Are we in a Depression? (Continued)

Posted October 31, 2008 by admin. tags:Tags: , , , ,
Old town

Written by Dave Young for Paragon’s 2008 3rd quarter newsletter.

photo by hamed masoumi

The Problem and its Cause

At the epicenter of the current economic crisis is the subprime lending mess. Over the past few years banks began making loans to borrowers that normally wouldn’t qualify for loans. Those loans were then repackaged in blocks by Wall Street and sold to banks to hold as investments. Banks are required to have capital reserves that equal about 10% of the amount that they make loans on. If their capital reserves fall below 10% then they either have to raise capital or liquidate holdings to bring their ratio back to 10%.

Initially, the subprime loans were assigned a value based on estimates of what the banks believed them to be worth. As our economy weakened and housing prices began to decline the actual value of these subprime loans were questioned.

In an effort to strengthen their balance sheets many financial institutions tried to sell their subprime loan portfolios. Because so many were up for sale at the same time and no one knew for certain what they were worth the value of portfolios of subprime loans began to plummet. Banks were stuck because they were being forced to sell these securities and since no one really knew what they were worth, they were assumed to be almost worthless. For example, when Merrill Lynch was forced into a merger it was assumed that their subprime debt was worth an absurd 22 cents on the dollar.

This evolved into a credit crunch.

Because of the subprime debt on their balance sheets banks weren’t sure if their capital ratios were in line or not. If those ratios aren’t in line then legally they aren’t allowed to lend. If they can’t lend then consumers can’t buy cars and houses, businesses can’t borrow to buy inventory or meet payroll, and local governments can’t borrow to cover short term needs. In essence, everything comes grinding to a halt.

As a result of this credit crisis, the markets continued their sell off. By way of analogy, credit is to our economy what oil is to an automobile.

The essence of the federal bailout plan was that the government would buy the subprime mortgages from the financial institutions at a deep discount but for more than ridiculous fire sale prices. This in turn would alleviate the banks short term capital needs. Because the government doesn’t have the same accounting requirements as the banks, they could hold the subprime mortgages “long term” giving them time to determine what they are really worth and allow the depressed real estate market time to recover. In reality, it is highly probable that the bailout won’t cost 700 billion and that the government may actually make money. (That would be a first)

With all of the finger pointing who really is at fault in this mess?

The Clinton administration started it by making a politically popular decision and mandating that consumers all be treated equally regardless of whether or not they actually qualified for their loan. Banks were pressured to make loans that they had historically avoided. Republicans attempted to rein in the liberal lending practices with regulations in 2005 but were stonewalled by democrats.

Once the mandate occurred, then banks and mortgage brokers discovered that they could charge much higher fees if the quality of the loans were subprime. At this point they were incentivized to make the lower quality loans. Wall Street’s role was to buy the loans from the banks, repackage them in blocks, and then resale them to other financial institutions. They were the delivery system. Because many of them held them on their books, the balance sheets of Bear Stearns, Fannie Mae and Freddie Mac, Lehman Brothers, AIG, Merrill Lynch and other major players were vaporized as the subprime mortgages became impossible to value.

The other guilty party was the consumer. Hundreds of thousands of loans were irresponsibly taken out by consumers that made purchases and then were unable to make their payments. Contrary to popular opinion there is plenty of blame to go around to all parties involved.



Where do we go from here?

Based on market history we know that this bear market has hit the median numbers in terms of time and decline. The previous 34 bear markets have lasted a median of 363 days and declined 26.9%. Through September 30th, this current bear has gone on for 354 days and the S&P 500 has declined about 24%.

Unfortunately, even though many of our “bottom watch” indicators have triggered, we don’t know for certain if we are at the bottom or not. What we do know is that previous bear markets have often reversed when the news has been the most dire.

We also know that some of the sharpest declines have been followed by the strongest rebounds.

Historically it has been a huge mistake to sell during the depths of a bear market.

As always, if you have any concerns about your investments, please call us at (801) 375-2500 and we will evaluate how your portfolio is invested versus your goals and individual risk tolerance.

Are we in a Depression?

Posted October 29, 2008 by admin. tags:Tags: , ,
Overlooking water

Written by Dave Young for Paragon’s 2008 3rd quarter newsletter.

