SPENCE Asset Management

4 Years Later... October 2011

Four years ago, the global financial meltdown began. We remember it like it was yesterday. Two large hedge funds that borrowed heavily to take huge positions in sub-prime mortgages incurred gigantic losses and were forced to dump assets. Losses quickly spread to other large firms when nearly every trading desk decided to dump their mortgage securities at the same time and liquidity evaporated. Before long, several large commercial-investment banks were begging for emergency financial support. Under pressure from Wall Street, the Federal Reserve and the U.S. Treasury Department orchestrated an enormous bailout of many of the most well-heeled financial service companies in the U.S.

By the summer of 2008 it became clear that the government’s “affordable housing mission” had produced the unintended consequences of a historic housing price bubble. And thanks to outrageously shoddy lending practices (with government backing), regulators finally reluctantly seized Fannie Mae and Freddie Mac.

Unemployment shot up and output fell. By September of 2008, Wall Street’s Lehman Brothers went bankrupt. Then broker powerhouse Merrill Lynch had to be rescued by the likes of Bank of America. Current Goldman Sachs CEO Lloyd Blankfein managed to convince former Goldman Sachs CEO Hank Paulson (then U.S. Treasury Secretary) to use taxpayer’s dollars to rescue Insurance giant AIG. (It came as no surprise that later, when the dust settled, the biggest beneficiary of the government intervention into AIG’s problems was……..Goldman Sachs.) In the meantime, retail sales cratered and consumer confidence hit all-time lows.

Some of the bleeding stopped by March of 2009. The stock market bottomed and eventually before the end of that year, economic activity actually stabilized. What we have seen since is a terribly tepid rebound that has already begun to sputter. Whether the story of the global financial crisis has finally ended or continues on remains an open question.

As the third quarter of 2011 comes to an end, some of the economic metrics that fueled the panic in 2008 are at worse levels. Unemployment is higher, home prices have continued to fall, and what seemed to be rock bottom interest rates available to savers two years ago have continued to plummet.

What have we learned?

1. EVERYTHING is cyclical. Industries that we never expected to experience a slowdown did. Even the demand for blood declined during the downturn.
2. Expect the worst, even if you hope for better. Just because it hasn’t happened in the past doesn’t mean it can’t happen. Just because we have never seen five year treasury notes yielding less than 1% doesn’t mean they can’t be priced to yield next to nothing.
3. Get on the right side of the government. No matter how inefficient or inept, if the federal government is injecting stimulus that benefits a certain industry, investment performance is likely to be superior there, especially when compared to companies in industries in which government regulations are raising costs.
4. The tedious work of business analysis is more essential than ever before. Understanding the competition facing a business, the conditions affecting customers of a business, the historical performance of a business, the debt structure of a business, and the potential that the competitive advantages a business currently enjoys may not be DURABLE, is more critical than ever. We cannot simply believe in “the long term historical performance of the stock market.”
5. Sometimes prolonged downturns are part of investing; they have happened before and they will happen again. Sometimes extraordinary patience is required for small increments of success.

The good news is the current downturn is no longer young. Historically, it is beginning to rival those that began in the early 1930’s and the mid-1960’s. During those downturns it was possible to prosper owning stocks, but only if an investor was proficient in doing the tedious work of individual business analysis and only if an investor heeded lessons learned from previous downturns. We are hard at work doing both.

Jim Spence, Eric Walton

The information contained herein is for informational purposes only without regard to any particular user’s investment objectives, risk tolerances or financial situation and does not constitute investment advice, nor should it be considered a solicitation or offering to investors. To determine if investment in a Separately Managed Account with Spence Asset Management is an appropriate investment for you please call 1.800.230.1840.

Investment Advisory Services are offered through Spence Asset Management, a federally registered Investment Advisor. Investment Advisory Services offered through IAR’s of Spence Asset Management, a Registered Investment Advisor to all residents of the United States.

The views expressed here are those of Spence Asset Management and are subject to change with market conditions. The information contained in this newsletter is derived from sources believed to be accurate. You should discuss any legal, tax, or financial matters with the appropriate professional. Neither the information presented nor any opinion expressed constitutes investment advice or a solicitation for the purchase or sale of any security. Market forecasts cannot be guaranteed. Past performance does not guarantee future results.