LJL Funding Blog

With five consecutive daily advances in the stock market, investors are anticipating a Santa Claus rally for December to end what was a miserable investment year on a positive note. Preliminary sales results for Black Friday suggest an increase of 3% over last year which will be the lowest since 2005, but at least it is an increase. An operational credit market that will key to the resumption of economic activity still seems far off with the spread between the 3-month LIBOR and the 3-month Treasury at more than 2% (normal should be around 0.5%). LIBOR is now close to 2004 levels, but the demand for ultimate security in Treasury Bills has kept the yield at 0.3%. Investor confidence in the Obama administration’s handling of the crisis will have to be established before the economy will start to dig itself out of the hole. As seen in the Investor Section, president elect Obama’s economic team has the credentials and is centrist enough to warrant investors confidence.

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The TED spread (chart in the Interest Rate Section)– the spread between the 3-month Treasury and the 3-month LIBOR – is a good indicator of the financial system’s health and remains at elevated levels. In medical terms the patient (financial markets) has stabilized but remains in the intensive care unit. Once the spread declines to below 2% the patient will be transferred to a hospital ward and below 1% released from hospital. Based on this analysis (spread over 2%) we can expect a continuation of the turbulence in the markets. President elect Obama, whose slogan “Change” won him the office, finally announced the appointment of a new face to Washington after a slew of consummate insiders, in the person of Timothy Geithner as the new Treasury Secretary and the markets rallied 500 points. This is a clear indication that the country is ready for a president Obama to bring real change to Washington and use his oratory skills in a Reagan like manner to boost confidence that in turn would lead to a resumption of economic activity by all that is required for any recovery. Everyone is bruised and battered by this years’ financial setbacks and many are left with anxious, gloomy and uncertain futures making this Thanksgiving week a real challenge but in giving thanks for the blessings we do enjoy we can focus on what is truly important and realize that this great country was founded by the Pilgrims who instituted the tradition of Thanksgiving notwithstanding the fact that the Pilgrims, in the words of H.U. Westermayer , made seven times more graves than huts and no Americans have been more impoverished than these who, nevertheless, set aside a day of thanksgiving.

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On Thursday last week the Dow Jones Industrial Index opened up approximately 150 points it then dropped to minus 300 points and ended the day on the plus side by nearly 600 points only to give back more than 300 points on Friday. This is heaven if you are a day trader AND you are on the right side of the wave. Unfortunately most investment portfolios are drifting rudderless in the waves of this windblown volatile market. The adages that buy and hold over the long term is the best way to invest in the stock market and that investing in the stock market delivers the highest returns in the overall investment arena are true if you really invest for the long term. The Dow was at 169 in 1937 and at its current level of 8,497 has yielded a whopping 4,988% in 70 years! But dissecting this return one finds that the Dow was indeed 169 in 1937 and again 167 in 1949 down 1% after 12 years. Then a time of explosive growth from 167 in 1949 to 969 in 1965 an appreciation of 480% over 16 years. These returns were tempered from 969 in 1965 to 896 in 1982, losing 14% over 17 years. In 1982 the Dow rallied from 896 to 11,497 in 1999, a positive return of 1,183% over 17 years. And now we are at 8,497 in 2007 down 26% from 1999 and down 39% from the highs in 2007. It is therefore a question of how long your time horizon is. Since the inception of the LJL Secured High Yield Income Fund in April 2007 investors would lost 35% in the Dow, down 26% in oil stocks, even down 7% in owning Warren Buffett’s Berkshire Hathaway! Investing in the 2-year Treasury investors would have earned approximately 3% in 2007 on an annualized basis and half that in 2008. Investors who invested in the LJL Secured High Yield Fund in April 2007 and selected the compound interest feature have seen their investment grow by 17.02%!

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In the wake of a global euphoria surrounding the election of Barrack Obama as the next president of the United States, the economic horizon continues to darken and the markets continue to act with little logic. The Wall Street Journal reported that the legendary financial analyst Benjamin Graham first wrote about the stock market in 1949 to describe the way investors, acting collectively, often seem to resemble a person with bipolar disorder. In the manic phase, Graham wrote, investor’s enthusiasm puts “a ridiculously high price” on stocks. When the market becomes depressed, investor’s “fears run away them,” and they are so eager to sell stocks that their behavior is “a little short of silly.” We are in the depressed phase of the market with irrational buying and selling of stocks in light of economic statistics being released, and by interest seeking investors accepting negative real returns on their bond investments.

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The gremlins and goblins of Halloween night was a fitting end to the most volatile month in the financial markets, since market data has been collected. With the 3-month LIBOR at around 3% banks are feeling confident enough to start lending to each other (obviously with massive governmental cash and guarantees)this newly found comfort should slowly trickle down to businesses and the consumer. The threat of inflation remains in retreat led by the decline in oil prices and other commodities including food. The root cause of the financial crisis – the housing market – continues to show some signs of abating with increased sales volumes albeit still at declining prices. Real plans, backed by cash to renegotiate and modify mortgages should solve the ever lower prices over time as inventories decline. The recession (although technically we still need a second quarter of negative growth to comply with the definition of a recession – two negative growth quarters) may well not be as drastic and lasting as is the accepted wisdom of the day would predict, as a result of the relaxation in lending, continued low interest rates in a low inflationary environment and a stabilizing housing market. The results of the presidential election, but more importantly the announcement of the president elect’s cabinet should indicate the administration’s economic direction for at least the next four years.

