Smart401k Blog

In the headlines
A look at some of the market movers over the past week:

• JPMorgan (NYSE: JPM) raised its bid for Bear Stearns (NYSE: BSC) to $10 per share
• Former Countrywide (NYSE: CFC) executives are setting up a new company to profit from the real estate troubles
• The US Department of Justice approved the merger between XM Satellite Radio (Nasdaq: XMSR) and Sirius Satellite Radio (Nasdaq: SIRI)
• Existing home sales in the US were better than expected in February
• Consumer confidence continued to fall in March
• Oracle (Nasdaq: ORCL) fell as its much-watched earnings report came up short
• Motorola (NYSE: MOT) announced that it will be splitting itself into two companies
• Investors were disappointed with a report that Google (Nasdaq: GOOG) may not be growing ad clicks very fast
• US fourth quarter GDP was left unchanged at 0.6% annualized in updated data

Commentary
After such an exciting week last week, this week was comparatively quiet. In the early part of the week, the S&P 500 built on the big gains from the week prior, but lost steam mid-week and ended up losing ground for the week.

The embattled investment bank Bear Stearns, continued to absorb a lot of press ink during the week. On Monday, acquirer JPMorgan announced that it would be raising its offer to $10 per share and simultaneously taking a 40% stake in Bear to head off any competing offers. The rest of the week continued to see debate over what the Bear Stearns situation means and whether the buyout is fair.

Meanwhile, economic news continued to be poor, signaling loud and clear that the economy has not turned any corners yet. In fact, there is yet a thick fog over the US economy and financial system, leaving lingering questions of whether we should be looking for a near-term turnaround or whether investors should be anticipating further deterioration in conditions.

Looking ahead

With questions about how deep and how long the US downturn will be, further market volatility is a virtual promise. For investors saving for retirement, this volatility can be damaging because it can inspire a change in course where none is warranted.

Investors with a long term focus — five years or more — are going to be best served by sticking to a balanced investment plan and otherwise tuning out the gyrations of the market. This allows them to take advantage of the long term growth of the US and global economy without having to make short term guesses on which direction the markets will swing.

In the headlines

A look at some of the market movers over the past week:

• JPMorgan (NYSE: JPM) announced that it will be acquiring Bear Stearns (NYSE: BSC) for $2 per share
• The Federal Reserve cut the discount rate 25 basis points and gave investment banks like Goldman Sachs (NYSE: GS) access to the discount window
• CME Group (NYSE: CME) announced it is acquiring NYMEX Holdings (NYSE: NMX)
• Economic indicators are still making a weak showing
• Brokerages Goldman Sachs and Lehman Brothers (NYSE: LEH) reported better than expected earnings
• The Federal Reserve cut 75 basis points from the federal funds rate and the discount rate
• Housing starts continued to tumble
• Visa (NYSE: V) raised the largest IPO in US history
• Capital requirements were relaxed at Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) allowing them purchase more mortgages
• Commodities fell sharply from their nosebleed levels
• Nike (NYSE: NKE) earnings showed that not everybody is hurting
• CIT (NYSE: CIT) dropped sharply on liquidity concerns

Commentary

It was an action packed week despite the fact that the market was only open for four days due to the Good Friday holiday. It was a particularly volatile week, but the S&P 500 finished up better than 3%, leading many commentators to debate whether we’ve seen a bottom to this downturn or we’re experiencing a “bear market rally.”

Though the week started with declines on Monday, the small drop was considered a positive start to the week given the Bear Stearns news. On Sunday, it was announced that JPMorgan will be buying Bear Stearns for $2 per share in a deal partially engineered by the US Federal Reserve amidst severe liquidity concerns and risk of bankruptcy at Bear. The $2 per share offer represents a dizzying fall from the stock’s peak of $170. The reaction to the outcome of the Bear situation was likely muted due to the strong and decisive action by The Federal Reserve.

The sentiment at the start of the week was stoked further on Tuesday by a strong earnings showing by Bear Stearns’ competitors Goldman Sachs and Lehman Brothers, along with the announcement by The Federal Reserve that it is cutting its target rates by 75 basis points. The news had markets soaring, and the S&P closed the day up more than 4%. Though investors reversed some of those gains on Wednesday, the markets charged back on Thursday to finish the week on a high note.

Credit card company Visa also made major waves during the week, completing its $19 billion IPO. The IPO is the largest in US history and is notable not only because it was completed in the current environment, but that it was priced even higher than originally expected.

Looking ahead

Just as it’s important not to get overly cautious when the markets are depressed, it’s likewise important to not get overly excited when the markets are exuberant. The events of the week were notable, but they were notable just as much for showing how severe the current situation is as they were for the gains on the major indices.

