Printer Friendly Version

"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way - in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or evil, in the superlative degree of comparison only."

Charles Dickens, A Tale of Two Cities

Reflections on 2008

2008 A Wonderful Year

You might think I am off my rocker when I describe 2008 as a wonderful year, but we do have choices in life.  We can look at the past and concentrate on the worst of times, or we can look back and remember the best of times.   As I've become more familiar with myself, I have made an effort to seek out the good in all.  If I didn't look for the good that comes from life experiences, it would be easy to throw in the towel.  I don't mean by this, however, that we should bury our heads and not look at what actually took place. I actually mean the opposite.

Most of you have been tested throughout your life. When you look back on those tests, once you've made it through, either passing or failing, and whether they were tests of knowledge, love, faith, or even financial tests, I hope the knowledge you learned about yourself through the process created a "best of times" memory, as my tests have done for me.  The following are just a few tests I will remember from 2008.

Our firm's basic investment beliefs were tested, and, contrary to the opinions of many academics and a multitude of consultants who believe in back-testing a model, testing an investment approach must be accomplished in real time.  Day to day psychological pressures from making financial decisions are usually absent in quantitative studies of investment rules proposed by non-investment professionals.  Our test results were compiled, made public, and reported to multiple sources for comparison.  I am proud to say that our approach passed in flying colors when compared to our peer group of managers.

My finances were also tested in 2008. All of you know that I do eat my own cooking, so the cash flow necessary to run our business and, for that matter, to provide my personal income, is directly related to the current market value of your portfolio as well as that of the other portfolios we manage.  We once again can say that we passed, perhaps not with flying colors, but with the knowledge of knowing that even a 100-year storm would not produce enough damage to make us shut our doors.

My political beliefs were also tested. The national election held in 2008 forced me to make a choice on who I believed would best lead this country. It also taught me that an open discussion of political ideals is a much more constructive way to understand and learn about the individual candidates and their political parties' approaches to governing rather than simply receiving sound bites.  The results of this test will not be known for some time; however, I can feel good about the fact that I have seen a rise of political passion in all corners of society which can only result in a better future.

Before we look at the market results of 2008, I'd like to send out a special thank you.  During this year, I personally received calls from many of you (I wish I could list you all by name) who were concerned about how I was doing given the turmoil of the markets. This was an act of kindness that I will never forget.  Thank you. You can't possibly know how much this meant to me.

The 2008 Market Results

All of us are aware that 2008 did not treat our finances very well. They say a picture is worth a thousand words, and we believe the following table of results is a good substitute for a picture.

These listed returns are total market returns by country and are not a standard set of indices you may be familiar with, i.e., S&P 500, Dow Jones Industrial Average, etc. These results come from our friends at Seeking Alpha and Morningstar.

To some of you, these returns are best forgotten. Instead, you are already looking forward to the New Year where things will surely improve. Others may feel as if the New Year will bring yet another round of disappointment with no improvement.  However, I hope you can minimize these thoughts. The reality is that the calendar is meaningless to the markets. To the markets, January 1 is simply the day that follows December 31^st. It has no other meaning.  I know our human nature (and maybe also the tax man) causes us to place significance on the calendar days, as the calendar does provide order for our day-to-day lives and of course January 1 may have a special meaning to us independent from the markets.

However, making a decision to invest or not invest based simply on a calendar day without any other rational expectations formed from logical research of what you are investing into is not a wise decision.  Judging from the past twelve months, it actually seems that November 20^th, just "another day" on the calendar, will have a much greater place in history than December 31^st. November 20^th was the day that the markets closed at their lowest level since the bear came out of hibernation in October of 2007.  Since then the market, as measured by the S&P 500, is up more than 24%.

2008 A Chronology of Economic and Market Changing Events

The past year will ultimately go down in history not so much for the returns we have just reviewed, but instead for the massive amount of market moving and economic changing events that have taken place. We feel that these days will be remembered and written about for many years to come.  As our memories weaken with time and these events take on a historical perspective, it will be beneficial to have a written chronology.  I will apologize in advance for the additional bulk on top of all the other items this month. However, in the future, when your children, grandchildren, and great grandchildren would like to know how bad 2008 was, or who Ben Bernanke, Bear Sternes, Lehman Brothers, Merrill Lynch, Washington Mutual, IndyMac or Wachovia was, you will have your memory right in front of you.  Our thanks go out to Edmundo Braverman for his efforts in compiling this information in a simple and readable format.  You will find it attached.

Expectations for 2009

A look at last year's comments

It has been twelve months since we made the pledge to you that our letters would provide more of the personal insights and thoughts that drive our decision-making.  I hope we have been true to this pledge.  Of course by providing this written correspondence, we're including a record of what we have said in the past; we don't want to highlight our mistakes when making projections, but we have no way to hide what is available in written form.

Given the knowledge that you could easily pull out past letters and judge our accuracy, I thought I'd beat you to the punch and look back at our first letter sent in January 2008 to highlight some of our expectations at that time.

Here it goes. The following are quoted from our December 31, 2007 letter, along with some new comments (italicized):

"What amazes me is that we did not have a market crash."  I spoke too soon as the market did crash a few months later.

"As you listen to the news and read the papers it seems that a liquidity crisis has caused the meltdown of sub-prime mortgages and their related group of loans with names such as CMO, CDO, and SIV.  The results of this crisis will surely end with the consumer spending less.  Less spending will lead to a whopper of a recession".  I agreed in one respect but I never expected the depth or duration of this recession as I concluded that since "interest rates are low, the presumed liquidity crisis must be based on a failure to lend, a short-term phenomenon, at most, that will quickly pass".  Someone may consider one-year a short-term period of time, unless you are living in it one day at a time.

