Letter to Clients
By Stephen Smith
January 23rd, 2008
Dear Clients:
There is an adage in the bond market which applies to equities as well, “Quality remains long after the price is forgotten.”
For a lot of investors, even those with quality holdings and a long-term time horizon, the natural human reaction to a precipitous drop in the stock market like we are currently experiencing is to reduce or sell equities, with the hope of stemming future losses. In reality, however, sharp stock market declines in the neighborhood of ten percent are not unusual. Declines of this nature do cause a reaction and not just from investors, but regulators as well.
The Federal Open Market Committee started lowering the Federal Funds Rate and the Federal Discount Rate in late 2007. Tuesday, the Federal Open Market Committee lowered the Federal Funds Rate by 75 basis points to 3.5% and it also lowered the Federal Discount rate by 75 basis points to 4.0%. Both of these moves by the Fed will help add liquidity to the credit markets by making it easier for banks to lend money to consumers and businesses. The LIBOR rate, which most residential and commercial loans are tied to, has also declined substantially and is below the Fed Funds rate.
Global economic growth will moderate in 2008 but should remain above historic trends. Corporate balance sheets are solid. Debt-to-equity ratios are reasonable and cash reserves are high. Additionally, sovereign wealth funds have emerged as a source of financial stability. This is all good news for the long-term health of the capital markets.
We are now in a period of irrationally exuberant selling brought on by the antithesis of quality; namely, the undisciplined enthusiasm for sub-prime debt. In time, the market will return to reason, and the disciplined investor will ultimately be rewarded. As you know, our investment discipline emphasizes the diversified allocation of assets among quality securities. Market history tells us that this is the proper course for the prudent investor.
