The 2008 First Quarter
By Akber Zaidi
Yorba Linda, CA
The first quarter of 2008 was a downbeat one for the US stock market and other markets around the world. The S&P 500 was down 9.5% for the quarter and ended its fifth down month in a row. The last time that happened was in 1990 when we were in another financial crisis.
We believe we are in a recession. And, it's the worst kind of recession where a falling housing market leads to reduced consumer spending and falling employment which then feeds on itself in a downward spiral. We are in this situation because extremely low rates allowed people to buy homes at teaser rates which were artificially low. When these rates adjusted higher and home prices had already started to decline because of overbuilding, the homeowners could neither refinance nor sell their home. Many of these homes have now been foreclosed and many more will be foreclosed in the future.
On the other side of the transaction, greedy mortgage companies had issued mortgages with no documentation to home buyers who did not have the income to support a regular 30-year mortgage. These mortgages to sub-prime borrowers have defaulted at a much higher rate than imagined even by the rating agencies, who rated them with higher quality than they should have. Countrywide Financial, the nation’s largest mortgage company, is already bankrupt and being taken over by Bank of America. The other culprit, investment banks, repackaged these loans and leveraged them multiple fold and sold them to other investors including hedge funds. These investments have already brought down Carlyle Capital, a $21 billion hedge fund and Bear Stearns, the fifth largest investment bank in the nation. On a side note, UBS last week devalued all auction rate securities held in customer accounts by 5%. We believe other banks will follow suit and that we are far from the end to this crisis in the financial community.
Where will it all end? In the recent technology bear market, the problem was caused by a mania in technology stocks. It didn’t end until stock valuations were cheap again. This time the trouble has been caused by a mania in housing prices compounded by a credit crisis. Home prices will only stop falling when they are cheap and the economy will stop contracting once de-leveraging of the entire economy has run its course.
Where can we hide? We are currently experiencing negative real interest rates. Historically gold and hard assets have done well during periods of negative real interest rates. This scenario will only end when the Federal Reserve starts raising rates to above the inflation rate which will not be any time soon. With that in mind, we believe the recent sell-off in the gold market is a correction and not an end to the bull market.
Recently the Consumer Expectations index fell to a 35-year low. The last time we had a drop like this was back in Dec 73, at the height of the Watergate crisis and Arab oil embargo. Because of such extreme negativity the stock market may have a short-lived bounce higher. We continue to believe investors should underweight equities as an asset class.
As the Fed has drastically cut interest rates the Dollar has declined significantly against major world currencies and should continue to do so as the Fed cuts further. Holding everything in dollars and maintaining the traditional 60/40 stock and bond mix could prove catastrophic because these asset classes are all at risk. Yet, this is what most financial advisors recommend and it's also the course set by most pension funds. Investors should be aware that investments that have historically worked in similar environments include high dividend paying stocks, foreign stocks, energy stocks, gold stocks, gold, hard commodities, foreign currencies and foreign bonds.
(Akber Zaidi is the President of Alpha Asset Management, an independent, fee-only professional investment advisory firm based in Yorba Linda, California. He can be reached at azaidi@alphaassetllc.com)
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