August 1, 2009 Investor Update
66End of July 2009 Investor Update from Blake T. Todd
Crowell Weedon & Co
Your Independent Investment Team
Established: 1932
Members SIPC / FINRA
Dear Fellow Investors,
This will be my first blog posted to Hub Pages. I hope to be able to write something from time to time and keep you all posted on our view of the markets or significant events. So stay tuned by subscribing to the link.
A small disclaimer before I get started. The investment industry has rules and regulations in place to keep the investment public protected. I embrace those rules and want to be sure that we work within them at all times. So while you may be able to post comments on this site, I will not be able to respond to them. All communication that I have with the public must be supervised and routed through my business email. So I would ask you to direct any comments or questions you have that you want a response to my business email address of btodd@crowellweedon.com Thank you.
Overview
Time for a little bit of that “straight talk”, without spin or rose colored glasses, that some of my investors find refreshing. Nobody is pleased when numbers have a negative sign in front of them. Even if your performance is superior to the S&P 500 or the MSCI US REIT Indexes, you will not feel any degree of satisfaction seeing the decline in the value of your investments. So while the year to date averages have regained positive territory for 2009, all it takes is looking back over the past two years to give many investors a dose of reality as to the risk side of investment returns. No matter how much of a “perfect storm” the financial markets have experienced over the past two years, the economic disruption is challenging all investors that maintain a longer-term time horizon. The disruption in the banking system that led to the paralysis of the credit markets and the decline in all markets is what has caused the decline in the value of holdings. Fundamentally we believe in the long-term value and the income creation of the portfolios we manage. In this post we will provide you some information and viewpoints that we hope will reinforce long-term investors commitment to stay invested through market cycles. I can say that in the portfolios we manage we are pleased to be delivering a cash flow in the form of dividends that our investors can use to fund their lives while we patiently wait for the underlying value of our companies to be recognized in the marketplace once again; and we believe that will occur.
I am not breaking the news to anyone reading this post that the economy this past year has been in decline. Everywhere you have turned, the focus has been on our generation’s major economic disruption. As we look back through history we can see just about every generation has such an experience. Whether or not the economy contracts by 10% or more to be called a depression, or if it will finally just be called a severe recession, I believe this decline in the economy will be viewed as more than just a cyclical cleansing of the excesses of the most recent business cycle. Because there is such a disproportionate share of our population in the United States that are closing in on their senior years, I see a huge paradigm shift of investment and personal financial management mentality in the very near future.
For many years investment emphasis has focused on appreciation and accumulating assets that could someday be converted into income producing securities. After all, in retirement the hope is that, instead of our paychecks, our investments (supplemented by social security benefits) will generate the income on which we can fund our lifestyle. That time is fast approaching for so many in our population, and as they get closer to that age they no longer can afford to see their principal decline precipitously before it has been converted to income producing assets such as the portfolios we manage. Many have come to the stark realization that they will have to continue working beyond when they hoped to attain the leisure life of their “golden years”. It is one of those realizations that is the beginning of that paradigm shift I am referring to.
Many in America have been forced to accept the reality that their primary residence is an expense rather than a bank they can tap into to fund an unsustainable lifestyle. With the era of gross speculation on home prices behind us I think that today’s homeowners will work towards the eventual goal of owning their residence free and clear. While they are paying their home off they have a non-inflating housing expense that will go away for the rest of their lives when the mortgage is paid off. It will certainly take time but the shift is happening and the demographic pressures will continue to force the change on people. It is one piece of a necessary deleveraging of the personal balance sheets of most investors.
I am happy to report that our portfolios are positioned for the changing paradigm. Not only do your investments continued to pay dividend that yield that is over twice that of the stock market, but, we have an investment philosophy of investing in companies that have a history of increasing their dividend payouts to their shareholders. Over time, we anticipate that the distributable income from our portfolios will increase to offset the effects of inflation, thereby helping our investors maintain their purchasing power. And for the fortunate investors that are able to compound their investments with dividend reinvestment until such time as they need the income, cyclical declines such as we have been in are treated as great opportunities to accumulate even more dividend paying shares.
The Equity Markets
Fundamental changes that are taking place that will likely affect how we view investments as well as the role of government will take in our lives and the economy. Those of you who know me best understand my fears of a gradual shift into a socialist based society. I worry about issues such as the abrogation of contract law by governmental fiat, writing socially well-meaning benefit checks that the economy cannot cash over the long term, and the removal of the profit incentive through over taxation to the entrepreneurial spirit. The strength of our country and our economy comes not from a few politicians but from the large working middle class, the millions of small business owners, and the entrepreneurs and risk takers that make up the diversity of our economy.
I remain a true believer that our country is the greatest place to live; where we have to put up fences to keep people out, not in; where people from meager circumstances can strive to the highest office in the land; where a person can choose to not finish college and become one of the wealthiest people in the world; where truly incredible forefathers drafted a constitution that has powerful checks and balances to see that our liberties and way of life are not undone by the fervor of the moment. Many have forgotten that quite a number of the “New Deal” programs were struck down by the courts. We may find that some of the draconian actions that were perceived as necessary at this time to address what were perceived to be systemic risks may yet be struck down or reversed by a more deliberate and patient judicial branch of our government.
