The Quarter in Review, Meltdown
By Marjorie L. Fox,JD, CFP®, AIF®
Meltdown....As recently as the end ofthe third quarter, observers were comparing the decline in the equity marketssince October 2007 to declines during the 1987 stock market crash, the 1989-1990 savings and loan crisis,the 1998 bailout of Long-Term Capital Management, and the 2000 dot.comcrash. After the S&P dropped22% in the first eight trading days of October, the comparison shifted to theGreat Depression.
Given the turmoil inthe capital markets, it seems fitting to review our investment strategy and thesteps that we have taken/are taking with our clients and their portfolios. When we effectively manage whatwe are able to control, we reduce the impact on portfolios of what is beyondour control.
Our InvestmentStrategy....
Allocation: In the design andimplementation of globally diversified portfolios, Fox, Joss & Yankee focuseson the return, risk and correlation characteristics of the various fixed incomeand equity asset classes.
Recall that correlation measures the extent to which prices of securitiesmove in the same direction. Many ofthe asset classes that we include in portfolios are non-correlated. That is, there are periods of time whenprices tend to move together and other times when prices move in differentdirections. As we saw in 2003, 2004 and 2005, there can be years when all of the equity asset classes produce positive returns. The 2000-2002 bear market demonstratedthat there can be years when positive returns from some (real estate andcommodities) partially offset negative returns from others (domestic andinternational equities). And, weare seeing in 2008 a year when all the equity asset classes decline.
Since it isn't possible to completely diversify away risk within the equityasset classes, we need an allocation to fixed income. As equities have declined in 2008, theallocation to the domestic and international fixed income asset classes has provideda measure of stability. Our client portfolios are down significantly less thanthe 40% decline of the S&P 500 since October 2007 because of the allocationto fixed income.
Selection: The mutual funds and separately managed accounts that werecommend are chosen to provide exposure to the various asset classes. Success in selection is an investment that delivers or bests the return ofthe benchmark for its asset class over full market cycles. Our choices in both the fixed incomeand equity asset classes have passed the test.
Cash: Fundsneeded in the near-term for retirement spending, the repayment of a mortgage,the payment of tuition, etc., should not be in the equity markets; they should be held in cash orcash-equivalents in the form ofchecking, savings and money market accounts at commercial banks, and moneymarket funds at custodians such as Schwab or Fidelity. As part of our comprehensive planningprocess, we continue to work proactively with our clients to anticipate cash needs and ensure that the necessaryfunds are available.
Steps We Are Taking....
Rebalancing: Across the board declines in the equity markets have leftportfolios below the target allocation to equities and above the targetallocation to fixed income. Ourrebalancing discipline would have clientstrimming fixed income positions (selling "high") and adding to equity holdings (buying"low"). We are encouraging ourclients to rebalance back to their target allocations; nevertheless, given thestomach-wrenching declines in equities, we understand when you choose to staywith the more conservative fixed income oriented allocation to which themarkets have moved your portfolio.
Tax Losses: For clients with taxable accounts, weare in the process of realizing capital losses to offset capital gains fromsales and distributions in 2008 and beyond. Up to $3,000 in net capital losses can be deducted fromordinary income, and excess losses may be carried forward to future tax years.
LookingAhead....The turmoilin the capital markets has been unsettling and unnerving, to say the least. Sticking withequities during markets such as these is difficult. But, the market's response,as measured by the S&P 500, to past financial crises is instructive: up 16.8% in 1988 following the 1987stock market crash; up 30.5% in 1991 following the 1989-1990 savings and loancrisis; up 21% in 1999 following the 1998 bailout of Long-Term CapitalManagement, and up 28.7% in 2003 following the 2000 dot.com crash and the 2001terrorist attacks. And, now thatcomparisons are being made to the Great Depression, it is relevant to note thatthe S&P 500 was up 54% in 1933.