It's shaping up to be another interesting year for investment markets in 2012.
In my previous commentary from a few weeks ago, I discussed how investment markets were polarized between two widely divergent forces - the challenging reality of the slowing U.S. economy and Europe's deteriorating sovereign debt crisis versus the hope that U.S. and European policy makers would intervene with extraordinary measures to combat these issues. But after what has now been several months of choppy action for investment markets, it appears that the forces of reality may soon overwhelm any lingering hope.
The key concern as we close out 2011 and enter into the New Year is the European sovereign debt crisis. While the U.S. economy has actually shown some signs of improvement in recent weeks, conditions in Europe are continuing to unravel. Whereas Europe's sovereign debt problems were once confined to smaller periphery nations such as Greece, Ireland and Portugal (a combined 6% of Euro Zone GDP), it has since spread in earnest to the vastly larger core nations of France, Italy and Spain (a combined 56% of Euro Zone GDP). As a result, the probability for a major sovereign default in Europe is rising with each passing day, and the fallout effects for the global economy could become severe.
European policy makers squandered what could end up being their last chance to finally get ahead of the problem. The European Central Bank met on Thursday with expectations that they may surprise with a larger than expected interest rate cut. Instead, they delivered only what the market was expecting and couldn't even come to a consensus on that decision, as some committee members were arguing for even less. European leaders also held a summit on Thursday and Friday with hopes that decisive action would finally be taken to address the mounting debt problems across the region. Instead, EU leaders continued to dither and struggled to come to consensus on even minor points. The summit ended with an agreement characterized by the same vagueness and indecision that has limited their ability to adequately address the problem all along. Although EU leaders are scheduled to meet again in March 2012, by then it may be too late.
A critical market to watch in the coming weeks is Italy, which is the third largest bond market in the world. In 2012, Italy has sovereign debt redemptions needing to be refinanced totaling nearly $300 billion. This includes $43 billion at the end of January and another $63 billion at the end of February. As long as European policy inaction persists, the odds are rising that Italy may forced to default when attempting to carrying out one of these massive refinancing rounds. The potential is also rising for a hard default by another sovereign or a systemically important banking institution as well. And such an event would be the likely catalyst of another contagion like we saw starting in late 2008.
For these reasons, it is prudent to begin dialing down risk in investment portfolios at the present time. Although the situation in Europe has deteriorated meaningfully in recent months, the U.S. stock market as measured by the S&P 500 is actually well above early October lows thanks in part to several additional injections of stimulus by the U.S. Federal Reserve. And given that short-term risks to the downside meaningfully outweigh the potential to the upside, I have been using recent strength as an opportunity to lock in recent gains on stock positions and reallocate. Sales have focused on stocks that have a larger percentage of sales coming from international markets including Europe. The few remaining stock positions are those that have U.S. focused businesses from defensive sectors such as Consumer Staples and Utilities.
The variety of other asset classes beyond the stock market are positioned to hold up well if not benefit in the event of a full blown crisis event unfolding in Europe. Two categories that would likely move to the upside during such an episode are U.S. Treasury Inflation Protected Securities (TIPS) and Agency Mortgage Backed Securities (MBS). Fortunately, both would also be expected to perform consistently well if the European situation gets resolved. As a result, portfolio weights have been increased to both of these asset classes. TIPS have particular appeal because they represent a safe haven during times of crisis and have performed with consistent upside during both periods of economic calm and instability. Agency MBS is also poised to benefit due to its short duration - many of these bonds mature within one to three years - the virtually explicit backing of the U.S. government and its generous yield premium relative to comparable U.S. Treasuries. In addition, if the U.S. Federal Reserve were to add more stimulus with the launch of a third round of quantitative easing, Agency MBS is almost certainly what they will be buying in the dual effort of trying to support U.S. banks and the housing market. Given the already limited supply of Agency MBS, history has shown that it has been worthwhile to own the MBS securities that the Fed is seeking to buy.
Another category that should hold steady and is likely to benefit regardless of whether we see crisis or resolution is Utilities Preferred Stocks. Most of the preferred stock market is concentrated in financials, which is problematic because the banks have already come under pressure in anticipation of a crisis episode. But a select group of non-financial preferred stocks exist in the Utilities sector that are stable and generate predictable cash flows, as most people will continue to keep their lights on regardless of the economic environment and these preferred stocks directly benefit from this characteristic. While these securities might experience an initial price shock during a crisis episode due to mechanical market forces, they are likely to quickly recover their value within days and provide another safe haven destination for investors.
The next asset class worth mentioning are the precious metals of Gold and Silver. Gold is the classic hard asset defense against both crisis as well as aggressive stimulus efforts from the U.S. Federal Reserve that weakens the U.S. dollar. During a crisis episode, however, it may be subject to short-term price shocks. This is due to the fact that it is a highly liquid investment that is often sold to raise cash during mass liquidation phases. But any such sell-offs have historically proven to be short lived and ideal buying opportunities, as the price quickly recovers as investors seek to snap up this safe haven asset on sale. Thus, Gold positions remain in portfolios but remain under close watch. Silver is the far more volatile of the two precious metals, but it serves two functions. First, it provides direct protection against an aggressive monetary policy move by the U.S. Federal Reserve or other global central banks. It also provides a vehicle to maintain stock like exposure with a much smaller concentration of overall portfolio assets. While the percentage allocation to Silver in portfolios is relatively small, it serves as an important portfolio hedge against a swift and decisive policy turn to stimulate by global central banks.
Lastly, it is worthwhile to make mention of cash. While I typically prefer to be fully invested during most markets, an allocation to cash makes sense in the current environment. It enables for the short-term protection of principal value while also enabling the flexibility to step in and potentially purchase stocks and other assets at a discount following any liquidation sell-offs.
Perhaps in the end, European policy makers will finally take the decisive action needed to address their crisis (this, of course, assumes that they still have time to do so). Stocks would likely cheer the news and it would go a long way in helping to return a sense of calm to the markets. Unfortunately, such an outcome is becoming an unsettlingly low probability event as each day passes. Even if the U.S. Federal Reserve were to launch QE3 in the weeks ahead, the positive impact on stocks would likely be muted if Europe remains unresolved. As a result, the priority for portfolios as we move toward the end of the year is to continue dialing down risk. This way, if a crisis event were to erupt, portfolios will already be positioned in advance to hold steady if not benefit from such a scenario. And if it turns out that crisis is averted, the opportunity will still be available to reallocate back into higher risk assets such as stocks at that time. I will continue to keep a close eye on the markets and will keep you updated as events unfold.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Monday, December 12, 2011
Sunday, November 6, 2011
Opposing Forces
Two widely divergent forces are currently impacting investment markets.
On the downside is the challenging reality. The pace of the U.S. economic recovery remains sluggish and the threat of a recession in the coming months is rising. Looking abroad, policy makers have struggled for well over a year to contain the European crisis, but the situation continues to deteriorate. Greece is teetering on the brink of default and problems are worsening in major sovereigns such as Italy, Spain and even France. The end result in Europe may ultimately lead to another global financial contagion. The threat of such an outcome is deeply negative for risk assets such as stocks, but would benefit safe haven assets such as U.S. Treasuries and Gold.
On the upside is the hope by investors that the U.S. Federal Reserve (the Fed) will intervene with more aggressive monetary support. The most recent Fed stimulus program known as QE2 ended on June 30. And stocks began plunging sharply within weeks after the end of QE2, declining by nearly -20% from July 22 to August 8. But then the Fed stepped in with a new round of stimulus by promising to keep interest rates at 0% until mid-2013. This helped put a floor under the market. After stocks went on to thrash back and forth through August and September, the Fed launched another stimulus program known as Operation Twist at the beginning of October, and stocks have rallied by +14% in the weeks since. Finally, the Fed just this past Wednesday strongly suggested that yet another round of stimulus in QE3 would soon be on its way. Stocks tend to react euphorically to Fed stimulus, so this aggressive outpouring of monetary support has certainly helped to offset the extreme risks currently facing the market to this point.
These two strongly opposing forces have resulted in a wildly volatile market environment on a day-to-day basis. On days when investors are optimistic about the U.S. outlook or believe the situation in Europe may be headed toward a resolution, the stock market soars. But on days when it appears that the situation may be set to unravel Europe or the economy is weakening in the U.S., stocks plunge sharply. Such dramatic up and down shifts have been occurring daily if not hourly during any given trading session.
Given these diametrically opposing forces, two very different outcomes both appear high probable in the coming months. The first would be the outbreak of a full blown crisis in Europe and a recession in the U.S., which would likely push stocks sharply lower. The second would be a stabilization of the situation in Europe, which would instead allow the forces of Fed stimulus to propel stocks sharply higher.
The meaningful probability associated with these two widely divergent outcomes emphasizes the importance of maintaining portfolio hedging strategies to navigate the current environment. Recent portfolio adjustments in response to this backdrop include shifting away from exposures that would be too heavily impacted by one single outcome. Relating it to a seesaw, it is the equivalent of moving away from either end of the lever and toward the fulcrum. This includes exiting positions in nominal U.S. Treasuries and more economically sensitive stocks toward positions such as Treasury Inflation Protected Securities (TIPS), Gold and selected defensive stocks that stand to benefit from either outcome. The emphasis of such a risk controlled strategy is to neutralize the potential downside while also capturing the upside opportunity associated with either outcome.
On the downside is the challenging reality. The pace of the U.S. economic recovery remains sluggish and the threat of a recession in the coming months is rising. Looking abroad, policy makers have struggled for well over a year to contain the European crisis, but the situation continues to deteriorate. Greece is teetering on the brink of default and problems are worsening in major sovereigns such as Italy, Spain and even France. The end result in Europe may ultimately lead to another global financial contagion. The threat of such an outcome is deeply negative for risk assets such as stocks, but would benefit safe haven assets such as U.S. Treasuries and Gold.
On the upside is the hope by investors that the U.S. Federal Reserve (the Fed) will intervene with more aggressive monetary support. The most recent Fed stimulus program known as QE2 ended on June 30. And stocks began plunging sharply within weeks after the end of QE2, declining by nearly -20% from July 22 to August 8. But then the Fed stepped in with a new round of stimulus by promising to keep interest rates at 0% until mid-2013. This helped put a floor under the market. After stocks went on to thrash back and forth through August and September, the Fed launched another stimulus program known as Operation Twist at the beginning of October, and stocks have rallied by +14% in the weeks since. Finally, the Fed just this past Wednesday strongly suggested that yet another round of stimulus in QE3 would soon be on its way. Stocks tend to react euphorically to Fed stimulus, so this aggressive outpouring of monetary support has certainly helped to offset the extreme risks currently facing the market to this point.
These two strongly opposing forces have resulted in a wildly volatile market environment on a day-to-day basis. On days when investors are optimistic about the U.S. outlook or believe the situation in Europe may be headed toward a resolution, the stock market soars. But on days when it appears that the situation may be set to unravel Europe or the economy is weakening in the U.S., stocks plunge sharply. Such dramatic up and down shifts have been occurring daily if not hourly during any given trading session.
Given these diametrically opposing forces, two very different outcomes both appear high probable in the coming months. The first would be the outbreak of a full blown crisis in Europe and a recession in the U.S., which would likely push stocks sharply lower. The second would be a stabilization of the situation in Europe, which would instead allow the forces of Fed stimulus to propel stocks sharply higher.
The meaningful probability associated with these two widely divergent outcomes emphasizes the importance of maintaining portfolio hedging strategies to navigate the current environment. Recent portfolio adjustments in response to this backdrop include shifting away from exposures that would be too heavily impacted by one single outcome. Relating it to a seesaw, it is the equivalent of moving away from either end of the lever and toward the fulcrum. This includes exiting positions in nominal U.S. Treasuries and more economically sensitive stocks toward positions such as Treasury Inflation Protected Securities (TIPS), Gold and selected defensive stocks that stand to benefit from either outcome. The emphasis of such a risk controlled strategy is to neutralize the potential downside while also capturing the upside opportunity associated with either outcome.
Monday, August 8, 2011
The Day After The Downgrade
It was quite a day in the stock market, which plunged by -6.7% as measured by the S&P 500 Index. Given the events of the day, I wanted to provide a brief update on the markets and portfolio performance.
I'll begin with the bottom line. portfolios ended up for the day. Although gains for the day were modest at less than +1%, this result was favorable given the considerable downside pressure coming from stocks. Portfolio gains were supported primarily by precious metals such as Gold (+3.3% today), Silver (+1.7%) and Agnico Eagle Mines (+1.4%). U.S. Treasuries also posted another strong advance, with government debt reaching new highs across the yield curve including TIPS (+1.2%), 3-7 Year Treasuries (+0.6%), 7-10 Year Treasuries (+1.6%) and 20+ Year Treasuries (+3.2%). As a result, the hedging strategies in place to protect portfolios against major downside stock market events had a positive net effect today.
One fact coming out of today was notable. Given that S&P, which is one of the three major credit rating agencies, downgraded the United States from AAA to AA+, it might have been reasonable to expect that U.S. Treasuries would have declined substantially today. Instead, they traded sharply higher.
