Bear Market #34

Written by Dave Young, President (April 6, 2008)

It appears as though we have almost talked ourselves into a recession.

Our U.S. President is elected every four years. What most people don't realize is presidents only have two productive years, and then we suffer through an election from the next two years.

When Bill Clinton first ran for office he discovered he could win if he convinced everyone that the economy was terrible. Ever since then politicians have shouted one basic theme as loud as they could, "Everything is awful, terrible and bad. You need us (the politicians) to save you." Since the media loves to promote anything negative, the politician's message has a direct conduit into our homes.

Twelve months ago our economy was very strong and running on all cylinders. Six to eight months ago we started to get our first glimpses of the seriousness of the problems surrounding the sub prime mortgage market. Even though most facets of our economy were still strong as ever, politicians and their messengers in the media did their best to convince us just how bad things "really" were. And they continued day after day with their drumbeat of doom.

I believe that constant message of doom and gloom has a negative effect on consumers. Recent polls show that four in 10 American adults are holding off on major life decisions and purchases because they are worried about the economy.

Since consumers and consumption drive the economy, if consumers become nervous about their future and stop spending, the economy slows.

That is what has happened. It was amazing how fast we went from  "everything is great" to "everything is horrible". Consumer confidence dropped from a rating above 105 last July to 64.5 most recently in March.

In March, consumer expectations, which is just one category in the consumer confidence report, was touted as being the worst in 35 years. While that is true and makes good headlines, the overall consumer confidence index was the worst in five years (not 25). Never the less, all of this fear, much of it unwarranted, caused our economy to go from boom to bust, in a short amount of time.

Because the markets are driven by emotions of fear and greed, they retreat in textbook fashion. We endured the worst first quarter in six years. Other than precious metals and some commodities there have been few places to hide. Regardless of where you were invested during the first quarter, everything went down. The S&P 500 declined -9.5%. According to Lipper, the average mutual fund lost -10.6%. The MSCIEAFE international index lost -15% of its value. Even the average "defensive" health care fund lost -10.8%.

In very difficult market conditions, Paragon's Managed Income portfolio ended the quarter down only -1.46%. Its first objective is to preserve capital which it did very well. Its second objective is to generate as good of return as is possible within its conservative constraints. In view of what we had to work with during the first quarter we feel good about its performance.

Paragon's Top Flight portfolio declined -9.06% for the quarter. While we never enjoy losing money, we can live with those numbers. Top Flight tripled the S&P 500 last year. This year we are down slightly less than the S&P 500. Traditional financial theory is that if we tripled it on the upside then we would be expected to triple it on the downside. IN fact, while we tripled the index on the upside we were able to hold down our losses and simply match the S&P 500 index on the downside. This is even more impressive when you realize that Top Flight was primarily invested internationally, where many markets experienced significantly greater losses than the S&P 500.

To be continued on Thursday, May 8. Click here to read the second half of the article.

Investment performance reflects time-weighted geometric composite returns of actual client accounts. Investment returns are net of all management fees and transaction costs, and reflect the reinvestment of all dividends and distributions. The Lehman Bond Index is a benchmark index made up of the Lehman Brothers Government/Corporate Bond. Benchmarks are used for comparative purposes only. The Paragon Managed Income Portfolio is not designed to track the Lehman Aggregate. Past performance is no guarantee of future results. Investments in securities involve the risk of loss.