Bear Stearns was one of the largest brokerages and investment banks in the US and has existed since 1923. The company survived multiple bear markets including the Great Depression. So the collapse of this venerable institution gives a good snapshot of just how dangerous current conditions are.

But of course, the past week’s events also highlight the fact that we have a flexible, adaptive, and resilient financial system which is rapidly adjusting itself to recover from the excesses of the past few years. It is likely that there is an ample amount of bad news still ahead, and the economy has certainly yet to show signs of a recovery, but long term investors can sleep well knowing that the big picture for the US and global economy remains positive.

As always, the best approach is to invest steadily in a diversified set of asset classes, not getting swayed by current market sentiment or the investment flavor of the week.

Questions about company stock are some of the most frequently asked by our clients, and in light of the recent events involving Bear Stearns (NYSE: BSC) and JP Morgan (NYSE: JPM) we thought we would remind you about the importance of diversification and the risk of holding a large percentage of your retirement assets in your employer’s stock.  I, like many of you, have been reading about the troubles at Bear Stearns and its recent acquisition by JP Morgan. What caught my eye was that almost one-third of the company’s stock was held by employees of the firm. After digging a bit more, I found the following statistics that surprised me (Source: Hewitt Associates & Employee Benefits Research Institute and the Investment Company Institute): Â

• 40% of employees have at least 20% of their 401(k) in their employer’s stock.
• 16% of employees have more than 50% of their account in their employer’s stock.
• 9% of employees have 80% or more of the 401(k) assets in their employer’s stock.

There are several reasons often cited for holding significant amounts of company stock, including the following:

• Many employees feel their company’s stock is safer than a mutual fund.
• Employer matching contributions often come in the form of company stock.
• Employees want to invest in what they know.

However, our belief, and the message we communicate to our clients, is that if you do decide to invest in your employer’s stock, you should limit your holding to no more than 10% of your overall account balance. This will provide you with exposure to your company’s stock, but also give you the opportunity to properly diversify your account.  If you hold more than 10%, you may want to consider rebalancing your account to increase your account’s diversification.

As a reminder to our clients, we advise you to revisit our risk tolerance questionnaire at least once a year to determine whether your recommended allocation properly reflects your current situation and risk tolerance.  If you have any questions or comments, please feel free to contact us at 877-627-8401.

Buck Wendel, Investment Advisor

In the headlines

A look at some of the market movers over the past week:

• Countrywide Financial (NYSE: CFC) found itself the subject of an FBI investigation
• Rumors of liquidity problems at Bear Stearns (NYSE: BSC) turned out to be the real thing
• Health insurers dropped as WellPoint (NYSE: WLP) cut its earnings projections
• The markets had their best gain since 2003 when The Federal Reserve announced a plan to add more liquidity to the financial markets
• A Wall Street Journal survey suggested that the US is already in a recession
• Oil prices fluctuated a bit on recession fears, but stayed well above $100

• Treasury secretary Hank Paulson talked about tightening mortgage standards in the future

• Gold was high as the dollar suffered
• Southwest Airlines (NYSE: LUV) canceled flights and grounded 38 of its planes for maintenance
• Carlyle Capital, a Carlyle Group fund, found itself in $17 billion worth of hot water
• Standard & Poor’s said financial company write-downs on subprime loans could be nearing an end

Commentary

What a week! Early in the week some commentators were abuzz with the idea that the Federal Reserve’s newest liquidity injection plan would spell the end of the current financial troubles. Economic worries very quickly crept back into the picture though, and by Friday the markets were plunging on the news that JPMorgan (NYSE: JPM) would be providing a Fed-sponsored bailout for Bear Stearns. And all this despite S&P’s prediction that much of the subprime write-downs had already taken place.

The plan that The Fed announced early in the week is significant because it differs from the actions it has taken previously. The plan offers up to $200 billion in borrowings to banks on a 28-day term (versus the standard overnight loan). It’s notable that The Fed will accept agency mortgage backed securities as well as non-agency AAA/Aaa mortgage backed securities as collateral for the loans. Potentially even more notable, though, is the fact that this was not a unilateral action taken by The Fed — the announcement came in conjunction with similar announcements from the Bank of Canada, the Bank of England, the European Central Bank, and the Swiss National Bank.

Most of the early week optimism stemming from that move was wiped clean by the end of the week though. Bear Stearns, which has had some of the worst struggles of all the investment banks since the credit crunch began, found that by the end of the week its liquidity had dried up to such a point that it was at the brink of meltdown. The company seemed to blame early week liquidity rumors as being self fulfilling and conspiring to dry up its liquidity sources. Though the stock is about half of what it was earlier in the week, the company is still alive for now after JPMorgan funneled funds from The Fed to Bear.