This highlights an important point. The sell off in stocks today had little to do with the U.S. credit downgrade. Instead, it had much more to do with the ongoing financial crisis in Europe. Over the weekend and into today, European leaders worked to try and resolve what is a rapidly deteriorating situation in Spain and Italy. Despite their latest efforts to address the problem, financial markets remain unsatisfied and are starting to become impatient. Hence the sell off in stocks today and the move to Gold, Silver and U.S. Treasuries, which are all still considered safe havens during times of market uncertainty. Highlighting the fact that Europe remains the key overhang for the market, European financial preferred stocks were down between -10% to -20% today alone. These types of moves in preferred stocks are highly unusual and help isolate the source of market stress.
As for the U.S. credit rating downgrade, it will likely continue to do its part to add to market uncertainty and volatility, but its impact is currently secondary. However, any unanticipated fallout effects from the downgrade will likely only begin to become apparent after a few weeks or longer if at all. I will be watching this very closely and will keep you updated if I begin to see such effects beginning to boil to the surface.
Looking ahead, the stock market is now well overdue for a meaningful bounce higher, as it hasn't been this oversold since late 2008. But the fact that it is oversold does not mean that it won't decline further. After all, it was also oversold when the S&P was at both 1250 and 1200 just a few days ago, and today it closed at 1119. And any bounce higher in stocks will likely be short lived - perhaps a few days to a week or two at most - given the weakening global economic outlook and the ongoing financial challenges in Europe.
The one caveat to this stock outlook is the potential for action by global central banks including the U.S. Federal Reserve (Fed) or the European Central Bank (ECB). For example, if the Fed were to announce another round of stimulus (QE3) either at their FOMC meeting tomorrow or at Jackson Hole at the end of the month, this could be the catalyst for a new rally higher in stocks. Another example would be unprecedented steps by the ECB to finally try to get ahead of the crisis in Europe. Once again, I will keep you updated on any developments on this front.
In the meantime, the emphasis will remain on keeping hedging strategies in place including positions in precious metals and U.S. Treasuries in working to generate further portfolio upside amid stock market turbulence. Taking the opportunity when it presents itself to selectively add high quality stock names that have been pulled lower along with the broader stock market sell off will also be a priority in the coming days.
I'll begin with the bottom line. portfolios ended up for the day. Although gains for the day were modest at less than +1%, this result was favorable given the considerable downside pressure coming from stocks. Portfolio gains were supported primarily by precious metals such as Gold (+3.3% today), Silver (+1.7%) and Agnico Eagle Mines (+1.4%). U.S. Treasuries also posted another strong advance, with government debt reaching new highs across the yield curve including TIPS (+1.2%), 3-7 Year Treasuries (+0.6%), 7-10 Year Treasuries (+1.6%) and 20+ Year Treasuries (+3.2%). As a result, the hedging strategies in place to protect portfolios against major downside stock market events had a positive net effect today.
One fact coming out of today was notable. Given that S&P, which is one of the three major credit rating agencies, downgraded the United States from AAA to AA+, it might have been reasonable to expect that U.S. Treasuries would have declined substantially today. Instead, they traded sharply higher.
This highlights an important point. The sell off in stocks today had little to do with the U.S. credit downgrade. Instead, it had much more to do with the ongoing financial crisis in Europe. Over the weekend and into today, European leaders worked to try and resolve what is a rapidly deteriorating situation in Spain and Italy. Despite their latest efforts to address the problem, financial markets remain unsatisfied and are starting to become impatient. Hence the sell off in stocks today and the move to Gold, Silver and U.S. Treasuries, which are all still considered safe havens during times of market uncertainty. Highlighting the fact that Europe remains the key overhang for the market, European financial preferred stocks were down between -10% to -20% today alone. These types of moves in preferred stocks are highly unusual and help isolate the source of market stress.
As for the U.S. credit rating downgrade, it will likely continue to do its part to add to market uncertainty and volatility, but its impact is currently secondary. However, any unanticipated fallout effects from the downgrade will likely only begin to become apparent after a few weeks or longer if at all. I will be watching this very closely and will keep you updated if I begin to see such effects beginning to boil to the surface.
Looking ahead, the stock market is now well overdue for a meaningful bounce higher, as it hasn't been this oversold since late 2008. But the fact that it is oversold does not mean that it won't decline further. After all, it was also oversold when the S&P was at both 1250 and 1200 just a few days ago, and today it closed at 1119. And any bounce higher in stocks will likely be short lived - perhaps a few days to a week or two at most - given the weakening global economic outlook and the ongoing financial challenges in Europe.
The one caveat to this stock outlook is the potential for action by global central banks including the U.S. Federal Reserve (Fed) or the European Central Bank (ECB). For example, if the Fed were to announce another round of stimulus (QE3) either at their FOMC meeting tomorrow or at Jackson Hole at the end of the month, this could be the catalyst for a new rally higher in stocks. Another example would be unprecedented steps by the ECB to finally try to get ahead of the crisis in Europe. Once again, I will keep you updated on any developments on this front.
In the meantime, the emphasis will remain on keeping hedging strategies in place including positions in precious metals and U.S. Treasuries in working to generate further portfolio upside amid stock market turbulence. Taking the opportunity when it presents itself to selectively add high quality stock names that have been pulled lower along with the broader stock market sell off will also be a priority in the coming days.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Thursday, August 4, 2011
Thursday's Stock Decline
Thursday was a tough day for stocks to say the least. Overall, stocks as measured by the S&P 500 declined by -4.71%, which marked the worst one day performance for stocks since before the March 2009 lows.
The primary driver for the sell off was the situation in Europe. In recent days, Spain and Italy, which both rank among the twelve largest economies in the world, have come under increasing pressure due to their government debt problems. The European Central Bank held a meeting today where it was hoped that they would provide some clarity on how they would address the problems in these two ailing countries. Instead, they managed to perplex the market with several policy decisions that were widely inconsistent with recent actions and out of step with the views of Eurogroup leaders and the International Monetary Fund. This sparked market concerns that confusion and lack of coordination among European leaders may result in the current crisis eventually growing out of control. From there, the stock market rout was on.
Fortunately, portfolios were prepared for today's events. While money was draining out of stocks, it was flowing into U.S. Treasuries. As a result, a heavy portfolio weighting to Treasuries added considerable value. For example, longer duration U.S. Treasuries (maturing in over 20 years) gained +3.56% today, and other areas of the Treasury market also rose +1% or more. This helped meaningfully offset the impact of the stock market decline. And although Gold sold off today, its decline was only -0.53%. In total, any declines in portfolio value were limited to considerably less than -1%.
Looking ahead, today's stock drop had the feel of liquidation selling by financial institutions and hedge funds, which was a common occurrence in late 2008 and early 2009 during the days following the outbreak of the financial crisis. Supporting this idea was the fact that several stocks were actually up in the late morning, but ended the day down -5% or more. Such volatile price activity is a sign of sellers being forced to liquidate into a stock market where there's not enough buyers to pick up the slack. And when such liquidation selling gets underway, it's unpredictable to say exactly when it's going to end. But the stock market is now oversold - it has gone down too far, too fast - and many high quality stocks are now considerably less expensive today than they were just a few weeks ago. Thus, this sell off should provide the opportunity to add selected high quality names once the stock market finds some stability. The only question is whether this stability comes at 1200 on the S&P where it closed today or at an even lower level before its all said and done. The next few trading days will tell us a lot in this regard.
The primary driver for the sell off was the situation in Europe. In recent days, Spain and Italy, which both rank among the twelve largest economies in the world, have come under increasing pressure due to their government debt problems. The European Central Bank held a meeting today where it was hoped that they would provide some clarity on how they would address the problems in these two ailing countries. Instead, they managed to perplex the market with several policy decisions that were widely inconsistent with recent actions and out of step with the views of Eurogroup leaders and the International Monetary Fund. This sparked market concerns that confusion and lack of coordination among European leaders may result in the current crisis eventually growing out of control. From there, the stock market rout was on.
Fortunately, portfolios were prepared for today's events. While money was draining out of stocks, it was flowing into U.S. Treasuries. As a result, a heavy portfolio weighting to Treasuries added considerable value. For example, longer duration U.S. Treasuries (maturing in over 20 years) gained +3.56% today, and other areas of the Treasury market also rose +1% or more. This helped meaningfully offset the impact of the stock market decline. And although Gold sold off today, its decline was only -0.53%. In total, any declines in portfolio value were limited to considerably less than -1%.
Looking ahead, today's stock drop had the feel of liquidation selling by financial institutions and hedge funds, which was a common occurrence in late 2008 and early 2009 during the days following the outbreak of the financial crisis. Supporting this idea was the fact that several stocks were actually up in the late morning, but ended the day down -5% or more. Such volatile price activity is a sign of sellers being forced to liquidate into a stock market where there's not enough buyers to pick up the slack. And when such liquidation selling gets underway, it's unpredictable to say exactly when it's going to end. But the stock market is now oversold - it has gone down too far, too fast - and many high quality stocks are now considerably less expensive today than they were just a few weeks ago. Thus, this sell off should provide the opportunity to add selected high quality names once the stock market finds some stability. The only question is whether this stability comes at 1200 on the S&P where it closed today or at an even lower level before its all said and done. The next few trading days will tell us a lot in this regard.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Sunday, July 31, 2011
Beyond the Debt Ceiling Debate
The recent national drama is drawing to a close. After weeks of intense negotiation, it appears that politicians in Washington have come to an agreement to raise the debt ceiling. Investment markets are cheering the news, as stocks are signaling a strong opening when trading resumes tomorrow. The relief rally is only likely to last a few days, however, as far greater challenges lie ahead in the coming weeks. As a result, the priority is to keep portfolios focused on the investments that have been rising while stocks have been struggling.
Although the media was transfixed with the debate, the debt ceiling issue and the risk of the U.S. defaulting on its debt was never much of a concern for investment markets over the last few weeks. If it had been, we would have likely seen a major sell off in Treasuries with yields spiking higher. Instead, the Treasury market has been in rally mode, gaining +3.2% for the month of July including +1.3% last week in the final tense days leading up to the ultimate resolution.
So what explains why stocks have been struggling over the past few weeks? Certainly, the uncertainty resulting from the debt ceiling debate has not helped stocks, but this has been an ancillary reason at best. Instead, three factors have had stocks under increasing pressure, and these challenges will still remain once the debt ceiling debate goes away. They are the following:
1. The Economy is Slowing
A growing economy is the primary fuel to sustain higher stock prices. But nearly all signals suggest that the economy is weakening with each passing month and recession risks are on the rise.
2. Fiscal and Monetary Stimulus is Spent
A primary driver of the market rally over the last two years has been the massive support from government spending and Fed stimulus programs like near zero interest rates, QE1 and QE2. But a key takeaway from the debt ceiling debate is that any additional government spending to boost the economy is highly unlikely going forward. And the Fed’s QE2 program came to an end on June 30 with no talk of QE3 coming any time soon.
3. The European Crisis Keeps Getting Worse
Euro Zone leaders announced a major rescue package on July 21 that was supposed to provide the continent six months to a year to regroup and stabilize. But problems are already starting to resurface after only a week. And although the issue is in Europe, it has the potential for major negative spillover effects on the global banking system including the U.S. Looking ahead, Spain and Italy are the countries that are likely to garner the most media attention for their problems in the coming weeks.
So while we’re likely to see stocks rally strongly over the next few days in celebration of the debt ceiling debate finally ending, they’re likely to soon falter and begin struggling once again primarily for these three reasons.
Fortunately, a variety of asset classes perform very well in such economic environments like we have today, and portfolios have been positioned to benefit. These include bonds such as U.S. Treasuries and precious metals such as Gold, both of which are considered safe haven investments during times of uncertainty. Both of these categories have been performing very well over the past several weeks and portfolios have been meaningfully weighted to both Treasuries and Gold to capitalize. Treasuries are up +6.8% for 2011 year to date including a +3.2% advance in July, while Gold is up +14.1% for the year including an +8.4% gain this past month.
In the coming days, the debt ceiling relief rally should provide a good trading opportunity to lock in gains on selected stock positions. And the accompanying safe haven sell off may also provide the potential to add to existing bond and precious metals positions on the dip, as these are the categories that are likely to continue to perform well in the coming months as markets work to navigate through ongoing economic challenges.
I will continue to keep you posted as events unfold.
Although the media was transfixed with the debate, the debt ceiling issue and the risk of the U.S. defaulting on its debt was never much of a concern for investment markets over the last few weeks. If it had been, we would have likely seen a major sell off in Treasuries with yields spiking higher. Instead, the Treasury market has been in rally mode, gaining +3.2% for the month of July including +1.3% last week in the final tense days leading up to the ultimate resolution.
So what explains why stocks have been struggling over the past few weeks? Certainly, the uncertainty resulting from the debt ceiling debate has not helped stocks, but this has been an ancillary reason at best. Instead, three factors have had stocks under increasing pressure, and these challenges will still remain once the debt ceiling debate goes away. They are the following:
1. The Economy is Slowing
A growing economy is the primary fuel to sustain higher stock prices. But nearly all signals suggest that the economy is weakening with each passing month and recession risks are on the rise.
2. Fiscal and Monetary Stimulus is Spent
A primary driver of the market rally over the last two years has been the massive support from government spending and Fed stimulus programs like near zero interest rates, QE1 and QE2. But a key takeaway from the debt ceiling debate is that any additional government spending to boost the economy is highly unlikely going forward. And the Fed’s QE2 program came to an end on June 30 with no talk of QE3 coming any time soon.
