2. Is It Different this Time? A look at the credit crisis, its causes, remedies, and implications for the future A Perfect Storm in the Making Crisis Unfolds Economy Markets Where do we go from here Questions Agenda
4. There are some things that are always different and some things that are never different. “History never repeats itself, but it rhymes.” Mark Twain Is It Different this Time?
5. A Perfect Storm in the Making Three Primary Causes Housing Bubble Credit Bubble Willful Ignorance
8. Perfect Storm: Housing + Presidential / Legislative Support President Carter in 1977 signed the Community Reinvestment Act, which pushed Fannie and Freddie to aggressively lend to minority communities In 1994 President Clinton unveiled his National Homeownership Strategy; rewrites rules regarding Fannie Mae and Freddie Mac President Bush set a goal to increase the number of minority homeowners by 5.5 million families by the end of the decade. Signed five legislative initiatives promoting this goal. Source: LoanPerformance, Paulson presentation; USA Today via T2Partners Presentation
9. Perfect Storm: Housing + Declining Underwriting Standards Source: LoanPerformance, Paulson presentation; USA Today via T2Partners Presentation
10. Perfect Storm: Housing = Housing Bubble Source: Robert J. Shiller, Irrational Exuberance, 2nd. Edition, as updated by author: http://www.econ.yale.edu
17. Perfect Storm: Credit Too Much Leverage - Banking In 2004 the SEC granted special permission to the five largest U.S. investment banks, allowing them to increase leverage ratios from 15-1 up to 40-to-1 Source: http://andstillipersist.com
19. Perfect Storm: Credit Explosion of Securitization: Car Loans Residential Mortgages Credit Cards SBA Loans Student Loans HELOCs Equipment Commercial Mortgages Excluding Residential and Commercial Mortgages Source: SIMFA, New York Times, ABA
20. Perfect Storm: Credit Explosion of Moral Hazard Everyone gets paid upfront Mortgage broker Underwriting bank Investment bank Servicer Rating agency No one shoulders any risk Or do they???? Source: Ken Andrews
21. Perfect Storm: Credit Explosion of Derivatives Warren Buffet’s famous “weapons of mass destruction” Massive issuance of CDS contracts, completely unregulated Used as insurance and risk mitigation No requirement of insurable interest – the equivalent of buying a life insurance policy on a stranger; illegal for a reason Plus, insurance is only as good as the company selling it – Lehman, AIG Source: New York Times
23. Perfect Storm: Oversight Everyone dropped the ball: Gramm-Leach-Bliley Act (1999) repeals Glass Steagall and opens door for future shenanigans Fed and Treasury encouraged development of unregulated CDS markets Office of Federal Housing Enterprise Oversight (OFHEO) specifically tasked with regulating Fannie and Freddie – stifled by political lobbying Justice Department - unrestrained consolidation left the top 19 banks controlling 66% of bank assets
24. Perfect Storm: Oversight More ball dropping: SEC got little right Corporate Boards – encouraged risk taking; embraced short term funding of balance sheet (Robert Rubin, former Treasury Secretary, Chairman of CitiGroup) Greenspan – a perennial advocate of deregulation, leverage, and free markets Rating Agencies – completely disregarded the special role they play in capitalism; sold their soul
26. A Perfect Storm in the Making Crisis Unfolds Economy Markets Where do we go from here Questions Agenda
27. Calm Before Storm 2003 - 2006 Upside: Solid (but not great) GDP growth Record profit margins – driven by outsourcing, leverage People felt safe/low risk premiums Record asset prices Downside: Everyone felt richer than they were Everyone lived beyond their means Everyone borrowed accordingly Real GDP Growth Source: New York Federal Reserve; JP Morgan
28. Crisis Unfolds 2006 - 2008 Cloudy Skies – late 2006 Drizzle – 2007 Dow Jones Industrials reach record high – 14,164 on October 9th, 2007; problem looks contained Steady Rain – Late 2007 – 2008 Deluge – September 2008
