Financial Market Update
StrategicPoint of View®
July 6, 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
There was lots of economic data this past week, but little of it was promising. Personal spending and confidence inched up, but personal income, factory orders and manufacturing activity moved down. The big news was the jobs report. Fewer private jobs were added in June than expected/needed, and while the unemployment rate dipped to 9.5%, most of the decline was due to discouraged job seekers leaving the labor force. The yield on the ten year treasury dipped below 3%, while the yield on the two year reached a record low of 0.59%.
S&P 500: 1023 (down 5.01% for the week and down 8.3% on the year)
Dow: 9686 (down 4.51% for the week and down 7.12% on the year)
NASDAQ: 2092 (down 5.89% for the week and down 7.80% on the year)
US Treasury 10 yr: 2.96% (from 3.11% last week)
Crude Oil (August): $72.24 (from $78..86 last week)
Gold (August): $1,212 (from $1,255 last week)
USD/Euro: $1.2541 (from $1.2378 last week)
THIS WEEK
Data will be thin this week, keeping the markets – which want certainty – on edge. The Institute for Supply Management published its non-manufacturing index, jobless claims and consumer credit come on Thursday, and on Friday we take a peek at wholesale inventories. Not much to get excited about.
COMMENTARY
Less Good is Worse
Do you remember last year at this time, when the markets were surging forward and the cheer leading section was screaming, “Less Bad Is Good!” The data was pointing to an economy that was still reporting declining values of just about everything, but the rate of decline was slowing. Traders thought this was a marvelous entry point. In retrospect, they were right. The data did turn around and the economy eventually, by year end, entered what most are calling a recovery.
So maybe the traders have it right this time, “Less Good is Worse.” The economic data this past week was disappointing and investors bailed on stocks coming into the long weekend. There has been a consensus building that the economic recovery is pausing and that longer term economic growth is likely to be slower than originally expected.
After that, the consensus breaks down.
Double dip recession?
The talk is all out there. Double dips are rare, however. Only 3 of the last 33 recessions were double dips and the last one was engineered by Paul Volcker in his attack on inflation back in 1980-1982. Once the bottom of a cycle has been reached and companies are just about as lean as they are going to get, it requires some pretty strong, new, jarring news to pull a nascent recovery back into recession.
Can it happen? Yes. One scenario might be that if a new, full blown credit crisis in Europe (other location) ensnares the rest of the world. For now the ECB/EU/IMF rescue package seems to be holding this at bay. Or major tax increases in 2011 eat into growth sufficiently to turn GDP negative. But expectations for slowing economic growth alone do not seem to be predictive of a double dip recession.
Then again, if growth slips to 1.5% (no double dip) or slides to minus 0.5% for two quarters (double dip), who cares? The outcome will likely be less than desirable for most Americans. We can call it whatever we want.
No matter what happens in the economy, markets can operate separately. Which brings us to:
Correction or Bear?
Full blown bear markets (down 20% or more) have been far more common in the last 30 years than corrections (declines of between 10% and 20%). There have been six bears vs. two corrections. For the last 80 years, however, corrections outnumbered bear markets. Perhaps we will get lucky this time.
But not if the media has its way. A suddenly popular term Death Cross (when the S&P 500’s 50 day moving average suddenly crosses below the 200 day moving average) is back in the news. In spite of its somewhat dubious history for predictive value, the coverage does point out the role of technical traders in the markets.
Markets move on fundamentals (economic data), technical analysis (charts) and valuations (analysis of individual companies/holdings). The first and the last depend on outside information. Technical analysis relies – to a certain degree - on itself and has the potential problem of becoming self-fulfilling. If chartists predict a bear market will ensue if the S&P falls below a certain price level, then once that price level is breached, wary investors conceivably could pull back, creating their own bear market. This can be independent of economic data and valuations. Sentiment is not to be underrated when it comes to the direction of the markets.
Assume a Bear
So let’s assume for the moment that the correction turns into a bear market and stocks decline 20%.
While history has repeatedly shown that portfolios can, over time, recover from losses, smaller losses make any recovery easier, especially when the subsequent growth is muted. For instance, assume that you have $100,000. And, for the sake of simplicity, assume that you own only stocks and cash. If you are 75% invested in stocks, your portfolio – after our bear market - is now worth $85,000 (75% of the 20% loss is 15%. 15% of $100,000 is $15,000, which is subtracted from the $100,000). If you are 50% in the market, your portfolio is worth $90,000 and if you are 25% in equities, your portfolio has dropped to $95,000.
Now assume the portfolios are rebalanced to their original allocations and the market recovers and advances 20%. The $85,000 has turned into $97,750 (same 15% now attributed to the starting value of $85K). The 50% risk investor returns to $99,000 and the 25% risk investors are essentially made whole.
Over time, as markets move beyond recovery, the aggressive investors pull ahead. If the market rally were 40% (not 20%) the aggressive investor would be repositioned at $110,500 at the end of the rally, while the conservative investor’s portfolio would be valued at $104,500.
Clearly, portfolios are more complicated than this. Many types of assets classes can be held in the portfolios, which provide varying rates of return, and allocations are often adjusted over time. But whether we look at the simple version or complex, the lesson remains. For some investors, the longer term opportunity for growth outweighs the volatility along the way. For others, some growth can be sacrificed if it means sleeping better at night.
No one likes to open their statements and see their portfolio balance fall. But investing involves risk. It comes down to timeframe and tolerance. Investors choose how long they are willing to wait and how much fluctuation they can handle. When they can correctly assess their comfort zone, riding out the storm can be a lot easier.
Tune in to News Talk 630 WPRO and 99.7 FM daily for our "Making Money Updates". Get the latest market news and our take on the day's events with our market commentary at 8:10am and 5:32pm. For more information, visit 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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