The third quarter market volatility and storyline had enough plots and subplots for a multi-week television mini-series. Things started with the “spillover effect” of the subprime mortgage meltdown. As you have read, risk premiums in the bond market which had “come in” for many months, widened substantially, almost overnight. Then, when all looked quite bleak, Chairman Bernanke and the Federal Reserve came to the rescue by substantially reducing both the Fed Fund and discount rates.
The impact of all the above resulted in a sharp stock market drop of more than 10%, and a dramatic recovery which is continuing into October. The best performance during the quarter was achieved by large cap companies, particularly growth stocks. Small cap companies and value stocks generally underperformed as they do when there are expectations of an economic downturn. They were also negatively impacted by tightening credit. Just when many pundits were declaring that market leadership had changed for the foreseeable future (towards large and growth, and away from small and value), in the last few days the market leadership has changed again. Our performance was slightly less than the broad market benchmarks for the quarter, yet our stocks are still comfortably ahead of the market for the year. (Indeed, any third quarter shortfall has already been made up in the first three days of this new Quarter.)
We have the flexibility to adapt to changing market conditions, and are constantly assessing opportunities across the market. While we remain diversified in small, mid and large cap stocks, we can, and do, change these weightings as conditions warrant. Also, our flexibility to invest in a combination of value and growth at reasonable prices, gives us the freedom to tilt your portfolios in the most attractive direction. Indeed, our level of turnover in the last quarter was higher than normal due to a few stocks being taken over this year (two more in process), and having added new stocks to the portfolio during the market downturn.
While the chances of a recession have increased, we believe that a slow-down will occur, but monetary policy will prevent a more negative development. We look forward opportunistically to favorable business and stock market conditions over the next several months.