The long-term rhythm of a capitalist society repeats patterns from generation to generation. These economic patterns are manifest in the booms and busts in the past, and in the future. As we look at the valuation of the equity markets now, we are encouraged to see that as incredible value presents itself, fear is eventually overcome and buyers will accumulate assets. In early March of this year we witnessed such a period. And as the weeks have rolled on, and it appears as if a bottom may have been put in on the averages, the fragile confidence that the worst may be behind us is emerging. Simultaneously the government continues a very accommodative monetary policy. With that confidence businesses will be more proactive in their thinking instead of reactive. And while they cannot have the confidence yet to give guidance on earnings, the cost reductions and productivity enhancements, which many businesses have instituted out of necessity, should lead to tremendous future profitability as business confidence recovers.
The Real Estate Markets
The REIT index has suffered the same sort of decline as prior bubbles like the internet securities of the late 90’s that burst in 2000, or the gold stocks of the late 70’s that burst in the early 80’s. The MSCI REIT index went from a high on Feb. 7th 2007 of 1,233.66 to a low on March 6th 2009 of 287.87 – a decline of 76.67%. Fortunately our portfolios have been under allocated to the sector during that entire period of time. It is only recently that we have moved the allocation of the portfolios up to a neutral allocation. And yet we still are favoring the cumulative preferred shares of these REITs over the common shares. Even though our portfolio disciplines direct us to have a portion of the assets invested in this sector, our disciplined approach allowed the portfolios to weather the storm and still produce overall results that outperformed equity markets.
We acknowledge that the commercial real estate markets are going to become the headlines of the next six months. Financial institutions are using far more conservative underwriting standards to make and renew loans on commercial real estate. As a result many loans will be determined to be out of compliance and be the subject of the news services. Rather than focusing on these short-term attention grabbers, we are focusing on what is happening at the grass roots level. Liquidity is returning to the sector. For almost a half a year there were no new loans being made at any pricing level, and now there are. Publicly traded REITs have been able to come to the equity markets and raise billions of dollars of equity in the first few months of this year. Banks are extending maturities and working with borrowers. Some are calling it “Extend and Pretend” on the banks part, but we have talked to a number of regional bankers recently who would be only too happy to foreclose and become the owners of the properties securing their loans. After all, whether you call it interest income or rental income, it is still income. If the income gives you an acceptable rate of return on your invested (or loaned) capital you are content and can wait for a return to sanity on the pricing of the asset when it will accurately reflect the cash being generated.
We are very conscious that not all sectors of real estate will pattern the same recovery. Those where we feel the demographic trends will be in our favor, or where the length of the leases insulates us against cyclical volatility, continue to be the sectors we emphasize.
The Fixed Income Markets
In a recent interview I was quoted as saying “The seeds of the next major problem in the economy are being sewn as part of the solution to your current difficulties.” It is our belief that with all the best intentions the Federal Reserve and the Treasury Department (with the authorization of Congress) have provided the liquidity needed to stabilize the economy as the leverage bubble of personal Real Estate, off balance sheet derivatives, and speculative excess is being corrected. Normally such massive infusion of liquidity into the economic system would be inflationary. So far it has been counterbalanced by unemployment increases and the deleveraging of personal and corporate balance sheets. However, as soon as the economy starts to recover, and the demand for money and borrowing starts to increase again, those massive infusions of capital by the government will need to be reversed or inflation will become the next issue we have to deal with. Worst of all will be an economy that is not growing and a government that continues to expand its balance sheet; which could result in a return to the stagflation of the late seventies.
Certainly that does not have to come to pass. When banks repay the TARP monies, the government could pay off the bonds issued to create that money. Of course it remains to be seen if money once created by a government will ever be used to retire debt when it could be spent on social issues or pet projects!
We therefore are predicting the return of higher inflation in the years ahead. Costs for money will increase leading to the destruction of wealth for long-term bond holders. Therefore our fixed income investments will continue to be short in duration or inflation protected.
In Summary
More than one great investor has said, “short term the market is emotional and company valuations make no sense. In the long term prices will reflect the value created by the company”. We agree with that sentiment and wish to remind investors of the unfortunate reality that our emotions would have us sell at the bottoms of markets and wait until the markets moved up again to validate reinvestment – thereby investing near the tops of markets. The long-term investor that stays with a disciplined common sense investment philosophy through market cycles should obtain the expected long-term rates of return. Our counsel remains to stay the course and continue to add money into an investment program to dollar cost average over time.
The investing disciplines of our portfolios dictate that we will be balanced with investments in each of the three major asset classes – Stocks, Bonds, and Real Estate. We maintain those disciplines and add to them our own proprietary research and analytical tools that are the hall marks of our “common sense investing” for the long term. Should you desire to read more of our investment philosophy and investment methodology, we invite you to pick up a copy of our book “Independence Day$” on Amazon.com.
We wish to thank our investors for their continued confidence and the opportunity to manage their portfolios. We take very seriously our responsibility and will always endeavor to be responsive to your questions and concerns. We welcome and encourage your comments as well, but remind you that any communication must be through our business email address.
Blake T. Todd
Partner
Portfolio Manager
The material herein has been obtained from various sources and is not guaranteed by us as to accuracy or authenticity. The opinions expressed herein are those of the financial advisor and do not necessarily reflect those of Crowell Weedon & CO., its managers and/or partners. Hubpages Inc. provides compensation for advertising from certain pages it maintains. The author of this Hubpage has agreed to give any advertising compensation directly from this Hubpage to charity.
