August 11, 2011
Once again all of us, and especially those who are responsible for looking after your retirement assets, are dealing with the impact that a broad selloff in the markets has had upon your portfolios. We are following recent events closely and taking action where prudent and for the long-term benefit of your assets.
What is happening?
Since the middle of July, economists and market participants have become increasingly concerned about the pace of economic growth here in the U.S. and abroad. In the U.S., weak employment figures for June gave rise to skepticism about economic growth in the second half of 2011. The approach that U.S. politicians took to debt ceiling issues alienated the public at home and gave rise to questions from abroad, as evidenced by critical comments out of China, a large holder of U.S. government debt. In addition, serious concerns about the Eurozone and most particularly Italy and Spain and the resulting negative impact on European growth and the banking system have heightened concerns that global stock markets are in for a repeat of the 2008-2009 crisis from which we are still recovering. As a result, while our bond and balanced portfolios have benefitted from the flight to quality to U.S. Treasuries, global stock markets have sold off and have experienced more than a 10% correction from the highs in early July.
On top of all of this news, on August 6, Standard & Poor’s (S&P), one of the ratings agencies, took action to downgrade the government debt of the United States from its highest rating to its second highest rating. While in and of itself this is not tragic (indeed, U.S. bond yields have been falling throughout this equity selloff; bond prices have actually risen), the timing of this news during an equity market selloff and during a period of concern about global growth is not helpful and exacerbates the negative market sentiment.
What we believe
Along with others, we had been reasonably optimistic about the prospects for a resumption of reasonable economic growth in the second half of 2011 and that a slowdown would be transitory and short-lived. This outlook, combined with a fairly robust picture of corporate profits and balance sheets, as well as reasonable price/earnings multiples for equities, would enable equities to produce 9-11% returns for the year, in our opinion.
Clearly there is reason to consider the possibility that we may be headed for a really subpar period of growth, particularly in developed countries, and thus would be at the mercy of policymakers here and in Europe to act to support the economy and financial markets. That time has come in Europe in the form of European Central Bank purchases of sovereign debt of countries such as Italy and Spain. While there has been no response from the U.S. Federal Reserve in the form of a QE3 (Quantitative Easing) yet, statements on August 9 that the Fed would keep short-term interest rates low until mid-2013 caused the market to rally.
In terms of positives, there has to be some benefit from dramatically lower interest rates here in the U.S. as well as markedly lower oil prices, which are coming to a gas station near you. The July employment reports were much more positive than June. Corporations have plenty of cash and plenty of options, even though they are reluctant to hire. They can raise dividends and continue to buy back stock. Thus, there are offsets to all the negatives that have surfaced again recently.
What we will do
The best strategy we know of to benefit your assets is to keep our perspective and look for opportunities to preserve and position the portfolio for the next move upward in equities. While we are not certain when it will occur, history has shown that following corrections of this magnitude, prices are often higher over the next period. Ned Davis, a strategist I have relied on over the years, says:
“Since the (recent) bull market began, we have had 8 days where the S&P 500 shed at least 3%. Below is a table of what has happened 5, 21, and 63 days after such occurrences. Hopefully this is helpful to put some numbers to the action. Assuming that the bull market still has legs, this study should be a good guide. When investors panic and Bloomberg, CNBC, etc. anchors start talking about all the negatives, that's precisely when it’s most likely to pan out in the exact opposite manner!”
Putting all these thoughts together, we remain extremely conscious of the extreme valuation disparities between stocks (attractive) and bonds (not so much after the recent price appreciation) and will be vigilant to look within the equity market for opportunities as well as places where we have the ability to influence the mix of stocks and bonds, such as in balanced portfolios. History has shown that investors benefit from not panicking and selling stocks after periods like this, and we believe this period will not be an exception.
We will update you as the situation warrants it. Thank you for your continued trust in us.
Sincerely,
