Some market bears think very little has changed. They could be right.
Memories of 2008 are still fresh: The credit crisis; the collapse of Lehman Brothers and Washington Mutual; the federal takeover of Fannie and Freddie; the market downturn. There’s little doubt Wall Street would like to erase it all from its conscience, and maybe it has.
Part of the anger of the Occupy Wall Street movement comes from the perception that nothing has changed. While the Dodd-Frank Act (designed to make the financial system more accountable and transparent) is now taking effect, the Volcker Rule (intended to stop banks from trading for their own accounts) may be watered down or put off. Beyond that, the U.S. economic recovery from the Great Recession has sputtered and made people question the recent bullish sentiment.
Stocks have rebounded strongly since 2009, but there are still many factors to worry about; this may lead to a little contrarian thinking.
This bull market may be a diversion from a secular bear market. For most of 2011, the S&P 500 has been above 1,200 (a great rebound from the March 2009 low of 676). What was behind that? The short answer: a weak dollar. We haven’t exactly had a boom economy in that timeframe.1,2
Some analysts look at Wall Street right now and see a rerun of the 1970s, when you had momentous rallies masking a bear market that went from 1967-82. In addition, researchers at the Federal Reserve Bank of San Francisco are concerned about the possibility of a generational sell off; a potential market “headwind” for 10 or 20 years stemming from greying Baby Boomers getting out of stocks as they get closer to retirement, countered only partly by overseas investment.3,4
What has changed on Wall Street since 2008? Perhaps not much. The general perception that the CEOs of the big investment banks and mortgage companies whose thoughtlessness contributed to the Great Recession met with no real consequence seems to be taking hold, as evidenced by the Occupy Wall Street movement.
By the way, remember the furor directed at risky derivatives trading? In September 2011, the Comptroller of the Currency had recorded an 11% year-over-year increase in derivatives investment in the banking industry. Banks now hold almost $250 trillion of the contracts.5
A truly severe punishment of Wall Street would come at a dear price for Washington. Some of the biggest names from Wall Street (and the real estate sector) have also been major lobbyists and campaign contributors. According to the nonpartisan Center for Responsive Politics, the National Association of Realtors has contributed more than $40 million to federal-level political campaigns since 1989; Goldman Sachs has contributed almost $36 million since then, and Citigroup nearly $29 million. The financial, insurance and real estate industries have collectively spent over $4.6 billion in lobbying efforts since 1998.6,7
What is happening with the recovery? Not much. While unemployment is above 9%, underemployment is the real story – in September, 16.5% of Americans worked less than 40 hours a week. No wonder homes sit on the market and consumer spending increases mostly in response to rising food and energy prices. Wages even retreated 0.2% in September and incomes fell 0.1% - the first monthly decrease in income since October 2009. Assorted 2012 forecasts see slow or slowing growth in various European and Asian nations.8,9
Is there a bright side for Wall Street? Actually, there could be. The European Union is making decisive moves to address its debt crisis. Indicators still show that our economy is growing, not contracting; September was the best month for U.S. retail sales since March. Many analysts think that the Dodd-Frank regulations will discernibly impact the Wall Street mindset. Lastly, the strength and duration of seemingly every major bull market has been questioned by the bears; history may record that a secular bull market began in 2009, after all.10
Only time will tell. Over time, the stock market has faced some great challenges – and risen to meet them again and again. This time around, the hope is that Wall Street’s behavior (and behavioral assumptions) won’t sabotage the rally.
Citations.
1 - money.cnn.com/data/markets/sandp/ [10/13/11]
2 - moneywatch.bnet.com/economic-news/blog/financial-decoder/jill-on-money-stock-anniversary-mortgages-cash/5308/ [10/8/11]
3 - montoyaregistry.com/Financial-Market.aspx?financial-market=the-financial-security-rulebook-5-crucial-steps&category=3 [10/13/11]
4 - money.msn.com/retirement-investment/latest.aspx?post=9bb7f5b7-8c8a-4723-a543-7930cb51e2af [8/23/11]
5 - dealbook.nytimes.com/2011/09/23/banks-increase-holdings-in-derivatives/ [9/23/11]
6 - opensecrets.org/orgs/list.php?order=A [10/13/11]
7 - opensecrets.org/lobby/top.php?indexType=c [10/13/11]
8 - articles.latimes.com/2011/oct/08/business/la-fi-jobs-report-20111008 [10/8/11]
9 - businessweek.com/news/2011-09-30/u-s-economy-consumer-spending-cooled-in-august-as-wages-fell.html [9/30/11]
10 - latimes.com/business/la-fi-economy-retail-20111014,0,1716584.story?track=rss [10/14/11]
Tuesday, October 25, 2011
Tuesday, October 18, 2011
Another Recession? Don't Believe It
Key indicators point to an economy (slowly) on the mend.
This year, assorted economists and journalists have contended that the U.S. is on the edge of a new recession. Yet recent indicators hint that the economy is doing a bit better than some analysts think.
U.S. retail sales were up 1.1% in September. This is the kind of monthly number that you might expect during a typical recession recovery, and it surpassed the +0.7% consensus forecast of economists polled by Bloomberg News. Additionally, the Commerce Department revised August retail spending (formerly flat) to +0.3%. The year-over-year numbers in the September report really impress: we see annual gains of 7.9% for overall retail sales, 10.1% for online retailers, 6.9% for the restaurant and nightlife component, 7.6% for clothing shops and 6.5% for home and garden stores.1,2,3
As Credit Suisse economist Jonathan Basile told CNBC.com, “The fear of recession recedes when you see a retail sales report like this.” Basile said he was revising Credit Suisse’s 3Q 2011 GDP forecast for the U.S. north from +2.5% to +2.9%.4
GDP did improve in the second quarter. Real GDP was +0.4% in the first quarter of 2011, but the third and final real GDP estimate for the second quarter from the Bureau of Economic Analysis was +1.3%.5
“As of today, the recovery is still underway,” Berkshire Hathaway CEO Warren Buffett commented at an October 4 Fortune Magazine conference. “Our railroad carried 200,000 carloads last week,” he said, referring to the Burlington Northern Santa Fe company. “That’s the highest total in three years. And that’s stuff moving around the country, supplying merchants and doing all kinds of things.”6
Other signs of growth & stability can be seen. Here in October 2011, many corporations appear to be in better shape: U.S. non-financial firms have $15 trillion of potentially liquid cash or investments on hand compared to $13.7 trillion a year ago. American residential investment spending is up by $9 billion since a low-water mark last spring; existing home sales rose 7.7% in August and the backlog of homes for sale fell to an 8.5-month supply from the previous 9.5-month inventory. The Institute for Supply Management’s twin purchasing manager indexes still show ongoing sector expansion; the service sector has grown for 22 months.7,8,9
The continued vitality in consumer spending and other encouraging factors points to a recovery. It may seem unimpressive or frustrating, but it doesn’t indicate a recession.
Citations.
