“IRRATIONAL EXUBERANCE"
By Richard L. Kesner, President
The CommonWealth Group
September 2008
“The most dangerous positions are the perceived safest ones because when they blow up, the losses are far greater than one would have expected, and of course with leverage can be devastating.”
Michael Gordon – Angelo Gordon & Co.
Over the last 13 months the US Equity markets have shown enormous volatility and created substantial pain to investors. The greed of the credit crisis, the use of substantial leverage, and the subprime mortgage crisis has caused “Irrational Exuberance” on the downside just like Alan Greenspan described the bull market of the 90’s.
I never heard the term used for negative markets or even the real estate markets that were out of control due to his continuation of low interest rates, but in effect that is what we are experiencing.
I still believe in the equity markets. I believe that this crisis will pass and that the US Markets will be better and stronger going forward. Long term investors with long term investment plans should stay the course and continue with their long term strategy. Corrections pass as do bull markets but in the long run the markets should deliver excellent results.
Here in the US, we have lost faith in our leaders, we have lost faith in our financial systems and we have lost faith in our currency, the U.S. dollar. Fortunately, this is changing and should change very rapidly.
Due to “financial engineering”, bravado and the use of leverage, the world is now facing a global recession. Sound steps are being taken to right the ship, and these steps will be successful. The United States will be the first nation to emerge from the global recession. It is important to note that the problems in Europe and Asia, which hold over sixty percent of the structured products are only starting to be recognized.
Oil prices, except for occasional bumps, continue to decrease as do most other commodity prices. A global slowdown will force these prices down as demand lessons. This will allow food and energy prices to be reduced effectively giving the consumer more spendable income.
Because of the strengthening dollar we expect many foreign nations to move money into the U.S. Much of it will find its way into the equity markets as the best companies in the world are on sale. Even though the economic instability will worsen in the short term, the markets will stabilize and rebound long before the economy. That is why long term investors need to be patient and stay the course.
The general election will bring in a new administration and a new leader that should create more optimism for the country and the world. We have seen this before and I believe that although it may take longer, the ending will be the same, long term positive growth for the country and the equity markets.
Sometime in the last ten to fifteen years, Congress, and in particular the SEC, lost sight of what was learned during the Great Depression. Forgotten were thousand of pages of testimony about bear raids and how they should be eliminated. Eventually the “uptick rule” was instituted to prevent abuses in short-selling. The “uptick rule”, a rule that prevented the shorting of stocks with an uptick of at least 1/8th of a point was eliminated last July. The volatility of the markets started last July. The rule worked for 70 years, but the SEC, in an attempt to curb hedge fund abuse eliminated it without any warning or hearings. We believe this is a major problem that needs to be addressed to prevent short sellers from beating down stocks.
The last bull market, a 17 year bull market, ended in 2000. It has been a tough and rough ride for investors since then. This last bull market was extraordinary in creating extremely high returns for almost every equity investor. Today, some investor’s were still expecting this type of return. We think expectations have now been changed enough to bring even the most optimistic investors back to reality. The only way to make returns that are outside the norm is through the use of leverage. We have seen what leverage has done to Bear Stearns, Wachovia, Washington Mutual, and Lehman Brothers etc etc etc. At Commonwealth, we have always minimized the use of leverage because of the dangers.
No one knows whether the markets have hit bottom or if there is still more to come. However, we do believe that extraordinary opportunities are available to be realized for those who stick to their long-term plan.
Richard L. Kesner
The Commonwealth Group, Inc.
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