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Quarterly Letter to Clients

April, 2009

Indices at quarter-end (March 31, 2009):

Dow Jones Industrials: 7,608.92 1Q'09 -13.30% YTD -13.30%

Standard & Poor's 500: 797.87 1Q'09 -11.66% YTD -11.66%

There are those who will say that that experience is what makes us stop and think for a moment before we proceed to goof up again.

By early March stocks had lost 25% over the ten weeks since the first of the year. The Dow had fallen below 6550, a drop of nearly 55% from the peak north of 14,100 it saw in October of 2007. Then a very robust rally carried that venerable average to near 8000, a more than 20% rise in three weeks of trading.

Some would say that a 20%-plus rally constitutes a bull market. It doesn't quite feel that way; it feels more like a little bit of relief within a bear market. But it does offer some hope. The rally notwithstanding, it has not been a fun ride. The year is only three months old, and the Dow Jones Industrials have lost 13.30% on top of last year’s 33.78% giveback.

Capitulation is the emotional state that causes investors to throw in the towel. They simply cannot stand the losses and instruct their brokers and advisers to sell. Capitulation’s usual hallmarks are a severe spike decline, often under extreme volume, which generally marks the bottom of a falling market.

We have yet to see the classic traits of capitulation and bottoming, but there is no law that says that a bottom has to look a certain way. All that we can say with certainty is that we will know the bottom only in hindsight.

The stock market is unique in that it is a mechanism that causes people to want to buy something that is higher today than it was yesterday, and conversely to sell something that is lower today than it was yesterday. Your home, for example, has probably fallen in value by 30% to 40%, but surely you are not anxious to sell your house simply because of that decline. But with stocks, a fall in price leads some folks to be sellers at the precise moment that they should be buyers.

A typical phrase is: “I’ll get back in when the market is better”. This means that the person will be a buyer at a higher price, and is a recipe for losses.

Believe me, I understand the pressure of seeing your securities fall; I am my own client, after all, and I suffer equally with all of you. I believe it is a learned response to be emotionally stable enough to ride out a bear market; experience is the best teacher, my opening quip notwithstanding.

It is at times like this that you become aware that the proper way to participate in the markets is to always have enough money in “safe” investments so that you can weather any storm that may happen in equities. By “safe” I mean bonds. It is not a perfect hedge, by any means, but it is better than almost any other strategy. It is important to find the balance that suits you, your needs, your personality and your age. When you have struck this balance you can more easily face the vicissitudes of the marketplace. It does require a bit of a philosophical mindset, along with a bit of intestinal fortitude.

Stocks—make that markets in general—tend to overshoot in either direction, up or down. The end of the quarter finds us with a somewhat improved outlook on the economy and on the markets, helped by the fact that we have done nicely better than the averages. We are by no means done with the problems, but there is cause for optimism. I expect a rocky road, but I also feel that the worst may well be behind us.

Jim Pappas