1 - sfgate.com/cgi-bin/article.cgi?f=/g/a/2011/10/14/bloomberg_articlesLT22VK6JTSEL.DTL [10/14/11]
2 - census.gov/retail/marts/www/marts_current.pdf [10/14/11]
3 - montoyaregistry.com/Financial-Market.aspx?financial-market=money-and-happiness&category=29 [10/7/11]
4 - cnbc.com/id/44906873 [9/30/11]
5 - bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm [9/29/11]
6 - businessweek.com/news/2011-10-07/rail-cargo-starts-to-peak-as-buffett-sees-no-recession-freight.html [10/7/11]
7 - washingtonpost.com/business/economy/the-simple-math-of-recession/2011/10/12/gIQAszvWiL_print.html [10/12/11]
8 - realtor.org/press_room/news_releases/2011/09/ehs_aug [9/21/11]
9 - ism.ws/ISMReport/NonMfgROB.cfm [10/5/11]
This year, assorted economists and journalists have contended that the U.S. is on the edge of a new recession. Yet recent indicators hint that the economy is doing a bit better than some analysts think.
U.S. retail sales were up 1.1% in September. This is the kind of monthly number that you might expect during a typical recession recovery, and it surpassed the +0.7% consensus forecast of economists polled by Bloomberg News. Additionally, the Commerce Department revised August retail spending (formerly flat) to +0.3%. The year-over-year numbers in the September report really impress: we see annual gains of 7.9% for overall retail sales, 10.1% for online retailers, 6.9% for the restaurant and nightlife component, 7.6% for clothing shops and 6.5% for home and garden stores.1,2,3
As Credit Suisse economist Jonathan Basile told CNBC.com, “The fear of recession recedes when you see a retail sales report like this.” Basile said he was revising Credit Suisse’s 3Q 2011 GDP forecast for the U.S. north from +2.5% to +2.9%.4
GDP did improve in the second quarter. Real GDP was +0.4% in the first quarter of 2011, but the third and final real GDP estimate for the second quarter from the Bureau of Economic Analysis was +1.3%.5
“As of today, the recovery is still underway,” Berkshire Hathaway CEO Warren Buffett commented at an October 4 Fortune Magazine conference. “Our railroad carried 200,000 carloads last week,” he said, referring to the Burlington Northern Santa Fe company. “That’s the highest total in three years. And that’s stuff moving around the country, supplying merchants and doing all kinds of things.”6
Other signs of growth & stability can be seen. Here in October 2011, many corporations appear to be in better shape: U.S. non-financial firms have $15 trillion of potentially liquid cash or investments on hand compared to $13.7 trillion a year ago. American residential investment spending is up by $9 billion since a low-water mark last spring; existing home sales rose 7.7% in August and the backlog of homes for sale fell to an 8.5-month supply from the previous 9.5-month inventory. The Institute for Supply Management’s twin purchasing manager indexes still show ongoing sector expansion; the service sector has grown for 22 months.7,8,9
The continued vitality in consumer spending and other encouraging factors points to a recovery. It may seem unimpressive or frustrating, but it doesn’t indicate a recession.
Citations.
1 - sfgate.com/cgi-bin/article.cgi?f=/g/a/2011/10/14/bloomberg_articlesLT22VK6JTSEL.DTL [10/14/11]
2 - census.gov/retail/marts/www/marts_current.pdf [10/14/11]
3 - montoyaregistry.com/Financial-Market.aspx?financial-market=money-and-happiness&category=29 [10/7/11]
4 - cnbc.com/id/44906873 [9/30/11]
5 - bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm [9/29/11]
6 - businessweek.com/news/2011-10-07/rail-cargo-starts-to-peak-as-buffett-sees-no-recession-freight.html [10/7/11]
7 - washingtonpost.com/business/economy/the-simple-math-of-recession/2011/10/12/gIQAszvWiL_print.html [10/12/11]
8 - realtor.org/press_room/news_releases/2011/09/ehs_aug [9/21/11]
9 - ism.ws/ISMReport/NonMfgROB.cfm [10/5/11]
Tuesday, October 11, 2011
STOCKS IN THE FOURTH QUARTER
Can the last quarter of 2011 live up to historical averages?
Is a rally ahead? You may have heard that stocks tend to do well in the fourth quarter. History affirms that perception: while past performance is no guarantee of future results, the last quarter of the year has historically been the best quarter of the year for U.S. equities. As data from Bespoke Investment Group notes:
• The S&P 500 has averaged a +2.44% performance in fourth quarters since 1928.
• In the last 20 years, it has averaged +4.57% in fourth quarters.
• In the last 30 years, it has advanced in 24 of 30 fourth quarters with an average price return of better than 7%.1
Will the Street put its anxieties aside? Right now, you have a lot of uncertainty. Many analysts see a stock market unimpressed by tepid domestic growth and waiting fearfully for the other shoe to drop (meaning Greece).They see more pain ahead for U.S. investors. On the other hand, there is also talk of when a point of capitulation might be reached, i.e., is Wall Street simply ready to rally even in the face of the debt troubles in Europe and the slow recovery here.
You could argue that certain Wall Street psychologies (and tensions) aid 4Q rallies. After all, the pay of money managers relates to performance and there is renewed pressure on them to come through as the end of a year looms.
Could new optimism surface? Perhaps it is surfacing now. As the third quarter wrapped up, Reuters polled 350 stock market analysts worldwide. Their consensus forecast was that 18 of 19 major world stock indices would either advance or suffer insignificant losses in the fourth quarter (Taiwan’s TAIEX was the lone exception in the forecast).2
They also felt that two indices would achieve 2011 gains: South Korea’s Kospi, and the Dow Jones Industrial Average. They think the Dow will end 2011 up about 2%. The Dow was at -5.74% YTD at the closing bell on September 30.3,4
On a particularly bullish note, Bloomberg surveyed 12 Wall Street strategists in early October and found them collectively forecasting the greatest 4Q rally in 13 years. They think that the S&P 500 will rise 15% this quarter, which would mean a push to 1,300 by New Year’s Day.5
Stocks certainly are cheap. Bloomberg data also indicated that when the S&P nearly closed at bear market levels in early October, it was down to 12x reported earnings; valuations were lower than they had been at any point since 2009. At the end of September, the MSCI World Index was trading at just above 10x its 12-month forward earnings, well under its average of 14.3x earnings since 2001.2,5
Some analysts are optimistic about the coming quarters. Indeed, the 350 analysts surveyed by Reuters are envisioning some impressive bull runs. They think Russia’s RTSI will advance 32% between now and mid-2012; they feel Brazil’s Bovespa will rise approximately as much in the next three quarters. If you follow emerging markets, forecasts like these may not surprise you much. However, they also see double-digit advances for the Dow, Nikkei 225, All Ordinaries, CAC 40 and DAX by mid-2012.2
Historically, stocks have had impressive resilience. Here are two other encouraging statistics in the wake of the Dow and S&P’s double-digit third quarter drops:
• The Dow had 14 quarterly losses of 10% or more in the period from 1962-2009. In 79% of the ensuing quarters, the Dow pulled off a quarterly gain.
• The S&P suffered 11 quarterly losses of 10% or more during a stretch from 1981-2009. In 80% of the following quarters, it posted a quarterly gain.6
Another 4Q rally depends on many variables, but if Greece avoids default and 3Q earnings don’t disappoint, we might see a better end to 2011 than the bears anticipate.
