Volatility in today’s markets & the Sub-prime lending “crisis.”

Undoubtedly, you have noticed the market turbulence (volatility in Wall-Street speak) of the last three weeks. While the news media can exacerbate the problems, it helps to keep this short two- to three-week period of activity in perspective of the bigger picture. For instance, the well-regarded industry rag Barron’s recently proclaimed in huge red type “MARKET TURMOIL!” as its front-page cover. What they neglected to tell you until well into that week’s issue is that the DOW and Russell indices actually closed up for the previous week, despite a day when the Dow was down 3.05% or 287 points. Somehow, the truth doesn’t seem to sell as many newspapers. One sage of market prowess, Peter Lynch, said once ”The key to making money in stocks is not getting scared out of them.” Warren Buffett, the second-wealthiest man in America, put it this way “You want to try to be greedy when others are fearful and fearful when others are greedy.” With this in mind, know that we are watching your accounts daily. We will make adjustments when we believe it is in your account’s (and, therefore, your) best interest. We will not respond to emotional “chatter” in market activity that does not affect the longer-term trend. Since early 2003, that trend is up until proven otherwise.

I have had a few clients ask me: “Is the current sub-prime mortgage going to affect my portfolio?” The answer is, yes, it likely will – in the short-term (see above). The real question is this: is this a credit crisis or credibility crisis? The word credit comes from the Latin root “to believe.” And I do not believe that the credit problems are going to be quickly resolved. There are millions of loans that were made to homeowners who agreed to accept a teaser lending rate with the full knowledge that, at some point in the future, those rates would increase. Over the next eighteen months, those loan rates will increase as their “teaser” rates expire. At the same time, homeowners are finding it difficult to refinance as the values of their properties have declined, on average, 8 to 12% throughout the U.S. Taken en masse, this problem 1) was predictable, and, 2) is healthy for the real estate market in the long run. It will inevitably return sensible mortgage financing practices to the levels of credit worthiness at which they should be. The credibility of the mortgage financing industry is, in our opinion, on the line during this “cleansing.” Will this affect your portfolio? There’s bound to be some negative spillover for some time. In the end, both the real estate and the equity markets will be healthier from this cleansing that is currently transpiring in America.

Volatility in today’s markets & the Sub-prime lending “crisis” (cont.) In addition to the mortgage industries woes, several large alternative investment firms have been caught in what appears to be a large wave of deleveraging by long/short hedge funds. The irony of some of these hedge funds is that they are failing at a time when their typical trading objectives are at a maximum opportunity: i.e. scooping up solid assets that are being tossed aside by the market at large. And yet they can’t afford to do so due to a lack of liquidity. These hedge funds are falling due to the same reason the sub-prime lenders are. My opinion: if you have to use massive leverage to make an investment work (in a home or your portfolio), the investment is probably not able to stand on its own profit-potential merit.

Please feel free to write with any questions or comments: cbrown [at] weg1 [dot] com

Until next time,