Hello Readers,
I am writing to let you know that my blog has moved. My new blog is on my main website at the following link:
www.gerringwm.com
Please visit my new blog and join as a follower if you are interested.
Thanks,
Eric Parnell
Monday, March 5, 2012
Saturday, February 18, 2012
The Greek Paradox
A default by Greece is inevitable. It is not a matter of if, but when. And it appears that this final outcome may now be drawing near.
The problem for Greece all along has never changed. Greece borrowed too much money. Now they can't pay it back. In order to receive help from its European neighbors in the hope to eventually pay back these loans in the future, it is being required to raise taxes and cut government spending. But both of these policy actions will cause growth in the Greek economy to slow even more, which further reduces their ability to pay back these loans. In short, the problems only become worse over time, not better.
Yet policy makers have insisted on preventing Greece from defaulting for the last several years now. Why? Because a Greek default threatens to create a domino effect that could result in another global financial crisis. This is due to the fact that many banks across Europe hold Greek bonds. If these bonds become worthless, many of these banks may subsequently fail themselves. And the Lehman scenario from late 2008 starts to unfold all over again.
The next key debt refinancing deadline for Greece is quickly approaching on March 20. Negotiations have been ongoing for months now to ensure that Greece receives the latest round of bailout funds from Europe. But as we draw closer to the breaking point for getting something done, the posture of European policy makers appears to be changing. While Greek leaders continue to push feverishly with newly approved austerity promises, European leaders are responding with greater skepticism and complacency. Given the urgency of the situation, this more relaxed stance suggests European policy makers are becoming increasingly resigned to the fact that Greece simply cannot be saved. And instead of throwing more money at a situation that cannot be solved, perhaps it is time to just get on with it already and see what happens.
In many respects, global policy makers have been preparing for months behind the scenes for a Greek default. Their focus has been setting up support for the banking system. Back in late November, global central banks coordinated to opened up currency swap lines to ensure that at risk banks have adequate liquidity access. Then in December, the European Central Bank (ECB) made collateralized loans for 3-years at 1% with virtually no strings attached to banks across the region that needed the funds. And the ECB is set to do offer another round of loans at the end of February just in case any banks need to be topped off with liquidity and balance sheet support. All the while, global central banks from around the world including the U.S. Federal Reserve continue their own aggressive monetary stimulus programs. These are just some of the actions that have occurred recently that have the look and feel of a world that is getting ready for a potential shock. Fully liquefy the system in advance, stand ready to act once the event strikes and hope for the best going forward.
The stock market has thus far been remarkably complacent in the face of this risk, rising seemingly every day and often without much of a reason. This phenomenon, however, is also due to the ongoing distorting effects of monetary stimulus on stocks. Put simply, the stock market becomes artificially inflated when liquidity is being injected into the financial system. But the problem with this distortion is that the stock market quickly collapses once this artificial support is removed. This was why the stock market corrected so sharply starting in late April 2010 and again in late July 2011. In both instances, stocks were detoxing from the withdrawal of monetary stimulus.
At present, the stock market is once again elevating behind the influence of monetary stimulus, but this may not last for much longer. This is due not only because stocks are now vastly overbought, but also due to the fact that stocks have shown the increasing tendency over the last year to decline swiftly and sharply even when they are still receiving the support of monetary stimulus. Last year around this time it was Libya, Egypt, rising oil prices and the Japanese earthquake that sent stocks for a ride lower over several pullbacks in the spring. This year, the unfolding situation in Greece may be the catalyst to spark the latest sell off.
So what can we reasonably expect from investment markets in the event that Greece actually goes into default in the coming weeks? The answer here is far more nuanced than might be expected.
If Greece defaults, the initial stock market reaction is likely to be fairly muted. An immediate sell off followed by an equally quick recovery is a very likely possibility. It would not be surprising after the immediate reaction to even see stocks gradually rise in the subsequent week or two. This is due to the fact that the financial system is prepared for a Greek default. This is the event that everyone is watching and anticipating. And it is directly around the Greece situation where all of the monetary levees have been placed.