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On Friday morning the US stock Index futures opened limit down – the maximum allowed down move in the stock market before circuit breakers in the market takes effect. These circuit breakers are designed to slow down market momentum and avoid a catastrophic decline. Fortunately by the time that all the stocks were opened on the floor, buying pressure had avoided the circuit breakers being used and by the close of the market the Dow Jones Industrial average was only down a respectable 300 points! Down 300 points can only be “respectable” in a severe bear market. But it does in a way indicate that the potential for a depression has subsided, a statement also reaffirmed by the LIBOR rate declining to around 3.5%. Investors still face some tough choices with the stock market now trading at the lower range of historical earnings multiples, but with earnings expectations being lowered on a daily basis. Interest bearing investment returns remain at historical lows as central bankers continue to flood the system with liquidity and housing prices continue to decline, albeit at lower rates and with significantly increased volumes. The LJL Secured High Yield Income Fund continues to deliver 10%+ returns to its investors backed by trust deeds with at least 40% equity based upon a conservative valuation process that should continue to do well even if real estate prices continue to decline another 10% as is expected by most analysts.

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What a roller coaster ride we experienced last week and although it may not feel like it the Dow had its best week since 2003! Common consensus is that the world is now in a recession that could drag economic activity down until 2010. But all commodity prices are down, including oil, which means inflationary pressures have been relieved, making it easier for the Fed to lower or at the very least keep interest rates at their current low levels. Consumers who have jobs (the unemployment rate at 6.1% is still at historical lows), will have more to spend on discretionary items rather than gasoline. The dollar is regaining its strength which is not good for US exporters, but helps local US businesses as imports become more expensive, and we sure do import a lot more than we export. Even the low levels of home building and construction has a silver lining as it gives the market an opportunity to digest existing inventories allowing a bottom in house prices to solidify. All in all the facts are not all bad if the fear would just subside with banks starting to lend to each other (a clear sign would be if the 3-month LIBOR rate would drop to below 3% again), consumers start spending and investors start investing.

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With the worst week in 112 years behind us, and who knows is still ahead of us, investors are quite justifiably nervous. Cash under the mattress does not sound like a bad strategy at this stage of the game, especially if one considers that a 30% decline (and in today’s market that is a good week) requires a 43% recovery in the market to just break even! This coming week we will again send out our monthly investor’s letter to the fortunate investors of the LJL Secured High Yield Income Fund and pay their monthly interest – as we have done without fail since April 2007 when we started with the investment program. Our investors have enjoyed a 10%+ return WITHOUT VOLATILITY during the worst year in real estate finance since the 1930’s. In addition, their investment has been secured by mortgages with at least 40% equity (our portfolio loan-to-value is 56% on values lower than the appraisals) at the real estate value when the loan was made and most of our loans were made in the last four months when the major decline in real estate prices had already occurred. As we also lend money to a very special borrower, a fiscally conservative person who has lived in their family home for more than a decade; did not participate in the refinance and spend boom and now have as their major asset the equity in their home, we have not taken back a single home in foreclosure although we have had to make some (7 out of 55 loans made) modifications and agree to payment plans that assist the borrower without sacrificing yield or security of our investors. IT SURE BEATS KEEPING YOUR MONEY UNDER YOUR MATTRESS.

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“We have had a bad banking situation. Some of our bankers had shown themselves either incompetent or dishonest in their handling of the people’s funds. They had used the money entrusted to them in speculations and unwise loans. This was, of course, not true in the vast majority of our banks, but it was true in enough of them to shock the people of the United States, for a time, into a sense of insecurity and to put them into a frame of mind where they did not differentiate, but seemed to assume that the acts of a comparative few had tainted them all. And so it became the Government’s job to straighten out this situation and do it as quickly as possible. And that job is being performed.” An extremely good description of the events of last week. This of course was part of the first fireside chat, termed the “The Banking Crisis” delivered on March 12, 1933 by President Franklin Delano Roosevelt which signaled the end of the Depression.

We all face the crisis of inaction because of fear, without rational thinking. If the banks stop lending, and we follow suit by not investing, spending and working hard to develop and grow our economy, the financial losses that we fear will become a self fulfilling prophesy. We should all read and implement President Roosevelt’s final words in his fireside chat:

“After all, there is an element in the readjustment of our financial system more important than currency, more important than gold, and that is the confidence of the people themselves. Confidence and courage are the essentials of success in carrying out our plan. You people must have faith; you must not be stampeded by rumors or guesses. Let us unite in banishing fear. We have provided the machinery to restore our financial system, and it is up to you to support and make it work. It is your problem, my friends, your problem no less than it is mine.

Together we cannot fail.”

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The news that the US Mint had to suspend sales of gold coins because of the surge in demand was a perfect headline for last week and for the time we are living in. The Federal Government (roughly translated into “we the taxpayers”) will in all likelihood provide the funding for the largest bailout in history. The actual cost or profit will take many years to calculate, but the bailout should provide sufficient encouragement to the system to allow credit to start flowing and life to return to normal, which would include up and down markets. The blame game will also increase in intensity, but we should all try to remember that everyone benefitted from cheap and easy credit for many years, people who would never have been able to afford houses, luxury cars or vacations, now enjoyed those benefits; local authorities enjoyed higher property tax revenues as prices soared, benefitting the community at large. Clearly there were also excess greed with massive bonuses and salaries, independent of whether companies were doing well and on occasion highly expensive shower curtains, but just about everyone enjoyed the abundance of cheap money and now it is time for all to pay the price as the pendulum swings back from deregulation to over regulation.

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