Citations.1 - moneywatch.bnet.com/investing/blog/investment-insights/stocks-ready-for-fourth-quarter-rally/2833/ [10/3/11]
2 - reuters.com/article/2011/09/29/us-markets-stocks-poll-idUSTRE78S4EK20110929 [9/29/11]
3 - montoyaregistry.com/Financial-Market.aspx?financial-market=an-introduction-to-the-stock-market&category=29 [10/7/11]
4 - cnbc.com/id/44729786 [9/30/11]
5 - bloomberg.com/news/2011-10-07/stock-index-futures-in-u-s-rally-after-employment-growth-beats-forecasts.html [10/7/11]
6 - cnbc.com/id/44677114/Third_Quarter_Pain_Fourth_Quarter_Gain [9/29/11]
Is a rally ahead? You may have heard that stocks tend to do well in the fourth quarter. History affirms that perception: while past performance is no guarantee of future results, the last quarter of the year has historically been the best quarter of the year for U.S. equities. As data from Bespoke Investment Group notes:
• The S&P 500 has averaged a +2.44% performance in fourth quarters since 1928.
• In the last 20 years, it has averaged +4.57% in fourth quarters.
• In the last 30 years, it has advanced in 24 of 30 fourth quarters with an average price return of better than 7%.1
Will the Street put its anxieties aside? Right now, you have a lot of uncertainty. Many analysts see a stock market unimpressed by tepid domestic growth and waiting fearfully for the other shoe to drop (meaning Greece).They see more pain ahead for U.S. investors. On the other hand, there is also talk of when a point of capitulation might be reached, i.e., is Wall Street simply ready to rally even in the face of the debt troubles in Europe and the slow recovery here.
You could argue that certain Wall Street psychologies (and tensions) aid 4Q rallies. After all, the pay of money managers relates to performance and there is renewed pressure on them to come through as the end of a year looms.
Could new optimism surface? Perhaps it is surfacing now. As the third quarter wrapped up, Reuters polled 350 stock market analysts worldwide. Their consensus forecast was that 18 of 19 major world stock indices would either advance or suffer insignificant losses in the fourth quarter (Taiwan’s TAIEX was the lone exception in the forecast).2
They also felt that two indices would achieve 2011 gains: South Korea’s Kospi, and the Dow Jones Industrial Average. They think the Dow will end 2011 up about 2%. The Dow was at -5.74% YTD at the closing bell on September 30.3,4
On a particularly bullish note, Bloomberg surveyed 12 Wall Street strategists in early October and found them collectively forecasting the greatest 4Q rally in 13 years. They think that the S&P 500 will rise 15% this quarter, which would mean a push to 1,300 by New Year’s Day.5
Stocks certainly are cheap. Bloomberg data also indicated that when the S&P nearly closed at bear market levels in early October, it was down to 12x reported earnings; valuations were lower than they had been at any point since 2009. At the end of September, the MSCI World Index was trading at just above 10x its 12-month forward earnings, well under its average of 14.3x earnings since 2001.2,5
Some analysts are optimistic about the coming quarters. Indeed, the 350 analysts surveyed by Reuters are envisioning some impressive bull runs. They think Russia’s RTSI will advance 32% between now and mid-2012; they feel Brazil’s Bovespa will rise approximately as much in the next three quarters. If you follow emerging markets, forecasts like these may not surprise you much. However, they also see double-digit advances for the Dow, Nikkei 225, All Ordinaries, CAC 40 and DAX by mid-2012.2
Historically, stocks have had impressive resilience. Here are two other encouraging statistics in the wake of the Dow and S&P’s double-digit third quarter drops:
• The Dow had 14 quarterly losses of 10% or more in the period from 1962-2009. In 79% of the ensuing quarters, the Dow pulled off a quarterly gain.
• The S&P suffered 11 quarterly losses of 10% or more during a stretch from 1981-2009. In 80% of the following quarters, it posted a quarterly gain.6
Another 4Q rally depends on many variables, but if Greece avoids default and 3Q earnings don’t disappoint, we might see a better end to 2011 than the bears anticipate.
Citations.1 - moneywatch.bnet.com/investing/blog/investment-insights/stocks-ready-for-fourth-quarter-rally/2833/ [10/3/11]
2 - reuters.com/article/2011/09/29/us-markets-stocks-poll-idUSTRE78S4EK20110929 [9/29/11]
3 - montoyaregistry.com/Financial-Market.aspx?financial-market=an-introduction-to-the-stock-market&category=29 [10/7/11]
4 - cnbc.com/id/44729786 [9/30/11]
5 - bloomberg.com/news/2011-10-07/stock-index-futures-in-u-s-rally-after-employment-growth-beats-forecasts.html [10/7/11]
6 - cnbc.com/id/44677114/Third_Quarter_Pain_Fourth_Quarter_Gain [9/29/11]
Thursday, October 6, 2011
How Does Greece Impact Me?
Is it all negative, or are there opportunities to consider because of the crisis?
Many economists think a Greek default is inevitable. As we enter 4Q 2011, Greece has a debt-to-GDP ratio of about 160% (and that percentage is rising). While Greece accounts for less than 3% of Eurozone GDP, ripples from a Greek default could strain the European banking sector and global financial markets.1,7
Struggling for the best worst-case scenario. Greece is redoing its financial system, but it is still facing one of five potential (and painful) outcomes.
Greece renegotiates its debts & forces its lenders into write-offs. Many Greek banks are nationalized; Greece endures a long recession.
Greece can't renegotiate its debts. It sinks into a multi-year depression exacerbated by additional austerity measures.
Greece rejects further austerity cuts recommended by the EU. A standoff with the International Monetary Fund and European Central Bank results; the ECB and IMF blink and continue bailout payments to Greece; Italy and Spain see the way Greece made the ECB and IMF cave in and later wrestle the ECB and IMF into submission in the same way; Germany gets frustrated with all this and ditches the euro.
Greece rejects more austerity cuts & the EU stops bailout payments. Civil unrest jeopardizes the country. Its banks close; its public services halt. The CIA has advised that a coup may occur in Greece in such a scenario.
Greece lapses into a banking/cash flow crisis & leaves the euro.This is the "doomsday" scenario. Assume #4 occurs with Greece also electing to go back to the drachma. That could mean a run on Greek banks, and then Spanish and Italian banks. A return to the drachma could mean frozen borrowing for Italy and Spain and possibly lead to insolvency for major banks in Europe. Picture 17 nations trying to agree on and quickly implement an EU version of TARP. Havoc could result for stocks and the global economy.2
This all sounds very gloomy, but prospects may emerge from the gloom.
A(nother) golden opportunity? In the event Greece defaults, the search for safe havens could mean a quick flight to gold. If a Greek bailout succeeds, there may still be fiscal instability among EU members, and presumably an easy monetary policy fostering loose credit. If Greece defaults, then you could see big drops in the spot prices of currencies plus some competitive devaluation. All of this could make gold look very, very good.
On the other hand, if true systemic risk hits global markets, investment banks and hedge funds might need capital fast - and gold is easily liquidated. So a gold selloff could also possibly occur if the situation becomes dire.
What about Treasuries & the dollar? Treasuries remain popular, and demand for them could jump after a Greek default. What other choices do central banks have if they want to shop around for a stable, readily available, reasonably liquid investment? The euro is hardly a rival to the greenback right now.
How about emerging markets? Here is another option. The BRICs and some of the other emerging-market nations have managed to ride out the recent volatility fairly well - there has been some "decoupling", if you will.8 No one is saying these markets would be immune from a continental banking crisis or a flight from stocks, but you have to concede that emerging markets have the capability for independent behavior.
