Sunday, April 6, 2008

Jersey Benefits Advisors Newsletter Spring 2008

Market Watch

After months of downbeat news and the housing, credit and stock markets being pummeled almost daily, the first quarter of 2008 ended with a positive whimper and the second quarter began with a surge. Whether or not the positive signs continue will depend on the statistical information forthcoming in regard to the economic cycle. In the mean time, we’ve closed the books on the first quarter, and while the news seemed quite dire for much of the time, the DJIA and S&P 500 haven’t reached bear market levels.

The Dow Jones Industrial Average ended the first quarter at 12,262.89 down 7.6%, while the S&P 500 finished at 1,322.70 shedding 9.9%. The NASDAQ actually hit bear market territory (20% decline) during the quarter, but closed at 2279.10 which was 14% lower than where it started the year. Considering all of the headwinds the markets faced during the winter, the damage has been minimal thus far.

Of course, it is far from apparent if the carnage in the various markets is over, since we don’t even have a definitive answer on whether or not the economy is in recession. The latest GDP numbers indicated extremely slow growth, just .6% for the fourth quarter of 2007. The first estimate of GDP growth for the first quarter will be provided at the end of April.

While many economists felt the economy would avoid recession this year, when polled at the beginning of the year, the debate has shifted to how long and how deep the downturn will be. Officially, a recession is the contraction of GDP for two consecutive quarters. The length of the recession represents the trough or bottom of the economic cycle from which a new economic cycle begins.

The wild card right now is the stimulus the Federal Reserve has injected into the credit markets, which have been paralyzed due to the fiasco created by the housing debacle and subprime mortgage mess. The results of some of the Fed’s actions are already being felt, as banks and investment firms have utilized the Federal Reserve as the bank of last resort. While this is a function of the Federal Reserve for banks, opening the discount window to investment firms is something that hasn’t been done since the 1930’s.

Chairman Bernanke has taken some drastic steps with monetary policy to shore up the financial system, and his study of the blunders made during the Great Depression have been quite evident. Fiscal stimulus, like the rebates headed our way this quarter, will also be felt later this year. Whether the stimulus will be enough to keep the economy out of recession remains to be seen.

Of course the politicians are having a field day recommending bailouts of mortgage holders, job programs, protectionism, taxes on “big oil” and more regulation. Most of the programs being championed will not have the slightest chance of implementation, but they make great sound bites to constituencies during an election year. A huge “shot over the bough” was fired by Treasury Secretary Henry Paulson with his proposal to streamline US financial regulation. It should encourage debate for months!

Finally, it is sufficient to say that if you are like me and believe the sun will shine again tomorrow, this particular phase of the economic cycle represents a buying opportunity. All markets are the same, and when there is a 10% - 15% sale, it is time to buy.

What Happened to Bear Stearns’ Client Accounts?

With the demise of such a large investment firm as Bear Stearns so prominently discussed in the news, many investors have asked what happens to the client accounts held at the firm. Client accounts are insured by the Securities Investor Protection Corporation (SIPC) for $500,000 per account but only $100,000 can be cash, the remainder must be in securities.

In the case of Bear Stearns, the company will more than likely become part of a division of JP Morgan Chase and Bear Stearns’ client accounts remain unaffected. SIPC involvement was not necessary. Bankruptcies of securities firms usually result in client accounts being transferred to another firm. Client accounts of brokers, such as Transamerica, are held by a third party (Pershing) which segregates client assets.

Ways To Protect Assets During Market Turmoil

A bright spot during this particularly gloomy period in the markets has been the performance of the variable annuities developed after the dotcom bubble. Insurance companies responded to the market turmoil from 2000 - 2002 by developing living benefits, which could be used to protect assets from significant downside risk. While many acronyms have been used to describe the various riders companies have developed, the main theme is to allow participation in market gains through separate accounts, and also guarantee a minimum amount of asset appreciation each year, which is usually 5% or 6%.

Each year the principal (amount invested) basically has two calculated values. The market value is the amount invested plus whatever gains are made in the separate accounts during the year. The withdrawal value or guaranteed value is the amount invested plus the rider’s guaranteed appreciation, which is the 5% or 6% discussed above. If the market declines, the client knows the amount which can be withdrawn for retirement will still increase by the 5% or 6%. If the market increases 10% or 15%, then the client can withdraw even more during retirement. Newer versions of these variable annuity riders allow a step up of the market value on an annual and even monthly basis, reducing downside risk even more effectively.

While there are fees charged by the insurance companies for annuities and their living benefits riders, they are quite reasonable when compared to the downside risk protection they provide. If market risk to principal is a concern, as it is to many investors approaching retirement, the peace of mind provided by a variable annuity may be worth the additional expense. Mutual funds are a less expensive way to participate in the various markets, but they provide no downside protection.

Variable annuity fees don’t even begin to compare to the whopping fees charged by hedge funds, which are supposed to be inversely correlated to the stock market. Unfortunately, this inverse correlation has not held up during this market cycle as hedge funds have been imploding under the weight of subprime mortgage debt. In fact, the demise of Bear Stearns was due to the default of two of their hedge funds, which went belly-up during the summer.

An analysis of my clients’ accounts who have invested in a variable annuity since 2002 showed the market value higher than the guaranteed value for the most part. The few clients whose market value was less than the guaranteed value, made recent large investments in 2007. Everyone has a higher account value than the amount invested and are breathing a bit easier these days.

If you feel a variable annuity is worth discussing for your investments, be sure to contact me.


Investment Advisory Services offered through:
Jersey Benefits Advisors
P.O. Box 1406
Ocean City, N.J. 08226
Phone: 609 827 0194
Fax: 609 861 9257

Securities offered through:
Transamerica Financial Advisors, Inc.
A registered Broker/Dealer
1150 S. Olive St. Suite T-25
Los Angeles, CA 90015

Third Party Administration and Insurance Services offered through:
Jersey Benefits Group, Inc
P.O. Box 1406
Ocean City, N.J. 08226
Phone: 609 827 0194
Fax: 609 861 9257

John Kaighn

Jersey Benefits Advisors

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