- 2007 4th Quarter

Each quarter at Pension Advisors, I write a commentary about what happened in the market for the latest quarter as well as the past year.  I also discuss what I expect to see affecting the market in the months ahead.  While I will go through the events of the 4th Quarter of 2007, I will focus more on what is going on now and what we see ahead.

What is happening? What will be happening?  What should we do to be prepared?

In December, I was on the west coast for a business meeting.  I had booked a direct flight home from San Francisco after a long week on the road.  The flight was delayed because of bad weather in the Bay area.  Magically, after 30 minutes, we were able to take off.  Almost immediately, I wished we were still on the ground.  Unfortunately, the airline did not ask my opinion on whether it was a good time to fly, and they were certainly not asking me to join them in the cockpit to smooth out our bumpy flight.  Less then 30 minutes into the flight, I was sweaty, nervous and my stomach was churning.  Worst of all, there was nothing I could do except deal with it, and hope that things would not be this bad for the entire flight home.  I knew eventually we would be on solid ground once again.

The above is a true story, and my agony lasted for almost 3 of the 4-hour flight back to Cleveland.  In the 4th quarter of 2007, and especially since we turned the calendar to 2008, we have all been experiencing the same type of turbulence.  As your “Investment Pilot", I want to discuss the current journey we are on and what we can expect. 

While we are experiencing a lot of turbulence in the early part of 2008, I suggest you do nothing about it.  (I NEED EACH OF YOU TO UNDERSTAND THAT THIS IS THE MOST IMPORTANT MESSAGE THAT I WILL WRITE IN THIS COMMENTARY.)  DO NOT sell everything and go into cash.  DO NOT stop contributing to your 401(k) Plan.  DO plan on staying the course and riding out the "turbulence".  It might make you sick for a short time but know calmer times are ahead and things should go back to a smooth ride.

What has occurred to create the extreme "turbulence" we are facing today?  As we discussed last quarter, the root of most of our current problems trace back to September 11, 2001.  In its aftermath, financial markets were in chaos.  In an attempt to restore order, the Federal Reserve began slashing interest rates, which, in essence, made it cheaper for people to borrow money.  This money was used primarily for home loans, but it was also used for start-up businesses.  The intent was to loan out money and make it easier to repay these loans to stimulate the marketplace.  Where things went overboard is that in addition to "cheaper money", virtually every bank and/or lending institution bent lending practices to a level of flexibility that our country had never seen.  Since then, these activities of 2001 were not only masked, but appeared to be a good thing.  People could get loans and their dollars went further.  This created a housing boom and the real estate market went out of control.   The cheaper dollars made it easier for businesses to expand, hire more people, and the economy and market seemed to flourish.  Meanwhile, the Fed, who had been watching the economy and market get better, started to raise interest rates.  The Fed raised interest rates 17 consecutive times for a total of 4.25%.  It seemed that overnight the dollar was no longer as cheap, nor did it go as far. 

We sailed along smoothly into the beginning of 2007, then the current started to pick up.  In 2007 many of the loans taken since 2001 came due or the interest rates (and payments) increased.  When the adjustable interest rate clause kicked in, many people simply could not afford to make the loan payments.  In the spring of 2007, the residential housing market came to a screeching halt.  Suddenly, the inventory of houses was up and accumulating, getting a loan was difficult and expensive, and the first massive wave of foreclosures hit the market place.  The Fed stepped in, and started reducing interest rates, but in some ways it is like trying to bail water out of boat with a spoon.  The problems are far more significant then how they have been treated, and things have continued to escalate.

The early and significant problems of 2008 are that, in addition to the lending institutions, several big name banks have started releasing their earnings reports.  In the reports so far, we find that they all have significant losses due to the significant number of bad loans.  As a result, the market and the economy have come tumbling down.

Unfortunately, we expect the situation to get worse before it gets better.  The second big wave of foreclosures will hit the market during the 1st quarter of 2008.  There are many companies that still have to announce their 2007 earnings, or lack-of earnings, in the weeks and months ahead.  Each announcement seems to drag down the market.  While the Fed has helped, and will continue to help by lowering the interest rate, we have such a back-log of homes, and with things still not hitting rock-bottom, the downward trend will continue on for sometime.  When asked what "sometime" means, the so-called experts have said that it will be for roughly the first six months of 2008.  The thought is that by that time, rates will be reduced to a level at which people can afford to borrow money again.  The real estate market, which had been a seller’s market and appreciated tremendously, will be adjusted to a more accurate level, and people will again start spending.  In addition, the price of oil, which had exceeded $100 per barrel, is expected to fall back into the high $70's to low $80's.  Consequently, the high gas prices we are paying today should come down when the price per barrel calms down.

So the outlook for 2008 is one of "turbulence" for the first six months of the year. The good news is that I have an optimistic outlook for the second half of 2008.  This is crunch time for investments.  When you look at your accounts you will see that it is down.  Remember, this is only a paper-loss, unless you do something to affect the future results.  What I mean by that is, you have had, and will have, a certain number of shares of each mutual fund that you own.  This will not change in any way.  What is changing is the share price.  If you hold on to the shares you own, as long as the share price returns to where it once was by the time you pull your money out, you will be ahead of the game.   You most likely have been investing in that fund for the past several years.  During those years, the price has been increasing so you bought the fund at a higher price than it is today.  If you sell today when the market is down, you will find yourself selling low and taking a real loss.  A silver lining to any bad market is that if you continue to contribute to your 401(k) account, you are actually buying the mutual funds on sale.  You will not feel the effects of this sale immediately, but you will see them when the market moves in a positive direction.

As your Retirement Plan Advisor, or "Investment Pilot", I want to stress that we are here for you.  While we are not, nor would we ever be happy about a significant downturn in the market, we are aware of the situation, and we are calm and prepared for whatever the market throws our way.  The backbone of the AdviseMe!® program, which has held true, is that we do well in good markets, and we do extremely well in bad markets.  While I am not happy that some participants have received negative returns, I am happy to see that we have outperformed the industry benchmarks over the same time period.  While things have been bumpy, and make us uneasy, we are very well positioned for the trouble ahead.

I received a phone call today from a participant who called me with the full intention that he was going to change his account.  I explained to him, just as I have written, why he should not do it, and he responded with, "I knew that, I just needed to hear it from you."  If you want someone to look at your account, and to again let you know that you are doing the right thing even with the market turbulence, please do not hesitate to contact me.

Before we know it, the snow will be melting, baseball will be back, and I will be struggling with my golf game.  The bumpiness and the frustration of the market will smooth itself out and our previous optimism will return.

Happy New Year and best wishes for a healthy and successful 2008.

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