3. The European Crisis Keeps Getting Worse
Euro Zone leaders announced a major rescue package on July 21 that was supposed to provide the continent six months to a year to regroup and stabilize. But problems are already starting to resurface after only a week. And although the issue is in Europe, it has the potential for major negative spillover effects on the global banking system including the U.S. Looking ahead, Spain and Italy are the countries that are likely to garner the most media attention for their problems in the coming weeks.
So while we’re likely to see stocks rally strongly over the next few days in celebration of the debt ceiling debate finally ending, they’re likely to soon falter and begin struggling once again primarily for these three reasons.
Fortunately, a variety of asset classes perform very well in such economic environments like we have today, and portfolios have been positioned to benefit. These include bonds such as U.S. Treasuries and precious metals such as Gold, both of which are considered safe haven investments during times of uncertainty. Both of these categories have been performing very well over the past several weeks and portfolios have been meaningfully weighted to both Treasuries and Gold to capitalize. Treasuries are up +6.8% for 2011 year to date including a +3.2% advance in July, while Gold is up +14.1% for the year including an +8.4% gain this past month.
In the coming days, the debt ceiling relief rally should provide a good trading opportunity to lock in gains on selected stock positions. And the accompanying safe haven sell off may also provide the potential to add to existing bond and precious metals positions on the dip, as these are the categories that are likely to continue to perform well in the coming months as markets work to navigate through ongoing economic challenges.
I will continue to keep you posted as events unfold.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Monday, July 11, 2011
2011 Q3 Preview: A Second Look Behind the Curtain
In the film classic The Wizard of Oz, Dorothy follows the yellow brick road to see the magical Wizard, who supposedly has the powers to grant her wish to return home. But upon her arrival in the Emerald City, the Wizard’s curtain opens to reveal nothing other than an ordinary man carrying out a charade. Investors find themselves taking a similar look behind the market curtain as we move into the third quarter of 2011.
The Fed’s stimulus program – known as QE2 – came to an end on June 30. The idea behind the Fed’s effort was to provide support to the U.S. economy until it had recovered enough to stand on its own. Back in April 2010, investors had their first opportunity to look behind the market curtain when QE1 came to an end. And they did not like what they had found. The economy remained far too weak and the threat of another financial crisis was emanating from Europe. Stocks quickly plunged as a result. But unlike in the Wizard of Oz, the curtain was quickly pulled shut with the introduction of QE2. The message from the Fed – come back a year from now in June 2011 and the magical economy you’ve been waiting for will finally be here.
Upon drawing the curtain back a second time in July 2011, investors are still not bound to like what they’ve found. The economic recovery remains sluggish with job creation over the last few months all but stalled. The urgency of the crisis in Europe has spread from smaller countries like Greece to much larger nations like Italy. And all the while the U.S. government is deadlocked in a debate over raising the debt ceiling, only adding to the uncertainty.
Stocks have been remarkably resilient to this point in the face of mounting risks. But for how much longer? The stock market has a lot of air under it, as strong gains over the last few years have been justified by expectations that the economy would eventually recover strongly enough to support it. Unfortunately, this has not been the case. And the Fed’s QE stimulus that has helped lift stocks higher to this point has now gone away. As a result, it could be a very difficult time for stocks in the coming months. And the same is true for industrial and agricultural commodities for all of the same reasons.
Fortunately, stocks are only one of many asset class categories available in investment markets to capture opportunity and generate strong returns. And a variety of asset classes have attractive prospects as we move on in the Post QE2 marketplace. I’ve provided a brief summary on each below.
Gold – Although the yellow metal has risen strongly for many years, further upside is likely as long as global economic instability persists and major currencies such as the U.S. dollar and the euro suffer from a lack of confidence.
U.S. Treasuries and Treasury Inflation Protected Securities (TIPS) – If stocks come under pressure, particularly due to a weakening global economy or the threat of a crisis in Europe, investors will likely continue to migrate to the relative safety of Treasury bonds. TIPS are up +7% so far in 2011 and Treasuries have been rallying since February and are already up +1% in the first few days of Q3. These positions have a generally short-term focus, however, particularly if the Fed starts talking about QE3 in the coming months.
Non-Financial Preferred Stocks – These are essentially bonds from electric utilities that trade like stocks on an exchange. They have yields in the range of 6% to 8% and have performed well both during periods of market calm as well as when the market has entered into pullback and even crisis phases.
Investment Grade Corporate Bonds – A consistently strong performing asset class regardless of whether stocks are in rally mode or in a pullback phase. Highlighting this point, the category is up roughly +40% since the beginning of the financial crisis while stocks are still working their way out of negative territory. Corporations are flush with cash, which bodes well for future outperformance. However, if the situation currently brewing in Italy breaks out into another full-blown financial crisis, allocations here will likely be reduced or sold altogether until the dust settles.
High Quality Defensive Stocks – While the current outlook for stocks in general is currently poor, certain sectors are set to perform well. These include companies from the Food, Household Products and Utilities industries. Regardless of how the economy performs, people are still going to eat, use soap (at least we hope) and turn on the lights. Of course, just like with corporate bonds, if a full-blown crisis phase erupts even stock positions in these defensive industries will likely be exited until stability returns to markets.
So although stocks in general may come under pressure as we move through the summer, many other asset classes that even includes some selected stock industries are set to perform well.
It promises to be an interesting summer for investment markets, and I will keep you updated along the way.
The Fed’s stimulus program – known as QE2 – came to an end on June 30. The idea behind the Fed’s effort was to provide support to the U.S. economy until it had recovered enough to stand on its own. Back in April 2010, investors had their first opportunity to look behind the market curtain when QE1 came to an end. And they did not like what they had found. The economy remained far too weak and the threat of another financial crisis was emanating from Europe. Stocks quickly plunged as a result. But unlike in the Wizard of Oz, the curtain was quickly pulled shut with the introduction of QE2. The message from the Fed – come back a year from now in June 2011 and the magical economy you’ve been waiting for will finally be here.
Upon drawing the curtain back a second time in July 2011, investors are still not bound to like what they’ve found. The economic recovery remains sluggish with job creation over the last few months all but stalled. The urgency of the crisis in Europe has spread from smaller countries like Greece to much larger nations like Italy. And all the while the U.S. government is deadlocked in a debate over raising the debt ceiling, only adding to the uncertainty.
Stocks have been remarkably resilient to this point in the face of mounting risks. But for how much longer? The stock market has a lot of air under it, as strong gains over the last few years have been justified by expectations that the economy would eventually recover strongly enough to support it. Unfortunately, this has not been the case. And the Fed’s QE stimulus that has helped lift stocks higher to this point has now gone away. As a result, it could be a very difficult time for stocks in the coming months. And the same is true for industrial and agricultural commodities for all of the same reasons.
Fortunately, stocks are only one of many asset class categories available in investment markets to capture opportunity and generate strong returns. And a variety of asset classes have attractive prospects as we move on in the Post QE2 marketplace. I’ve provided a brief summary on each below.
Gold – Although the yellow metal has risen strongly for many years, further upside is likely as long as global economic instability persists and major currencies such as the U.S. dollar and the euro suffer from a lack of confidence.
U.S. Treasuries and Treasury Inflation Protected Securities (TIPS) – If stocks come under pressure, particularly due to a weakening global economy or the threat of a crisis in Europe, investors will likely continue to migrate to the relative safety of Treasury bonds. TIPS are up +7% so far in 2011 and Treasuries have been rallying since February and are already up +1% in the first few days of Q3. These positions have a generally short-term focus, however, particularly if the Fed starts talking about QE3 in the coming months.
Non-Financial Preferred Stocks – These are essentially bonds from electric utilities that trade like stocks on an exchange. They have yields in the range of 6% to 8% and have performed well both during periods of market calm as well as when the market has entered into pullback and even crisis phases.
Investment Grade Corporate Bonds – A consistently strong performing asset class regardless of whether stocks are in rally mode or in a pullback phase. Highlighting this point, the category is up roughly +40% since the beginning of the financial crisis while stocks are still working their way out of negative territory. Corporations are flush with cash, which bodes well for future outperformance. However, if the situation currently brewing in Italy breaks out into another full-blown financial crisis, allocations here will likely be reduced or sold altogether until the dust settles.
High Quality Defensive Stocks – While the current outlook for stocks in general is currently poor, certain sectors are set to perform well. These include companies from the Food, Household Products and Utilities industries. Regardless of how the economy performs, people are still going to eat, use soap (at least we hope) and turn on the lights. Of course, just like with corporate bonds, if a full-blown crisis phase erupts even stock positions in these defensive industries will likely be exited until stability returns to markets.
So although stocks in general may come under pressure as we move through the summer, many other asset classes that even includes some selected stock industries are set to perform well.
It promises to be an interesting summer for investment markets, and I will keep you updated along the way.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Friday, June 24, 2011
Greece
Investment markets will be coping with the threat of crisis early next week. On Tuesday, the Greek parliament is set to vote on a new austerity program that is required for the country to receive the latest round of bailout funds from international creditors. While the approval of this vote remains the probable outcome, the failure to pass these measures could result in a severely negative reaction from investment markets. As a result, maintaining a close watch on portfolio risks and working to capture any potential opportunities will be particularly important over the coming days.
The situation in Greece remains critical. This is due to the fact that the country has billions in debt and interest payments coming due in July, and they don’t have the money to make these payments. As a result, Greece needs the latest round of bailout funds totaling 12 billion euros from the European Union (EU) and the International Monetary Fund (IMF) in order to avoid bankruptcy. The key to getting these funds is the austerity vote on Tuesday. If the Greek parliament fails to pass this latest round of budget cuts and tax hikes, the EU and IMF have stated they would withhold disbursing these funds.
If Greece were to default on its debts, it has the potential to spark a market crisis similar to the Lehman collapse in 2008. While Greece itself is relatively small, a key risk associated with a Greek default is the uncertainty over exactly what financial institutions are exposed to the resulting final losses and to what degree. European banks would be particularly at risk, and the spillover effects could impact U.S. banks as well.
Given this crisis risk, it is important to determine how portfolios can be allocated to both sidestep any potential chaos and capture upside opportunity. The following are the asset classes that would be poised to gain in the event of a new crisis emanating from the Euro Zone:
U.S. Treasuries
U.S. Treasury Inflation Protected Securities (TIPS)
Gold
Non-Financial Preferred Stocks
Fortunately, portfolio allocations are already heavily emphasizing these asset classes. This is due to the fact that the U.S. Federal Reserve’s latest stimulus program known as QE2 is set to end on Thursday just two days after the Greek parliamentary vote. And all of the categories listed above are also among those expected to perform best once QE2 comes to an end. As a result, portfolio allocations have already been shifted toward these asset classes well in advance of current events. One additional point - while positions such as Gold continue to represent long-term investments, other allocations like U.S. Treasuries are more likely to remain in place for the short-term until current risk conditions start to fade.
In the end, it is probable that the Greek parliament will end up passing these austerity measures and will push their debt problem down the road a few more months. But “probable” is far from “certain”, so monitoring these events closely through the weekend and into early next week will be important. I’ll keep you updated.
And with the end of the quarter coming on Thursday, I’ll also be checking back soon with a preview for what we can expect in the upcoming third quarter of 2011.
The situation in Greece remains critical. This is due to the fact that the country has billions in debt and interest payments coming due in July, and they don’t have the money to make these payments. As a result, Greece needs the latest round of bailout funds totaling 12 billion euros from the European Union (EU) and the International Monetary Fund (IMF) in order to avoid bankruptcy. The key to getting these funds is the austerity vote on Tuesday. If the Greek parliament fails to pass this latest round of budget cuts and tax hikes, the EU and IMF have stated they would withhold disbursing these funds.
If Greece were to default on its debts, it has the potential to spark a market crisis similar to the Lehman collapse in 2008. While Greece itself is relatively small, a key risk associated with a Greek default is the uncertainty over exactly what financial institutions are exposed to the resulting final losses and to what degree. European banks would be particularly at risk, and the spillover effects could impact U.S. banks as well.
Given this crisis risk, it is important to determine how portfolios can be allocated to both sidestep any potential chaos and capture upside opportunity. The following are the asset classes that would be poised to gain in the event of a new crisis emanating from the Euro Zone:
U.S. Treasuries
U.S. Treasury Inflation Protected Securities (TIPS)
Gold
Non-Financial Preferred Stocks
Fortunately, portfolio allocations are already heavily emphasizing these asset classes. This is due to the fact that the U.S. Federal Reserve’s latest stimulus program known as QE2 is set to end on Thursday just two days after the Greek parliamentary vote. And all of the categories listed above are also among those expected to perform best once QE2 comes to an end. As a result, portfolio allocations have already been shifted toward these asset classes well in advance of current events. One additional point - while positions such as Gold continue to represent long-term investments, other allocations like U.S. Treasuries are more likely to remain in place for the short-term until current risk conditions start to fade.
In the end, it is probable that the Greek parliament will end up passing these austerity measures and will push their debt problem down the road a few more months. But “probable” is far from “certain”, so monitoring these events closely through the weekend and into early next week will be important. I’ll keep you updated.
And with the end of the quarter coming on Thursday, I’ll also be checking back soon with a preview for what we can expect in the upcoming third quarter of 2011.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Saturday, June 11, 2011
June Swoon
The post QE2 stock market correction is now underway. Although the U.S. Federal Reserve’s stimulus plan is not set to end until June 30, a definitive move to the exits in stocks has already begun on June 1. This shift lower in stocks in advance of the end of QE2 has long been expected, and the good news is that many other asset classes beyond stocks are filling the void with solid results.