No, and it is ludicrous to even make the comparison.

We are not even officially in a recession yet, let alone a depression. The word depression is used perpetually in the media to describe our economy. These comparisons are irresponsible and only do more to unnecessarily destroy confidence.

Confidence is what makes the economy work.

By way of comparison between today and the Great Depression:

· Unemployment was 25% during the depression, today it is about 6%.

· Our economic output (GDP) shrank by 25% during the depression, over the past year it grew at 3% .

· Consumer prices fell by 30% during the depression, today they are still rising.

· 40% of all mortgages were late by 1934; today only 4% are late.

· In the 1930’s more than 9,000 banks failed, in the past two years there have been about 30 failures.

*statistics taken from MarketWatch.


Extraordinary Circumstances

Extraordinary circumstances are driving this bear market. One year ago, according to actual statistical measures, our economy was extremely strong and hitting on all cylinders. Eighteen months ago, the presidential candidates began telling us how bad things were. At that time their mantra of economic weakness was completely untrue.

Since political gain is much more important to most politicians than speaking the truth, they continued their drumbeat of doom.

They told us that we were in recession when we weren’t. They told us unemployment was bad when it wasn’t. They remind me of the annoying salesman whose strategy is to scare you to death in order to make the sale. Their goal is to convince us that in order to be saved (from whatever) we must elect them.

As I mentioned above our economy is based on confidence. It is plain and simple. When its participants are confident, they spend, they expand and they maximize growth. When they lose confidence and are scared they stop spending, stop borrowing, stop growing and effectively huddle in the corner. That lack of confidence causes the economy to slow or stop growing.

About six months into the campaign the political scare tactics began to work.

They were killing consumer confidence. One year ago in October the stock market started its decent and then six months later we began to see the first signs of economic weakness.


To be continued. Click here to read more.

Earnings (less) Season?

Posted October 23, 2008 by admin. tags:Tags: , , , ,
3rd World

Written by Nathan White, CFA

 Photo by FourthFloor

Isn’t it ironic that the credit crisis induced market crash occurred just before earnings season?

Bad timing?

Well, that’s the humbling mechanism of the market in fine form. There is nothing like a bear market and a recession to give companies cover to lower expectations. Therein lays the silver lining with the current situation.

I believe that times like these give companies cover to bring out all of their dirty laundry. 

Take a look at the management comments on earnings reports that are coming out and you will see some common themes:  “Business has deteriorated due to an uncertain economy, business has been good, but due to the uncertain economic situation we are unable to forecast the future…, due to the current economic environment…, due to the factors beyond our control…, etc.”

At times like these all companies, good and bad, justified or not will take this “opportunity” to lower expectations while performance is low.

Some of it comes in the form of write-offs and charges that wouldn’t come during good times and some of it in the form of lowering guidance going forward.

It’s the “everyone is doing it” mentality of the herd.

Once earnings season is over and everyone’s expectations are rock bottom, what then?

This lowering of expectations is a crucial component of the bottoming-out process and could take a few more months to pan out as the majority of society starts to feel the repercussions of the recessison first-hand. However, once all of the bad news is priced the market usually has no where to go but up.

Another positive note:  companies come out of a recession leaner, meaner and more efficient.

Stay tuned…

Warren Buffett Says Now is the Time to Buy

Posted October 17, 2008 by admin. tags:Tags: , ,
Uncle Warren



Warren Buffett is known as one of the most famous investors, businessmen and philanthropists in the world.

It is interesting that he is calm at this time when everyone else is panicking. He has told other investors to buy because he is.

Below is an article that was on Bloomberg‘s site today.

Oct. 17 (Bloomberg) — Warren Buffett said he’s buying U.S. stocks and, if prices stay attractive, his personal investments, as distinct from his stake in Berkshire Hathaway Inc., will soon be wholly in American equities.

Writing in the New York Times, he said he’s following the principle: be fearful when others are greedy, and greedy when others are fearful.

Exaggerated concern about the long-term prosperity of the many sound U.S. companies is foolish, and most will probably be setting profit records in years to come, Buffett said.

While short-term stock-market movements can’t be foretold, the likelihood is that the market will recover before the economy or general investor sentiment do so, and “if you wait for the robins, spring will be over,” he said.

