Investing through October

The S&P 500 gained 2.0% in the 3rd quarter and is up 9.1% on the year. Looking at quarterly returns for the major US Indexes, it was a quiet three months for US stocks.  Looking at the month by month returns - what a wild ride!  From the start of the quarter, the S&P500 gained 3.3% to a new record.  Over the next month, the S&P 500 plunged 9.4% as hedge funds dumped stocks to meet credit derivative related margin calls.  Once the selling stopped, stocks regained their footing rallying 8.5% through quarter end.  The S&P 500 is now 0.4% away from making a new record and the Dow Industrials made a new high today.

As we wrote August 13th when the situation looked the grimmest,

"A tug of war is still going on between investors who are frantically dumping stocks to raise case to cover losses in their credit strategies, and investors with cash who are eager to snap up bargains.  We believe that the combination of solid earnings growth for US corporations, solid economic growth in the US and worldwide, and low inflation despite record prices in many commodities favors the bulls, so we're staying fully invested.  We believe that the current correction will be in the rear view mirror by the end of September, with the S&P 500 closing out the year up 8-10%."

The S&P 500 might gain a few percent between now and year end, but for the most part events have turned out as we expected.  The only surprise is finding out that firms such as Bear Stearns, Goldman Sachs and Citibank got burned pretty badly by exposure to credit derivatives based on sub-prime mortgages - we would have thought that management of these firms knew better. 

Quite a few of our financial service stocks declined 15-40% on the quarter, which hurt our overall returns.  However, we regard the situation as a temporary impairment of earnings and continue to hold these companies.  We don't own the primary lenders in the sub-prime market such as Countrywide and American Home Mortgage, so avoided the worst of the pain. 

Unnoticed in the general melee is that technology stocks, particularly telecommunications stocks, are doing quite well this year from a combination of good earnings, rising demand and limited borrowing needs.

Read the entire commentary here.