MARKET COMMENTARY (Current Issue of The TANDEM Report)
Please take a deep breath and recognize that the world is not coming to an end. It just feels that way. Nothing is as it seems, and the dire predictions are motivated more by fear than by logic. Take comfort in knowing that the masses are usually wrong. As we have written previously, market movement is governed by fear and greed. Fear is having a field day, but greed can only be suppressed but for so long.
We are paying a steep price for the stupidity of others. Eager for better returns after the last bear market, many poured money into alternative investments like hedge funds and commodities. These types of investments have two important characteristics in common: the use of borrowed money and a lack of liquidity. The flaws of both are concealed when prices go up, but become dangerously exposed when prices fall. The problem seems to be that those who chose these investments failed to adequately perceive the risk associated with them. Worse, most of the culprits actually got paid for their investment “expertise.”
Nearly anything hedge funds collectively touched has experienced bubble-like symptoms. Emerging markets, credit markets and commodities all popular with the hedge fund crowd, experienced dramatic ascents, followed most recently by precipitous declines. As illiquid (meaning hard to sell), leveraged (meaning bought with borrowed money) assets fall in price, lenders start to want their money back, or at least more collateral. Since stocks were not in a bubble and are typically less leveraged and far more liquid, they were the best asset these speculators could sell. Unfortunately, when dealing with the unwinding of massive debt, selling begets more selling. And here we find ourselves.
It would be unfair of us to singularly blame hedge funds. What is fair to find fault with, and we have done so for years, is the widespread risk-ignorance of investment professionals, banks and governments around the globe. Their folly has put us all in the middle of a giant mess. Bear Stearns, Fannie Mae, Freddie Mac, AIG, and Lehman Brothers are all essentially gone. These are not reassuring events, to be sure. In order for Capitalism to work, flawed institutions must fail. These entities borrowed more money than they could repay. They were houses of cards. Others will likely fail as well, as we have predicted. The world will go on. As competition shrinks, strong institutions take market share and profit as a result of their competitors’ misfortune. It will not be different this time. It never is.
Navigating through the rubble is easier than navigating while the bombs are still falling. You expect us to do both, and you should. We believe that we have been mindful of risk all along, and that our holdings are not likely to fall prey
to the troubles of the day. Certainly share prices are suffering, but good businesses will be able to withstand the environment. Companies that have relied on debt are now having trouble financing their needs. We will continue to do our best to avoid these. Banks are now obligated to the Federal Government. Other industries may well follow suit. We grudgingly applaud the actions taken thus far, but are uncomfortable with the long-term ramifications of the U.S. Treasury as shareholder. The landscape is clouded. Nonetheless, we will continue to be guided by our principles as we navigate.
For the time being, there is no asset class that is working. Panicked investors are literally selling everything and fleeing to the safety of U.S. Treasury Bills. Yields on T-Bills briefly became negative in September, as investors were willing to accept a loss on their money as long as they were able to be sure they got most of it back. We are reminded of the old adage about throwing the baby out with the bath water.
Eventually the forced selling will be done. There are already values in the marketplace that make us salivate. However, there has yet to be reward for those brave enough to venture in. For our part, buying this month has been a bit like trying to catch a falling spear. It looks doable, but it might be easier to just pick it up off the ground.
Our Market Commentary column is typically more about details and less about adages. Forgive us, but we believe that psyche is more important at the moment. It is our hope that when reason is restored, as it certainly will be, we will find a world that adequately prices risk - a world that makes sense. This may be asking a lot, but we are hopeful.