Referring to the 1930s depression, Buffett pointed out that the Dow reached its nadir on July 8, 1932; economic conditions continued to deteriorate until Franklin Roosevelt became president in March, 1933, but by that time the market had climbed 30 percent.

Bad news, Buffett concluded, is an investor’s best friend, for it enables you to buy “a slice of America’s future at a marked-down price.”

Market Crash Update

Posted October 10, 2008 by admin. tags:Tags: ,
Don't Panic!

Written by Dave Young, president


photo by fotologic

After falling all week, today the panic selling intensified with the Dow Industrials dropping 700 points at the open only to reverse course and completely erase the loss in the first 45 minutes of trading.

That represented a 1400 point swing. Then through the rest of the day the market moved in a 1000 point range. The Dow Industrials closed down 128 points on the day after one of the wildest rides I’ve ever seen since the 2002 bear market. One the week, the Dow lost 18.2%, making it the worst waterfall type declines since 1987.

Both of our primary portfolios have done better than the broad market, but have still suffered. Paragon’s Managed Income has been holding about 40% cash and several traditionally defensive positions through this decline. Paragon’s Top Flight has been holding 10-15% cash and about another 35% of the portfolio in traditionally defensive positions. Our problem has been that those traditionally defensive positions in both portfolios have been sold in this panic with everything else. While they have provided some protection, they have not helped anywhere near as much as they usually do.

One of the highly respected research services we subscribe to uses 12 separate indicators to identify when the stock market is at a bottom.

They look at the seven bear market bottoms through 1982 and what the measurements of these indicators were then. When a majority (7) of the indicators flash that has historically meant we are at or close to the bottom. Currently, there are an unprecedented 10 indicators that have triggered. That is more than have ever triggered in any market sell off. There is no way to know “if things are different this time,” but based on history, it appears we should be close to a bottom.

A few other things to consider:

— This recent decline is the type of waterfall decline that usually occurs at the end of a bear market when fear feeds on itself.

— With declines ranging from -24% to -67% around the world an incredible amount of bad news has been priced into this sell off. With so much bad news priced in, as all of the global governments begin to implement their bailout programs, it should be very positive for stocks.

–The median recovery from a bear market decline of -33% has been +55%.

— This is not the first time there have been massive government bailouts. In 1907, 1984, and 1989 bailouts occurred near bear market bottoms. Nine months after the bailouts, the DJIA was up by 26%, 9% and 29% respectively.

I obviously don’t want to infer that I can see into the future or that I can guarantee we are at a bottom.

However, I do think that it is important to understand what has happened historically when the market has been in similar situations.

Market declines are painful. That pain usually translates into a panic. Emotional decisions quickly made in a panic state are usually wrong. This panic has priced our market a the same level it was in June of 1997, eleven years ago. Just as we have in the past, we will continue to follow our discipline through this decline and out the other side of it.

Please call us if you would like to talk. You can reach us at 801-375-2500, Mon.-Fri. MST.

It’s a Wonderful Life Clip

Posted October 10, 2008 by admin. tags:Tags:

This short clip from the movie, "It’s a Wonderful Life" depicts a classic panic similar to what is going on now on a larger scale in the stock market. Human nature never changes. (Approximately 7 minutes)

Are the Clouds About to Break?

Posted October 8, 2008 by admin. tags:Tags: , ,
Sunset over a lake

Written by Nathan White, CFA

photo by Per Ola Wiberg

Central banks across the globe took an unprecedented step today in lowering interest rates in a coordinated move. The price of credit is amazingly cheap. The problem is no one can get it.

It takes time for the government actions to have a real effect on the economy and the liquidity situation.

Right now we are seeing the market price in all of the economic cost of the credit freeze up, and it is not a pretty sight.

The current sell-off indicates that many thought the positive ramifications from the government actions would lift the markets right away. The markets of course like to do the opposite of what the crowd intends and when no instant bounce materialized, everyone rushed for the exits.

Over the course of the next few weeks the government actions to unfreeze the credit markets will start to occur and then we will be able to see if they have any real effect.

Look for the effect it will have on banks willingness to lend to each other.

If credit can start flowing again and at the same time the cost of credit is significantly lower you could very well see market sentiment change very quickly.