Would it still be worthwhile to own blue chips? Keep in mind that the Dow did not fall to 4,000 after the Lehman Bros. and Washington Mutual failures and the initial rejection of TARP by Congress. Stocks did pull out of that plunge, and spectacularly so; bargains abounded, for that matter. So it might certainly be worthwhile to hold onto stocks in the coming months, especially as some European governments have hinted at possible capital injections for banks if the need arises. On September 13, German chancellor Angela Merkel noted that the EU would not let Greece fall into "uncontrolled insolvency" and reports surfaced of China getting ready to purchase Greek debt. Treasury Secretary Timothy Geithner even got involved in the search for solutions in mid-September.3
Europe's biggest private lenders may be deemed "too big to fail" by the EU and ECB, and if unwinding of any financial institutions is needed, the authorities should do everything within their reach to try and make it gradual.
It could be that Wall Street has already priced in a Greek default and will just wince, not stumble, at its confirmation - assuming the news arrives with more inevitability than frenzy.
The biggest fear of all: contagion. Italy and Spain may be "too big to fail" in the eyes of the EU and IMF, but they also face big debt problems. Standard & Poor's cut Italy's credit rating to 'A' in September; Moody's Investors Service is weighing downgrades for Italy and Spain before November.4,5
How diversified are you? These debt issues in Europe may linger for years.With the market so volatile, don't forget the wisdom of having a diversely allocated portfolio.
Citations.
1 - business.financialpost.com/2011/09/21/preparations-for-greek-default-gathering-steam/ [9/21/11]
2 - bbc.co.uk/news/business-14977728 [9/21/11]
3 - thestreet.com/story/11246102/1/stock-futures-sept-13.html [9/13/11]
4 - nytimes.com/2010/01/29/business/global/29bailout.html [1/29/10]
5 - businessweek.com/news/2011-09-20/italy-credit
Many economists think a Greek default is inevitable. As we enter 4Q 2011, Greece has a debt-to-GDP ratio of about 160% (and that percentage is rising). While Greece accounts for less than 3% of Eurozone GDP, ripples from a Greek default could strain the European banking sector and global financial markets.1,7
Struggling for the best worst-case scenario. Greece is redoing its financial system, but it is still facing one of five potential (and painful) outcomes.
Greece renegotiates its debts & forces its lenders into write-offs. Many Greek banks are nationalized; Greece endures a long recession.
Greece can't renegotiate its debts. It sinks into a multi-year depression exacerbated by additional austerity measures.
Greece rejects further austerity cuts recommended by the EU. A standoff with the International Monetary Fund and European Central Bank results; the ECB and IMF blink and continue bailout payments to Greece; Italy and Spain see the way Greece made the ECB and IMF cave in and later wrestle the ECB and IMF into submission in the same way; Germany gets frustrated with all this and ditches the euro.
Greece rejects more austerity cuts & the EU stops bailout payments. Civil unrest jeopardizes the country. Its banks close; its public services halt. The CIA has advised that a coup may occur in Greece in such a scenario.
Greece lapses into a banking/cash flow crisis & leaves the euro.This is the "doomsday" scenario. Assume #4 occurs with Greece also electing to go back to the drachma. That could mean a run on Greek banks, and then Spanish and Italian banks. A return to the drachma could mean frozen borrowing for Italy and Spain and possibly lead to insolvency for major banks in Europe. Picture 17 nations trying to agree on and quickly implement an EU version of TARP. Havoc could result for stocks and the global economy.2
This all sounds very gloomy, but prospects may emerge from the gloom.
A(nother) golden opportunity? In the event Greece defaults, the search for safe havens could mean a quick flight to gold. If a Greek bailout succeeds, there may still be fiscal instability among EU members, and presumably an easy monetary policy fostering loose credit. If Greece defaults, then you could see big drops in the spot prices of currencies plus some competitive devaluation. All of this could make gold look very, very good.
On the other hand, if true systemic risk hits global markets, investment banks and hedge funds might need capital fast - and gold is easily liquidated. So a gold selloff could also possibly occur if the situation becomes dire.
What about Treasuries & the dollar? Treasuries remain popular, and demand for them could jump after a Greek default. What other choices do central banks have if they want to shop around for a stable, readily available, reasonably liquid investment? The euro is hardly a rival to the greenback right now.
How about emerging markets? Here is another option. The BRICs and some of the other emerging-market nations have managed to ride out the recent volatility fairly well - there has been some "decoupling", if you will.8 No one is saying these markets would be immune from a continental banking crisis or a flight from stocks, but you have to concede that emerging markets have the capability for independent behavior.
Would it still be worthwhile to own blue chips? Keep in mind that the Dow did not fall to 4,000 after the Lehman Bros. and Washington Mutual failures and the initial rejection of TARP by Congress. Stocks did pull out of that plunge, and spectacularly so; bargains abounded, for that matter. So it might certainly be worthwhile to hold onto stocks in the coming months, especially as some European governments have hinted at possible capital injections for banks if the need arises. On September 13, German chancellor Angela Merkel noted that the EU would not let Greece fall into "uncontrolled insolvency" and reports surfaced of China getting ready to purchase Greek debt. Treasury Secretary Timothy Geithner even got involved in the search for solutions in mid-September.3
Europe's biggest private lenders may be deemed "too big to fail" by the EU and ECB, and if unwinding of any financial institutions is needed, the authorities should do everything within their reach to try and make it gradual.
It could be that Wall Street has already priced in a Greek default and will just wince, not stumble, at its confirmation - assuming the news arrives with more inevitability than frenzy.
The biggest fear of all: contagion. Italy and Spain may be "too big to fail" in the eyes of the EU and IMF, but they also face big debt problems. Standard & Poor's cut Italy's credit rating to 'A' in September; Moody's Investors Service is weighing downgrades for Italy and Spain before November.4,5
How diversified are you? These debt issues in Europe may linger for years.With the market so volatile, don't forget the wisdom of having a diversely allocated portfolio.
Citations.
1 - business.financialpost.com/2011/09/21/preparations-for-greek-default-gathering-steam/ [9/21/11]
2 - bbc.co.uk/news/business-14977728 [9/21/11]
3 - thestreet.com/story/11246102/1/stock-futures-sept-13.html [9/13/11]
4 - nytimes.com/2010/01/29/business/global/29bailout.html [1/29/10]
5 - businessweek.com/news/2011-09-20/italy-credit
Obama's New Tax Proposals and the "Buffet Rule"
How tax rates might change for the wealthy under the new plan.
On September 19, President Obama laid out a plan to slash $4.4 trillion from the federal deficit by fiscal year 2021 - a plan featuring $1.6 trillion in tax increases for upper-income Americans and corporations.
· The Bush-era income tax cuts would expire in 2013 for high-income households (the highest tax brackets would presumably reset to 36% and 39.6%).
· The federal estate tax would return to 2009 levels in 2013 (a 45% rate with a $3.5 million exemption).
· Tax deductions would presently be reduced for individuals making $200,000 or more annually and households making $250,000 annually.
· The LIFO accounting method for business inventories would be invalid starting in 2013.
· The lower-of-cost-or-market-inventory accounting method for deductions on unsold goods would also be jettisoned.
· Investment partnerships would face higher taxes in future years.
