Important Perspective on Recent Market Events
As you are surely aware, following Tuesday’s debt ceiling compromise, attention quickly shifted to whether the government has what it takes to solve its budget problems. Add to this the fact that Italy is now in the forefront of debt problems in Europe and anemic economic news has been pushing investor sentiment downward, and you have a near-perfect recipe for a stock market correction. And a correction – defined as a 10% drop from recent highs – is exactly what we experienced last week as major indexes erased their gains for the year. At times like this, we are wise to view events in the proper context and avoid letting brief periods of negativity derail our long-term strategies.
Market corrections are not unusual events. From the market lows of July 2010 to the highs of April 2011, the S&P 500 was up over 26% without experiencing a correction. To put that 26% run-up in perspective, the best 20-year time period for the stock market was 1948-1968, and the market only returned an average of 8.4% annually during that period. This illustrates that we were overdue for a correction. During recovery periods, stocks are prone to sudden declines in value. Unexpected drops in the market can be painful, but they are part of the healing process.
In our assessment, the turmoil of recent weeks reflects the fact that fear is still dominating investor sentiment. What are people afraid of? While there are several factors that could be cited, we believe debt problems domestically and abroad are in the forefront.
While it is true that European countries have spent themselves into a corner, correcting this mistake will be good for long term growth, not bad. While some financial institutions may face losses in the process, the minimal level of European exposure U.S. banks have, makes them well equipped to face this challenge. Our research tells us that the odds of significant damage to the U.S. economic system resulting from European debt failures are very low.
Closer to home, although S&P downgraded the nation’s bond rating from AAA to AA+, Moodys Investors Service took the opportunity to reaffirm the United State’s AAA rating. The U.S. now has a split rating from the two largest ratings agencies. The third-largest ratings agency, FitchRatings, also agreed with Moody’s AAA rating.
In confirming the AAA rating, Moody's recognized that the budget compromise is a first step toward achieving long-term fiscal improvement. The legislation passed on August 2nd calls for $917 billion in specific spending cuts over the next decade and established a congressional committee charged with making recommendations for achieving a further $1.5 trillion in deficit reduction over the same time period.
Successful investing is a long term project undertaken with risk and uncertainty. Equity markets do not move in a straight line, and neither do economic recoveries. We wish we had the ability to trade every move, but that just isn’t possible. We encourage you to tune out the media fanfare and remember that we have been through much worse. Please try to see recent events in context and do not allow them to disrupt your long term financial objectives.
ECONOMIC CALENDAR: Tuesday – Productivity and Costs, FOMC Meeting Announcement Wednesday – EIA Petroleum Status Report, Treasury Budget
Thursday – International Trade, Jobless Claims Friday – Retail Sales, Consumer Sentiment, Business Inventories
Data as of 08/05/2011 1-Week YTD 1-Year 5-Year 10-Year
Standard & Poor's 500 -7.19 -4.63 6.53 -1.25 -0.12
Dow -5.75 -1.15 7.21 0.36 0.89
NASDAQ -8.13 -4.54 10.4 4.29 2.26
MSCI EAFE -8.47 -5.90 3.19 -1.36 1.91
10-year Treasury Note (Yield Only) 2.81 NA 2.91 4.90 5.16
Notes: All index returns exclude reinvested dividends, and the 5-year and 10-year returns are annualized.
Sources: Yahoo! Finance, MSCI Barra. Past performance is no guarantee of future results.
Indices are unmanaged and cannot be invested into directly. NA means not available.
HEADLINES:
Treasury Secretary Timothy F. Geithner will not be stepping down, a Treasury Department official said Sunday, ending speculation that the key Obama administration advisor was preparing to resign.
It was announced Friday that the Postal Service lost $3.1 billion in the April through June period and could be forced to default on payments due to the federal government when the fiscal year ends in September. Several bills designed to change the law governing the post office, an independent government agency, are pending in the House and Senate.
After reaching a near-record $3.98 in May, tumbling in June, and rising throughout the month of July, gasoline prices finally settled around $3.70 a gallon in early August.
The job market strengthened in July, a welcome piece of good news that sharply contrasted other recent data pointing toward an economic slowdown. Employers added 117,000 jobs last month, easily topping the 75,000 gain economists surveyed by CNNMoney had predicted. And the unemployment rate improved slightly to 9.1%.
