Wednesday, October 5, 2011

Market Reflections


Written by Dr. Jason White, Director of Investments at Family Investment Center

EXECUTIVE CLIENT SUMMARY

“Grinding” is the most descriptive term I can muster to characterize the economic, market, political, and international events thus far in 2011. Our 24/7/365 news cycle and the old newspaper mantra “if it bleeds, it leads” seems to have paralyzed many in a fog of uncertainty. The issues we face really aren’t new: government debt, banking problems, geopolitical instability…but constant screeching media exposure takes a toll on our collective psyche.

Hyper-focus on the crisis of the day can suck investors into a vortex of fear, confusion, and perhaps worse – inaction. Helping clients overcome these natural human reactions to uncertainty is part of the reason we are hired to manage portfolios.

Following are some brief comments on observations I have made with regard to the economy and our client portfolios. I hope you find them helpful and informative!

MACROECONOMIC ANALYSIS

I have heard and read many experts comment on the potential for a double-dip recession in the second half of 2011 or early in 2012, but I find little evidence in my research to assign this a large probability of occurrence. The unemployment rate has ticked back down to 9.1%. Looking inside the numbers, public sector payrolls are generally decreasing, while private sector hiring is increasing, albeit at a speed that satisfies no one. GDP, the broadest measure of economic health, is grinding slowly higher. My 2011 forecast remains unchanged at 1.9% positive GDP growth for the year. Most economists believe we need a 3%+ GDP growth rate to see significant improvement in the unemployment picture, and I count myself among them. The economy needs to add close to 15 million new jobs to return to a “full employment” condition, where the unemployment rate is around 5%. This is the most important national challenge we face in the next 12 to 24 months.

MARKET OBSERVATIONS

The stock market moved with much volatility and with all companies in near lockstep during the first three quarters as large-, mid- and small-cap companies struggle for footing and clarity in the economy. Third quarter market uncertainty and isolated price shocks chewed up the gains for the year, mostly due to the uncertain outcome of Europe’s financial and debt crisis, and the future of the Euro currency itself. I wrote back in 1999 that a European currency union, with disaggregated fiscal and political systems, would be unsustainable in a national crisis (war, debt, natural disaster, etc.), and it appears the EU will need some emergency mending to hold the union together. Not impossible – but difficult and with an unpredictable outcome at this time.

Back in the United States, the Federal Reserve has continued to keep interest rates at historic lows to combat weakness and has announced guidance to continue relaxed monetary policy into 2013. The Fed has begun “Operation Twist,” a program to purchase longer-term government bonds with the proceeds of maturing short-term debt. Yet, corporate profits are consistently outperforming consensus expectations of analysts, despite higher energy costs and soft consumer demand.

THE DEBT CEILING

In our view, there is plenty of blame to go around for the embarrassing public display of sausage-making going on in Washington D.C. While this time seems different (as it always does), especially when amplified by the partisan media coverage coming from networks like NBC and FOX, this is no time for investors to run for the hills. We can take some comfort in the fact that the United States has been through this process many times, although there is some faint hope this time that the congressional “Super-Committee” might actually come up with some important reforms.

Pundits sarcastically comment that America always does the right thing after exhausting all other available options. They might be right in the short run, but the power of investment compounding always wins in the long run. We are still passionate practitioners of Modern Portfolio Theory, diversified asset allocation, and expense minimization. We will happily take any time necessary to help calm any fears clients may have regarding the long-run potential of the market. Contact us anytime for a “booster shot” on the science of long-run investment success!

FINAL THOUGHTS

Individual investors, thanks to the fear-and-greed genome of human nature, often make the classic and colossal mistake of trying to time the market in the short run. Academic and professional research shows repeatedly that investors tend to buy when the outlook is optimistic and sell when pessimism dominates opinion. The result is portfolio underperformance, failure to reach financial goals, and a smaller portfolio to do good works. Guiding investors toward a more dispassionate long-run diversified savings approach is what drives our thinking and actions every day.

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