· Deductions and credits for oil and gas activities would be removed.
· Tax rules for U.S. taxpayers subject to foreign taxes would be revised.1,2,3,4
A poll shows broad public approval. President Obama had mentioned tax hikes to pay for his recently unveiled $447 billion American Jobs Act. By linking taxes on the wealthy to job creation, Obama appealed not only to his progressive base but also to the broad middle class.
A September 20 Gallup survey showed 66% of Americans in favor of raising taxes for individuals making $200,000 or more annually and families making $250,000 annually. Additionally, 70% of respondents liked the idea of getting rid of certain corporate tax breaks.5
Will there be a tax floor for millionaires? President Obama referenced creating a "Buffett rule" in a nod to Warren Buffett's August 14 New York Times op-ed piece, in which Buffett mentioned that his 2010 federal tax bill amounted to only 17.4% of his taxable income and that Capitol Hill legislators seemed "compelled" to protect multimillionaires "as if we were spotted owls or some other endangered species." Buffett and Obama both think that the rich should pay proportionately greater federal taxes.6
But do they already? According to the non-partisan Tax Policy Center, they do. The TPC says the average U.S. millionaire pays 20.1% of his/her total income back to the IRS in income and payroll taxes, compared to 16.0% for the average American. While many millionaires generate income from sources besides wages and make the most of charitable gifting strategies, it seems many are being taxed proportionately.7
Where would the floor be? While the President views the proposed "Buffett rule" as a key starting point for tax reform, few details have emerged about it. On September 19, Treasury Secretary Timothy Geithner remarked that "we're not going to give the Congress a detailed proposal for how to meet that specific principle now because there's lots of different ways to do that."7
Daniel Indiviglio, a business writer for The Atlantic, recently spent a column exploring the hypothetical tax impact of a "Buffett rule". He ran some numbers using 2009 IRS data (the most recent available) on adjusted gross incomes. He found that if the government had instituted a 35% minimum tax for all Americans who earned more than $1 million in 2009, an additional $37 billion in revenue would have been generated - certainly handy, but not exactly a big dent in what was a $1.5 trillion shortfall. Raise the floor to the pre-EGTRRA 39.6% and the number climbs to $66 billion. Even if millionaires had been hit with a 75% marginal tax rate in 2009, the additional 2009 revenue would have amounted to less than 20% of the 2009 deficit. (Effective tax rates for these millionaires might have been a lot lower - after all, the S&P 500 gained 24% in 2009.)8
The "Buffett rule" could be modified ... or abridged ... or forgotten. While many Americans would like to see millionaires pay equivalent or greater income tax than the middle class, putting such a rule into play would be tricky.
Many middle-class families can take advantage of a bundle of deductions and exemptions which can lower their effective tax rate. Then you have the possibility of a multimillionaire receiving 100% of his or her income from long-term capital gains or dividends (15% current rate) or tax-exempt interest. Figuring a minimum tax rate for millionaires becomes harder when you consider these factors; in fact, Tax Policy Center senior fellow Roberton Williams told Bloomberg that it might require a federal definition of "income".9
The Obama-appointed National Commission on Fiscal Responsibility and Reform has proposed dropping the preferential capital gains tax rates as an element of a broad tax code revamp that would also reduce marginal tax rates. Bloomberg notes that "several bipartisan groups" including the NCFRR support this notion - and it might be the closest thing to a "Buffett rule" that emerges from the great tax and deficit discussion of 2011.
Citations.
1 - usatoday.com/news/washington/story/2011-09-19/Obama-deficit-reduction-plan/50470916/1 [9/19/11]
2 - forbes.com/2010/07/22/expiring-bush-cuts-affect-personal-finance-taxes.html [7/22/10]
3 - montoyaregistry.com/Financial-Market.aspx?financial-market=what-is-tax-efficiency-and-why-does-it-matter&category=31 [9/19/11]
4 - blogs.reuters.com/reuters-money/2010/10/04/estate-tax-uncertainty-planning-for-2011/ [10/4/10]
5 - usnews.com/opinion/blogs/robert-schlesinger/2011/09/20/poll-most-americans-support-obama-deficit-plan-to-tax-rich [9/20/11]
6 - nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.html [8/14/11]
7 - money.cnn.com/2011/09/20/news/economy/buffett_rule_milllonaires/index.htm [9/20/11]
8 - theatlantic.com/business/archive/2011/09/chart-of-the-day-buffett-rule-wouldnt-bring-in-much-revenue/245404/ [9/20/11]
9 - bloomberg.com/news/2011-09-19/-millionaire-tax-seen-easier-said-than-done.html [9/19/11]
On September 19, President Obama laid out a plan to slash $4.4 trillion from the federal deficit by fiscal year 2021 - a plan featuring $1.6 trillion in tax increases for upper-income Americans and corporations.
· The Bush-era income tax cuts would expire in 2013 for high-income households (the highest tax brackets would presumably reset to 36% and 39.6%).
· The federal estate tax would return to 2009 levels in 2013 (a 45% rate with a $3.5 million exemption).
· Tax deductions would presently be reduced for individuals making $200,000 or more annually and households making $250,000 annually.
· The LIFO accounting method for business inventories would be invalid starting in 2013.
· The lower-of-cost-or-market-inventory accounting method for deductions on unsold goods would also be jettisoned.
· Investment partnerships would face higher taxes in future years.
· Deductions and credits for oil and gas activities would be removed.
· Tax rules for U.S. taxpayers subject to foreign taxes would be revised.1,2,3,4
A poll shows broad public approval. President Obama had mentioned tax hikes to pay for his recently unveiled $447 billion American Jobs Act. By linking taxes on the wealthy to job creation, Obama appealed not only to his progressive base but also to the broad middle class.
A September 20 Gallup survey showed 66% of Americans in favor of raising taxes for individuals making $200,000 or more annually and families making $250,000 annually. Additionally, 70% of respondents liked the idea of getting rid of certain corporate tax breaks.5
Will there be a tax floor for millionaires? President Obama referenced creating a "Buffett rule" in a nod to Warren Buffett's August 14 New York Times op-ed piece, in which Buffett mentioned that his 2010 federal tax bill amounted to only 17.4% of his taxable income and that Capitol Hill legislators seemed "compelled" to protect multimillionaires "as if we were spotted owls or some other endangered species." Buffett and Obama both think that the rich should pay proportionately greater federal taxes.6
But do they already? According to the non-partisan Tax Policy Center, they do. The TPC says the average U.S. millionaire pays 20.1% of his/her total income back to the IRS in income and payroll taxes, compared to 16.0% for the average American. While many millionaires generate income from sources besides wages and make the most of charitable gifting strategies, it seems many are being taxed proportionately.7
Where would the floor be? While the President views the proposed "Buffett rule" as a key starting point for tax reform, few details have emerged about it. On September 19, Treasury Secretary Timothy Geithner remarked that "we're not going to give the Congress a detailed proposal for how to meet that specific principle now because there's lots of different ways to do that."7
Daniel Indiviglio, a business writer for The Atlantic, recently spent a column exploring the hypothetical tax impact of a "Buffett rule". He ran some numbers using 2009 IRS data (the most recent available) on adjusted gross incomes. He found that if the government had instituted a 35% minimum tax for all Americans who earned more than $1 million in 2009, an additional $37 billion in revenue would have been generated - certainly handy, but not exactly a big dent in what was a $1.5 trillion shortfall. Raise the floor to the pre-EGTRRA 39.6% and the number climbs to $66 billion. Even if millionaires had been hit with a 75% marginal tax rate in 2009, the additional 2009 revenue would have amounted to less than 20% of the 2009 deficit. (Effective tax rates for these millionaires might have been a lot lower - after all, the S&P 500 gained 24% in 2009.)8
The "Buffett rule" could be modified ... or abridged ... or forgotten. While many Americans would like to see millionaires pay equivalent or greater income tax than the middle class, putting such a rule into play would be tricky.
