SCM Missive | October 16th, 2008

Investors are divorcing their stocks. Here is the list of reasons they seek to dissolve their relationship with America’s best companies.

1. We are in a deep recession which could last one to two years. Most knowledgeable economists believe that since last December that our economic slowdown has had the characteristics of a recession. If it is deep (a 3 to 4% decline in economic activity) it will last another year. The stock market discounts the future 9 to 12 months out and has historically bottomed in the middle of a recession. In a deep recession, 97% of all the economic activity that went on the previous year happens. Would you divorce your spouse if he/she loved you 3% less for one year and then his/her love started growing almost uninterrupted in future years?
2. The Treasury Rescue Plan is not working. Most of the plan has not even begun to operate. No commercial paper loans, preferred stock investments in banks or auction buys of out-of-favor mortgage-backed securities have been purchased. Would you divorce your spouse just as you entered marriage counseling?
3. Hedge funds and wealthy executives owning stock on margin are being forced to sell. Do you divorce your spouse because the neighbors got a divorce or because a relative decides to call it quits? Hedge funds used huge leverage to create a fantasy that they deserved the assets of the wealthy. They are selling what they can (blue-chip stocks) to meet margin calls from the banks. Many executives have used borrowed money to expand their ownership of their own company or make additional outside investments and as shares have dropped, they are forced to sell. As the public sees the huge declines in the market and the temporary/violent declines in their 401k’s or personally owned mutual funds, they are redeeming their shares. This forces a portfolio manager who prefers to buy his/her favorite stocks to sell the very companies that they prefer to buy. We buy stocks with cash and therefore don’t run into these margin call pitfalls. MAJOR MARKET BOTTOMS COME WHEN THE SELLERS ARE INDIVIDUALS OR INSTITUTIONS WHICH PREFER TO BE BUYING, BUT ARE FORCED TO SELL AND ULTIMATELY THERE ENDS UP BEING NOBODY LEFT TO SELL!
4. We are never going to buy things or pay for services from each other any more. If that is true you don’t need a big cash position from divorcing your stocks, you need a big gun and ammunition position. In the “Great Depression”, quality blue-chip stocks did as good a job of maintaining your purchasing power from beginning to end as most any other place folks kept money. So divorce didn’t even make sense in 1930 or 1931 when investors had already been abused as much as we have been in the last 12 months.

Despite what we might have to go through in the next few weeks and months, we would like to marry as many of our favorite companies and hold onto the ones we have. We believe this might be the best entry point into the U.S. Stock Market in 50 years.

Warmest regards,

William Smead