“The Other S&P”

Spring 2007

It is often difficult to write an interesting or insightful newsletter every three months for the simple fact that three months is a very short period of time. Sometimes there is just not a great deal of activity upon which to report. The first quarter of 2007 was one of those quarters in which not much happened to immediately affect the markets. As the ultimate in contradictions, events were put into motion at the end of the quarter that could have a far reaching impact on many issues, both from a financial aspect and from a political tension viewpoint.

The first quarter equity markets basically ended in a tie. The Dow Jones Industrial Average closed down 0.87% for the quarter. The NASDAQ closed up 0.26% and the Standard and Poors 500 closed up 0.18% for the quarter. In a word, the markets were flat.

There was considerable excitement generated on February 27 th by Sir Alan Greenspan when he told a group of Asian investors by video conference that the US economy was likely to head into a recession by the end of 2007. We refer to Mr. Greenspan as Sir because he was duly knighted by Queen Elizabeth of England, joining other notable knights of dubious distinction such as Elton John and Paul McCartney. I would imagine that Ben Bernanke, the current head of the Federal Reserve, and millions of investors around the world may have had other adjectives to describe Mr. Greenspan after the markets closed at the end of the day. Mr. Greenspan’s comments spooked the markets. Asian markets closed down 9% for the day. The Dow, NASDAQ and the S&P all dropped over 3% for the day in the US equity markets.

A little bit of perspective is required to properly assess these comments made by Mr. Greenspan. Mr. Greenspan is brilliant. However, to comment that the US is likely to head into a recession by the end of 2007 is purely conjecture on his part. Mr. Greenspan is paid $150,000 per speech. Obviously, he feels that he needs to give his audience their money’s worth. Brash statements appear to be the order of the day. The US economy eventually will migrate into a recession. That is a correct statement based entirely upon the nature of free, capital markets. Every period of growth eventually is followed by a recession. Recessions are not to be feared. They are a perfectly normal side effect of capital markets that have undergone periods of growth. Aggressive investors can make money even during recessionary times. The basic problem is that Mr. Greenspan has no more idea when the recession will begin than any other well read individual investor would have. He may be correct or he may be wrong by several years. Mr. Greenspan’s guess is only that, an educated guess. However, to Mr. Bernanke’s chagrin, Mr. Greenspan can still move the markets by his comments. After reading his comments and observing the market’s reactions to them, we wondered if Mr. Greenspan wakes up in the morning and tells his wife, Andrea Mitchell of NBC News, that he wants to see how much power he still has over the markets.

On the purely technical side to Mr. Greenspan’s comments, the US equity markets had gone through an incredibly quiet period of time. The markets had gone through 990 consecutive trading days without a 3% drop in value. This is almost four years, an incredibly long period of time for such a benign occurrence. Will Mr. Greenspan’s comments presage more volatility in the markets in the coming months? Only time will tell but increased volatility by itself is nothing to fear.

Putting Mr. Greenspan’s comments aside, from a long term perspective, there were two significant issues that arose in the first quarter of 2007. Over the last five years, the US housing market has enjoyed a revival unlike anything seen since the end of World War II. House prices soared and websites such as Flipcondos.com surged in popularity as investors and families enjoyed mortgage rates that were considerably less than the inflation rate on the houses themselves. People could lock in an adjustable rate mortgage for 5 years at 3.25% and watch in amazement as the value of their property soared as much as 20% in value in one year! Many first time home buyers of dubious credit worthiness were able to borrow money to buy a home with absolutely no money down and even borrow as much as 120% of the value of the property in question. As the Federal Reserve raised interest rates 17 consecutive times, many of these five year adjustable rate mortgages matured and rolled over to the higher rates. The avalanche of foreclosures began. Home prices on both coasts collapsed as many of these foreclosures were dumped on the market for resale. Buyers became much more selective with the higher interest rates and waited for the prices of the excess home inventory to drop significantly more. These no money down and over 100% of value loans are referred to as the sub prime market. Several companies that specialized in the sub prime market went under in the first quarter of 2007. There is speculation that the collapse of the sub prime market will affect adversely the overall equity market in the US. It certainly bears monitoring, but the sub prime market is only between 5-9% of the total lending market depending upon whom you believe. We do not think that the collapse of such a specialized and unique market will have that much affect. However, it could add to the volatility of the markets throughout the summer and fall months as more difficulty in this area is reported.

Of considerably more significance to us was the taking of the 15 British sailors and marines by the Iranian army several weeks ago. These issues are always in a state of flux and I hope that by the time you read this, the kidnapped sailors will have been safely returned to British soil and our discussion of this will become a moot point. If they have not been returned, this issue could have serious ramifications for continued unrest, instability and saber rattling in an already incredibly tense part of the world. Oil shot up almost $10 a barrel and along with it, gasoline prices, upon the announcement of the impasse. We are of the opinion that energy still drives the US and world economies. Any spike in price, or even worse, inability to access oil, will have quite detrimental effects on the world economies. It is not a coincidence that the taking of 52 US hostages by Iranian students in 1979 for 444 days led to many years of stagflation in the world economies. This issue bears monitoring and as we said, we hope this whole paragraph is moot by the time you read it.

We are always fascinated by history. As you can see from the paragraph on Iranian hostages, specific actions do impact the markets as well as individuals and countries. One point of interest that I came upon recently had to do with Dwight D. Eisenhower, the President from 1953-1961. Earl Warren was the Republican Governor of California for three terms. He ran for Vice President of the United States with Presidential candidate Thomas Dewey in the famous election in 1948 in which, then President Harry Truman, came from nowhere in the last hours to capture the election that everyone predicted was Dewey’s and Warren’s. Earl Warren ran for the Republican nomination for President in 1952 against Eisenhower. In a classic tale of a deal gone wrong, at least from Eisenhower’s perspective, Eisenhower promised Warren the next seat on the US Supreme court if Warren would withdraw his candidacy and throw his delegates behind Eisenhower. Little did Eisenhower know that the next seat to become available during the first year of his Presidency in 1953 would be that of Chief Justice of the Supreme Court. True to his word, Eisenhower nominated Warren and he was confirmed by the Senate. Eisenhower thought that Earl Warren would be a moderate on the Supreme Court. To his ultimate surprise and regret, Warren turned out to be one of the most liberal Chief Justices in the history of the Court. When asked late in his life, what was the biggest mistake he had ever made, President Eisenhower did not refer to any battle or D-Day landing or his time as Supreme Commander of all Allied Forces during World War II. Instead he simply said, “Appointing Earl Warren to the Supreme court.” Historians might dispute this comment, but what does stick out is how important even the smallest action can become in retrospect.

We appreciate the opportunity to work with you and your businesses and families to assist you with your financial and personal goals. If there have been any changes in your financial circumstances or needs of which we should be made aware, please contact us immediately. If you would like a copy of our latest Form ADV, Part II, please contact us.

We greatly appreciate the many referrals that many of you have sent to us. We enjoy working with our clients and their families and greatly appreciate the confidence so many of you have shown in us by referring us to your family and friends. We thank you for this continued vote of confidence. Please mark your calendars for our Client Appreciation Event on September 12th.

The first quarter of another year has come and gone. We will continue to monitor your investments and assist you in every way possible to help you achieve your financial goals.