January 11, 2008

A Rocky Start to the New Year

Despite the very weak opening to the new year, investment prospects are favorable.

We expect the sub-prime credit problems to be resolved in coming months.

Does the very poor action in the stock market since the new year began presage a recession in the United States and weak stock markets across the world? A recession may be at hand (or have begun already), but the investment markets offer opportunity.

Conditions in credit markets are parlous; another round of huge write downs is at hand. The major commercial and investment banks will probably write off another $100 billion in assets in this quarter just begun. But these banks will rebuild their capital by selling stakes to foreign investors, especially the so-called sovereign wealth funds, awash with capital and eager to buy large positions in important global banks. (See our letter of May 30, 2007, discussing these increasingly influential pools of capital.) Meanwhile, the Federal
Reserve Board and the European Central Bank have made it abundantly clear that they will do whatever is required to provide liquidity and favorable conditions for the credit markets. Since late October the markets have been plagued by uncertainties about the extent of losses in subprime paper. Uncertainties are lessening. The scope of the problems for banks is enormous--but manageable. I think it quite likely that within three months we will have a fair understanding of the presently opaque situation.

One can hardly be sanguine about all this, but, as an investment matter, prospects are somewhat attractive. Although the impact of the collapse of the housing bubble in the United States is enormous here, global investors can earn favorable investment returns with rather little risk.

One cannot diminish the frightful impact on millions of Americans unable to meet mortgage payments, whose homes are worth far less than the amount of their mortgage debt. Rising food and energy prices and the very weak labor market mean that economic hardship is widespread and is likely to widen further. For better or worse, the investment impact of all this for investors like ourselves, who can invest globally, is not terribly severe. The US housing problem is, as an investment matter, a problem largely local to the United States. Moreover, the credit problems that it has spawned have, in fact, been taken up in significant part by European banks and investment funds, eager buyers before last summer of these toxic packages of securities. In effect, America succeeded in exporting a good chunk of its mortgage problems.



John N. Mayberry

Despite housing problems and economic stress in the United States, much of the world enjoys strong growth and offers attractive investments.

Outside the United States, and especially among the developing economies of Asia and the oil exporting countries, growth is strong and investment capital is abundant. Even beyond the headline success stories--India, China, and the OPEC countries--there are very attractive investment opportunities in central Europe, parts of Latin America, and other Asian economies like Taiwan and Singapore. Economic growth will remain reasonably strong in much of the world, despite the certain slow down in the United States. These growing economies will still be building their roads, bridges, apartment and office buildings, cars, refrigerators and all the rest. Demand for oil and other materials will continue to grow. Our large investments in these sectors will appreciate with this demand.

Opportunity. The credit crisis itself creates opportunity, as we have remarked in recent letters. The nearby chart shows the extent to which banks, brokers and the rest have fallen in the last many months. It is not a pretty sight for the owners of these stocks, but we have avoided investment in financial stocks for several years. Now opportunity is at hand and I look forward to investing in the banks and brokers in coming months. It does not yet appear to be the time to buy this sector aggressively. There are at least two factors that give pause: Firstly, we do not know yet just how serious the collapse of the housing bubble will be. Housing prices continue to weaken; mortgage financing becomes more difficult to secure; nearly $2 trillion of adjustable mortgages will reset in 2008; mortgage delinquencies will almost certainly rise; losses will spread. Secondly, there is growing risk that losses from credit card debt and auto loans will become significant. American Express just announced a large reserve against losses it foresees in its credit card business. I am quite confident that the sub-prime crisis and its progeny will resolve themselves in a manner that leaves us with a vibrant, well-capitalized banking sector. After the hundreds of billions of losses have been added up and banks stocks have ended their decline, we will be able to make low-risk investments in them and to enjoy a long period of investment gains.


Each year Core Asset Management files with the SEC a form ADV with information about our company. If you would like a copy of Part II of Form ADV, please contact us.

The dollar--stability in 2008? At its lows in November, the dollar had fallen by 20 percent in two years, as measured against a basket of the currencies of America’s principal trading partners. The decline since the beginning of 2002 is nearly 40 percent. The decline in the dollar has helped American exports; America’s debt with the rest of the world is falling as measured by the size of our economy. It is entirely possible that in 2008, the dollar will remain stable or even gain in value against major currencies. Already the pound sterling is falling against the dollar; Canadians are aghast at the rapid appreciation of their dollar against ours; Europeans are not happy with the euro’s gains. Currencies of developing economies, with their more rapid growth and accumulation of currency reserves from their exports, are likely to continue to gain against the dollar. Currency exchange rates are notoriously difficult to predict, but it makes sense to retain our large foreign investments.

This is a time of real uncertainty. We have a view about how things will unfold, but we may be wrong. Our approach is to form a long-term view and invest patiently in accord with it. Despite knowing that major economic trends, like growing demand for oil and other material things, persist for many years, we are mindful of the need to be alert to new risks we have not foreseen. We have a thesis, but we also have our eyes wide open.