Many middle-class families can take advantage of a bundle of deductions and exemptions which can lower their effective tax rate. Then you have the possibility of a multimillionaire receiving 100% of his or her income from long-term capital gains or dividends (15% current rate) or tax-exempt interest. Figuring a minimum tax rate for millionaires becomes harder when you consider these factors; in fact, Tax Policy Center senior fellow Roberton Williams told Bloomberg that it might require a federal definition of "income".9
The Obama-appointed National Commission on Fiscal Responsibility and Reform has proposed dropping the preferential capital gains tax rates as an element of a broad tax code revamp that would also reduce marginal tax rates. Bloomberg notes that "several bipartisan groups" including the NCFRR support this notion - and it might be the closest thing to a "Buffett rule" that emerges from the great tax and deficit discussion of 2011.
Citations.
1 - usatoday.com/news/washington/story/2011-09-19/Obama-deficit-reduction-plan/50470916/1 [9/19/11]
2 - forbes.com/2010/07/22/expiring-bush-cuts-affect-personal-finance-taxes.html [7/22/10]
3 - montoyaregistry.com/Financial-Market.aspx?financial-market=what-is-tax-efficiency-and-why-does-it-matter&category=31 [9/19/11]
4 - blogs.reuters.com/reuters-money/2010/10/04/estate-tax-uncertainty-planning-for-2011/ [10/4/10]
5 - usnews.com/opinion/blogs/robert-schlesinger/2011/09/20/poll-most-americans-support-obama-deficit-plan-to-tax-rich [9/20/11]
6 - nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.html [8/14/11]
7 - money.cnn.com/2011/09/20/news/economy/buffett_rule_milllonaires/index.htm [9/20/11]
8 - theatlantic.com/business/archive/2011/09/chart-of-the-day-buffett-rule-wouldnt-bring-in-much-revenue/245404/ [9/20/11]
9 - bloomberg.com/news/2011-09-19/-millionaire-tax-seen-easier-said-than-done.html [9/19/11]
What's the Worst That Could Happen?
If you've been paying close attention, you might have noticed that the U.S. and global investment markets have been bouncing around unpredictably from one day to the next, and every time there is a major move, you hear analysts mumbling something about the debt crisis in Europe. On the up days, they talk about light at the end of the tunnel. On the down days, they talk about the possible collapse of the Euro as a currency, or the breakup of the Eurozone.
The assumption seems to be that if Europe were to devolve back into multiple currencies, there would be dire consequences for the global economy--and your stock portfolio. Or, if the various bailout measures work, people seem to assume that the world will enjoy economic sunshine.
On September 29, the German parliament will vote on whether to authorize a major bailout, and Austria and the Netherlands expected to vote on similar proposals soon thereafter. We can expect more volatility in the next week or so, as pundits, economists and day traders speculate on which way the political winds are blowing.
But how important are these votes, really? What if the gloomiest predictions are right? What if Germany decides to leave the Greeks to their fate, and Greece were forced to secede from the Euro and start printing drachmas all over again? What if Ireland took back control of its own currency? Or (what seems to be the scariest scenario) if Italy were to drop out of the Euro to get its fiscal house in order?
A recent analysis by Stratfor Global Intelligence points out something that many people (especially investors) seem to have forgotten: that Europe's individual countries were the world's leading economic powers for centuries without the convenience of a common currency, and often while they were engaged in fierce wars with each other. Since World War II, before the advent of the Euro, the various citizens of Europe created a local free-trade zone. But even they adopted common guidelines for managing fiscal policy, and voted to create a common currency, they never gave up their local languages, customs or pride in their individual nationalities.
The Stratfor article points out the obvious: that Germany and Greece are still different countries in different places with different value systems and interests. The idea of sacrificing for each other was always a dubious concept, especially the idea of sacrificing in order to hang onto a mutual currency that nearly 50% of both populations never wanted in the first place.
If Greece--or any other nation--were to secede from the Euro, it might actually relieve the pressure that the world is experiencing now. Greece would be able to print more Drachmas, inflate its currency a bit, and make its foreign debt less onerous. Of course, this would function like a stealth tax on its citizens--their income would be worth less--so the pain would be shared among the European banks holding Greek bonds and the citizens who fiercely oppose paying higher taxes in order to pay off foreign creditors. This might be a more workable solution that either an outright default or German citizens reaching deep into their own pockets.
In fact, the Stratfor analysis suggests that this breakup might be inevitable anyway. "Does Greece or Portugal really want to give Germany a blank check to export what it wants, or would they prefer managed trade under their control?" it asks plausibly. "Play this forward past the euro crisis, and the foundations of a unified Europe become questionable."
Stratfor's conclusion is that Europe will remain an enormously prosperous place under either scenario--bailout or not. Does anybody seriously disagree with that? And yet isn't that what the pundits and others are ultimately calling into question?
If the worst case were to play out, if Germany votes not to fund a bailout and several PIIGs decide to opt out of the Euro, what then? If our worst fears are realized and the consequences are not nearly as bad as everyone seemed to imagine, you might see a lot of investors returning to the market to buy the stocks they unloaded when they thought the world was going to end.
Sources:
Germany's vote: http://money.cnn.com/2011/09/08/markets/europe_debt_crisis_/index.htm
Europe's potential breakup: http://www.stratfor.com/weekly/20110912-crisis-europe-and-european-nationalism
The assumption seems to be that if Europe were to devolve back into multiple currencies, there would be dire consequences for the global economy--and your stock portfolio. Or, if the various bailout measures work, people seem to assume that the world will enjoy economic sunshine.
On September 29, the German parliament will vote on whether to authorize a major bailout, and Austria and the Netherlands expected to vote on similar proposals soon thereafter. We can expect more volatility in the next week or so, as pundits, economists and day traders speculate on which way the political winds are blowing.
But how important are these votes, really? What if the gloomiest predictions are right? What if Germany decides to leave the Greeks to their fate, and Greece were forced to secede from the Euro and start printing drachmas all over again? What if Ireland took back control of its own currency? Or (what seems to be the scariest scenario) if Italy were to drop out of the Euro to get its fiscal house in order?
A recent analysis by Stratfor Global Intelligence points out something that many people (especially investors) seem to have forgotten: that Europe's individual countries were the world's leading economic powers for centuries without the convenience of a common currency, and often while they were engaged in fierce wars with each other. Since World War II, before the advent of the Euro, the various citizens of Europe created a local free-trade zone. But even they adopted common guidelines for managing fiscal policy, and voted to create a common currency, they never gave up their local languages, customs or pride in their individual nationalities.