Could this current sell-off just be shaking out the impatient people who thought that the “bail-out” bill would spark a large rally?

Once their done selling could the storm be over?

Feel free to leave comments.

The Only Thing We Have to Fear is Fear Itself

Posted October 6, 2008 by admin. tags:Tags: ,
Blue sky above a hill

This is an excellent article written by Trent at The Simple Dollar. It helps put things in perspective.



photo by tico24

Over the last several days, many readers have asked for my take on the economic crisis. I’m not an economist – my opinion is just that of an average person who has read a number of economics books and talked to a lot of people from all walks of life. Here’s my humble take on the situation.

From Franklin Roosevelt’s first inaugural address, March 4, 1933 (please, listen in):

I am certain that my fellow Americans expect that on my induction into the Presidency I will address them with a candor and a decision which the present situation of our Nation impels. This is preeminently the time to speak the truth, the whole truth, frankly and boldly. Nor need we shrink from honestly facing conditions in our country today. This great Nation will endure as it has endured, will revive and will prosper. So, first of all, let me assert my firm belief that the only thing we have to fear is fear itself — nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance. In every dark hour of our national life a leadership of frankness and vigor has met with that understanding and support of the people themselves which is essential to victory. I am convinced that you will again give that support to leadership in these critical days.

Over the last two weeks, I’ve read countless articles and heard countless podcasts talking about financial apocalypse, spreading fear around like mayonnaise on a turkey sandwich. Most of the suggestions are maddening – I’ve heard previously rational people talking about pulling all of their money out of FDIC-insured bank accounts and putting them under their mattresses.

All of this is based on fear, not fact. Over the last few months, several financial institutions have failed, but in each case, the resources of those institutions were immediately absorbed by other companies or, in a few cases, by governmental buyouts. No one has lost a dime in a bank account. No one has lost a single cent of insurance coverage. Many large banks – like Bank of America – have already taken their losses from the subprime mortgages and rolled right through them, and they’re strong enough that they see this as a buying opportunity.

We all know the general storyline by now – these failures were the result of investing too much in bad mortgages. The truth is that no one knows how serious the actual problem is. No one. The ludicrous plan that Paulson proposed last week served one purpose alone – it gave him tons of cash to make sure that the banks run by his cronies wouldn’t outright fail. The truth is that he doesn’t know how bad it actually is. Neither does Bernanke. Neither do you, and neither do I.

The panicked talk, the whispered statements about apocalypse – they’re fear. Nothing more, nothing less.

I don’t claim to know what the “best” plan for resolving the situation is. My level of information about the true nature of the economic situation is extremely limited – and so is yours.

I’ll tell you what I do see, though.

I look out my window here in Iowa and I see the ongoing harvest of one of the largest soybean and corn crops ever – not the cropless Dust Bowl of the 1930s.

I don’t see a single person with a bank account that has lost their deposits, like my grandfather’s family did circa 1932.

I see people going to work, working hard and producing value for their wage, coming home, and buying the things that they need to keep their family going, which puts money directly into the economy.

I see unemployment barely over six percent, not the 25% rate at the time of FDR’s address.

I see industrial production still rising – in 1932, it had fallen by more than half in just three years.

I see a dollar that’s actually strengthening, not weakening, while the price of oil is down sharply from its highs earlier this year.

In short, I see a lot of things that make me optimistic about our ecnomic situation, a pretty stark contrast from the fear being peddled by some. I’m actually much more reminded of 1987, when banks were failing thanks to the Savings and Loan crisis and Black Monday, when the Dow dropped 22% of its value in a single day. We haven’t yet seen anything as worrisome as that, in my opinion – and that was just a drop in the bucket compared to the 1930s.

To put it simply, I’m still not worried a bit, and when I see the fear being bandied about, I’m reminded of FDR’s words.

So what have I been doing with my money as of late?

First, I haven’t taken a dime out of any bank. I haven’t seen any FDIC-insured bank account fail, and none have in the history of the FDIC.

Second, I actually maxed out my Roth IRA contributions earlier this month. Almost all of that money went into broad based index funds.

Third, I haven’t made a single change in any plans I’ve had for investing other than the early Roth IRA buy. I’m still following my own game plan.