Stocks are down over -5% thus far in June. While a snapback rally cannot be ruled out over the next few weeks with a final $56 billion dose of Fed stimulus still on its way between now and June 30, the breakdown in several fundamental, technical and behavioral indicators suggest that the recent downturn in stocks will likely have much further to go as we move through the summer:
The Economy:
Recent readings on the U.S. economy have been increasingly weak, which does not bode well for stocks in an environment where stimulus is about to disappear. In addition, the situation in Greece continues to deteriorate, with potential fallout effects that could impact both the European and global economy.
Technical Chart Patterns:
During the entire QE2 rally since last August, stocks had been firmly holding various support levels. But since the beginning of June, stocks have been cutting like a hot knife through many of these important support levels including its 50-day, 100-day and 150-day moving averages and its previous low on April 18. While several levels of major support still exist including the 200-day moving average and the March 16 lows, it has been notable how decisively the market has plunged through previously bulletproof support levels over the course of just a few days in June.
1st Day of the Month Effect:
Since the aftermath of the financial crisis, stocks have typically rallied on the first day of the month. For example, stocks have risen by nearly +1% on average on the first day of the month since the Fed launched QE2 last year. This trend is driven by mechanical reasons including the flow of retirement plan money into the market as well as sentiment factors such as portfolio managers positioning for return opportunities to start the new month. On June 1, stocks dropped by -2.28%, signaling investor concern about the outlook.
1st Day of the Week Effect:
Over the same time frame, stocks have also tended to perform well on the first day of the week. Sometimes referred to as Mutual Fund Monday, this effect is driven by capital flows into mutual funds that are put to work in the market on Mondays. Although this indicator has been deteriorating for months, the -1.08% decline on June 6 was one of the worst Monday outings for stocks in a QE supported market. This coupled with the fact that volume was notably low indicates reluctance by mutual fund managers to put fresh cash to work in stocks.
Bernanke Effect:
Since the beginning of the QE era in March 2009, stocks have typically rallied when the Fed Chairman makes a major speech. Even if he says nothing of consequence, stock investors have usually found a way of gleaning something positive from his words to rally higher. But when the Fed chairman took the podium on Tuesday, June 7, markets immediately rolled over and dropped by nearly -1% in about an hour. Once again, this price movement had little to do with anything Bernanke said – much of his speech had already been leaked into the market earlier in the day. Instead, this market response was likely a signal to the Chairman of investor concern that without more Fed stimulus (QE3), stocks will lack the fuel to continue to rally higher.
It has been expected for some time that stocks would begin to weaken in anticipation of the end of QE2 on June 30. And portfolio allocations have been adjusted for months in preparation for this eventual turn in stocks.
Many of the asset class categories that are expected to perform well during a Post QE2 stock market correction are off to a good start. Leading among these are U.S. Treasuries, which are up nearly +1% for the month. Selected non-financial preferred stocks have also jumped roughly +1%. In addition, Treasury Inflation Protected Securities (TIPS) are up +0.5% in June, while other categories such as Investment Grade Corporate Bonds and Gold are holding steady near breakeven so far for the month.
Looking ahead to the coming week, the next few trading days will be important in signaling whether one last rally in stocks is coming before QE2 draws to a close on June 30. Otherwise, the pace could begin to pick up to the downside. Stay tuned.
Stocks are down over -5% thus far in June. While a snapback rally cannot be ruled out over the next few weeks with a final $56 billion dose of Fed stimulus still on its way between now and June 30, the breakdown in several fundamental, technical and behavioral indicators suggest that the recent downturn in stocks will likely have much further to go as we move through the summer:
The Economy:
Recent readings on the U.S. economy have been increasingly weak, which does not bode well for stocks in an environment where stimulus is about to disappear. In addition, the situation in Greece continues to deteriorate, with potential fallout effects that could impact both the European and global economy.
Technical Chart Patterns:
During the entire QE2 rally since last August, stocks had been firmly holding various support levels. But since the beginning of June, stocks have been cutting like a hot knife through many of these important support levels including its 50-day, 100-day and 150-day moving averages and its previous low on April 18. While several levels of major support still exist including the 200-day moving average and the March 16 lows, it has been notable how decisively the market has plunged through previously bulletproof support levels over the course of just a few days in June.
1st Day of the Month Effect:
Since the aftermath of the financial crisis, stocks have typically rallied on the first day of the month. For example, stocks have risen by nearly +1% on average on the first day of the month since the Fed launched QE2 last year. This trend is driven by mechanical reasons including the flow of retirement plan money into the market as well as sentiment factors such as portfolio managers positioning for return opportunities to start the new month. On June 1, stocks dropped by -2.28%, signaling investor concern about the outlook.
1st Day of the Week Effect:
Over the same time frame, stocks have also tended to perform well on the first day of the week. Sometimes referred to as Mutual Fund Monday, this effect is driven by capital flows into mutual funds that are put to work in the market on Mondays. Although this indicator has been deteriorating for months, the -1.08% decline on June 6 was one of the worst Monday outings for stocks in a QE supported market. This coupled with the fact that volume was notably low indicates reluctance by mutual fund managers to put fresh cash to work in stocks.
Bernanke Effect:
Since the beginning of the QE era in March 2009, stocks have typically rallied when the Fed Chairman makes a major speech. Even if he says nothing of consequence, stock investors have usually found a way of gleaning something positive from his words to rally higher. But when the Fed chairman took the podium on Tuesday, June 7, markets immediately rolled over and dropped by nearly -1% in about an hour. Once again, this price movement had little to do with anything Bernanke said – much of his speech had already been leaked into the market earlier in the day. Instead, this market response was likely a signal to the Chairman of investor concern that without more Fed stimulus (QE3), stocks will lack the fuel to continue to rally higher.
It has been expected for some time that stocks would begin to weaken in anticipation of the end of QE2 on June 30. And portfolio allocations have been adjusted for months in preparation for this eventual turn in stocks.
Many of the asset class categories that are expected to perform well during a Post QE2 stock market correction are off to a good start. Leading among these are U.S. Treasuries, which are up nearly +1% for the month. Selected non-financial preferred stocks have also jumped roughly +1%. In addition, Treasury Inflation Protected Securities (TIPS) are up +0.5% in June, while other categories such as Investment Grade Corporate Bonds and Gold are holding steady near breakeven so far for the month.
Looking ahead to the coming week, the next few trading days will be important in signaling whether one last rally in stocks is coming before QE2 draws to a close on June 30. Otherwise, the pace could begin to pick up to the downside. Stay tuned.
Tuesday, May 31, 2011
Looking Beyond QE2
The post QE2 path for the economy and markets is becoming increasingly clear. It was known from the beginning when the U.S. Federal Reserve’s launched its current $600 billion stimulus program late last year (widely known as “the second round of quantitative easing” or QE2) that it would come down to two possible outcomes in the end.
The ideal outcome: Economic growth picks up and becomes strong enough to support asset prices inflated by Fed stimulus along the way including stocks and commodities. In other words, the economy would eventually grow up to support higher markets.
The deficient outcome: Economic growth remains sluggish despite Fed stimulus, placing inflated stock and commodities prices at risk for a meaningful pullback. More simply, higher markets are left to fall back to the weak economy.
As we enter the final days before the end of QE2 on June 30, it is becoming increasingly clear that the deficient outcome will be the most likely. Recent U.S. economic data has been disappointing to say the least. Not only is the pace of growth sluggish at best, the economy is actually showing signs of slowing down with many readings coming in below expectations. Beyond the U.S., the economic situation in Europe remains no better than it was a year ago at this time. Instead, it is actually quite a bit worse.
With the deficient outcome most likely after QE2, what can we expect from markets?
First, stocks and commodities are likely to enjoy at least one more rally in the days leading up to the end of QE2 regardless of the fundamentals. Today was another classic example of what we’ve seen throughout QE2. Despite a day filled with lousy U.S. economic data, stocks rallied sharply higher on the news that Greece was set to receive another bailout and would avoid bankruptcy - for now. No matter that Greece will simply be unable to repay its debts - they already can’t pay their current loans back, so lending them even more money isn’t going to solve the problem. But while a market that can celebrate the can being kicked further down the road is certainly dubious, it does provide an ideal environment to gradually transition portfolios into the expected post QE2 winners.
So which categories are these expected winners. They are listed below:
Likely post QE2 winners:
Selected Defensive U.S. Large Cap Growth Stocks
Selected Defensive U.S. Mid-Cap Growth Stocks
Gold
Investment Grade Corporate Bonds
High Yield Corporate Bonds
Non-Financial Preferred Stocks
U.S. Treasuries
This list comes with precedent - all of these categories either held steady or posted solid gains when the deficient outcome occurred after the end of QE1 last summer. And many if not all are set up well to repeat this performance a second time around.
Of course, many market segments are likely to struggle under the deficient outcome. The list of likely post QE2 losers are shown below (many of these have been winners in the current environment):
Likely post QE2 losers:
Most U.S. Stock categories – Cyclicals and Financials in particular
International Stocks
Emerging Market Stocks
Industrial Commodities – Copper, Oil, etc.
Agricultural Commodities
Financial Preferred Stocks
Non-US Sovereign Bonds
Emerging Market Bonds
What about the wild cards? Preparing for the unexpected is critical, particularly in today’s markets. While there are too many to mention in this e-mail, two particular events bear close watching in the coming months after QE2. The first is the arrival of QE3 – just as they did last summer, the Fed could eventually step back in with another round of stimulus. This would be a signal to potentially shift allocations back to the current “post QE2 loser” list. The second is the situation in Europe – if things begin to really come apart in the Euro Zone, this would be a potential shock that could narrow and change the “post QE2 winner” list above quite a bit. Stay tuned on both of these items – I’ll keep you updated.
The priority over the last several weeks and continuing in the coming weeks will be to gradually shift allocations away from the expected post QE2 losers and reallocate toward the anticipated post QE2 winners. Closely monitoring the potential wild cards will also be important along the way. Through it all, the focus remains on generating positive absolute returns, managing risk and seeking to capitalize on positive return opportunities regardless of the overall market environment.
The ideal outcome: Economic growth picks up and becomes strong enough to support asset prices inflated by Fed stimulus along the way including stocks and commodities. In other words, the economy would eventually grow up to support higher markets.
The deficient outcome: Economic growth remains sluggish despite Fed stimulus, placing inflated stock and commodities prices at risk for a meaningful pullback. More simply, higher markets are left to fall back to the weak economy.
As we enter the final days before the end of QE2 on June 30, it is becoming increasingly clear that the deficient outcome will be the most likely. Recent U.S. economic data has been disappointing to say the least. Not only is the pace of growth sluggish at best, the economy is actually showing signs of slowing down with many readings coming in below expectations. Beyond the U.S., the economic situation in Europe remains no better than it was a year ago at this time. Instead, it is actually quite a bit worse.
With the deficient outcome most likely after QE2, what can we expect from markets?
First, stocks and commodities are likely to enjoy at least one more rally in the days leading up to the end of QE2 regardless of the fundamentals. Today was another classic example of what we’ve seen throughout QE2. Despite a day filled with lousy U.S. economic data, stocks rallied sharply higher on the news that Greece was set to receive another bailout and would avoid bankruptcy - for now. No matter that Greece will simply be unable to repay its debts - they already can’t pay their current loans back, so lending them even more money isn’t going to solve the problem. But while a market that can celebrate the can being kicked further down the road is certainly dubious, it does provide an ideal environment to gradually transition portfolios into the expected post QE2 winners.
So which categories are these expected winners. They are listed below:
Likely post QE2 winners:
Selected Defensive U.S. Large Cap Growth Stocks
Selected Defensive U.S. Mid-Cap Growth Stocks
Gold
Investment Grade Corporate Bonds
High Yield Corporate Bonds
Non-Financial Preferred Stocks
U.S. Treasuries
This list comes with precedent - all of these categories either held steady or posted solid gains when the deficient outcome occurred after the end of QE1 last summer. And many if not all are set up well to repeat this performance a second time around.
Of course, many market segments are likely to struggle under the deficient outcome. The list of likely post QE2 losers are shown below (many of these have been winners in the current environment):
Likely post QE2 losers:
Most U.S. Stock categories – Cyclicals and Financials in particular
International Stocks
Emerging Market Stocks
Industrial Commodities – Copper, Oil, etc.
Agricultural Commodities
Financial Preferred Stocks
Non-US Sovereign Bonds
Emerging Market Bonds
What about the wild cards? Preparing for the unexpected is critical, particularly in today’s markets. While there are too many to mention in this e-mail, two particular events bear close watching in the coming months after QE2. The first is the arrival of QE3 – just as they did last summer, the Fed could eventually step back in with another round of stimulus. This would be a signal to potentially shift allocations back to the current “post QE2 loser” list. The second is the situation in Europe – if things begin to really come apart in the Euro Zone, this would be a potential shock that could narrow and change the “post QE2 winner” list above quite a bit. Stay tuned on both of these items – I’ll keep you updated.
