Lost In Transition

Most people do not like change, and this is well illustrated in the financial markets. Economists speak of price stability; central bankers desire equilibrium in markets and private sector bankers and most investors seek liquidity and low volatility. What all this means is that long range-bound periods of tranquility constitutes the majority sentiment of “Wall Streeters” throughout the world, and this is pretty much the way it was when I last penned an investor’s letter in July. In the interim, as clients know from my September update, much has changed. The world’s credit markets are in the throes of a serious liquidity crisis, which was the product of lax underwriting standards by U.S. banks in a variety of debt instruments. Most of the media has focused on the sub prime mortgage market, but the drunks and their punchbowls have extended their reach deep into the corporate bond, high yield, commercial paper, and, yes, even “safe money markets. The equity markets have reacted with severe volatility- November was one of the worst months for indexes, hedge funds and other managers in five years. Here’s a look at the damage to the Dow (blue), the S&P (green), led downward by the U.S. financial sector (denoted by the XLF exchange traded fund in the chart, appropriately in red): Investors and advisory clients of Core already know that we have weathered this storm so far with performances exceeding all our benchmarks.

This is largely due to our decision to severely underweight real estate and financials beginning late last year and our decision to hold on to our energy positions, which have provided outstanding returns this year. We also have held more cash than usual (see my January ’07 note, “The Goldilocks Paradox”, anticipating volatility) and we used it to invest on dips in some of our holdings representative of our long term secular themes, most notably global companies doing business with emerging economies.

Our outlook for 2008 is eerily similar to 2007. We believe the global commodities boom will continue as emerging countries strive to build their middle classes and become wealthier nations. Except for U.S. large caps focused on global markets (mentioned above and excluding commercial banks), we prefer non-dollar equities for most of our sector-related ideas. Finally, despite the recent Fed action to cut rates by only 25 bps, we believe that the Fed and other central banks will try to be accommodative to help the world’s commercial banks and the private credit system out of its muddle—an outright recession will be short or pushed out to 2009. While we may be at an inflection point in the current business cycle (which for us corresponds to a U.S. presidential term and is therefore entering its last year), we still believe that we have 8-10 years left on our long term secular thesis and that our asset allocation process will capture solid returns as we head back toward 1980-type market capitalizations:

The larger transition that I have alluded to frequently in these letters is that the U.S. must manage its own change from the dominant world economic player to a leading world economic player. To become a leader during this period we must make more consensual foreign policy decisions and manage our own finances and economic policies more carefully, while remaining a beacon of free trade and economic freedom for the world’s emerging powers. This is not an easy task, because it is our belief that energy policies will determine much of the U.S. transition success --and the record there is dismal.

We believe that innovations in combustion technologies (hybrids and better gasoline engine technologies) and non-food energy conversion processes (solar, hydrogen, wind, nuclear, liquids from coal) are the winners, and we have made our bets. Our script goes like this: with trillions invested in roads, cars and gasoline infrastructure, the U.S. will be dependent on oil as long as it is available; conservation and smart alternatives will slowly take over; and, over time, nations and their fast growing “Sovereign Funds” are powerful forces to be reckoned with:

Finally, as most of you already know, I have become President of our Registered Investment Advisory, Core Asset Management. This is a natural and comfortable transition to work more closely with our Chairman Jack Mayberry as we look to manage our growth over the next few years. Change is good if you manage for it and embrace it as it invariably comes along. Managing for the long haul is what we do here at Core, and we are glad you are with us for the ride.

Happy Holidays to All,


John III

Core Asset Management
Investment Advisory

jforlines@coreasset.com