Now, ask yourself this. If you make any irrational moves, like pulling all of your money out of stocks, does someone profit from it? Of course they do. Your brokerage will make a fee from the sale, and a happy buyer out there will be glad to buy that stock from you at a nice discount. Fear is the best salesman, after all.

My sole piece of advice to you is this: don’t panic.

Don’t make any hasty decisions. Sit back and get informed – and don’t just rely on one source for information, either.

Get a bunch of different angles on what’s happening, from liberals and conservatives and moderates alike. If you’re worried about your money, do your own research and find out reasonable things to do with it.

Take a serious look at what people who really know what they’re doing are doing with their money – in the last two weeks, Warren Buffett has invested $3 billion in General Electric stock and $5 billion in Goldman Sachs stock (an investment bank … weren’t we supposed to be afraid of those?) – he sees this current situation as an opportunity to buy, not sell.

And one more thing. Even in the darkest heart of the Great Depression, 75% of Americans had a steady job with a steady paycheck, which they steadily used to buy the things they needed. Those years also produced the Greatest Generation and an economic steamroller that ran through the last half of the Twentieth Century like a tidal wave.

It was true 75 years ago. It’s true now.

The only thing we have to fear is fear itself.

The World Turned Upside Down

Posted October 2, 2008 by admin. tags:Tags: ,

Written by Nathan White, CFA


photo by wolfgang staudt

Cash is always king. Cash flow, cash in hand — whatever form and in whatever economic condition.

The true value of any asset is its ability to produce cash flow — either immediate or in the future. Why else does anyone make an investment?

Did you know that Fannie Mae and Freddie Mac have not drawn a single penny of the $200 billion that was set aside to bail them out?

Why? Because the companies are cash flow positive. In what way has their tenuous situation changed to make this possible?

Market-to-market accounting was institutional with the right idea in mind — create more transparency of a company’s assets for investors. Unfortunately, it is implemented in the wrong manner.

During good times companies are forced to mark assets up (which of course they gladly do!) and record those gains as income.

It’s kind of like your neighbors who kept bragging about the appraised values of their homes during the real-estate mania as if to show one another up.

Until you actually complete a sale and get the cash in hand you never completely know what something is worth.

Any analyst worth his/her salt knows that this type of non-cash income is not really income per se, but just potential income. Remember, cash flow is king!

Companies that exhibit Strong cash flow returns over time end up being the most valuable companies in my estimation. Now companies are feeling the pernicious effects of the downside of market-to-market accounting as they are forced to market their assets down at ridiculous prices and record the loss on their capital accounts.

Why will the government bail-out plan work?

Because Washington doesn’t have to play by the same rules that it makes the private market play by.

Private is frozen because investors do not want to place their money in a company that if forced by regulators to market their assets at fire-sale prices which in turn reduces their capital ratio below what the government regulates it has to be. It is a death spiral in the current environment!

In my view there is no single more important thing that can be done to stop the credit crisis than to fix the market-to-market accounting regulations and it would cost the taxpayers nothing!!

These truly are amazing times.

SO much doom and gloom and irony! It can make your head spin.

The smart money is buying – Buffet, the few smart savvy hedge funds, and I can’t believe I am going to say this – the government!

There are so many quality assets on sale, but the irony is that when everyone is panicking even those assets continue to fall.

Smart investors, because they have never overextended themselves during boom times, are able to take advantage of these deals and wait out the short term volatility.

That is the irony of economic busts, deals abound but the majority do not have the capital to take advantage of it! Consider real estate, now is the time to buy and as a buyer you can negotiate some unbelievable deals, but that is only if you can a loan, which almost no one can right now. So unless you have the cash on hand it is nearly impossible to take advantage of the situation.

Well, the same is true in the capital markets right now. There are great deals on quality assets all around, but because banks aren’t lending no one can buy unless they have cash.

That is why you only see people like Buffet, certain hedge funds, and the government being able to buy assets in the current environment.

Where do you stand in this environment?

Are you overextended and unable to take advantage of the bear market or are you in a sound financial position and regardless of the outcome of the current crisis (for bad or for good) you will be on a stronger financial condition than most people.

Remember, the market can stay irrational longer than you can stay solvent.

Don’t bet the farm — do it in increments.

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