Financial Market Update
StrategicPoint of View®
October 3, 2011
LAST WEEK
Friday closed out the third quarter on a dismal note for stocks – the worst September since 2008 and the weakest quarter since 2002. The S&P fell 14.3% from July 1st through September 30th. Gold fell over 11% on the month; copper dropped 25% and oil finished down 10% for September.
Here is a silver lining. The third quarter is traditionally the worst quarter of the year; the fourth quarter the best. According to Barron’s magazine, since 1964, the S&P has lost over 10% in 15 different quarters. 12% of the subsequent 15 quarters saw rallies, with an average return of 10%. Every year is different, and this one may prove to be more challenging to investors than history would indicate, but the record does provide a bit of hope.
Economic data for the week included new and pending homes sales falling, housing prices retreating, and personal income declining. Durable goods orders dipped slightly. However, jobless claims slipped below 400,000 for the first time in six months; consumer spending stayed positive; consumer confidence and sentiment both rose; and second quarter GDP was revised higher.
S&P 500: 1131 (down 0.44% for the week and down 10.02% on the year)
NASDAQ: 2415 (down 2.74% for the week and down 8.94% on the year)
Dow: 10,913 (up 1.32% for the week and down 5.74% on the year)
US Treasury 10 yr: 1.92% (from 1.84% last week)
Crude Oil (November): $79.20 (from $79.85 last week)
Gold (December): $1,622 (from $1,640 last week)
USD/Euro: $1.3387 (from $1.3458 last week)
THIS WEEK
The first week of each month is often heralded as the most important one in terms of economic data. On the first business day of each month, the Institute of Supply Management’s PMI Composite Index is published. Last month (August), the index fell to 50.6%, a year over year decline of 8.3%. Economists expect the September index to pullback modestly to 50.4%, consistent with sluggish economic growth. On Friday the nonfarm payroll numbers will be released. Expectations are subdued: 51,000 new jobs to be created – well below the number needed to put the unemployed back to work. The week will also include an update on motor vehicle sales, factory orders, the ISM non-manufacturing index, wholesale inventories and consumer credit.
COMMENTARY
The Final Stretch
The euro zone sovereign debt crisis will continue to influence the markets for the final quarter of the year. The path political leaders take can greatly affect whether the markets end the year in positive or negative territory.
There are three broad trajectories the markets could follow from now until January:
1) Euro zone leaders defy their history of indecisiveness and inflexibility, recapitalize the European banks and find some believable solution to their sovereign debt issues. Markets rally - perhaps substantially.
While we believe the European Union will settle on some resolution, we aren’t sure that it will be deemed strong enough or permanent enough to erase most doubts. Count this one as low probability.
2) One or more euro zone leaders make a bad judgment call, either in national self-interest or out of lack of understanding of the seriousness of the situation. A European banking crisis ensues leading the markets sharply down.
While people never cease to surprise us, there is too much information and global pressure to believe that political leaders would be willing to jeopardize the financial system. Mark this as a low, but scary, probability as well.
3) The euro zone dithers but provides just enough liquidity to avoid a banking crisis and an uncontrolled Greek default. Global economies slow; growth is unglamorous, with some locations potentially experiencing outright contraction. Markets bounce around but neither soar nor collapse.
For now, we are positioning our portfolios for this last scenario.
It is important to remember the difference between a recession and a credit crisis. The latter is far more potent and dangerous to the financial markets. We had both in 2008 – first the credit crisis when the banking system froze up and the US government stepped in to ensure adequate flow of money and capital throughout the banking system. It was a necessary step to allow banks, businesses and consumers to deleverage and improve their balance sheets. This was followed by the Great Recession, a much deeper slowdown in growth than was anticipated. The Great Recession presumably ended in June of 2009.
While another global recession is entirely possible, the greatest danger comes from a renewed credit crisis in Europe. Sometimes it is easy to be critical of the financial system, but whether you like banks or not, the global economy is dependent on them – and, more importantly, they are dependent on each other. That is why it is so important for the European Union to support (recapitalize) its banks. Only if it does so will the euro zone be able to handle a default by Greece and avoid a potential banking meltdown resulting from Italian or Spanish insolvency. The dangers seem obvious; viable solutions clear. The world is waiting for the political will.
Assuming the European Union will not throw its weight behind a full-scale solution to its debt dilemma, some level of uncertainty is likely to remain, causing the markets to bounce between hope and fear in the ensuing months. It also means that the globe will likely be lacking a catalyst for strong economic growth anytime soon. Europe is already on the brink of recession. The US is drifting towards one. And the impact of slowing European growth on emerging markets is starting to be felt.
As a result, investing could continue to be challenging in the final quarter of the year. Recently, equity markets have been lodged in a trading range. In this type of investment environment, holdings with a decent yield above the ten year treasury tend to do well, as do defensive sectors, such as consumer staples, utilities and healthcare. Financials and European exposure should be minimized, while on the fixed income side, yield from corporations, municipals and some asset back securities can add support for the portfolio. If an investor can emphasize securities that have a high proportion of their expected return coming from income, they should be able to weather the coming quarter without undue volatility and potentially give themselves an advantage. *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.
Visit the weekly eNews archive
|