First Quarter 2009 Letter to Clients

The past six months have left most everyone with the inescapable feeling that we are living in historic times. The near-collapse of the financial system in the fall of 2008 led to a market panic the likes of which the world hasn’t witnessed in nearly a century. That, in turn, led the governments of the major developed countries of the world to take what can only be described as an activist role in the global economy, priming the pump of the financial markets with massive capital infusions, bailing out one huge multinational corporation after another deemed “too big to fail” and launching creative lending programs that in many respects are real-time economic experiments.

Concurrent with this, we have heard a variety of worried comments that have cropped up so often that they are starting to feel like conventional wisdom. The refrains vary, but the essential kernel of fear we hear constantly is the same:

“It’s different this time.”


Some folks mean it economically. Some mean it politically. Some, it seems, mean it apocalyptically.

And indeed, it is different this time. Major crises are always different – they are unanticipated events that lead to never-before experienced circumstances. But we do not diminish the seriousness of this particular crisis or imply that we will simply skip through it unscathed. After all, the Great Depression and the 1990 recession were both economic crises, and they were both different in their own way from other crises our country experienced previously. But, as George Orwell might have said, one was more different than the other.

It will be left to history to write the story of the current economic times. And since we can’t know how that story will play out in present tense, perhaps we should turn our attention to a question that, from an investment perspective, is essential to what our personal experience of this time will be:

What should we do?

Do we “stay the course”, as many financial advisors (us included) have urged in the face of market declines that have exceeded 50%? Or do we “take action”, as all those pundits in the media and hucksters selling $250-a-year newsletters are urging us to do, claiming to have “The One True Vision” of what the future holds?
In our opinion, this can all be distilled down to another question:

Do markets still work?


It is a reflection of our current economic and political climate that such a question even merits asking. And yet it is being asked, and answered, repeatedly these days. Some say “yes.” Some say “no.”

We say, unequivocally: “Yes.”

At their most basic, markets are a testament to the human spirit; they attest to man’s innate desire to better his current situation. To buy a part of the long-running story of growth and innovation that the capital markets make possible. Absent utter and absolute repression such as we see in North Korea and Cuba, people will find a way to gather together and wager their opinions – with their hard-earned money – about where the smart investments will be in the future. This is not limited to New York or London or Hong Kong. This is a universal story as old as time itself. Consider this passage from an October 10, 2008 article in the New York Post about the fledgling Iraqi stock market:

As the Dow plummeted nearly 700 points yesterday to fall well below the 9,000 mark, the Iraqi stock exchange…was flourishing, buoyed by four-year lows in violence and hopes of a reconstruction windfall. Last month, Iraq's general index went up nearly 40 percent, about the same percentage the Dow dropped over the past year. The jovial trading-floor mood is reminiscent of Wall Street's bygone "greed is good" era of the 1980s.

Clearly, the human spirit is resilient. Markets are a reflection of that resiliency. And market-based investing, such as we employ at Capital Directions, is about capturing that resiliency. It is a statement of faith that the free-market model is the best the world has at allocating capital, sorting winners from losers, and compensating investors for the risk they assumed. It is a statement of belief that short-term conditions – be they economic, political, military, or what have you – will not trump the long-term reality that free markets work.

The other alternative is to embrace the notion that markets no longer work. That economic and political winds have shifted in such a way that we cannot expect markets to function properly, and we must, therefore, “do something” about this situation. What that something is depends on the individual’s perspective, or that of the guru they are following. Inflation… deflation… stagflation… depression... calamity… collapse. There are so many hypotheses to choose from, and whichever hypothesis one subscribes to obligates one to make a decision about what to do with one’s money. For those who guess wrong the results will be catastrophic.

History is full of examples of people who made such mistakes in judgment, who believed that events and circumstances had fundamentally altered the way the world economy worked. People who believed the world was coming to an end over Y2K and stocked their bunkers with gold bullion. People who believed we were in a New Economy in 1999 and put all their money in dot-com stocks. People who thought it was a foregone conclusion in 1989 that Japan would rule the world economy for the rest of time and put all their money in the Japanese market. People who bought into Business Week’s 1979 cover story entitled “The Death of Equities” and missed out on the ensuing two decades of double-digit market gains.

All of these are examples of people embracing the notion that “it’s different this time.” No doubt it’s different this time, too. But the fact remains that the free-market model has been counted out many times by many people over the past two centuries, and at every turn such assumptions have been wrong. Who would have thought that Nazi Germany and Imperial Japan would be free-market economies only a few decades later? Who would have thought the U.S. economy could emerge from the wreckage of the Great Depression stronger and more diverse than before?

Such triumphs were not, suffice it to say, painless or easy. Markets function not like the gears on a finely tuned clock, but more like the pistons on a slightly out-of-tune engine. Some pistons fire up, while others turn down. Sometimes the engine stalls, and other times it races ahead. But the irrefutable reality is that the car continues its trip, inexorably onward and upward. Thus do we have the Dow Jones Industrial Average climbing from 47 to 11,500 during the 20th century. Thus do we have traders in Iraq in their makeshift stock exchange, thriving in the midst of suicide bombings and political chaos in a way they never could when things were ostensibly calm and secure under Saddam Hussein.

In many ways the past few years have been a cautionary tale about what happens when markets become unhinged from caution, prudence and integrity. It is the nature of free markets that such episodes can occur, but it is likewise the nature of free markets that the day of reckoning arrives sooner or later, and the playing field is leveled once again. It is not pretty to watch, nor pleasurable to be caught up in, but for those who stay above the fray, the story of the past two centuries has been that investors who keep their faith in the notion that free markets work have been rewarded.

At Capital Directions, we believe that story continues to be true.