"There is no doubt that our country is in a housing recession.  We have also seen the beginning of a decline in nonresidential construction.  The combination of these two could easily result in an overall reduction in GDP by enough to meet the accepted requirements of two consecutive quarterly declines in GDP, thus a recession".  ... "Our thoughts are that most investors have already factored construction spending into their decisions.  Because they have, the actual numbers should not have a major impact on stock prices".  This turned out to be true, however, I didn't anticipate all of the other factors which did impact stock prices.

"Investors who are speculating on short-term swings in prices probably should worry a little more about the next six months.  This would include people using margin, in need of raising cash by selling stock, and those who own stock in companies without the staying power of strong cash flow".  I should have said the next twelve months.

"It seems interesting that in 2007, US investors sent more money overseas to gamble on some of the most overvalued and politically unstable markets in the world via emerging markets funds than they invested in world leading US companies".  It's nice when you can be right once in awhile.

With that freshly in your mind, let's go out on a limb and look into the future.

With hindsight we can easily see that predicting short term swings in the market is an exercise in humility. Longer-term market predictions (12 to 18 months or more) do have some value, but they should be based on a form of valuation methodology of the underlying securities which make up the market of choice, and a consideration of the current mood of the market participants should be included.

Personally, I don't believe there are scientific factors which can be isolated and replicated to provide insight into short-term market predictions. However, we do know that over longer periods of time, the price of a security or the total market value of all the securities in a market will accurately represent the underlying capital retained and available for earning future income for its owners. This may not make much sense, so I'll illustrate with an example. Wal-Mart is the world's largest retailer.  Most of us know the story of Sam Walton and his creation of Wal-Mart in 1962 with a single store.  In 1970, the company issued stock for the first time and raised $3,400,000.  If the market never recognized the value of capital growth over time, then Wal-Mart would only be valued for $3,400,000 instead of the $220 billion that it is today.

With that mind it's easier to understand how our approach to predicting market returns is based primarily on the analysis of current capital and the return potential of that capital with only a stab at predicting the current mood of investors.  Let's look at our valuation for the five years of earnings, dividends and potential returns at today's prices.

S&P 500 5-Year Estimated Earnings, Dividends and Projected Returns

BV = Book Value  P/B = Price to Book  P = Current Price  BVG = Book Value Growth

ROE = Return on Equity  EEPS = Est. Earnings Per Share EBV = Est. Book Value

Prj% = Projected return as %  Div = Dividend Yield

This chart may have confused you already, but it gives us a basis for a projection of both the level of the market five years into the future as well as of the expected returns, in the form of dividends and growth of capital over time.  Beware of taking this at face value, however. Our methods are based on a statistical model which does not take into consideration human emotions, the primary driver of short-term market prices both at the market level and at the individual stock level. These valuations will not mirror others because our calculation methods are based on a proprietary weighting method.  The chart also does not factor in any changes yet to occur which may affect prices or emotions.  Given these caveats our projections would indicate the following:

An investor's expected five year compounded return from 12-31-08:                    14.73%

S&P 500 Index level ending five years from 12-31-08:                                           1511.36

We update our projections weekly.  We not only complete this work for the S&P 500 but also for the mid-cap index, the small-cap index, and each major sector of the economy. It is time consuming and takes both Justin and I together a full day simply to run the quantitative models.  But what is more important to you is that these models are used as a guide in the overall direction of your portfolio.  We use these numbers to compare one alternative to all other alternatives, and this is the real value of the work.  Every day the market offers us a choice of where we can invest.  By producing a quantitative study based on sound theory, a choice as to where to deploy our funds can be made on an apple-to-apple comparison.

What about emotions?

Emotions are and will continue to be the drivers of short-term demand for stocks and bonds. At the individual stock level we believe we can isolate certain human traits which drive this demand.  However, at the broader market levels, we believe that markets regress to the mean, and the method to judge emotions is more intuitive than quantitative.  In other words, it pays to be somewhat of a contrarian and to try not to become a member of the Buy High/Sell Low Club. Over the next twelve months we believe that history will be a helpful guide to understanding "regression to the mean" and the emotions that had driven previous investor buying decisions after other market declines.

Courtesy of Zacks Research

Given our quantitative work combined with history and a regression to the mean, it would seem logical to make a commitment to common stocks relative to alternatives in the market place. For those of you who are number crunchers who would like to speak with us in more detail about our quantitative work, by all means give us a call.

An Invitation to Listen

For many years now I have taken on the dubious task of sharing our predictions via our good friends at WRHI's  "Straight Talk" program.  WRHI is the news/talk radio station that has served our local community since 1944 (WRHI AM 1340 and FM 94.3). This month our program will be broadcast at 12:30PM EST on January 20^th. We encourage you to listen to the live show, and you can access the program from anywhere in the world via the internet at www.wrhi.com. However, we will also have an access point through our own site at www.andersongriggs.com for at least 30 days.

An invitation to read

During the month of December, we posted five new market commentaries, five audio programs, and two new articles we felt worth highlighting. Our market commentaries are some of our thoughts about what is currently going on in the financial world.  If you do not have internet access, please give us a call and we will be glad to package them up and send copies off to you.  For those of you who do have access, please take a moment to visit www.andersongriggs.com and read the commentaries.

A Big Thank You!

Last month we updated you on our "Email this page" link at the bottom of each of our commentaries and letters on our site and how easy it is to share our thoughts with others.  I am amazed at how many of you chose to use this option...  I don't know who you are, but both Justin and I want to say thanks.

Until Next Time,

Kendall J. Anderson, CFA

P.S.  In accordance with The Securities and Exchange Commission Regulation S-P (Privacy of Consumer Financial Information) under section 504 of the Gramm-Leach-Bliley Act, our firm's privacy policy is enclosed.