The priority over the last several weeks and continuing in the coming weeks will be to gradually shift allocations away from the expected post QE2 losers and reallocate toward the anticipated post QE2 winners. Closely monitoring the potential wild cards will also be important along the way. Through it all, the focus remains on generating positive absolute returns, managing risk and seeking to capitalize on positive return opportunities regardless of the overall market environment.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Tuesday, May 17, 2011
2011 Q2 Mid Quarter Update: Anticipating the End of QE2
Investment markets have pretty much followed the script so far in 2011 Q2. Many of the risks that were hanging over the market at the beginning of April are still lingering. The situation in the Middle East is far from resolved and the U.S. economic outlook remains muddled at best. And some risks have risen to the next level. Leading among these is the deteriorating situation in Europe. Not only is the risk for default in places like Ireland and Portugal continuing to rise, but rumors even bubbled to the surface that Greece was threatening to leave the Euro Zone altogether. But just as before, investment markets have continued to largely ignore these ongoing risks so far in Q2. Instead, the focus remains almost exclusively on QE2, the Fed’s stimulus program that’s set to end on June 30.
Since QE2 is such a key driver for the markets, a few important questions are worth considering. First, what can we expect from investment markets in the final weeks before the end of QE2 on June 30? Second, how will investment markets react starting in early July once QE2 is finished? Finally, what is the likelihood that the Fed will return with another round of stimulus (QE3) at some point later in the year?
To answer the first two questions, it’s worthwhile to examine the market by asset class:
Stocks – The steady rise in stocks that started with the launch of QE2 last year is becoming replaced by swinging volatility as we approach the end of QE2. While stocks remain in an uptrend and reached a new post crisis high as recently as May 2, they are clearly losing steam. Short-term corrections are also becoming more frequent and violent, suggesting a shift to the downside for stocks may soon be on its way. Dissecting the stock market into its sector components is even more revealing. When QE2 was launched last August, the more cyclical sectors including industrials, retailers and commodities were the market leaders. But since the beginning of the second quarter, investors have fled these more economically sensitive areas in favor of more defensive sectors such as consumer staples, utilities and health care. This type of sector rotation from cyclical to defensive sectors is also common during the late stages of a stock rally. Portfolios benefitted from having a defensive stock emphasis heading into this shift, but many of these sectors are now starting to become a bit frothy in their own right. As a result, individual stock selection will become increasingly important in generating returns and protecting against risk as we head into the post QE2 summer months, particularly if the broader stock market moves lower as expected.
High Yield Corporate Bonds – This “stocks-lite” asset class continues to post consistently strong performance. High yield bonds have also avoided the swings of volatility that have been increasingly disrupting the stock market. As mentioned in the past, companies that make up the high yield bond category are building cash reserves and paying down debt, which is positive for the sustainability of these upside returns going forward. High yield bonds also remain reasonably valued and provide a +6% yield to go along with the steady price appreciation. While high yield bonds are likely to experience a pullback to some degree following the end of QE2, they represent an ideal way to still maintain stock-like exposure in portfolios while also protecting against downside risk in what could be a turbulent summer for stocks.
Investment Grade Corporate Bonds – Put simply, investment grade corporate bonds are among the best investment choices in a post QE2 environment. Most big companies are flush with cash and are ready to make the interest payments on their debts. In addition, if the economy slows as expected once QE2 ends, investors will likely flock to the high quality yield provided by investment grade corporate bonds. Although a bit overbought at the moment, investment grade corporate bonds valuations still remain reasonable, and the price performance of this asset class has also been consistently higher since the early days following the financial crisis, steadily rising both when QE is on and when QE is off.
Preferred Stocks – While this asset class should be generally avoided due to the near 90% weighting to financials, selected high yielding preferred stocks in the telecom and utilities sector may set up for attractive short-term investment opportunities in the coming months, particularly once we get into the post QE2 summer months.
Silver – The silver mania peaked and came to an end in Q2. Portfolio gains were locked in near the peak of the silver market and downside volatility has become extreme in the aftermath. While the thesis behind holding silver remains in tact, trading in this category has become toxic and remains overrun by speculators. As a result, it is best to avoid the silver trade going forward and look for more stable opportunities elsewhere.
Gold – Unlike silver, gold continues to represent an attractive investment opportunity. Chronic U.S. dollar weakening is a key driver behind the rising gold price, and this theme remains in tact with the U.S. government and the Fed still actively engaged in programs to promote money printing and currency debasement. Secondary themes including the threat of a double dip recession and geopolitical instability in Europe and the Middle East also remain supportive of gold. And the frequent talk in the press about gold being in a bubble is misguided, as trading activity in gold has instead been both rational and predictable for the last several years. If anything, stocks are far more “bubbly” than gold at this point. While short-term corrections like the pullback since the beginning of May should be expected along the way, the trend for gold remains very much in place. The key level to watch for gold as we move through the post QE2 summer is the 150-day moving average, which is now at $1,404 per ounce but will continue to rise as we move through the summer. As long as gold remains above its 150-day moving average – it is currently trading at $1,486 per ounce - the gold theme remains in tact. On the other hand, if gold were to eventually break below it’s 150-day moving average on a sustained basis, it may then be the time to lock in gains. Updates will follow along the way.
Treasuries – A variety of long-term risks face the U.S. Treasury market including massive fiscal deficits, declining demand from foreign lenders, ongoing political wrangling over raising the debt ceiling and the loss of a key buyer in the Fed once QE2 ends in June. Despite these risks, Treasuries still have the potential to be an attractive short-term investment theme for the post QE2 markets. The following are some key reasons. First, the economy may show signs of slowing down post QE2. Second, the situation in either Europe or the Middle East might take a turn for the worse. Third, the U.S. government may finally make progress in getting its fiscal house back in order. And finally, if the stock market falls into correction like it did after QE1, the trillions of QE2 dollars that poured into stocks will need to find a safe haven. All of these forces would be positive for Treasuries and would not be unprecedented. After all, many of these same forces helped drive Treasuries as the best performing asset class last summer – while stocks declined by over -15% from April 2010 to August 2010, long-term Treasuries gained +22%. And the +8% rally in these same long-term Treasuries since early April 2011 suggests some are anticipating more of the same for the coming summer. Any positions in Treasuries should be viewed as short-term holdings, however.
TIPS – Treasury Inflation Protected Securities (TIPS) perform particularly well when investors are concerned about inflation or deflation. Recent worries over inflation have driven TIPS prices +8% higher since February, but they are currently overbought following this strong run. The focus on inflation is likely to soon be replaced by the threat of a weakening economy, which is deflationary and would provide further support to TIPS. Despite these advantages, many of the same risks that overhang the Treasury market are also risks for TIPS. As a result, portfolio weightings to TIPS are likely to be reduced somewhat moving ahead.
Returning to the final question from the list above, it is very possible that the Fed may return later in the summer with talk about a new round of QE3 stimulus. I would assign odds at better than 50% at this point given persistent global geopolitical instabilities and the fact that the U.S. economic recovery remains sluggish. But the final result will depend on how the economy and markets perform in the aftermath of QE2. Regardless of what form the Fed might deliver stimulus to the market, it would be reasonable to expect that this would spark yet another artificial rally in stocks and other higher risk markets. How this all unfolds and the likelihood of QE3 will be the next key theme to watch as we move into the third quarter.
Bottom line – Investment markets are currently rotating in anticipation of the end of QE2. The stock rally has lost steam and has become more defensive. But many of the areas outside of stocks that are expected to perform well in a post QE2 environment have already begun to rally. Advanced positioning in these areas has proven beneficial so far, but close attention to markets will continue be critical in the coming weeks as volatility is expected to increase further as we move past the end of QE2. Fortunately, many investment categories remain set to perform well and provide opportunity in a post QE2 environment.
Since QE2 is such a key driver for the markets, a few important questions are worth considering. First, what can we expect from investment markets in the final weeks before the end of QE2 on June 30? Second, how will investment markets react starting in early July once QE2 is finished? Finally, what is the likelihood that the Fed will return with another round of stimulus (QE3) at some point later in the year?
To answer the first two questions, it’s worthwhile to examine the market by asset class:
Stocks – The steady rise in stocks that started with the launch of QE2 last year is becoming replaced by swinging volatility as we approach the end of QE2. While stocks remain in an uptrend and reached a new post crisis high as recently as May 2, they are clearly losing steam. Short-term corrections are also becoming more frequent and violent, suggesting a shift to the downside for stocks may soon be on its way. Dissecting the stock market into its sector components is even more revealing. When QE2 was launched last August, the more cyclical sectors including industrials, retailers and commodities were the market leaders. But since the beginning of the second quarter, investors have fled these more economically sensitive areas in favor of more defensive sectors such as consumer staples, utilities and health care. This type of sector rotation from cyclical to defensive sectors is also common during the late stages of a stock rally. Portfolios benefitted from having a defensive stock emphasis heading into this shift, but many of these sectors are now starting to become a bit frothy in their own right. As a result, individual stock selection will become increasingly important in generating returns and protecting against risk as we head into the post QE2 summer months, particularly if the broader stock market moves lower as expected.
High Yield Corporate Bonds – This “stocks-lite” asset class continues to post consistently strong performance. High yield bonds have also avoided the swings of volatility that have been increasingly disrupting the stock market. As mentioned in the past, companies that make up the high yield bond category are building cash reserves and paying down debt, which is positive for the sustainability of these upside returns going forward. High yield bonds also remain reasonably valued and provide a +6% yield to go along with the steady price appreciation. While high yield bonds are likely to experience a pullback to some degree following the end of QE2, they represent an ideal way to still maintain stock-like exposure in portfolios while also protecting against downside risk in what could be a turbulent summer for stocks.
Investment Grade Corporate Bonds – Put simply, investment grade corporate bonds are among the best investment choices in a post QE2 environment. Most big companies are flush with cash and are ready to make the interest payments on their debts. In addition, if the economy slows as expected once QE2 ends, investors will likely flock to the high quality yield provided by investment grade corporate bonds. Although a bit overbought at the moment, investment grade corporate bonds valuations still remain reasonable, and the price performance of this asset class has also been consistently higher since the early days following the financial crisis, steadily rising both when QE is on and when QE is off.
Preferred Stocks – While this asset class should be generally avoided due to the near 90% weighting to financials, selected high yielding preferred stocks in the telecom and utilities sector may set up for attractive short-term investment opportunities in the coming months, particularly once we get into the post QE2 summer months.
Silver – The silver mania peaked and came to an end in Q2. Portfolio gains were locked in near the peak of the silver market and downside volatility has become extreme in the aftermath. While the thesis behind holding silver remains in tact, trading in this category has become toxic and remains overrun by speculators. As a result, it is best to avoid the silver trade going forward and look for more stable opportunities elsewhere.
Gold – Unlike silver, gold continues to represent an attractive investment opportunity. Chronic U.S. dollar weakening is a key driver behind the rising gold price, and this theme remains in tact with the U.S. government and the Fed still actively engaged in programs to promote money printing and currency debasement. Secondary themes including the threat of a double dip recession and geopolitical instability in Europe and the Middle East also remain supportive of gold. And the frequent talk in the press about gold being in a bubble is misguided, as trading activity in gold has instead been both rational and predictable for the last several years. If anything, stocks are far more “bubbly” than gold at this point. While short-term corrections like the pullback since the beginning of May should be expected along the way, the trend for gold remains very much in place. The key level to watch for gold as we move through the post QE2 summer is the 150-day moving average, which is now at $1,404 per ounce but will continue to rise as we move through the summer. As long as gold remains above its 150-day moving average – it is currently trading at $1,486 per ounce - the gold theme remains in tact. On the other hand, if gold were to eventually break below it’s 150-day moving average on a sustained basis, it may then be the time to lock in gains. Updates will follow along the way.
Treasuries – A variety of long-term risks face the U.S. Treasury market including massive fiscal deficits, declining demand from foreign lenders, ongoing political wrangling over raising the debt ceiling and the loss of a key buyer in the Fed once QE2 ends in June. Despite these risks, Treasuries still have the potential to be an attractive short-term investment theme for the post QE2 markets. The following are some key reasons. First, the economy may show signs of slowing down post QE2. Second, the situation in either Europe or the Middle East might take a turn for the worse. Third, the U.S. government may finally make progress in getting its fiscal house back in order. And finally, if the stock market falls into correction like it did after QE1, the trillions of QE2 dollars that poured into stocks will need to find a safe haven. All of these forces would be positive for Treasuries and would not be unprecedented. After all, many of these same forces helped drive Treasuries as the best performing asset class last summer – while stocks declined by over -15% from April 2010 to August 2010, long-term Treasuries gained +22%. And the +8% rally in these same long-term Treasuries since early April 2011 suggests some are anticipating more of the same for the coming summer. Any positions in Treasuries should be viewed as short-term holdings, however.
TIPS – Treasury Inflation Protected Securities (TIPS) perform particularly well when investors are concerned about inflation or deflation. Recent worries over inflation have driven TIPS prices +8% higher since February, but they are currently overbought following this strong run. The focus on inflation is likely to soon be replaced by the threat of a weakening economy, which is deflationary and would provide further support to TIPS. Despite these advantages, many of the same risks that overhang the Treasury market are also risks for TIPS. As a result, portfolio weightings to TIPS are likely to be reduced somewhat moving ahead.
