

Last week marked the end of the 2008 trading year. Surely most investors are glad to see 2008 come to an end, as last year marked the worst stock market performance since 1937! How bad was it? The S&P 500 lost 38.48% for the year, and the NASDAQ followed suit losing 40.58%. Those are horrendous numbers, but frankly it could have been worse as the market had lost nearly 50% from market highs at one point. According to Lipper Analytical Services, which tracks returns on 4,000 publicly traded mutual funds, as of early December, there were ZERO US stock funds that had a positive 2008 YTD return! Wow, that is amazing. No one likes to lose money, but we all were in good company. The trick is to at least lose less than the market averages, thereby earning market beating returns and real gains in relative wealth. Our portfolios did lose money in 2008, but we lost less than the market as each portfolio beat the market averages significantly by a difference of more than 10%, 10%, and 25% across three portfolios.

Recession in Full Force!

No surprise to anyone that the economy has been shattered. Eventually, we got official word that the recession began in late 2007, which of course by the time of the announcement, was well known. This may come to be the worst recession since the great depression. It started with the subprime mortgage collapse which then spread to the rest of the mortgage market and asset backed securities. Credit markets became locked and a liquidity crisis ensued. The housing market collapsed as home prices fell to levels not seen in years which put many homeowners underwater on mortgages. Increasing delinquencies and massive corporate write-downs brought a financial collapse that will permanently changed the landscape on Wall Street as companies fell, got acquired at fire sale prices, while survivors became bank holding companies for access to government bailout funds. But the problem became bigger than Wall Street, as job losses began to mount, home equity vanished, and consumers slowed spending. Consumer confidence hit record lows, while investor fear hit record highs. Volatility (VIX), often viewed as the investor fear gauge, started the year just above 22 and hit an intra-year high over 89, a disastrous 300% increase. Furthermore, the market had 18 daily moves of 5% or more in the S&P 500 over just the last three months of the year. That is a higher volatility than the market experienced over the last 50 years combined! That volatility and the bear market certainly pushed many investors out of stocks, as the cash levels on the sideline continues to grow. Yep, no doubt we are in a severe recession, one that has roiled the stock market and frankly nearly every other asset class as well.

Hope? What Can We Cling To?

No one can predict what 2009 will bring. However, in our view, we see more job losses, foreclosures, bankruptcies, and spending cutbacks as the economy continues to contract and deleverage. This will be painful, but will probably not carry the same shock value that we experienced in 2008 as companies and consumers adjust. On the positive side, we have a new administration taking office that has big stimulus plans and a government eager to intervene with bailout funds and additional spending. Interest rates are extremely low, at levels not seen in many years. Rates will likely remain low for most if not all of 2009, which will help spur economic activity. Low interest rates and lower commodity prices will improve cash flow for consumers and over time spur consumer confidence. All of these factors are positive for the economy and the stock market, but all will not be cured overnight. We expect the economy to be very sluggish over the first 6 to 9 months of the new-year, as more time is needed for all these measures to take effect. For the stock market, volatility ended the year at 43, still on the high side, but much lower than 2008 highs. Volatility has been trending down, and if that continues, investors will return to the market. In addition, with the flight to safety, there is a lot of cash on the sidelines and in Treasuries, as investors wait out this rocky period. The stock market may skyrocket once this money comes back into the market propelling the demand for stocks higher. History is also on our side with respect to a strong recovery. Since World War II, the S&P 500 index has soared 32% on average during the nine months following a bear market. The trick, of course, is identifying when the bear market ends and the recovery begins.

Market Beating Foresight, 2009 Outlook

Overall, we think the economy has a long way to go before it gets better. However, the stock market has begun to show signs of life. We are very encouraged with the downward trend in volatility. Stability is critical to bringing investors back to the market which will increase the demand for stocks and therefore prices. The market has also been showing strength over the last few weeks and has shown resistance to the lows hit in November. However, trading has been light over this time, and the real test will be the first quarter 2009. If the market can hold current levels through the first quarter, the worst may indeed be over for the stock market. A case can be made that equity prices today represent compelling values. The PE ratio of the S&P 500 index now stands at 11 or 50% below its ten year average. In addition, the S&P dividend yield is a juicy 3.4%, which is more than twice its ten year average. Although stocks are compelling, it does not mean that prices could not fall further, as we saw even lower PE ratios during the depression. But we do not think lower valuations are all that likely, as governments worldwide demonstrate their inclination to take action and provide the economic stimulus needed in 2009. However, we do think that the market will likely remain rocky over the first half as the economy searches for bottoms in housing and jobs. Hopefully, by the second half, enough time will have passed for government interventions to take hold, for corporate earnings to stabilize, and for deflationary concerns to subside. Interest rates will likely remain low and by fourth quarter 2009, consumer confidence should hopefully already be trending upward. With time, the market will return to normalcy, that is, a market not ruled solely by fear. The stock market is usually a leading indicator for an economic turnaround, so in that light we expect a more consistent and upward market trend later this year.

Investment Themes for the New Year

Our themes for the New Year are to stick with defensive industries such as utilities, healthcare, food, and consumer staples. Focus on value stocks that have strong balance sheets, are well capitalized, and have high cash levels, as those are the companies that will survive and even prosper in difficult economic times. Strong companies that are paying high and sustainable dividend yields are also good longer term investments. For speculative investors, we think there is a bubble right now in US Treasury Bonds as investors have driven yields down to incredible levels not seen in many years. We do not think that yields will be rising anytime soon so buying now may mean carrying losses short term, but that may still be better than missing the reversal which tends to happen quickly with bubbles. Investors will eventually begin to move money out of treasuries and back into stocks, and when that begins, investors should be ready to move as bond prices will surely fall. Oil and other commodities are also good places for speculators to invest. Demand for commodities will likely grow as the year unfolds, so prices could be substantially higher by the end of the 2009 and 2010.

Remember, our complete list of stocks is Available Online At: http://www.marketbeatingstocks.com