Stock prices declined significantly today on a lack of any specific news, but continued negative sentiment about the financial industry and possibly tougher economic conditions in the near term. Though we believe that the problems in the financial sector are serious and that the economy is likely to be challenging for the next few quarters, our research suggests stock prices have already discounted most of this future bad news.

Stock market bottoms are very difficult to predict, but do share common characteristics that this market is beginning to exhibit such as: a dividend yield on the S&P 500 which exceeds that of ten year treasuries, a reading on VIX (volatility index) above 50, significant mutual fund redemptions, a number of days of significant (greater than 3%) stock market declines, and lastly, one day when global stock markets decline by more than 7%. Prior to recovering today, stocks were down 7.5% at session lows.

Stock market bottoms take time to form, so there is no need to rush significantly into stocks. This bottoming phase typically takes three to four months. Keep in mind that stock markets typically revive six months prior to the economy. These bottoming periods are usually marked by a trading range, punctuated by volatility and some efforts by the government to assist the economy. In this case, we highly anticipate that the Federal Reserve will be lowering interest rates and may do so in coordination with overseas governments to give global economies the necessary “kick start” so desperately needed.

Our research is suggesting that the market is beginning its bottoming phase and we welcome its arrival. However, it is not yet time to put our higher than normal cash and bond reserves to work. Again, bottoms take time to form and we will allow time to patiently and thoughtfully become more growth oriented. In recent months, we have created a list of great companies that will likely benefit from a market recovery. The time to start buying these companies is not today, but is getting closer. Moreover, even when we do begin buying, we will be doing so in phases over months and not in just one day.

The past twelve months have been a very challenging environment for investors and today’s market decline does not help. However, keep in mind that the bulk of the recessionary bear market is not ahead of us, but is now in the past. We will continue to monitor events closely with an eye towards managing any further downside risk. However, for the first time in a year, we will begin to have an eye towards participating in the benefits of a global stock market rebound.

If you have any questions or thoughts, feel free to contact us at your earliest convenience.

Sincerely,

James E. Demmert
Managing Partner