Returning to the final question from the list above, it is very possible that the Fed may return later in the summer with talk about a new round of QE3 stimulus. I would assign odds at better than 50% at this point given persistent global geopolitical instabilities and the fact that the U.S. economic recovery remains sluggish. But the final result will depend on how the economy and markets perform in the aftermath of QE2. Regardless of what form the Fed might deliver stimulus to the market, it would be reasonable to expect that this would spark yet another artificial rally in stocks and other higher risk markets. How this all unfolds and the likelihood of QE3 will be the next key theme to watch as we move into the third quarter.
Bottom line – Investment markets are currently rotating in anticipation of the end of QE2. The stock rally has lost steam and has become more defensive. But many of the areas outside of stocks that are expected to perform well in a post QE2 environment have already begun to rally. Advanced positioning in these areas has proven beneficial so far, but close attention to markets will continue be critical in the coming weeks as volatility is expected to increase further as we move past the end of QE2. Fortunately, many investment categories remain set to perform well and provide opportunity in a post QE2 environment.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Tuesday, May 10, 2011
Agriculture Prices: Early Warning Signal
A key debate with QE2 ending in June is whether the economy can continue its recovery without government support. If the pace of economic growth persists, higher risk assets such as cyclical stocks and commodities would likely continue to lead. And if the economy stalls after QE2, lower risk assets such as defensive stocks and bonds would likely benefit. In anticipating which result to expect, it is worthwhile to identify any leading indicators to the ultimate outcome.
In recent years, agriculture prices have provided a fairly reliable early warning signal, shifting roughly three months in advance of the stock market. For example, while the stock market peaked in April 2010 after QE1 ended, agricultural prices had already crested three months earlier in January 2010.
Today, we see the same trend starting to take shape. Agriculture prices peaked in early March 2011 and have been trending lower since. However, stocks continue to rise. If past precedence holds, the March top in agriculture prices would imply a peak for stocks in June 2011, which is also when QE2 is set to end.
The turn in agriculture prices is another signal that the broader stock rally may be nearing an end. Thus, a portfolio shift away from economically sensitive cyclical and commodities stocks toward more defensive consumer staples and utilities stocks as well as bonds may be prudent. These latter categories posted solid gains following the end of QE1 and have already begun to move higher ahead of the end of QE2.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Monday, May 2, 2011
Silver Exited on Friday
Silver corrected sharply today. For the day, it was down over -13% at its lows intraday before ending the session down -10%. But today’s outcome was not necessarily a surprise. After rising over +160% since last August, silver has been in a full-blown mania. Such manias are accompanied by increasingly volatility and usually end badly. Recognizing these extreme risks in advance, all silver positions were sold last Friday, April 27. The sale price was $47.87, which was near the recent price peak for silver and +12% above today’s close.
The underlying fundamental story behind owning silver - hard asset protection against aggressive monetary stimulus, inflation and currency debasement - remains in tact. But the decision to sell silver last Friday was driven by several factors.
First, speculative activity in silver is becoming increasingly frothy. Silver is a relatively small segment of the precious metals space and trading volume is typical a tiny fraction of what is seen in the broader stock market. So when the trading volume of the iShares Silver Trust (SLV) exceeded that of the SPDR S&P 500 (SPY) last Wednesday with nearly 50% of all outstanding shares changing hands, this reconfirmed growing signs that far more that just fundamental investor conviction is at work in the silver market right now.
Second, after skyrocketing since last summer, silver had reached a critical resistance level in the $50 range. This was the previous high from all the way back in 1980. Silver made a run at $50 three times last week on Monday, Thursday and Friday and failed to break through this level in each instance. This indicated that selling pressure was strong at $50 and would ultimately lead to a price pullback, as recent speculative entrants into the silver market eventually opt to exit the trade while the more aggressive speculators start to descend on silver with their bets that the price is going down.
Price swings are also becoming more violent. Last Tuesday, silver plunged over -4% on options expiration. The next day, it soared +7% following Bernanke’s speech. And today it plunged -10%. Such massive price swings are characteristic of what’s often seen at the ending stages of a mania, and the subsequent downside is typically sudden and sharp.
Finally, some qualitative indicators were also setting off alarms. For example, silver is typically an investment that flies below the radar. The mention of silver once a week on the mainstream business television channels would be a lot in a normal environment. But in recent weeks, silver has been getting daily headline coverage on the major networks. Such attention historically indicates that speculative buying activity is close to exhaustion, as the final marginal buyers are drawn into the market and selling demand begins to overwhelm buying demand.
While silver could continue to rise higher from here, risks are overwhelmingly to the downside from recent price peaks. Now that the silver position has been exited, I will continue to monitor the market for any potential reentry points. This will be unlikely in the near-term, at least until the speculative froth has been worked off, and any future positions would likely have a small allocation relative to past positions. Instead, other asset classes currently offer better opportunities. This includes gold, which has been behaving much more rationally with a much more predictable trading pattern.
The underlying fundamental story behind owning silver - hard asset protection against aggressive monetary stimulus, inflation and currency debasement - remains in tact. But the decision to sell silver last Friday was driven by several factors.
First, speculative activity in silver is becoming increasingly frothy. Silver is a relatively small segment of the precious metals space and trading volume is typical a tiny fraction of what is seen in the broader stock market. So when the trading volume of the iShares Silver Trust (SLV) exceeded that of the SPDR S&P 500 (SPY) last Wednesday with nearly 50% of all outstanding shares changing hands, this reconfirmed growing signs that far more that just fundamental investor conviction is at work in the silver market right now.
Second, after skyrocketing since last summer, silver had reached a critical resistance level in the $50 range. This was the previous high from all the way back in 1980. Silver made a run at $50 three times last week on Monday, Thursday and Friday and failed to break through this level in each instance. This indicated that selling pressure was strong at $50 and would ultimately lead to a price pullback, as recent speculative entrants into the silver market eventually opt to exit the trade while the more aggressive speculators start to descend on silver with their bets that the price is going down.
Price swings are also becoming more violent. Last Tuesday, silver plunged over -4% on options expiration. The next day, it soared +7% following Bernanke’s speech. And today it plunged -10%. Such massive price swings are characteristic of what’s often seen at the ending stages of a mania, and the subsequent downside is typically sudden and sharp.
Finally, some qualitative indicators were also setting off alarms. For example, silver is typically an investment that flies below the radar. The mention of silver once a week on the mainstream business television channels would be a lot in a normal environment. But in recent weeks, silver has been getting daily headline coverage on the major networks. Such attention historically indicates that speculative buying activity is close to exhaustion, as the final marginal buyers are drawn into the market and selling demand begins to overwhelm buying demand.
While silver could continue to rise higher from here, risks are overwhelmingly to the downside from recent price peaks. Now that the silver position has been exited, I will continue to monitor the market for any potential reentry points. This will be unlikely in the near-term, at least until the speculative froth has been worked off, and any future positions would likely have a small allocation relative to past positions. Instead, other asset classes currently offer better opportunities. This includes gold, which has been behaving much more rationally with a much more predictable trading pattern.
Monday, April 25, 2011
The Fed Speaks
This Wednesday will mark a historic event for financial markets. At 2:15PM on April 27, U.S. Federal Reserve Chairman Ben Bernanke will hold his first ever press conference. The session will occur immediately after the latest Federal Open Markets Committee (FOMC) meeting where the course of monetary policy and interest rates is decided. Given that investors are highly sensitive to anything that is merely discussed during these meetings, this press event may also end up being particularly memorable for its impact on the markets.
Until recent years, the Fed was an organization that mostly operated behind the scenes. The fact that investment markets are so reactive to changes in interest rates was a primary reason for this discretion. For the first 80 years after its founding in 1913, the Fed didn’t even disclose the outcome of these meetings. Starting in 1994, they began issuing statements only when they changed interest rates. And it was only just 12 years ago in 1999 when they started issuing statements at the end of each meeting. Since then, investors have anxiously awaited each statement to comb it over, dissecting each and every word across a handful of paragraphs for any hint of a change in the direction of monetary policy.
The Fed holding a post FOMC press conference is the latest in what has been a rapid public relations evolution. This change has been an attempt to better inform investment markets about Fed actions on monetary policy. In recent years, members of the FOMC including Bernanke, the Board of Governors and selected regional Fed bank presidents have become increasingly ubiquitous. It is no longer uncommon to see Bernanke interviewed on 60 Minutes or a Fed governor/president speaking at some dinner event. And comments from FOMC members at speeches can range from the “dovish” members like Bill Dudley and Janet Yellen indicating they are inclined to keep interest rates low to the “hawkish” members like Richard Fisher and Charles Plosser suggesting the need to raise interest rates soon. It’s almost as if the FOMC as a group has coordinated to get a voice out there for everyone. This way, if you have concerns about what the Fed is doing – whether its keeping interest rates too low or raising them too quickly - you can be potentially reassured that somebody in the FOMC meetings is speaking on your behalf.
So what can we expect from the Fed’s latest PR outreach on Wednesday? The format is set for Bernanke to make an opening statement followed by a 45-minute question and answer session with the press. Under this format, those that have been concerned about the way the Fed is handling monetary policy, they will have an open shot to address these concerns directly with the Fed Chairman. For example, questions are likely to focus on the Fed potentially ignoring mounting global inflation pressures (low interest rates helps to ignite inflation) and the chronically weakening dollar. Instead of trying to translate these conclusions from a brief statement or cobbling together comments from different FOMC members, we can hear the answer straight from the Fed Chairman’s mouth directly to the press.
The true key to the meeting will be any signals from Bernanke on the end of the Fed’s stimulus program. It was at one of those speeches talked about above at the Federal Reserve Bank of Kansas City Economic Symposium in Jackson Hole on August 27, 2010 that Ben Bernanke kicked off the current stock market rally with his comments that definitively confirmed that another round of monetary stimulus to boost the economy was soon on its way. This latest program from the Fed – widely known as QE2 - is set to end on June 30, 2011, and FOMC members have widely suggested the need to avoid any further Fed stimulus (QE3) and let the economy stand on its own. However, a lively debate remains ongoing in investment markets as to whether the Fed will quickly return with QE3 once QE2 has come to an end. If the Fed really wants to make a splash at its first press conference, the setting would be right for Bernanke to communicate with clarity that the Fed intends to let QE2 expire and that it also has no plans to intervene again with QE3 later in the year (at least for now). Going a step further, any mention for the need for fiscal or monetary “austerity” would steal the headlines. Such comments would likely send stocks lower – just as monetary stimulus has helped inflate stocks to this point, the lack of stimulus would likely deflate stocks going forward.
So just as Bernanke’s Jackson Hole speech in August 2010 marked the beginning of the stock rally, Bernanke’s first press conference on Wednesday has the potential to mark the end. Of course, it is just as likely that Bernanke and the Fed will stay neutral in its comments on Wednesday and wait a few months before they begin to become more decisive on the end of QE2 and the potential for QE3 in the future. Regardless of the outcome, the Fed’s Wednesday press conference represents the first major potential inflection point for investment markets in the current stimulus cycle, which makes it certainly worth the watch.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Monday, April 18, 2011
S&P 'Negative Outlook' May Be a Catalyst for a Trade in Treasuries
From a contrarian perspective, the announcement by S&P that they have placed a negative outlook on the United States may actually serve as a buy signal to initiate a trade in U.S. Treasuries.
Several factors support this bullish case:
1. The Treasury market appears to have bottomed - After reaching a low in early February, the Treasury market has been gradually picking up momentum to the upside and is setting up well from a technical perspective.
2. The 'negative outlook' announcement is a call for fiscal discipline - While it's already a growing topic in Washington, such a headline event will encourage even greater emphasis on getting fiscal spending under greater control.
3. QE2 is ending in June - The last time Treasuries rallied was following the end of QE1. If the economy is not strong enough to hold up without government stimulus, investors may move to safe haven Treasuries
4. Major buyers have already exited the market - As an example, PIMCO, which is the largest bond fund in the world and one of the largest holders of U.S. Treasuries, has already made it well known that they have fully exited the Treasury market. As a result, they will be a net buyer of Treasuries if anything going forward.
Any positions, particularly longer duration exposures including ETFs like IEF and TLT, should be viewed as short-term trades at this stage, as more work must be done in Washington to change the long-term view.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Several factors support this bullish case:
1. The Treasury market appears to have bottomed - After reaching a low in early February, the Treasury market has been gradually picking up momentum to the upside and is setting up well from a technical perspective.
2. The 'negative outlook' announcement is a call for fiscal discipline - While it's already a growing topic in Washington, such a headline event will encourage even greater emphasis on getting fiscal spending under greater control.
3. QE2 is ending in June - The last time Treasuries rallied was following the end of QE1. If the economy is not strong enough to hold up without government stimulus, investors may move to safe haven Treasuries
4. Major buyers have already exited the market - As an example, PIMCO, which is the largest bond fund in the world and one of the largest holders of U.S. Treasuries, has already made it well known that they have fully exited the Treasury market. As a result, they will be a net buyer of Treasuries if anything going forward.
Any positions, particularly longer duration exposures including ETFs like IEF and TLT, should be viewed as short-term trades at this stage, as more work must be done in Washington to change the long-term view.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Two New Posts on Seeking Alpha
I have two new posts to Seeking Alpha that may be of interest.
The first is entitled Best Post-QE2 Opportunities Lie Beyond Stocks
The bottom line from this article: The best post QE2 opportunities lie beyond the stock market, as many asset classes performed well in the post QE1 market last summer. Positioning in these categories must be handled carefully, however, as the forces driving markets emerging from QE2 will be unique and different from the last time around. As a result, each category should be dissected for its merits and flaws in a post QE2 market.
