Taking stock of 2008

Well, 2008 is finally coming to a close, and there were definitely some fireworks this year, although not the kind that most businesses were happy to see.

One year ago, we noted several financial commentators who were predicting a recession in 2008, and why we felt their assumptions were incorrect. We agreed with the obvious assessment of the state of the housing market, but did not believe it would spill over into the broader economy, and ended with the conclusion that "The prospects for a happy 2008 are not as bleak as the news is making them out to be!"

While we were wrong about that, it has always been our assertion that investors should not attempt to time cycles and that we do not base our portfolio management process on an ability to make short-term calls about the direction of the economy, interest rates, or market movements. We have repeated that assertion many times on this blog, including in first sentence of our second post ever, and more recently in posts such as "Stock Market Guessing."

Furthermore, we believe there is ample evidence that the problems in the housing market and financial companies that unwisely overindulged in housing-related financial products would not have spilled over into the broader economy if it had not been for a stubborn adherence by regulators to two very damaging "good ideas": mark-to-market accounting and the removal of the uptick rule for short-sellers in July 2007.

We wrote of the dangers of over-reliance on mark-to-market accounting as early as Friday, March 14, prior to the stunning disappearance of Bear Stearns over the weekend. There were others who had been sounding the alarms on mark-to-market before that, and yet the nation's leaders have continued to ignore the problem. Had this accounting problem been corrected back then, and had the time-tested uptick rule been reinstated, it is very possible that the spectacular implosion of Wall Street in September and October could have been avoided.

We maintain that it was the violent downdraft of all asset values this past fall that finally shocked the rest of the business world to such a degree that they basically came to a stand-still; we called it a case of "jaw-dropping, screen-staring amazement." In the aftermath, corporate budgets were hastily rewritten, and plans for business activity were drastically cut back.

It is important to have the correct perspective on the events of 2008, because -- as we predicted back on October 6 -- many will want to interpret them as a failure of the entire idea of free market enterprise.

In fact, today there is an article in the Wall Street Journal from the consistently anti-business Frank Thomas entitled "The 'Market' isn't so Wise After All" in which the author happily concludes that the carnage of 2008 should show everyone except for the most dogmatic ideologues that the idea of "the market and its fantastic self-regulating powers" is a dangerous illusion.

But while that article is full of snide jabs, it has little substance. Pointing to the recent meltdown and saying "I told you free markets don't work" should not convince anyone. While painful, the recent events do not prove that free-market capitalism is a system that fails. In fact, the past hundred years have decisively proven the opposite.

Elsewhere in 2008, our business-focused perspective enabled us to warn readers about the significant bubbles in oil and commodities before they deflated with a collapse that was bigger than the collapse in stock prices.

For instance, on March 31 we wrote a post entitled "What about commodities???" in which we warned against the chorus of voices which had been advocating commodities since they began their most recent upward journey in February 2007. Since that post was published, the commodities index has dropped about 47% in nine months.

On June 4, we published a post entitled "A hard look at the current price of oil and gasoline," in which we noted that crude oil futures were at $135 and rising, and that many pundits were talking as though oil prices had become "the one investment that will 'always go up and never go down.'"

We warned that "the real culprit in the current price of oil has been excessive Fed easing" and advised investors that "trying to 'play' the run-up in oil, which is caused by political and monetary factors that have little to do with the long-term fundamentals of business and which can reverse rapidly, is a shaky foundation for building long-term wealth and one we would strongly caution against."

Since then, the price of oil futures has dropped more than 70% in less than seven months.

It must be repeated that we did not make these timely observations because we have some kind of extraordinary ability to tell you what direction markets will move next. That goes against everything we believe in. On the contrary, we were able to sound a note of caution about those former "flavors of the month" because we believe in building the foundation of wealth on the long-term performance of well-run businesses operating in fertile fields of growth, rather than on an ability to "play" the current hot ticket.

As we have said many times before, most of the big fortunes in this country were made by men who retained shares of exceptional businesses through market cycles -- even through market cycles that were as dramatic as those we experienced in 2008. Bill Gates, for instance, didn't become one of the world's wealthiest men by selling his position in Microsoft every time he thought the market was going to have a bad year, and then buying it all back again.*

At the end of 2008, our most important piece of advice to investors is exactly the same as it was at the beginning of 2008: entrust your long-term financial well-being to the ownership of well-run businesses that are positioned in front of substantial opportunities for future growth.

We look forward to discussing some of those opportunities with you in 2009. Happy New Year!

* The principals of Taylor Frigon Capital Management do not own securities issued by Microsoft (MSFT).

For later posts dealing with this same topic, see also:

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