The Stratfor article points out the obvious: that Germany and Greece are still different countries in different places with different value systems and interests. The idea of sacrificing for each other was always a dubious concept, especially the idea of sacrificing in order to hang onto a mutual currency that nearly 50% of both populations never wanted in the first place.
If Greece--or any other nation--were to secede from the Euro, it might actually relieve the pressure that the world is experiencing now. Greece would be able to print more Drachmas, inflate its currency a bit, and make its foreign debt less onerous. Of course, this would function like a stealth tax on its citizens--their income would be worth less--so the pain would be shared among the European banks holding Greek bonds and the citizens who fiercely oppose paying higher taxes in order to pay off foreign creditors. This might be a more workable solution that either an outright default or German citizens reaching deep into their own pockets.
In fact, the Stratfor analysis suggests that this breakup might be inevitable anyway. "Does Greece or Portugal really want to give Germany a blank check to export what it wants, or would they prefer managed trade under their control?" it asks plausibly. "Play this forward past the euro crisis, and the foundations of a unified Europe become questionable."
Stratfor's conclusion is that Europe will remain an enormously prosperous place under either scenario--bailout or not. Does anybody seriously disagree with that? And yet isn't that what the pundits and others are ultimately calling into question?
If the worst case were to play out, if Germany votes not to fund a bailout and several PIIGs decide to opt out of the Euro, what then? If our worst fears are realized and the consequences are not nearly as bad as everyone seemed to imagine, you might see a lot of investors returning to the market to buy the stocks they unloaded when they thought the world was going to end.
Sources:
Germany's vote: http://money.cnn.com/2011/09/08/markets/europe_debt_crisis_/index.htm
Europe's potential breakup: http://www.stratfor.com/weekly/20110912-crisis-europe-and-european-nationalism
Tuesday, October 4, 2011
Gloom, Doom and the Hidden Rays of Hope
By any reasonable measure, the past three months have been among the gloomiest fiscal quarters on record for the investment markets. The debt ceiling debate, constant dithering in Europe over whether or not Eurozone members should be allowed to default on their sovereign debt, partisan bickering, the downgrade of U.S. government debt, continued unemployment and a general unsettled feeling about the economic recovery have all combined to put investors in a pessimistic mood. When people are pessimistic about the future, they sell--as they did, steadily and persistently, through what will be remembered as the gloomy summer of 2011.
It is hard to remember now that in the first quarter, just a few months ago, the markets were flirting with a full recovery from the 2008 debacle, or that before this quarter started the markets were in positive territory overall for 2011.
The Wilshire 5000 index, which most closely reflects the total U.S. stock inventory, dropped a remarkable 12.85% of its total value for the quarter. This wiped out the gains of the previous two quarters; the index is now down 7.54% for the year. The comparable Russell 3000 index fell 15.28% in the three months ending September 30, ending the quarter down 9.90% for the year.
The Wilshire U.S. Large-Cap index fell 12.03% during the third quarter, and is now down 6.76% for the first three quarters of 2011. The Russell 1000 large cap index was down 14.68% for the third quarter; taking it to a negative 9.25% return for the first three quarters of the year. The more widely-followed S&P 500 index of the largest companies domiciled in the U.S. was down 13.87% for the quarter, giving it a loss of 8.68% so far this year.
The Wilshire U.S. Mid-Cap index dropped 18.93% over the third quarter, and is now down 11.15% for the year. The comparable Russell Midcap index fell 18.90%, putting it down 12.34% so far this year.
The Wilshire U.S. Small-Cap index plunged 19.34% over the three months ending September 30, and holds a 13.46% loss for the year. The Russell 2000 small cap index fell 21.87% in the third quarter, placing it down 17.02% for the year.
The technology-heavy Nasdaq Composite index retreated 12.91% in the three month period ending September 30, and is now down 8.95% for the year.
Internationally, the results were much the same--only more so. The EAFE index, which represents large cap stocks across the developed world, plunged 19.60% for the quarter, and is down 17.18% for the year. Europe as a whole was down 23.00% for the quarter; the Far East dropped 9.64%, and the EAFE emerging markets index of developing nations fell 22.88%.
Even the assets that are supposed to zig when the stock market zags were down comparably for the quarter. The Wilshire REIT index of real estate investment trusts was down 12.10% for the third quarter; moving it down 2.54% for the year. Commodities told the same story: energy stocks, including petroleum producers, were down 12.99% for the quarter, industrial metals fell 22.46%, and even gold, which finished the quarter up 7.82%, experienced a drop of 11.43% in September.
Just when you thought that yields on government bonds couldn't go any lower, they did: bonds of up to 1-year maturity are essentially paying zero interest, while five-year Treasuries are paying 1% a year, and 10-year Treasury issues lock you in at 2.125% a year.
It is usually more difficult to read the minds of the investing public than the cable financial programs and financial press makes it appear; the headlines one day will say that stocks fell after the Fed issued a warning about the economy, and the next day we will learn that stocks rose because the Fed was so worried about the economy that it might lower interest rates.
However, this summer there was a certain clarity about the cause of the malaise; the S&P 500 was routed to the tune of a 2.2% one-day loss on August 2, right after Congress finally agreed to a messy compromise on the debt ceiling. It was clear that many people were questioning whether our lawmakers have a clear grasp of the financial and economic challenges facing a nation that is still climbing out of the worst recession since the second world war. When they look overseas, they see that European governments are, if possible, even less functional in their approach to repairing the global economy. On August 4, the S&P 500 fell 4.3%; it fell 5.6% on August 6 and another 4.4% on August 8--and those four days represented nearly all of the damage for the quarter.
September, of course, was worse, and the handwriting was on the wall when the S&P 500 experienced its worst first week start in its five-decade history. (Yes, that includes the Fall of 2008.) A brief five-day rally gave us a 4% bump in value, but the end of the month was dismal, with a 2.9% drop on September 21, followed by a 3.2% fall the next trading day. Altogether, the index was down 6% for the month.
Is gloom and doom the real story about the economy, or is it a reflection of unfounded fear? The NumberNomics economic web site notes that the U.S. GDP (the broadest measure of economic activity) actually grew 2.3% for the past three months, a much faster growth rate that the anemic first quarter (0.4%) and only slightly-more-promising second quarter (1.3%). Do those numbers look like they are moving the economy toward a double-dip recession, as many investors seem to fear?
Another fear is that the Eurozone will collapse under the weight of Greek debt. But there is good news on that front as well; the German parliament voted on September 29 to support the expansion of the European Financial Stability Facility by a surprising 315-85 margin. Germany is the 10th--and most important--of the Eurozone members to ratify the bailout agreement
Meanwhile, supply shortages of oil have eased from the start of the year, causing oil prices to drop. Consumers have paid down enormous amounts of debt over the past three years, bringing them in line with where the consumer debt burden has been for the past 30 years. Corporate profits and cash levels remain at record high levels, and there are signs that the unemployment problem is starting to ease--although it will be years before we seen unemployment fall to levels seen in the early part of this century.
With all this good news hiding behind headlines about U.S. and European sovereign debt levels, it is hard to predict that the markets will rally decisively. But it is also difficult to bet against a sudden shift in sentiment, especially since there have been so many in the past few years. The wisest heads in the investment game tend to see the optimistic side of the situation when the markets are most gloomy, and see the dark clouds gathering when everyone else is enjoying a strong runup in stocks.
