All Clear Ahead
Last October began a period that I will remember vividly for my entire career. I’ve been managing client investment portfolios since 1984. No period of time over which I have worked matched the financial devastation for our country which spanned over last year but culminated in March of this year. Not the crash of 1987 or the high tech bubble burst of 2000-2002. The financial industry underwent a total transformation. The fallout in all business and industry is still being felt.
Last fall, the Dow Jones Average and stock markets worldwide were falling fast. On Friday, September 26th 2008, the Dow Jones closed at 11,143. It had already dropped over 1000 points in the preceding two weeks. Many people didn’t think it could fall any further. Then the slide really began. By year end, the Dow Jones Average had fallen to 8776. This decline in the market was far lower than I thought it would go at the time. As 2009 began, the market kept getting worse. Eventually the DJIA would fall to 6600 by early spring. This damage was of staggering proportions to investors. It marked a 55% decline from the high level only seventeen months before in October 2007. This decline put stocks back to levels seen twelve years ago. In other words, one dollar invested in 1997 would still be worth only one dollar after all of this time.
Today, the recovery for equities is solidly under way. Prices are steadily climbing. Have they advanced too far too fast? Despite continuing concerns about further economic weakness, the stock market has clearly shaken off the sickness that appeared so ominous at the beginning of the year. As stock prices keep rising, “expert” forecasters and pundits have been calling for caution and for a correction in the current rally. In my view, this appears unlikely to happen in the short term. Right now the road less traveled is to be invested in the stock market. Most people are not invested in preparation for the rally to continue. This creates a substantial opportunity for investors to buy at these levels which should prove profitable in the months ahead.
For the third quarter, the S&P 500 index surged 15.6%, recording one of its best third quarters ever. Stock market indices have gained for the past two quarters in a row following six consecutive down quarters. In the final two weeks of September the S&P 500 fell about 5% and this retreat has brought with it uncertainty as to the durability of the current economic recovery.
Skeptics point to many economic factors that could arrest the stock market’s recent rally. These include the decline of the dollar, the mountain of federal government deficits, and weakness in commercial real estate. While valid, these concerns ignore a more pressing need that the stock market can fulfill. Where will money go to find a home since interest rates on cash is next to zero?
The Case for Stocks Rising in a Weak Economy
Last quarter’s “Market Overview” (www.peregrineaa.com, 7-18-09) pointed out how poorly stocks had fared over the past ten years even before the decline in 2008. The logic was that since the market had performed so poorly over the past ten years, it is more likely to have above-average performance in the years ahead. This implies a high probability that stocks will grow in excess of ten percent per year to make up for ten years of no growth.
Stocks could power ahead in spite of a faltering economy. Money simply has to be invested somewhere to get any meaningful return. Furthermore, many companies made significant economic gains over the past decade while their stock prices languished. This occurred for many reasons, including real estate, which attracted the largest flow of speculative money during this period.
Take Walmart, for example. In 1998, Walmart made a high of 43 per share and did $137 billion in sales. In 2009, Walmart did $405 billion in sales and its stock is at 49 per share. Over an eleven year period, Walmart sales rose almost 200% while the stock advanced only 16%.
Microsoft provides another example. The company had sales of $19 billion in 1998 (FY 1999) and its stock price hit almost 39 by mid 1999. Today, Microsoft shares sit at about 24 despite the fact the company had over $58 billion in sales over the past year. This is one of many similar cases where a 200% gain in sales was accompanied by an actual decline in share price of 38%.
At some point, these valuations will be re-evaluated by investors and stock prices are due to catch up for lost time. If investors build a greater appreciation for the value of these large business enterprises, a new renaissance for stocks could emerge. Many experts are calling for higher inflation. Couldn’t sharply higher stock prices be the first derivative of inflation? Inflation, which is popularly recognized as the rising cost for goods and services, could materialize in the stock market before it is felt in the rest of the economy.
Staying Ahead of the Curve (Part Four)
Investing ahead of the curve in this new era of rising stock prices still presents difficulties for all investment managers. As stocks rise, like they did in the third quarter, it is crucial that our clients be invested as fully as possible in stocks. At the same time, we cannot afford to have our managed portfolios suffer in the event of a disruption that could cause a decline in stock prices. This caution can make it seem like we are behind the curve. We are relying on short term declines to increase our equity exposure and concurrently, we are also counting on our selected holdings to outperform the overall market.
Peregrine Returns and Strategy
Peregrine client returns lagged the overall market during the third quarter of 2009. The Peregrine Equity Composite gained 6.48% for the quarter and is up 7.69% for the year. Our Balanced Composite was up 3.97% for the quarter and is up 2.04% for the year.
The average mutual fund rose 16.7% in the third quarter and is up 25.2% for the nine months of 2009. It is meaningful to consider that the average mutual fund is still down 4.7% over the past twelve months. Mutual fund gains in 2009 have only brought investors back to the levels they were at before those fateful days last September. This perspective supports a view that despite the sharp rally over in recent months, stocks have considerable room to run on the upside.
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.