Quarter letter - oregonlive



Newsletter 1st Quarter 2011Quarterly Investment Commentary: How Long Do Bears Hibernate?Another tumultuous and volatile quarter led to yet another quarter of gains as stocks advanced despite numerous unsettling global events. Political turmoil in North Africa and the Middle East helped exacerbate upward pressures on already-rising oil prices and renewed festering concerns about the region’s stability. The devastating earthquake in Japan quickly evolved from a horrific human tragedy into a frightening ongoing drama focused on the potential perils of nuclear energy. Despite the market’s subsequent volatility, stocks recovered nicely as the quarter came to a close. The Dow Jones Industrial Average rose 742.22 points, or 6.4%, for its best-performing first-quarter (in percentage terms) in 12 years. This is a remarkable advance given the aforementioned crises, ongoing worries about the European debt crisis, renewed weakness in housing prices, and universal concerns about the ever-growing U.S. budget deficit.There were numerous positives events in which investors could take solace. Unemployment finally started a slow decline. Corporate profits continued to show robust improvement. Household net worth increased, climbing 5.1% in 2010 from 2009 levels. Total U.S. household debt, a consistent topic of concern to this author, fell for the second straight year to the lowest level since the fourth quarter of 2004. The personal savings rate, which reached a low of 1.4% in 2005, averaged 5.8% in 2010 - a level last seen in the early 1990s. As good as these improvements in the household balance sheet are, many experts feel we still have a considerable way to go. Many economists believe a healthy debt-to-disposable-income ratio should be 100% or lower. Even with the past 2 years’ decline, that ratio still stands at 116%. Let Sleeping Bears LieInvestors’ perceptions are invariably shaped primarily by their most recent experiences. In the 1980s and 1990s, as global stock markets charged inexorably upward, a surfeit of bullishness prevailed. Everyone loved the stock market, risk was given little serious consideration and bonds – to quote a former colleague – “are for sissies”. How times have changed! Today, faith in stocks is badly shaken, risk containment is back in vogue, and capital preservation is the greatest concern of most investors. Yet inflation continues to be a persistent problem and bonds, while excellent vehicles for preserving capital, have barely kept pace with inflation over the last 50 years.Twin severe bear markets have led to anxious investors universally wondering when the next bear market will emerge. After a decade in which stocks returned virtually nothing, this deep-seated fear and skepticism is more than understandable. This perception, however, may be overly skewed to the dark side due to the extreme depth and duration of these last two market contractions.A bear market is generally defined as market decline that exceeds 20% from the previous market peak. Using that metric, the broad market, as measured by the S&P 500, has endured ten bear markets since 1950. The average bear market has lasted 14 months and declined an average of 34.2%. The average bull market over this same period of time has lasted more than four years, with an average gain of 129%. Several elements contribute to the cautious and jaded perceptions prevalent today, the first being an extraordinarily long period with no market declines which met the classic definition of a bear market. The period after the “Crash of ‘87” through March of 2000 was an extraordinary period of above-average returns and a dearth of declines. Between 1991 and 2000, GDP increased at an annual average of 7.3% and the S&P 500 gained more than 18% annually - nearly twice the long-term average rate of return. When The Bear finally returned, he did so with a vengeance. The bear markets of 2000-02 and 2008-09 were much more severe and extended than the average market decline. Bear markets are a normal periodic part of the investing landscape, but the long-term history of such declines suggests that those waiting for “Armageddon 3” may be extrapolating too much gloom and doom from recent market history. Stocks, when measured by most valuation metrics, are no longer as phenomenally cheap as they were in March of 2009, but neither are they extraordinarily expensive. This is especially true of large company stocks. It is impossible to forecast the final box score will be for 2011, but many of the trends alluded to in this letter are headed in a positive direction. Recent dramatic and unsettling events notwithstanding, the recovery in the U.S. economy seems well-entrenched and unlikely to be derailed anytime soon. “The fishermen know that the sea is dangerous and the storm terrible, but they have never found these dangers sufficient reason for remaining ashore.” – Vincent van Gogh, 1853-1890Paul VermilyaCompass Investment Advisers LLC ................
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