Black Monday

Stock prices sank sharply on Monday in the wake of Lehman Brothers’ bankruptcy
announcement over the weekend. Other firms perceived to have credit-related
worries sank sharply as well: shares of insurance giant AIG fell 60.8%, Washington
Mutual was down 26.7%, and Citigroup lost 15.1%. Among the thirty Dow Industrial
component issues, only Coca-Cola managed to eke out a gain, closing up 25
cents for the day.

The S&P 500® Index fell 4.71%, its largest one-day percentage
loss since September 17, 2001 when the Index fell 4.92% following a four-day
trading suspension. Ranked by magnitude of one-day losses for the S&P
500® Index, Monday’s decline ranks fourteenth among all trading sessions
since January 1950. Although some market breaks are still fixed in our memory,
others have faded from view. We suspect few non-professionals can recall
what the news background was when stock prices plunged on October 27, 1997;
January 8, 1988; or September 11, 1986.

Rank Date S&P
500®Close
Change
vs. Prev Close
1 October 19, 1987 224.84 -20.47%
2 October 26, 1987 227.67 -8.28%
3 October 27, 1997 876.99 -6.87%
4 August 31, 1998 957.28 -6.80%
5 January 8, 1988 243.40 -6.77%
6 May 28, 1962 55.50 -6.68%
7 September 26, 1955 42.61 -6.62%
8 October 13, 1989 333.65 -3.12%
9 April 14, 2000 1,356.56 -5.83%
10 June 26, 1950 18.11 -5.38%
11 October 16, 1987 282.70 -5.16%
12 September 17, 2001 1,038.77 -4.92%
13 September 11, 1986 235.18 -4.81%
14 September 15, 2008 1,192.70 -4.71%

The S&P data are provided by Standard & Poor’s Index Services Group.

Financial journalists will undoubtedly be scribbling energetically in the
coming weeks to offer anxious investors an explanation for “what it all means.” A
sample appears in the most recent issue of Forbes, where three prominent
investment professionals offer their views of the future: one is quite bullish,
one is quite bearish, and the third is cautious but hopeful. Each offers
compelling evidence to make their case. Forbes editors helpfully
place each column on consecutive pages, making it easy for readers to determine
which pundit is promoting views most similar to their own. The only investors
likely to improve their portfolio results by reading such observations are
those who were not properly diversified to begin with and become motivated
to take action. The world is an uncertain place, and sharp fluctuations in
asset prices reflect that uncertainty.

History offers abundant evidence that market economies are resilient. The
world will find a way to manage its financial affairs without the advice
of Lehman Brothers, and the residential mortgage loan will survive even if
Fannie Mae does not. The key issue for investors is to make sure their financial
future does not get derailed by events at a handful of firms, and that their
portfolios are properly positioned to capture all the rewards the markets
have to offer when the next up cycle begins. Recent events have provided
an unusually harsh lesson of the importance of diversification. In a matter
of days, shareholders of three financial giants—Fannie Mae, Freddie
Mac, and Lehman Brothers Holdings—have seen their shares plunge into
the penny-stock category. A fourth, American International Group, is scrambling
for survival. For well-diversified investors, the financial damage associated
with these four firms has been minor; in aggregate, they represented less
than 1% of a diversified US equity portfolio on May 31, 2008, and even less
for a global strategy.1 Four
or five years from now, these investors may have a difficult time remembering
what happened and when.

However, for those with concentrated positions, especially employees with
large holdings of company stock, these events are a financial tornado inflicting
potentially irreparable damage. One business owner cited by the Wall
Street Journal
recently purchased 25,000 shares of Freddie Mac at roughly
$5 and lost most of his investment in a matter of days. Ironically, he claimed
to be through with day-trading strategies, and was seeking a profitable long-term
investment. Elsewhere, the Wall Street Journal estimated that the
24,000 employees of Lehman Brothers have seen $10 billion in personal wealth
evaporate as the value of Lehman shares collapsed. Many long-time employees
of Fannie Mae or Freddie Mac have experienced similarly catastrophic losses.
When times are good, the risk of a concentrated portfolio often appears extremely
remote. In March 2006, Fannie Mae was once characterized by Money magazine
as “America’s Safest Stock,” with a bulletproof business model that was “as
close as you’ll get to an invincible earnings machine.”

Events of 2008 demonstrate the importance of getting a few big issues right – namely
diversification and balance.  We expect that patience will prove critical
as well.

1Weights
for the US Core Equity
1 Portfolio
as of May 31, 2008 are used.

Bajaj, Vikas, Bajaj and Tara Bernard. “Worker Assets Shrink at Fannie and
Freddie.” New York Times, August 29, 2008.

Birger, Jon Birger. “The Rock.” Money, December 2001.

Dreman, David. Dreman. “Get Ready for Rising Prices.” Forbes, September
29, 2008.

Fisher, Ken Fisher. “The Unbubble.” Forbes, September 29, 2008.

Karmin, Craig Karmin. “Small Fannie, Freddie Holders Take Issue With Washington.” Wall
Street Journal,
September 12, 2008.

Karnitschnig, Matthew, Karnitschnig, Lian Leven, and Serena Ng. “AIG Faces
Cash Crisis As Stock Dives 61%.” Wall Street Journal, September
16, 2008.

Shilling, A. Gary Shilling. “Worse Is Yet to Come.” Forbes, September
29, 2008.

Smith, Randall, Smith and Susanne Craig. “The Lehman Stock Slide Hits Home.” Wall
Street Journal,
September 12, 2008.

Yahoo! Inc. Yahoo! Finance. In www.yahoo.com, accessed September
15, 2008.

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