Looking ahead

The problems at the end of the week easily out-shouted the positive notes from earlier in the week. With a market that tends to be very short sighted this is not all that surprising — the Bear Stearns situation is very immediate and very dire. I fully expect that this won’t be the last slug of terrible news we hear from a financial institution and I doubt that Bear Stearns will still be a separate entity by year end.

However, The Fed is keeping its wheels turning and the plan announced earlier this week should be a significant step. While the excitement was immediate, the effects of the plan aren’t — the loan auctions under the plan won’t begin until March 27th. Further, The Fed’s next meeting is this coming Tuesday and it is expected that it will try to further jostle the markets loose by lowering rates further.

Of course we don’t want to simply heap hope on The Fed. While there are very real concerns in some areas of the economy, the US’ long term prospects still look solid. Looking even better is the ongoing booming growth globally which will not only lead to gains for investors in overseas companies, but will benefit the US and those US companies that do business around the world.

Are we at a bottom right now? That’s a call that nobody has been able to make reliably. What’s for sure, though, is that markets are lower now, and investors that keep socking away savings in well diversified investments will benefit over the long term.

In the headlines

A look at some of the market movers over the past week:

• Concerns started to turn to commercial real estate
• United Technologies (NYSE: UTX) made an unwelcomed offer for Diebold (NYSE: DBD)
• Under regulatory pressure, Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) agreed to change appraisal standards
• US auto sales sagged in February
• Citigroup (NYSE: C) came under renewed scrutiny when reports surfaced that it would need additional cash injections
• Fed Chairman Ben Bernanke suggested that banks do more to quell the growing number of defaults
• Intel (Nasdaq: INTC) provided a weak outlook thanks to soft flash memory prices
• The National Association of Home Builders reported a sour outlook for housing
• Yahoo! (Nasdaq: YHOO) continues to do everything it can to out run Microsoft (Nasdaq: MSFT)
• Bond insurer Ambac (NYSE: ABK) finally came through with a much needed capital raise
• Thornburg Mortgage (NYSE: TMA) plummeted as lenders started asking for their money back
• Mortgage foreclosures aren’t getting any better yet, and home equity has fallen to 60-year low
• Retail sales provided some needed positive news

Commentary

In short, it was not a fun week for the US markets. Pessimism held center court most of the week and we finished close to the lows that were hit back in January.  The stimulus for the declines continued to be more of the same.  General economic data coupled with financial and housing industry reports continues to paint a picture of a stormy environment. Confidence in the economy and expectations of a near-term turnaround are, as of now, out of the picture.  And though the government is doing a lot of talking about the problem, the actions taken to date haven’t provided much daylight. 

The tune being played outside of the S&P 500 isn’t much more comforting.  Energy and commodities have been providing much of the little positive momentum that is out there — since the beginning of October the S&P is off around 16%, while the average energy stock is up over 5%. Other sectors, such as consumer discretionary, technology, and financials, have fared worse than the index, with financials off nearly 30% since October.  Though it had originally been hoped that overseas markets might hold up better than the US, the UK’s FTSE index has seen similar weakness to the US and Japan’s Nikkei has taken an even worse dip.

Looking ahead

The economic picture has not changed drastically from last week, even if the markets’ performance seems to say otherwise. Though there has not been any convincing data to show that we will be imminently turning the corner from the slowdown, there has likewise not been new data that would suggest that the current problems will cause long-term lasting damage to the economy.

In reading much of the commentary that comes from Wall Street and media outlets, it is important to remember the difference between Wall Street’s timelines and the timelines of most individual investors. Wall Street works in an environment where day-to-day action can be meaningful and one year often constitutes the long term. For this reason, pessimism over the coming three, six, or twelve months on Wall Street can constitute a good cause of significant pessimism. Media outlets have similar, if not shorter, time frames to Wall Street. News stories break on a day-to-day or even moment-to-moment basis and covering the long term, big picture meaning of these events is outside of the capacity of many journalists.

Further, since the goal in journalism is to attract readers, those stories that can create a sense of excitement, fear, or the like tend to get more air time than those that soberly weigh current events.

Retirement investors, on the other hand, look at the long term in five year or even decade increments. Economic slowdowns are not something to be ignored, but they are likewise not a reason for a long term investor to get excited over.  A look back over the history of US GDP growth or stock market performance will show that the up and down cycles of the economy and the markets are simply part of the big picture. Historically, most investors have had the best success by not getting excited at market peaks, or scared away in market troughs.