Despite what you hear on the cable financial news channels, nobody really knows how long stocks will remain on sale or how long it will take for the global economy to finally sort itself out. We DO know, from past experience, that eventually the economy recovers from even the most severe shocks, and (again, eventually) the markets return to health. History tells us that a recovery is inevitable, and it seems to be visibly underway somewhere behind the hubbub of the negative press, partisan bickering and occasional market panics.
When investors figure that out, there will be another bull run and (this we can predict with confidence), people in that happy time will forget all over again that stocks can go down as well as up. That's when you'll hear our lonely voices talking about the downside risks.
SOURCES:
GDP estimates, inflation and corporate profits: http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
Wilshire index data: http://www.wilshire.com/Indexes/calculator/
Russell index data: http://www.russell.com/indexes/data/daily_total_returns_us.asp
S%P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf--p-us-l--
Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP
International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html
Commodities index data: http://www.standardandpoors.com/indices/sp-gsci/en/us/?indexId=spgscirg--usd----sp------
Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
Numbernomics.com: http://www.numbernomics.com/nomicsnotes/
German bailout vote: http://www.bbc.co.uk/news/world-europe-15107538
It is hard to remember now that in the first quarter, just a few months ago, the markets were flirting with a full recovery from the 2008 debacle, or that before this quarter started the markets were in positive territory overall for 2011.
The Wilshire 5000 index, which most closely reflects the total U.S. stock inventory, dropped a remarkable 12.85% of its total value for the quarter. This wiped out the gains of the previous two quarters; the index is now down 7.54% for the year. The comparable Russell 3000 index fell 15.28% in the three months ending September 30, ending the quarter down 9.90% for the year.
The Wilshire U.S. Large-Cap index fell 12.03% during the third quarter, and is now down 6.76% for the first three quarters of 2011. The Russell 1000 large cap index was down 14.68% for the third quarter; taking it to a negative 9.25% return for the first three quarters of the year. The more widely-followed S&P 500 index of the largest companies domiciled in the U.S. was down 13.87% for the quarter, giving it a loss of 8.68% so far this year.
The Wilshire U.S. Mid-Cap index dropped 18.93% over the third quarter, and is now down 11.15% for the year. The comparable Russell Midcap index fell 18.90%, putting it down 12.34% so far this year.
The Wilshire U.S. Small-Cap index plunged 19.34% over the three months ending September 30, and holds a 13.46% loss for the year. The Russell 2000 small cap index fell 21.87% in the third quarter, placing it down 17.02% for the year.
The technology-heavy Nasdaq Composite index retreated 12.91% in the three month period ending September 30, and is now down 8.95% for the year.
Internationally, the results were much the same--only more so. The EAFE index, which represents large cap stocks across the developed world, plunged 19.60% for the quarter, and is down 17.18% for the year. Europe as a whole was down 23.00% for the quarter; the Far East dropped 9.64%, and the EAFE emerging markets index of developing nations fell 22.88%.
Even the assets that are supposed to zig when the stock market zags were down comparably for the quarter. The Wilshire REIT index of real estate investment trusts was down 12.10% for the third quarter; moving it down 2.54% for the year. Commodities told the same story: energy stocks, including petroleum producers, were down 12.99% for the quarter, industrial metals fell 22.46%, and even gold, which finished the quarter up 7.82%, experienced a drop of 11.43% in September.
Just when you thought that yields on government bonds couldn't go any lower, they did: bonds of up to 1-year maturity are essentially paying zero interest, while five-year Treasuries are paying 1% a year, and 10-year Treasury issues lock you in at 2.125% a year.
It is usually more difficult to read the minds of the investing public than the cable financial programs and financial press makes it appear; the headlines one day will say that stocks fell after the Fed issued a warning about the economy, and the next day we will learn that stocks rose because the Fed was so worried about the economy that it might lower interest rates.
However, this summer there was a certain clarity about the cause of the malaise; the S&P 500 was routed to the tune of a 2.2% one-day loss on August 2, right after Congress finally agreed to a messy compromise on the debt ceiling. It was clear that many people were questioning whether our lawmakers have a clear grasp of the financial and economic challenges facing a nation that is still climbing out of the worst recession since the second world war. When they look overseas, they see that European governments are, if possible, even less functional in their approach to repairing the global economy. On August 4, the S&P 500 fell 4.3%; it fell 5.6% on August 6 and another 4.4% on August 8--and those four days represented nearly all of the damage for the quarter.
September, of course, was worse, and the handwriting was on the wall when the S&P 500 experienced its worst first week start in its five-decade history. (Yes, that includes the Fall of 2008.) A brief five-day rally gave us a 4% bump in value, but the end of the month was dismal, with a 2.9% drop on September 21, followed by a 3.2% fall the next trading day. Altogether, the index was down 6% for the month.
Is gloom and doom the real story about the economy, or is it a reflection of unfounded fear? The NumberNomics economic web site notes that the U.S. GDP (the broadest measure of economic activity) actually grew 2.3% for the past three months, a much faster growth rate that the anemic first quarter (0.4%) and only slightly-more-promising second quarter (1.3%). Do those numbers look like they are moving the economy toward a double-dip recession, as many investors seem to fear?
Another fear is that the Eurozone will collapse under the weight of Greek debt. But there is good news on that front as well; the German parliament voted on September 29 to support the expansion of the European Financial Stability Facility by a surprising 315-85 margin. Germany is the 10th--and most important--of the Eurozone members to ratify the bailout agreement
Meanwhile, supply shortages of oil have eased from the start of the year, causing oil prices to drop. Consumers have paid down enormous amounts of debt over the past three years, bringing them in line with where the consumer debt burden has been for the past 30 years. Corporate profits and cash levels remain at record high levels, and there are signs that the unemployment problem is starting to ease--although it will be years before we seen unemployment fall to levels seen in the early part of this century.
With all this good news hiding behind headlines about U.S. and European sovereign debt levels, it is hard to predict that the markets will rally decisively. But it is also difficult to bet against a sudden shift in sentiment, especially since there have been so many in the past few years. The wisest heads in the investment game tend to see the optimistic side of the situation when the markets are most gloomy, and see the dark clouds gathering when everyone else is enjoying a strong runup in stocks.
Despite what you hear on the cable financial news channels, nobody really knows how long stocks will remain on sale or how long it will take for the global economy to finally sort itself out. We DO know, from past experience, that eventually the economy recovers from even the most severe shocks, and (again, eventually) the markets return to health. History tells us that a recovery is inevitable, and it seems to be visibly underway somewhere behind the hubbub of the negative press, partisan bickering and occasional market panics.
When investors figure that out, there will be another bull run and (this we can predict with confidence), people in that happy time will forget all over again that stocks can go down as well as up. That's when you'll hear our lonely voices talking about the downside risks.
SOURCES:
GDP estimates, inflation and corporate profits: http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
Wilshire index data: http://www.wilshire.com/Indexes/calculator/
Russell index data: http://www.russell.com/indexes/data/daily_total_returns_us.asp
S%P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf--p-us-l--
Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP
International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html
Commodities index data: http://www.standardandpoors.com/indices/sp-gsci/en/us/?indexId=spgscirg--usd----sp------
Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
Numbernomics.com: http://www.numbernomics.com/nomicsnotes/
German bailout vote: http://www.bbc.co.uk/news/world-europe-15107538
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