Insights & Issues
November 2008

The current market crisis is not unprecedented, nor is its course unpredictable.

LongVue clients’ third quarter performance statements - as do everyone’s in the country – show a decline in market values. But this letter will not join the financial and national press in anguishing over the markets’ demoralizing decline - though we are as unhappy as anyone about the effects of the current financial crisis. We certainly do not blame anyone for being scared. We too are only human and find recent events very, very scary for a variety of reasons.

Now, more than ever, we urge our clients – and their advisors - to take the long view

To paraphrase Thomas Paine, it’s times like these that try souls. And, to borrow a phrase Queen Elizabeth used a mere sixteen years ago, it has indeed been an annus horribilis for anyone involved in the markets. We’ve all heard it loudly proclaimed that America has never seen anything like this before.

The 20th century was riddled with financial crises

For anyone who wants indisputable proof that we have indeed seen far worse crises in our past, we recommend The Panic of 1907: Lessons Learned from the Market’s Perfect Storm by Robert F. Bruner and Sean D. Carr (2007). In analyzing that crash, they wrote:

The extent to which market prices depart from those dictated by economic fundamentals remains a topic of deep debate at the frontier of economics. The concept of an emotional market “panic” challenges economic assumptions about the rationality of economic decision makers. Rationality assumes that prices today reasonably reflect an expectation of prices tomorrow and that markets are efficient in impounding news into asset prices. On balance, large markets in standard assets appear to be rational on average and over time. But crashes and panics are exceptions to such “average” assumptions. To suspend the assumption of rationality admits the possibility of a great deal of bizarre behavior (p. 168).

This description of 1907 most certainly describes the autumn of 2008.

A thoughtful look at the Great Depression may actually make you feel better

Most historians and economists agree that the stock market crash of 1929 did not cause the Great Depression. Rather, it was the result of ill-fated actions, inactions and policy blunders on the part of the markets, industry and government. One commentator likened economic knowledge in the 1930's to medical knowledge in the Victorian Age - rudimentary, often causing more harm than good. The government was seemingly paralyzed by the market meltdown; in fact, it took more than three years after the crash of 1929 for the US government to launch any real efforts to end the Depression. Whatever you may think today about the Fed, it is clear that it and the Treasury Department are determined to provide the liquidity desperately needed to save this leaking ship.

If you really want to feel better about our current state of affairs, read one of the newest additions to the LongVue Reading List: The Forgotten Man: A New History of the Great Depression by Amity Shlaes, 2007. Another great book on the Great Depression is: The Defining Moment, FDR’s Hundred Days and the Triumph of Hope, Jonathan Alter, 2007, also our on reading list.

The 70’s offered a party of rampant inflation and “The Death of Equities”

Why is it that even people who lived through the rampant inflation and oil embargo of the 1970's are telling us they have never seen anything like the current crisis? Who remembers the declaration in Business Week in 1979 that proclaimed “The Death of Equities”? Stocks and bonds were deemed worthless. Metals, collectibles, and real estate were all the rage, but the smartest and most disciplined investors stayed in the markets and earned a nice 404% return measured by the S&P in the 1980's (“Take a Deep Breath. Now Stick to Your Plan.” William J. Bernstein, Money Magazine, September 2008).

Don’t forget the S&L crisis and the tech “bubble”

The gas crisis of the ‘70s was followed by the savings and loan crisis, the blow-up of Long-Term Capital Management, the very recent bursting of the tech bubble, and 9/11. People (according to the behavioral finance experts) are likely to forget that in all of those events, panic was rampant and people were arguing that the world as we knew it was over.

Are we simply blind to a new reality?

Lest you think we at LongVue view our current predicament with rose-colored glasses, be assured that we recognize that the Wall Street of our lifetimes has been forever changed. Vrtually every asset we can think of has tumbled dramatically this year, and tried and true assets like auction rate preferred stocks and commercial paper have been frozen. The credit freeze has gone global, with markets around the world freezing overnight. Even diversification, in the short term at least, is failing badly. And, there’s no doubt that we’re clearly in a recession. The rose-colored glasses were sold out when we went shopping.

Is cash the answer?

We know from mutual fund redemptions, stock sales, and some of our own clients, that many people are hitting the panic button and going to all cash. That, ironically, is the one strategy guaranteed to fail - if history is any guide. Turning from volatile stocks to cash might feel safe, but studies show that with an inflation rate of 4% a year, your purchasing power will be down 50% in a mere fifteen years (“Talking Investors Down Off the Ledge.” Scott D. Welsh, senior advisor at Fortigent, October 2008). Who would invest in stocks if that were their track record?