29. Deluge – September 2008 Fannie and Freddie in conservatorship Lehman Brothers files for bankruptcy protection Reserve MM “breaks the buck” Federal Reserve lends $85 billion to AIG to avoid bankruptcy, and further ripple affects Treasury proposes and finally gets TARP But……credit markets seize anyway Warren Buffett calls the economy “a great athlete that’s had a cardiac arrest” President Bush: “This sucker could go down”
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31. Deluge – September 2008 No Appetite for Risk Investors demand higher compensation to own risky assets In many cases, the highest ever Source: Wells Fargo
61. How Bad Is It? This is not “Great Depression 2.0”
62. How Bad Is It? This is not “Great Depression 2.0” Government shows a willingness to do “whatever it takes” – Fed Funds Rate, balance sheet, deficit spending Correct monetary policy response – lower rates, increased money supply Backstop of FDIC – bank losses not flowing through to consumer Social shock absorbers – unemployment insurance, Soc. Sec., Medicare, Food stamps Coordinated global response Source: Slate
63. How Bad Is It? But, This is the deepest and longest recession of the post WWII era Source: http://investorsconundrum.com
64. How Bad Is It? There is no room for error: Banks – healthier but far from healthy State and local government deficits Stimulus – poorly conceived; little bang for lots of bucks Current federal deficit – 13%+ of GDP Continued home price decline / second wave of mortgage defaults / commercial property / Europe Unemployment – 9.7%! (12.2% in CA, 12.2% OR, 15.2% MI, 11.5% in SC, 13.2% in NV as of September‘09) Possible vicious cycle – Paradox of Thrift – unemployment/defaults/banking losses/ tighter credit/unemployment……. Source: BLE, JP Morgan, Pimco
65. How Bad Is It? And…..great uncertainty in the short-term : De-leveraging Re-regulation De-globalization (protectionism) Increased taxes Political / legislative uncertainty Reduced corporate profits
67. What is Different This Time? Credit induced vs. Inventory or business cycle Systematic risk Global decline Deeper and longer than we’re used to
68. On the Bright Side Snapback is historically proportional to decline Source: Bank Credit Analyst
69. On the Bright Side Economic Indicators are getting better or have stopped getting worse: Consumer sentiment Initial unemployment claims Industrial production Retail sales Household savings Home affordability GDP -1.0% Q2 ‘09
70. A Perfect Storm in the Making Crisis Unfolds Economy Markets Where do we go from here Questions Agenda
71. Markets Steep declines driven by margin calls, redemptions, weak hands, flight to quality S&P 500 price only
72. Markets How bad was 2008? S&P 500: -37% Second worse year on record (-43% in 1931) Every asset class declines except high quality bonds International Equities (MSCI EAFA): -43.4% Emerging Markets (MSCI EM): -54.3% Commodities (Dow Jones AIG Index): -35.7% Real Estate (NAREIT Equity Index): -37.7% Source: Littman Gregory
73. Markets Q1 ‘09 Markets continued decline in January and February S&P 500 -56.7% peak to trough (price only) Markets looked broken, dysfunctional Diversification didn’t help as correlations go to 1.0 But, with dislocation comes opportunity
74. Markets Significant capitulation on March 9th Market is forward looking and sees brighter days ahead; continues to go up in the face of bad news Went from significantly undervalued to fairly valued S&P 500 price only ~60% recovery!
75. Markets US Equities not the only game in town YTD 2009 High Yield bonds up 31.4% Vanguard VWEHX Convertible bonds up 34.9% Vanguard VCVSX Emerging Markets up 62.1% Vanguard VEIEX Small Cap Growth up 37.9%Vanguard VISGX Even Muni Bonds up 14.3% Vanguard VWLTX Meanwhile……. Long-term Treasuries - 9.1%Vanguard VUSTX All numbers as of 9/21/09; Any past or expected return information (average annual returns, compound return, standard deviation, and yield) are provided for illustration only and are not a guarantee or prediction of future performance. They are not to be considered representative of securities recommended by us now or in the past.