The second extends the discussion from the first article, focusing on Silver. It is entitled Navigating the Silver Mania: Exiting Long Positions May Be Prudent
The bottom line from this article: The silver rally appears to be entering the late stages. Exiting current long positions and locking in gains may be prudent in the coming weeks leading up to the end of QE2 on June 30. Volatility is likely to continue for silver, particularly on the upside in the short-term, which may provide for early exit points ahead of mid June. Technical signals also merit close attention in the coming weeks to protect against any sustained breaks to the downside.
The first is entitled Best Post-QE2 Opportunities Lie Beyond Stocks
The bottom line from this article: The best post QE2 opportunities lie beyond the stock market, as many asset classes performed well in the post QE1 market last summer. Positioning in these categories must be handled carefully, however, as the forces driving markets emerging from QE2 will be unique and different from the last time around. As a result, each category should be dissected for its merits and flaws in a post QE2 market.
The second extends the discussion from the first article, focusing on Silver. It is entitled Navigating the Silver Mania: Exiting Long Positions May Be Prudent
The bottom line from this article: The silver rally appears to be entering the late stages. Exiting current long positions and locking in gains may be prudent in the coming weeks leading up to the end of QE2 on June 30. Volatility is likely to continue for silver, particularly on the upside in the short-term, which may provide for early exit points ahead of mid June. Technical signals also merit close attention in the coming weeks to protect against any sustained breaks to the downside.
Monday, April 11, 2011
2011 Q2 Preview: Cresting the Wave
As we emerge from the cold of winter, investment markets continue to run hot. Despite the risks and volatility pressing markets in 2011 Q1 - social unrest in the Middle East, an ongoing debt crisis in Europe, the tragic earthquake in Japan, a U.S. economic recovery that is still struggling to gain traction, etc. – virtually all asset classes ended the quarter solidly higher. This performance must be taken with a healthy grain of salt. After all, stocks were lower for the quarter as recently as March 16. But the market strength in the face of these challenges is notable.
As discussed in previous commentaries, the key behind this market strength remains the $600 billion “Quantitative Easing 2” (QE2) stimulus program from the U.S. Federal Reserve. This program set to end on June 30, 2011, which is the last day of Q2. As a result, is necessary it keep a sharp eye on the implications of the end of QE2 for each asset class as we move through the current quarter.
The following is a review and preview for each of the major asset classes:
Stocks – The upward move in stocks since last summer has been driven almost exclusively by QE2. And this benefit continued in the first quarter, with stocks up over +5%. Performance was particularly strong in U.S. Mid-Cap stocks, which were up over +9%. But stocks are likely to face increasing pressure as we approach the end of QE2. Stocks dropped by nearly -20% in a matter of weeks following the end of QE1, and this is a fact not at all lost on the market - investors will almost certainly be anticipating the end of QE this time around. Just as Fed Chairman Ben Bernanke’s speech in Jackson Hole on August 27, 2010 confirming QE2 marked the start of the rally in stocks, his first ever monetary decision press conference coming up on April 27 potentially confirming the end of QE2 may very well mark the peak in stocks and a shift to the downside. Stay tuned.
High Yield Corporate Bonds – High yield bonds enjoyed a nearly uninterrupted move higher in the second quarter, rising nearly +4%. Although the asset class has “bonds” in its name, high yield bonds actually trade more in line with stocks but usually with less volatility. In short, high yield bonds are more like “stocks lite”. But unlike stocks, high yield bonds continued to move steadily higher following the end of QE1 last summer following an initial pullback. With companies in this category continuing to stockpile cash and paying down debt, it is reasonable to expect that this category may hold up relatively well again this time around.
Gold & Silver – The money printing by global central banks including the Fed has raised concerns about the value of the U.S. dollar and other fiat currencies. This has led investors toward hard assets such as gold and silver as a store of value. Gold has spent the last few months consolidating gains and only recently experienced an upside breakout in the first few days of April. Silver, on the other hand, is now fully engaged in a mania phase. Overall, silver was up +22% in the first quarter, is up +8% already in the first few trading days of April and has nearly doubled since Bernanke’s August 27 Jackson Hole speech last summer. Manias like this usually end badly regardless of the fundamental reasons behind the story, so a very close watch is necessary in the coming weeks for even the first signs of any inflection point in the white metal. And while both gold and silver performed well following the end of QE1 last summer, gold will likely be the preferred position to emphasize in working to navigate the post QE2 environment. Caviat: the flood of central bank liquidity has clearly played a role in driving metals higher during QE2, so any subsequent post QE2 draining of liquidity may end up pushing gold to the downside.
Investment Grade Corporate Bonds – Investment Grade Corporate Bonds continue to provide steady performance since the days following the outbreak of the financial crisis in late 2008. Just like their high yield counterparts, higher quality investment grade companies are also flush with cash and working to pay down debt. But unlike their high yield brethren, this category trades independently of stocks. Investment grade corporate bonds have generally risen when stock markets were rising over the last two years, but they’ve done even better when stocks were falling. They gained +7% when stocks dropped by -20% after QE1 last summer, and they currently represent a decent value heading toward the end of QE2. While the potential for rising inflation is a threat for this category, investment grade corporate bonds still provide favorable portfolio diversification benefits overall.
Treasuries – This category has essentially become a trade against stocks. In short, when QE is on and stocks are going up, U.S. Treasuries are typically trading sideways or selling off. And when QE is off and stocks are going down, U.S. Treasuries have rallied. As a result, Treasuries may offer the potential for a short-term trading position heading into the post QE2 market. Otherwise, they remain richly priced and offer little long-term appeal given the current fiscal state of the U.S. government and rising inflation pressures. Caviat: if the U.S. economy fell back toward recession later in the year, Treasuries may provide more interesting total return prospects. But this is still a big “if” at this point.
TIPS – Treasury Inflation Protected Securities (TIPS) are a special category of U.S. Treasuries that are backed by the U.S. government but are also adjusted for inflation. As a result, they trade on their own path separate from the broader Treasury market. TIPS have traded steadily higher since the days following the financial crisis in late 2008. And unlike traditional Treasuries, they’ve traded higher both during stock rallies and stock pullbacks – TIPS gained +4% when stocks sold off after QE1 last summer and are up another +4% since. Mounting concerns about inflation have added to the appeal for TIPS, and these concerns are not likely to dissipate with gasoline prices heading north of $4.00 a gallon this summer. Despite all of these positives, these bonds are still issued by the U.S. government. If concerns about the U.S. fiscal situation or the government’s handling of it persist, investors could start to become wary.
The bottom line – Investment markets have performed well in recent months but may be approaching a major inflection point with the end of QE2 approaching at the end of June. As a result, increasing volatility should be expected as we move through the quarter. Also, an increasing priority will be to focus on investment categories that fundamentally make sense and are also positioned to rise in a post QE2 environment.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
As discussed in previous commentaries, the key behind this market strength remains the $600 billion “Quantitative Easing 2” (QE2) stimulus program from the U.S. Federal Reserve. This program set to end on June 30, 2011, which is the last day of Q2. As a result, is necessary it keep a sharp eye on the implications of the end of QE2 for each asset class as we move through the current quarter.
The following is a review and preview for each of the major asset classes:
Stocks – The upward move in stocks since last summer has been driven almost exclusively by QE2. And this benefit continued in the first quarter, with stocks up over +5%. Performance was particularly strong in U.S. Mid-Cap stocks, which were up over +9%. But stocks are likely to face increasing pressure as we approach the end of QE2. Stocks dropped by nearly -20% in a matter of weeks following the end of QE1, and this is a fact not at all lost on the market - investors will almost certainly be anticipating the end of QE this time around. Just as Fed Chairman Ben Bernanke’s speech in Jackson Hole on August 27, 2010 confirming QE2 marked the start of the rally in stocks, his first ever monetary decision press conference coming up on April 27 potentially confirming the end of QE2 may very well mark the peak in stocks and a shift to the downside. Stay tuned.
High Yield Corporate Bonds – High yield bonds enjoyed a nearly uninterrupted move higher in the second quarter, rising nearly +4%. Although the asset class has “bonds” in its name, high yield bonds actually trade more in line with stocks but usually with less volatility. In short, high yield bonds are more like “stocks lite”. But unlike stocks, high yield bonds continued to move steadily higher following the end of QE1 last summer following an initial pullback. With companies in this category continuing to stockpile cash and paying down debt, it is reasonable to expect that this category may hold up relatively well again this time around.
Gold & Silver – The money printing by global central banks including the Fed has raised concerns about the value of the U.S. dollar and other fiat currencies. This has led investors toward hard assets such as gold and silver as a store of value. Gold has spent the last few months consolidating gains and only recently experienced an upside breakout in the first few days of April. Silver, on the other hand, is now fully engaged in a mania phase. Overall, silver was up +22% in the first quarter, is up +8% already in the first few trading days of April and has nearly doubled since Bernanke’s August 27 Jackson Hole speech last summer. Manias like this usually end badly regardless of the fundamental reasons behind the story, so a very close watch is necessary in the coming weeks for even the first signs of any inflection point in the white metal. And while both gold and silver performed well following the end of QE1 last summer, gold will likely be the preferred position to emphasize in working to navigate the post QE2 environment. Caviat: the flood of central bank liquidity has clearly played a role in driving metals higher during QE2, so any subsequent post QE2 draining of liquidity may end up pushing gold to the downside.
Investment Grade Corporate Bonds – Investment Grade Corporate Bonds continue to provide steady performance since the days following the outbreak of the financial crisis in late 2008. Just like their high yield counterparts, higher quality investment grade companies are also flush with cash and working to pay down debt. But unlike their high yield brethren, this category trades independently of stocks. Investment grade corporate bonds have generally risen when stock markets were rising over the last two years, but they’ve done even better when stocks were falling. They gained +7% when stocks dropped by -20% after QE1 last summer, and they currently represent a decent value heading toward the end of QE2. While the potential for rising inflation is a threat for this category, investment grade corporate bonds still provide favorable portfolio diversification benefits overall.
Treasuries – This category has essentially become a trade against stocks. In short, when QE is on and stocks are going up, U.S. Treasuries are typically trading sideways or selling off. And when QE is off and stocks are going down, U.S. Treasuries have rallied. As a result, Treasuries may offer the potential for a short-term trading position heading into the post QE2 market. Otherwise, they remain richly priced and offer little long-term appeal given the current fiscal state of the U.S. government and rising inflation pressures. Caviat: if the U.S. economy fell back toward recession later in the year, Treasuries may provide more interesting total return prospects. But this is still a big “if” at this point.
TIPS – Treasury Inflation Protected Securities (TIPS) are a special category of U.S. Treasuries that are backed by the U.S. government but are also adjusted for inflation. As a result, they trade on their own path separate from the broader Treasury market. TIPS have traded steadily higher since the days following the financial crisis in late 2008. And unlike traditional Treasuries, they’ve traded higher both during stock rallies and stock pullbacks – TIPS gained +4% when stocks sold off after QE1 last summer and are up another +4% since. Mounting concerns about inflation have added to the appeal for TIPS, and these concerns are not likely to dissipate with gasoline prices heading north of $4.00 a gallon this summer. Despite all of these positives, these bonds are still issued by the U.S. government. If concerns about the U.S. fiscal situation or the government’s handling of it persist, investors could start to become wary.
The bottom line – Investment markets have performed well in recent months but may be approaching a major inflection point with the end of QE2 approaching at the end of June. As a result, increasing volatility should be expected as we move through the quarter. Also, an increasing priority will be to focus on investment categories that fundamentally make sense and are also positioned to rise in a post QE2 environment.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Sunday, April 3, 2011
Campbell Soup: Not Very Exciting as a Post QE2 Investment
Here is a link to another article that was posted to Seeking Alpha over the weekend.
http://seekingalpha.com/article/261460-campbell-soup-not-very-exciting-as-a-post-qe2-investment
The bottom line from the article: Campbell Soup is a largely unexciting investment opportunity at this time for a post QE2 market. The company faces operational headwinds and the technical outlook is currently weak. Campbell Soup is a financially solid company with a steadily increasing dividend, however, and its recent track record as a defensive stalwart during times of extreme market turmoil are notable. Thus, a reversal in technical trends may create some appeal in the coming months for a possible short-term position in the stock. Otherwise, better stock investment opportunities likely reside elsewhere.
I will be following up in the next day or two with a Quarterly Review for 2011 Q1.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
http://seekingalpha.com/article/261460-campbell-soup-not-very-exciting-as-a-post-qe2-investment
The bottom line from the article: Campbell Soup is a largely unexciting investment opportunity at this time for a post QE2 market. The company faces operational headwinds and the technical outlook is currently weak. Campbell Soup is a financially solid company with a steadily increasing dividend, however, and its recent track record as a defensive stalwart during times of extreme market turmoil are notable. Thus, a reversal in technical trends may create some appeal in the coming months for a possible short-term position in the stock. Otherwise, better stock investment opportunities likely reside elsewhere.
I will be following up in the next day or two with a Quarterly Review for 2011 Q1.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.
