First Quarterly Letter to All Clients

Published: April 23rd, 2009

The arrival of spring is something we all look forward to, and with the promise of long sunny days just around the corner, now is an opportune time to take stock of the Great Recession in which we find ourselves.

Turn to any media outlet, commentator, neighbor or friend and you hear a similar refrain that we are in a period of an unusually intense recession and a brutal bear market, triggered by an extraordinary financial crisis that is now being felt worldwide. Although the economy and the financial markets are both struggling, it is worth noting that the problems have evolved over the past year. In 2008, the main problems were soaring energy prices, the deflation of the housing bubble and turbulence in the financial markets.  The energy bubble has burst, housing is now at an affordable level relative to income and stock market volatility in early 2009 has halved since autumn of 2008.

It is important to be encouraged by the improvement of these problems; however, as the old problems have improved, new problems have emerged. Unemployment is on the rise, but it is important to remember that this is a lagging economic indicator.  Historically, the stock market has begun to improve before the end of the recession while unemployment will remain a concern until the expansion is well under way. Consumer spending has declined and Wall Street is concerned about the transition from a period of a lack of government intervention to one of dramatic intervention, as well as how the U.S. will finance its enormous resulting debt.

History has proven that no matter how bad the economy seems now, it will eventually improve. To provide some historical perspective, think back to the bear market following the tech bubble implosion in the early 2000s, when investors experienced three years of negative returns.

The following are some of the headlines that appeared during that period:

Outlook: A collapse in confidence that could take years to overcome. The Independent, July 23, 2002

Leading Indicators Decline on Muddled Outlook for Shares. New York Times, August 29, 2002

Litany of worries sends stocks down. War talk, gloomy outlook rattle investors. September 13, 2002

Weak market outlook makes gold shine. The American Intelligence Wire, January 24, 2003

Companies Stay Downbeat about Profit Outlook; Many cite war threat in gloomy forecasts. Los Angeles Times, Feb 3, 2003

As usual, the press and other “professional” prognosticators were happily spreading their short-sighted doom and gloom right up to the point when things had already turned a corner. Case in point – in April of 2003, the stock market turned and the S&P 500 closed the year with a 28.6% annual return.

At any given point in time, the risk of missing a gain is greater than the chance of missing a decline.  A Dalbar study showed that the average equity mutual fund investor doesn’t even keep pace with inflation over the long run because the average investor tends to be in and out of the market at all the wrong times.  It’s inevitable that we’re going to be most pessimistic when prices have fallen and most optimistic when they’ve risen.  If we give ourselves permission to act on that pessimism and optimism, it leads to a propensity to buy high and sell low.

History has proven that the stock market will idle along and then suddenly deliver a giant gain or loss and then promptly return to its former state of idleness.  If you took away the ten best performing days, two-thirds of the cumulative gains produced by the Dow over the past 109 years would disappear.  Within six months of a new bull market, more than a quarter of the gains occur and within the first year, 40% of the gains are booked.  On average, investors recoup 80% of their bear-market losses within the first year of the new bull market, according to Standard & Poors.

This past quarter has shown signs of improvement in the stock market.  Although the Dow and the broader S&P 500 got off to a rough start, they closed the quarter up more than 20% from their March 9 closing lows.  This recent surge is attributable to a few things.  The recent G-20 conference in London bolstered investor confidence around the world.  The Financial Accounting Standards Board has relaxed the US accounting standards for banks and now “toxic assets” will weigh less heavily on their balance sheets.  President Obama’s administration seems to have hit its stride after stumbling a bit after the inauguration and the market has reacted positively to the recent actions of the Federal Reserve and the US Treasury.  Finally, stocks have just become too cheap to resist, so investors and money managers have been tip-toeing back in to the stock market.

Right now, many clients want to know when the stock market has reached a bottom and if a turnaround is imminent.  There are a few signs, some of which we are already witnessing.  Housing sales and starts must show signs of improvement, vehicle sales and chain-store sales must increase and unemployment claims must stabilize.  This will lead to renewed consumer confidence and spending, which is imperative in any market recovery.  Finally, net flows into mutual funds (either a decrease in outflows or increase in inflows) will be a positive sign.  Another positive sign that is unique to this bear market is the recent divergence of global stock markets.

So what should we be doing? It is important to begin with a clear understanding of what we can control and what we cannot control.  None of us has control over what the stock market or the economy does.  That lack of control extends to making predictions about what will happen in the financial world. We can work to program resilience and survivability into our financial lives.  We can strive to gain a sense of perspective, although it’s hard to act rationally when the press is telling us every day that the world is coming to an end.  We must stay focused on our investment and financial plan and the goals that we have set for ourselves.

I have enclosed your quarterly report and encourage you to call me if you have questions or concerns or if you are in need of a review of your plan.  Your feedback is always welcome.

Sincerely,

ARISTA WEALTH ADVISORS

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