Nowhere to hide

Certainly, we have witnessed a breakdown across the entire financial system this year and there has been nowhere to hide. Diversification is clearly not working right now. However, as much as the financial landscape has changed, the fundamentals of investing have not and diversification is still the best long-term approach. Yes, if you can’t sleep at night, we do recommend making some changes so you feel less pain. And, yes, this is an excellent time to reevaluate your risk tolerance and, therefore, asset allocation.

Drum roll please…LongVue makes a prediction

As our clients and colleagues know by now, we will never predict the markets except to say, as J.P. Morgan did, that they will definitely fluctuate, and sometimes a great deal. If a man as wise as Warren Buffet says, “I have no idea what the market will do in the short term,” we don’t either (“Buy American, I Am.” New York Times op-ed, October 17, 2008). However, we will go out on a limb, bolstered by extensive reading of history as well as our own experiences, and say we truly believe that those courageous enough to take a long-term view will be rewarded.

A rationale for optimism

Consider the fact that in the last fifty years, a globally diversified portfolio of stocks had positive returns in more than 95% of all five-year periods and in 100% of all ten-year periods. (“Even if You Knew What to Do, Your Brain Might Not Let You.” Dan Solin, The Huffington Post, October 27, 2008). Consider the fact that John Bogle (the founder of Vanguard), Warren Buffet, Jeremy Grantham, and Steven Leuthold (the latter two being known in the industry as perma-bears) are all saying that the probabilities for stock market investing look good given current valuations.

An interview with Bogle in the New York Times entitled “Extolling the Value of the Long View” (October 26, 2008) reported that despite “an orgy of speculation” that has hurt the global economy, he remains convinced that if long-term investors stick to the basics,"put blinders on" and try to have "strong stomachs," they can ride out the rough patches and ultimately prosper.

After all the 20th century’s market crashes, investors did well

Buffet and Bogle seem to speak from their well-informed guts. However, historical data does support their actions. For example, anyone who bought after the crash of 1873 and held on for twenty years, reinvesting dividends, tripled their money. Anyone who did the same after the panic of 1907 made a 700% return. After the 1987 crash, the figure was 900%. Even someone who invested after the crash of 1929 eventually doubled their money after twenty years, and that takes into account the Great Depression and World War II (“A Brief History of Crashes.” Brett Arends, Wall Street Journal, October 19, 2008). Put another way, $100 invested in stocks on January 1, 1928 was worth $98.75 by the end of 1930, $110.18 by the end of 1935, and $107.37 by the end of 1940 (after the beginning of World War II in Europe and very dark days for the world). By the end of the 1940's, twenty years after that stalwart $100 investment, it was worth $355.60.

Historically, cash investors languish

As for the cash investor, he or she would have earned 5% by the end of 1935 and not much more by the end of 1940. Twenty years later, T-bills had gained just 11%. Ten-year Treasury bonds were better, but over the twenty-year period, they returned 81%, compared to the stocks’ return of 260%. (“What If We Were in a Great Depression?” James B. Stewart, www.smartmoney.com, November 2, 2008)

The markets may bottom out sooner rather than later

Steven Leuthold, who has been in the investment business for almost fifty years and bearish for the past decade, has even had a change of heart, saying that valuations are the most positive he has seen since 1984 (“A ‘Perma-Bear’ Warms to Stocks.” Lawrence C. Strauss, Barron’s, November 3, 2008). He also reminds us that the stock market is a leading indicator that historically turns up about 60% of the way through a recession - which could suggest that the bottom will be reached sooner rather than later.

Patience and perseverance have a magical effect

If this rings of predicting markets, we plead somewhat guilty in the long term. We, like Buffet, have no clue as to where stock prices will be a month or even a year from now. However, as students of finance and history, we remain keenly convinced that this time is really not different, that the panic will subside, and that diversification will work again. John Quincy Adams was right: “Patience and perseverance have a magical effect before which difficulties disappear and obstacles vanish.” David Ben-Gurion was also right when he said, “Courage is a special kind of knowledge: the knowledge of how to fear what ought to be feared and how not to fear what ought not to be feared.”

With our best wishes for a good night’s sleep, and our encouragement to take the long view…..

Randy Hustvedt          Charlie Walsh             Bruce Stewart
Managing Partner       Managing Partner      Chief Investment Officer and Partner         

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