Tuesday, March 29, 2011
McDonald's: A Solid Long-Term - and Post QE2 - Investment
The following is a link to article that I wrote that was posted to Seeking Alpha today
http://seekingalpha.com/article/260574-mcdonald-s-a-solid-long-term-and-post-qe2-investment
My bottom line from the article: McDonald’s represents at potentially attractive high quality equity portfolio position both for a post QE2 market as well as a core long-term holding. It also offers some appeal from a shorter-term trading perspective, although pullbacks toward the 200-day moving average may provide an even better entry point.
(This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.)
http://seekingalpha.com/article/260574-mcdonald-s-a-solid-long-term-and-post-qe2-investment
My bottom line from the article: McDonald’s represents at potentially attractive high quality equity portfolio position both for a post QE2 market as well as a core long-term holding. It also offers some appeal from a shorter-term trading perspective, although pullbacks toward the 200-day moving average may provide an even better entry point.
(This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.)
Thursday, March 24, 2011
A Day in the Life of a Fed Driven Market
A review of the headlines heading into yesterday’s trading day on March 23, 2011 was notable.
* Portugal braces for government collapse over austerity vote
* Ireland’s 10-year bond yield hits record at over 10%
* Bombing in Israel bus station
* Yemen’s pro-U.S. leader in talks on exit
* U.S. new home sales lowest on record, prices fall to December 2003 levels
* Federal Reserve rejects Bank of America dividend raise
Investment markets do not like uncertainty. And on any normal trading day, simply one of these headlines alone might provide justification for stock investors to take pause and reevaluate risk exposures. So with six such major headlines in a single day, it would have been more than reasonable to expect that stocks might head lower for the trading session, as investors would be inclined to take some money of the table as they analyze the implications of some if not all of these events. And such risk aversion would be particularly prudent in a stock market that has nearly doubled since the March 2009 lows and has risen by over +30% in a virtual straight line since last summer.
When trade opened yesterday morning at 9:30AM, a pullback was exactly what we saw, as the market quickly dropped by roughly -1%. But once we entered the second hour of trading, the downward trend suddenly reversed. By 10:30AM, the market showed signs of bottoming. And through the remainder of the morning and the rest of the trading day, the market elevated steadily higher to end the day up +0.5%. The fact that the market ended up on a day when a variety of new and meaningful risks bubbled to the surface certainly raises an eyebrow. After all, whether it's to the upside or the downside, you want to make sure your in a market that is acting at least somewhat rationally.
Trading days just like yesterday have become all too familiar over the last few years – down at open on negative news, bottom mid morning, rally through the remainder of the day to end higher. This raises the obvious question – what is happening around 10:30AM that sparks this market resilience to shake off any and all signs of worry and start ascending higher? The answer – the U.S. Federal Reserve.
Nearly every trading day, the Fed conducts Permanent Open Market Operations (POMO) starting at 10:30AM as part of their latest $600 billion asset purchase plan widely known as “QE2”. Between 10:30AM and 11:00AM, the Fed buys anywhere between $5.5 billion to $8.5 billion in U.S. Treasury securities from financial institutions such as the major banks. So by late morning on any given trading day, we have financial institutions that suddenly have a load of cash that they just received from the Fed and now need to do something with it. And a good chunk of this money has been finding its way into investment markets including stocks, which helps ignite the reversal and propel stocks higher. In other words, the Fed has essentially become the marginal buyer of stocks through their Open Market Operations.
This process has two key implications going forward. First, the Fed’s QE2 is set to run through June 30, 2011. As long as QE2 is running – we are currently around $360 billion, or 60%, through QE2 through today with 98 calendar days left before June 30, 2011 – it is reason expect these mid-morning reversal up days will continue to occur with regularity regardless of what risks the world throws at it. Second, the daily marginal buyer for stocks is set to go away once QE2 ends. Thus, a day like yesterday that opens down but reverses and heads higher is likely to become a day that opens lower and accelerates to the downside as the day progresses. It is also worth noting that the infamous stock market flash crash occurred on May 6, 2010, just days after the Fed rounded out QE1 back in late April of last year. As a result, increase volatility should be expected post QE2 and such unpredictable flash crash episodes should not be ruled out either. In short, current imperviousness to risk may quickly become heightened sensitivity to risk once QE2 goes away.
The bottom line – there’s likely still time to ride the stock wave higher between now and June. But barring a dramatic economic acceleration or rumblings of QE3 in the coming months, investors will be wise to beware what might lie ahead for stocks in the aftermath of QE2.
(This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.)
* Portugal braces for government collapse over austerity vote
* Ireland’s 10-year bond yield hits record at over 10%
* Bombing in Israel bus station
* Yemen’s pro-U.S. leader in talks on exit
* U.S. new home sales lowest on record, prices fall to December 2003 levels
* Federal Reserve rejects Bank of America dividend raise
Investment markets do not like uncertainty. And on any normal trading day, simply one of these headlines alone might provide justification for stock investors to take pause and reevaluate risk exposures. So with six such major headlines in a single day, it would have been more than reasonable to expect that stocks might head lower for the trading session, as investors would be inclined to take some money of the table as they analyze the implications of some if not all of these events. And such risk aversion would be particularly prudent in a stock market that has nearly doubled since the March 2009 lows and has risen by over +30% in a virtual straight line since last summer.
When trade opened yesterday morning at 9:30AM, a pullback was exactly what we saw, as the market quickly dropped by roughly -1%. But once we entered the second hour of trading, the downward trend suddenly reversed. By 10:30AM, the market showed signs of bottoming. And through the remainder of the morning and the rest of the trading day, the market elevated steadily higher to end the day up +0.5%. The fact that the market ended up on a day when a variety of new and meaningful risks bubbled to the surface certainly raises an eyebrow. After all, whether it's to the upside or the downside, you want to make sure your in a market that is acting at least somewhat rationally.
Trading days just like yesterday have become all too familiar over the last few years – down at open on negative news, bottom mid morning, rally through the remainder of the day to end higher. This raises the obvious question – what is happening around 10:30AM that sparks this market resilience to shake off any and all signs of worry and start ascending higher? The answer – the U.S. Federal Reserve.
Nearly every trading day, the Fed conducts Permanent Open Market Operations (POMO) starting at 10:30AM as part of their latest $600 billion asset purchase plan widely known as “QE2”. Between 10:30AM and 11:00AM, the Fed buys anywhere between $5.5 billion to $8.5 billion in U.S. Treasury securities from financial institutions such as the major banks. So by late morning on any given trading day, we have financial institutions that suddenly have a load of cash that they just received from the Fed and now need to do something with it. And a good chunk of this money has been finding its way into investment markets including stocks, which helps ignite the reversal and propel stocks higher. In other words, the Fed has essentially become the marginal buyer of stocks through their Open Market Operations.
This process has two key implications going forward. First, the Fed’s QE2 is set to run through June 30, 2011. As long as QE2 is running – we are currently around $360 billion, or 60%, through QE2 through today with 98 calendar days left before June 30, 2011 – it is reason expect these mid-morning reversal up days will continue to occur with regularity regardless of what risks the world throws at it. Second, the daily marginal buyer for stocks is set to go away once QE2 ends. Thus, a day like yesterday that opens down but reverses and heads higher is likely to become a day that opens lower and accelerates to the downside as the day progresses. It is also worth noting that the infamous stock market flash crash occurred on May 6, 2010, just days after the Fed rounded out QE1 back in late April of last year. As a result, increase volatility should be expected post QE2 and such unpredictable flash crash episodes should not be ruled out either. In short, current imperviousness to risk may quickly become heightened sensitivity to risk once QE2 goes away.
The bottom line – there’s likely still time to ride the stock wave higher between now and June. But barring a dramatic economic acceleration or rumblings of QE3 in the coming months, investors will be wise to beware what might lie ahead for stocks in the aftermath of QE2.
(This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.)
Sunday, March 20, 2011
GWM Commentary - Summer Holds the Key
Events around the world have certainly been unsettling for investment markets in recent weeks. Political unrest in the Middle East, ongoing sovereign debt concerns in Europe and the tragic humanitarian crisis in Japan are just a few of the many influences that drove the stock market down by over -7% since late February.
Given the ongoing uncertainties tied to many of these events, it is reasonable to consider whether this recent pullback represents the beginning of a more prolonged downturn in the stock market. The most likely answer – no, at least not yet.
The key factor has been driving investment markets over the last two years has been the unprecedentedly aggressive stimulus efforts from the U.S. Federal Reserve known as “Quantitative Easing” or “QE”. The Fed pumped $1.6 trillion in to the markets from March 2009 to April 2010 to rescue the economy from the financial crisis (QE1). And it stepped in with another $600 billion for markets starting in November 2010 to keep the economy from falling back into recession (QE2). As long as the Fed continues to pump stimulus into the system, investment markets including stocks are likely to have the support to hold their ground and resume moving higher, regardless of what happens politically or economically around the world. However, increasing market choppiness should be expected from here.
Through today, the Fed has deployed $332 billion under its current program and plans to distribute the remaining $268 billion by the end of June 2011. Therefore, we have a little over three months left before the Fed’s QE2 program comes to an end.
This leads to the key question. What will happen when QE2 is over at the end of June? An important clue is provided by what happened when the Fed ended QE1 back in April 2010. Immediately after the Fed stepped aside the first time around, the stock market plunged by -17% in just 10 weeks. And stocks would have likely fallen further had the Fed not stepped in starting in July 2010 with explicit signals that they would soon be implementing QE2 by Fall 2010.
Can we expect the same outcome at the end of QE2 in June 2011? The most likely answer – yes. The economy is simply not strong enough to fill the market void once the Fed stimulus goes away.
An important difference can be expected this time around – the market decline began literally as QE1 came to an end, but the market will now be anticipating this decline the second time around. As a result, we should expect stocks to begin to move lower at least a few weeks before the end of QE2 if not more.
So what’s the best way to position for the end of QE2? Many asset classes held up well and continued to rise following the end of QE1. These included TIPS, Investment Grade Corporate Bonds, High Yield Corporate Bonds and Gold. US Treasuries, the US Dollar and Volatility also rallied last summer after QE1 ended. An emphasis on these asset classes is likely to remain worthwhile the next time around. In addition, a focus on select high quality stocks, particularly in the Consumer Staples and Utilities sectors, was also rewarded after the end of QE1 and many of these stocks remain attractively valued today. I have been and will continue to shift investment strategies toward some of these categories and positions in the coming weeks and months as opportunities present themselves.
I will be checking back periodically with future commentaries on this topic as events unfold between now and the end of QE2 in June 2011.
Eric Parnell
Gerring Wealth Management
The contents are provided for information purposes only.
There are risks involved with investing including loss of principal. GWM
makes no explicit or implicit guarantee with respect to performance or the
outcome of any investment or projections made by GWM. There is no guarantee
that the goals of the strategies implemented will be met.
Given the ongoing uncertainties tied to many of these events, it is reasonable to consider whether this recent pullback represents the beginning of a more prolonged downturn in the stock market. The most likely answer – no, at least not yet.
The key factor has been driving investment markets over the last two years has been the unprecedentedly aggressive stimulus efforts from the U.S. Federal Reserve known as “Quantitative Easing” or “QE”. The Fed pumped $1.6 trillion in to the markets from March 2009 to April 2010 to rescue the economy from the financial crisis (QE1). And it stepped in with another $600 billion for markets starting in November 2010 to keep the economy from falling back into recession (QE2). As long as the Fed continues to pump stimulus into the system, investment markets including stocks are likely to have the support to hold their ground and resume moving higher, regardless of what happens politically or economically around the world. However, increasing market choppiness should be expected from here.
Through today, the Fed has deployed $332 billion under its current program and plans to distribute the remaining $268 billion by the end of June 2011. Therefore, we have a little over three months left before the Fed’s QE2 program comes to an end.
This leads to the key question. What will happen when QE2 is over at the end of June? An important clue is provided by what happened when the Fed ended QE1 back in April 2010. Immediately after the Fed stepped aside the first time around, the stock market plunged by -17% in just 10 weeks. And stocks would have likely fallen further had the Fed not stepped in starting in July 2010 with explicit signals that they would soon be implementing QE2 by Fall 2010.
Can we expect the same outcome at the end of QE2 in June 2011? The most likely answer – yes. The economy is simply not strong enough to fill the market void once the Fed stimulus goes away.
An important difference can be expected this time around – the market decline began literally as QE1 came to an end, but the market will now be anticipating this decline the second time around. As a result, we should expect stocks to begin to move lower at least a few weeks before the end of QE2 if not more.
So what’s the best way to position for the end of QE2? Many asset classes held up well and continued to rise following the end of QE1. These included TIPS, Investment Grade Corporate Bonds, High Yield Corporate Bonds and Gold. US Treasuries, the US Dollar and Volatility also rallied last summer after QE1 ended. An emphasis on these asset classes is likely to remain worthwhile the next time around. In addition, a focus on select high quality stocks, particularly in the Consumer Staples and Utilities sectors, was also rewarded after the end of QE1 and many of these stocks remain attractively valued today. I have been and will continue to shift investment strategies toward some of these categories and positions in the coming weeks and months as opportunities present themselves.
I will be checking back periodically with future commentaries on this topic as events unfold between now and the end of QE2 in June 2011.
Eric Parnell
Gerring Wealth Management
The contents are provided for information purposes only.
There are risks involved with investing including loss of principal. GWM
makes no explicit or implicit guarantee with respect to performance or the
outcome of any investment or projections made by GWM. There is no guarantee
that the goals of the strategies implemented will be met.
Subscribe to:
Posts (Atom)