76. Markets Can this last? Or is it a dead cat bounce? Source: Edward Jones
77. Markets Historically Markets begin recovery about halfway through recessions even as bad news continues and unemployment rates increase Source: JP Morgan
79. Markets: Long Term Wasted 10 years…………roller coaster ride -1.46% annualized return (S&P 500, Vanguard VFINX, 1/98-12/08, inc. div)
80. Markets: Long Term Again….US Equities not the only game in town 10 years 1/98 – 12/08, annualized returns S&P 500 - 1.46% Vanguard VFINX US Small Cap Value +7.32% DFA DFSVX Emerging Markets +9.49% DFA DFEMX Intl. Small Cap Value +9.52% DFA DISVX Real Estate +7.55% DFA DFREX And don’t forget bonds Total Bond Market Index +5.37% Vanguard VBMFX All numbers as of 12/31/08; Any past or expected return information (average annual returns, compound return, standard deviation, and yield) are provided for illustration only and are not a guarantee or prediction of future performance. They are not to be considered representative of securities recommended by us now or in the past.
81. Markets: Long Term And.….Over 20 years……respectable Note: Average Investor compared to markets; Why? Source: JP Morgan; The indexes used: S&P 500 Index: Standard & Poor’s 500 Index, REITS: NAREIT Equity ReitsIndex, EAFE: MSCI EAFE, Oil: West Texas Intermediate Index, Bonds: Barclays Capital U.S. Aggregate Index, Homes: Median Sales Price of Existing Single-family homes, Gold: USD/troy oz. All returns are annualized (andtotal return where applicable), and represent the 20-year period ending 6/30/09. Average equity investor return is based on an analysis by Dalbar, Inc. which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. *DALBAR returns are through 2007, next update due in 1Q09.
82. A result we could have all lived with: Markets: Long Term ~8% annual growth Source: Yahoo, Century Wealth Management
83. A Perfect Storm in the Making Crisis Unfolds Economy Markets Where do we go from here Questions Agenda
84. Where Do We Go From Here Going forward…next 10 years should be better Source: DWS
85. Where Do We Go From Here Why?...Reversion to the mean; driven by GDP Source: DFA, Federal Reserve; Hypothetical based on 15x P/E ratio
86. Where Do We Go From Here Another reason to be cheerful…… Stocks are cheap Price/ Peak Earnings Price/Normalized Earnings Price/Book Tobin’s Q Ratio Source: JP Morgan as of June 30, 2009
87. Where Do We Go From Here And, when stocks are cheap….future returns are good
88. Where Do We Go From Here Equity markets go up more than they go down
89. Where Do We Go From Here Short term is meaningless Source: DFA
90. Where Do We Go From Here Not much better Source: DFA
91. Where Do We Go From Here A meaningful trend developing Source: DFA
92. Where Do We Go From Here Only 2 negative ten year periods Source: DFA
93. Where Do We Go From Here 20 is the new 10 Source: DFA
94. Markets How should investors position their portfolios? Diversify globally – un-hedged international exposure Tactical vs. static allocation Be nimble; Buy what’s cheap, when it’s cheap Don’t forget bonds – high quality corporate vs. treasuries Use alternatives to diversify stock and bond exposure Market neutral strategies Arbitrage strategies Structured notes Inflation protection – down the road Tips Commodities
101. Conclusion Yes, this recession is different from others But, each contraction poses unique problems No, this is not a repeat of the Great Depression Yes, we are entering into a new era of de-leveraging and slower growth The short term outlook is cautious While, long term, the investment opportunities are encouraging based on fundamentals and valuation If we successfully navigate long term issues
109. Disclaimer The information contained in this document is for background purposes only, and does not purport to be full or complete. Any information contained herein is subject to revision, updating, completion, modification, and amendment. This document does not constitute an offer to sell or a solicitation of an offer to buy any securities, and may not be relied upon in connection with any offer or sale of securities. Past performance is not indicative of future performance. The views contained herein are solely of Jay Healy as of date of presentation, and not that of Century Wealth Management, and are subject to change without notice. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. This material may not be distributed to other than the intended recipients. Unauthorized reproduction or distribution of all or any of this material is strictly prohibited.
110. A Perfect Storm in the Making Crisis Unfolds Economy Markets Where do we go from here Questions Agenda
