Introduction

This quarter's newsletter attempts to provide clients with a rational perspective on the recent market turmoil. I hope that you will find some of these observations useful in putting the sharp market volatility into context as it relates to your own portfolios.

As I’ve repeated in the past several letters, continued uncertainty in the economy and financial markets is reducing investor expectations of future investment returns. Market volatility continues to highlight the acute problems we face as a society. It’s difficult to predict the ultimate outcome of our collective troubles as a global economy. This uncertainty brings out the worst of our fears and insecurities. In the short-term, investors are afraid of a repeat of 2008. In the longer-term, they’re afraid of not having sufficient assets in retirement to enjoy the lifestyle to which they’ve become accustomed.

Market performance in the third quarter

This has been a year of contrasts, starting with a first quarter that saw decent gains in the markets, followed by a second quarter in which most of those gains were given back.

The third quarter was very negative overall—accompanied by extreme volatility—and resulted in the sharpest decline since the first quarter of 2009 back when we were in the throes of the global financial crisis. The main drivers of the third quarter decline were: 1) sovereign debt worries in Europe; and 2) a dramatic downgrading of growth forecasts for both the U.S. and global economies. Contributing to the latter was a sharp slowdown in China and mounting talk of a double dip recession. This fueled anxiety on both Wall Street and Main Street.

I normally refrain from using charts and graphs in this newsletter, but decided to make an exception this quarter in order to illustrate how universally poorly all markets did in the third quarter. Below are results for all of the important world markets.

These are in local currencies so that the effects of swings in the dollar are not reflected here.

So that's what's behind us—the U.S. markets down about 10% year-to-date through September 30—and other world markets down much more, across the board. The key question—and one that is perplexing investors everywhere—is: what’s ahead?

Panel Discussion: “The End of America?”

A recent panel discussion entitled "The End of America?" featured four investment professionals with a wide array of experiences along with outstanding track records in the investment world. The four are: Lawrence Fink, CEO of Blackrock, the world's largest asset manager; Pierre Lagrange, a highly respected hedge fund manager based in London; Jim Leech, head of the Ontario, Canada Teachers' Pension Plan, a leading global institutional investor; and Meredith Whitney, an investment analyst who was among the first to identify the looming problems for U.S. banks in 2008.

Three themes emerged from this panel discussion. These themes were: 1) identifying the real challenges facing the U.S. and Europe; 2) the confidence we have in our ability to respond to those challenges; and 3) the cost of risk avoidance in investing.

Theme 1: Challenges for Western economies

The first theme relates to some of the troubling issues facing the United States and Europe. None of the experts sugarcoated the real challenges ahead.

Lawrence Fink on the role of government: "I don't think this environment is any different than the 1970s. In the 1970s, the United States was worried about Japan; we really questioned the vitality of this country. We were questioning the kinds of things we were manufacturing. We had Watergate, the oil crisis, and during those ten years the S&P was up 1.5% a year and yet corporate earnings were up 12% a year during those ten years.

The same thing is going on now where we're seeing earnings growth, but we're obviously seeing a flat market and a lot of it has to do with the uncertainty around government, very similar to the 1970s. As investors in the 1980's and 1990's and the first part of this past decade, government was not part of our thought process…today we don't even know what the foundation is."

Meredith Whitney on U.S. housing: "What really powered the U.S. economy for the past 20 years was housing. The biggest structural unemployment problems are in those states like California and Florida that were wed to housing. Housing is not coming back and it's hard to imagine housing becoming a driver of the U.S. economy going forward."

Theme 2: The End of America... or a new beginning?

Despite the issues facing it, there was broad consensus about America's ability to make the changes needed to compete.

Jim Leech on why the U.S. will adapt: “You can't count out the largest and the most innovative economy in the world…the U.S. has the economic, the political and the legal constitution to have the flexibility to solve issues. Those factors aren't apparent in the Far East, they aren't apparent in China, we don't have a democratic government in China, and we're not sure how the laws work. I think it would be foolish to go rushing off thinking the solution is totally in China and India."

Lawrence Fink on opportunities for U.S. companies: "People forget that we are still the largest exporter in the world, we just happen to be the largest importer in the world by a little more. And so having a stronger world actually is stabilizing this economy, it's not hurting this economy, it's providing the engine for stronger corporate growth; in most cases when selling products overseas creates jobs here too, and it is a myth that all of these jobs are being exported overseas."

Meredith Whitney on emerging markets within America: "Every generation the U.S. re-creates itself economically; we're doing that now, even though it's a painful process. If you look at the strength in America, agricultural rich states, what I call the emerging markets of the U.S., which also have the cleanest balance sheets, you have ‘22% plus’ growth dynamics. What they're really doing now is attracting businesses, attracting jobs; you've got incredible job opportunities, growth within these markets."

Theme 3: Understanding the price of avoiding risk

One topic that received a number of interesting comments was risk avoidance as now being the paramount objective for many investors.

Lawrence Fink on the biggest risk for investors: "I would avoid 2% treasuries, other than fear it's very hard to make a living earning 2%. So if I had to look where to invest I would own a core amount of treasuries just for liquidity purposes, and I would be looking towards dividend stocks…The greatest worry I have is under-investing and destroying your foundation, and I think that will be the greatest risk in the next few years."

Pierre Lagrange on being ruled by fear: "There are quite a few sectors like the Swiss franc that make no sense where you're only there because you're scared of everything else and that always backfires."

What This Means To You

The key points that emerged from this panel discussion of experts accurately reflect the types of conversations we’ve been having with clients over the past year or so.

Clearly, we should be cautious given the policy challenges ahead. But for those investors who need growth to achieve their long term goals, we also need to take a longer-term view on investing.

This means carefully monitoring our asset allocation and adjusting it as necessary to changing circumstances on an individualized, case-by-case basis, which is what we do for our clients each and every day.

One final point pertains to anyone who doubts America's ability to compete. Each year, Britain's Financial Times ranks universities around the globe on quality and reputation. In its last ranking, the U.S. had each of the top five—and 15 of the top 20—of the world's universities.

For all of its challenges, the best and the brightest talent is still clamoring to come to the United States of America. That gives us confidence about America's ability to do what it takes to compete and to maintain its global position of leadership and innovation.

Thank you for reading this newsletter and for your continuing interest.

Sincerely,

Andrew J. Fama, Principal

Andrew J. Fama Asset Management, LLC

Registered Investment Advisor

*Past performance is no guarantee of future results*

*Nothing contained in this quarterly newsletter should be construed as investment advice*

* To download a PDF copy of this Newsletter click here