Financial Market Update
StrategicPoint of View®
January 11, 2010
Welcome to the StrategicPoint of View -- a market and economic overview of what occurred last week, what's up for this week, and our commentary on the economy and current market activity in general for “Making Money listeners.
LAST WEEK
The employment numbers disappointed last week. A loss of 85,000 jobs and a 10% unemployment rate confirmed that the country’s labor woes continue. The number of discouraged workers rose by 287,000 (those no longer looking for jobs) added to the misery, although temporary employment improved, providing hope that companies are on the edge of hiring. Elsewhere, manufacturing activity rebounded while housing suffered a few setbacks.
S&P 500: 1145 (up 2.7% for the week)
Dow: 10618 (up 1.8% for the week)
NASDAQ: 2317 (up 2.1% for the week)
10-year: 3.84% (from 3.84% last week)
Crude Oil (February): $82.74 (from $79.67 last week)
Gold (February): $1,139 (from $1,095 last week)
USD/Euro: $1.4407 (from $1.4325 last week)
THIS WEEK
Retail sales, inflation, trade figures, industrial production and sentiment are all scheduled.
COMMENTARY
Prognosticators seem a bit conflicted and vague. There is a consensus that the markets are “due” for a pullback (although the date of that pullback is ill-defined), economic growth is likely to be quite challenged, and that the potential for rising interest rates (again – date to be determined) could prove the biggest stumbling block for the bond and equity markets this year. Beyond that, opinions are all over the place.
Even when hard data is released, the take on the numbers results in nuanced interpretations. Last week’s jobs report was hard to see as anything but dismal. Yet the markets inched higher on the hope that continued unemployment would keep interest rates low.
Then there is earnings season, which begins next week. Even here the good news/bad news can leave much to interpretation. Businesses should have performed well during fourth quarter. Cost cutting has led to increased productivity and expanding profit margins, while inventories need some replenishing. Yet companies may not be doing well enough to start hiring again. High unemployment is a drag on the economy.
Last year the markets seemed to follow some predetermined positive script with unstated underlying beliefs. Equities seemed to have nowhere to go but up after an abysmal year in 2008. Bonds recovered on the back of “less than bad” news, which morphed into “mixed data.” Commodities became the place to be along with emerging markets. It was easy to picture the end of the play (December 31, 2009) and ensure that all of the players were lined up in proper order to take their bows. 2010 is a different story. The scene has changed and the players - still on stage – are doing more adlibbing.
All of this uncertainty means that one of the most important determinants of portfolio performance this year will be risk management.
Portfolio risk management is often linked to diversification. Diversification is extremely important, but we are seeing it in a slightly different light in 2010.
Traditionally, diversification provides some safety, as investors avoid the pitfall of putting too much money in any one investment. The common belief has been that if you held a variety of assets in your portfolio, and one holding fell, another could rise, potentially offsetting the losses. This is because the performance of divergent asset classes was viewed as poorly correlated – with different holdings acting independently. The last two years have taught us that the international economy and global financial industry are increasingly interdependent. Every standard asset class (except U.S. Treasuries) went down in 2008; every standard asset class (except U.S. Treasuries) went up in 2009, albeit by varying degrees.
More recently, the correlation between assets has narrowed and, going forward, diversification may be less aligned with pure asset allocation and more aligned with various economic scenarios tied to different holdings. For instance, while most observers believe that inflation will remain tame for 2010, some portion of portfolios should be guarded against hyper-inflation. Treasury Inflation Protected Securities and a modest position in commodities are a good inflation hedge. If inflation remains minimal, traditional bond funds – even with low interest rates - work very well, so a portfolio should hold some of these as well. What about the dollar? A falling dollar benefits overseas holdings and commodities priced in dollars (add/keep those). A rising dollar is a sign that the economy is improving (increase equity holdings). Interest rates? That scenario is tied to inflation, but it wouldn’t hurt to keep some bond funds quite short term.
And what about sectors within equities? Well, that depends on who is buying. If you think business spending will improve, a technology play may benefit. If you are betting on the consumer, discretionary consumer stocks could be a better bet. And if you think the global economy is going to recover faster than the U.S., it becomes important to increase your overseas positions.
No matter which scenarios play out, portfolios still need a variety of assets and holdings. However, the rationale for diversification is no longer simply historical returns based on a correlation between assets. Rather, investors should have exposure to a variety of scripts on multiple stages. It’s all about risk management and where the probabilities are for economic growth. And in 2010 – a lot of different possibilities could play out.
Tune into the “Making Money” Show Weekdays at 5:30pm and Saturdays at 9am on AM790 WPRV or through our website, www.StrategicPoint.com.
*Past performance is not indicative of future results. Indices are unmanaged and you cannot directly invest in them. The Nasdaq Composite Index measures all NASDAQ U.S. and non-U.S. based common stocks listed on the Nasdaq Stock Market. The S&P 500 index is based on the average performance of 500 industrial stocks monitored by Standard and Poor’s. The data referred to above was taken from sources believed to be reliable. StrategicPoint Investment Advisors has not verified such data and no representation or warranty, expressed or implied, is made by StrategicPoint Investment Advisors.
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