Overview, Outlook, and Strategy
“Don’t judge a book by its cover.” “Don’t believe everything that you read.” “Things are not what they seem.” Investors should consider these maxims when they reflect on the past quarter and on what might lie ahead.
The stock market was very volatile during the quarter. During this time, we were all concerned for the health of our portfolios. The Dow Jones Industrial Average started July at 13,409, crested just above 14,000 on July 19th, then slipped below 13,000 by mid August. The Fed came to the rescue with a dramatic interest rate cut and this spurred the Dow back over 14,000 by early October. Over the past three months, there were seven days where the Dow either fell or rose by over 200 points intraday. And yet, what was the end result by the end of the quarter? A scant gain of 1.6% in the S&P and a 3.6% gain in the Dow. So what do we make of this “volatility”? “Things are not what they seem.”
In early August, comments from the Federal Reserve sighted inflation as enemy number-one and a strong worldwide economy as the basis for a sanguine job and economic outlook. Barely one month later, this view was shattered and the Fed even made two drastic discount rate cuts and a .5% Fed funds rate cut. These rate cuts coupled with subsequent statements by the Fed reflected concerns directed more toward the economy and job markets and less about inflation. “Don’t believe everything that you read.”
What about inflation as a problem? Inflation has been cited as a major concern over the past few months as oil, food, commodities, and gold have moved to multi year highs. In spite of all of this data, the Fed’s preferred monthly inflation gauge sank to its lowest level since February of 20041. “Don’t judge a book by its cover.”
What about real estate? What should we do with our real estate? Housing sales sagged to 795,000 units in August, down 40% from the 2005 peak. Median prices of homes-sold have dropped near 7.5% depending on whose data is being used2. Most economists believe problems in this sector will mushroom throughout the economy including the job market. We should be careful to jump to this conclusion.
The main message with respect to investment portfolios is to be careful about concluding anything or subscribing to any trend that might occupy the current conventional wisdom.
The housing slowdown is cause for concern, however. I don’t question the deterioration of this industry or the degree to which these problems could worsen. I heard an anecdotal remark on CNBC this week from an analyst that asked, “What inning of the housing recession are we in?” and his reply was, “We just finished the national anthem.” Despite this dark outlook for real estate, I actually make the case for declining real estate values being a positive factor for stocks. Since 9/11, real estate values have skyrocketed, largely due to investment capital flowing to real estate as a preferred asset class. Over the same period, corporate earnings grew at a robust 13.41% annual rate but stock prices grew at only a 6.6% annual rate3. This means that stock valuations essentially got cheaper while real estate became more expensive. My argument is for the pattern over the past six years to unwind and that stocks will emerge as the favorite asset class.
Peregrine Returns and Strategy
The S&P 500 was up 7.6% for the nine months of 2007. The Peregrine Equity Composite finished up 5.43% for the third quarter and was up 14.03% for calendar 2007. The Peregrine Balanced Composite was up 2.92% for the third quarter and was up 7.12% for this year.
At the outset of the third quarter, our main goal was to avoid damages to our portfolios from a pending correction. We tried to be very defensive during the summer months. Our philosophy is to consistently protect client portfolios and avoid sharp value declines.
The stock market has been prone to corrections following strong advances. We do believe that we will have market corrections in the fourth quarter but that they will be shallower than the drop in the third quarter. We will be guiding our client portfolios under the general view that the overall market is headed higher over the next few months.
We will still continue to sell stocks that look poised to correct. This means taking some profits in certain positions, just to be safe. We will also remain vigilant about stocks that reflect losses our client portfolios and look to delete these from our holdings. New companies with bright prospects will be good candidates to add to our current list. This is consistent with our outlook for a rising market.
1 Source: Wall Street Journal September 29th, 2007
2 Source: Barrons “Up and Down Wall Street” September 29th, 2007
3 Source: Bloomberg News Service
Past performance is no guarantee of future results. Investment management involves the possibility of losses. Significant general stock market moves up and down can influence the performance of client portfolios. Composite returns are based on client portfolios of over $100,000. Not all clients are included in the composites. All returns include the reinvestment of dividends. All returns are net of fees. Composite returns are derived from aggregated, time-weighted returns for clients of Peregrine Asset Advisers. Individual client returns can deviate from the composite returns. While Peregrine uses the S&P 500 as a benchmark, Peregrine does not attempt to mimic the structure of this index. Individual client portfolios vary. The number of securities held also varies per client.
Do you have questions or would you like to know more, contact Dan Botti.