Instead, it is in the aftermath of the Greek default where the true danger lies. This is due to the fact that when a major market dislocation like a Greek default occurs, the spark for contagion typically arises from unexpected sources in the end. When Lehman failed back in 2008, stocks did not collapse immediately. Although they thrashed about in the initial days, it took three weeks before they started to fully cascade lower. When Credit Anstalt failed back in 1931 during the Great Depression, the stock market sliced back and forth for over a month before falling off a cliff. In both cases, this delay was due to the fact that the problems that eventually pushed the stock market lower emerged from sources well removed from what was perceived by policy makers to be the primary areas of concern. And given the magnitude and complexity of the current crisis in Europe, there is no reason to expect anything different this time around with Greece. Stocks may not go down immediately, but they may eventually get pulled sharply lower once the true fallout effects eventually start to surface.
Fortunately, the market is made up of a variety of asset classes outside of the stock market, and each will have its own unique response to a Greek default if it were to occur. U.S. Treasuries would likely rally strongly as investors seek a safe haven from the crisis. U.S. TIPS, Agency Mortgage Backed Securities (MBS) and Utilities Preferred Stocks would also likely rise under the same influence, albeit at a more measured pace than nominal U.S. Treasuries. Precious metals such as Gold and Silver also provide a degree of portfolio protection. If history is any guide, they would likely rally immediately on the default announcement, pullback sharply once the mass liquidation activity gets underway, and then rally even more sharply once global central banks intervene with even more aggressive monetary support in an attempt to address any fallout.
Of course, European policy makers may eventually relent in the end and postpone the inevitable Greek default to yet another day. This is the reason to maintain stock exposures in the face of such risks even with a stock market that is already overbought. For as long as global policy makers continue to pour more money into the financial system, stocks have the potential to continue rising far beyond reasonable expectations until the policy support is finally removed or the next crisis flashpoint (military action in the Middle East?) rises to the surface. And just as the numerous categories outside of stocks provide support during a crisis event, most also stand to participate to varying degrees if stocks continue to move to the upside.
These remain interesting times. And while 2011 was an eventful year, 2012 may be even more memorable when it’s all said and done. It should be interesting to see how it all unfolds in the coming weeks.
The problem for Greece all along has never changed. Greece borrowed too much money. Now they can't pay it back. In order to receive help from its European neighbors in the hope to eventually pay back these loans in the future, it is being required to raise taxes and cut government spending. But both of these policy actions will cause growth in the Greek economy to slow even more, which further reduces their ability to pay back these loans. In short, the problems only become worse over time, not better.
Yet policy makers have insisted on preventing Greece from defaulting for the last several years now. Why? Because a Greek default threatens to create a domino effect that could result in another global financial crisis. This is due to the fact that many banks across Europe hold Greek bonds. If these bonds become worthless, many of these banks may subsequently fail themselves. And the Lehman scenario from late 2008 starts to unfold all over again.
The next key debt refinancing deadline for Greece is quickly approaching on March 20. Negotiations have been ongoing for months now to ensure that Greece receives the latest round of bailout funds from Europe. But as we draw closer to the breaking point for getting something done, the posture of European policy makers appears to be changing. While Greek leaders continue to push feverishly with newly approved austerity promises, European leaders are responding with greater skepticism and complacency. Given the urgency of the situation, this more relaxed stance suggests European policy makers are becoming increasingly resigned to the fact that Greece simply cannot be saved. And instead of throwing more money at a situation that cannot be solved, perhaps it is time to just get on with it already and see what happens.
In many respects, global policy makers have been preparing for months behind the scenes for a Greek default. Their focus has been setting up support for the banking system. Back in late November, global central banks coordinated to opened up currency swap lines to ensure that at risk banks have adequate liquidity access. Then in December, the European Central Bank (ECB) made collateralized loans for 3-years at 1% with virtually no strings attached to banks across the region that needed the funds. And the ECB is set to do offer another round of loans at the end of February just in case any banks need to be topped off with liquidity and balance sheet support. All the while, global central banks from around the world including the U.S. Federal Reserve continue their own aggressive monetary stimulus programs. These are just some of the actions that have occurred recently that have the look and feel of a world that is getting ready for a potential shock. Fully liquefy the system in advance, stand ready to act once the event strikes and hope for the best going forward.
The stock market has thus far been remarkably complacent in the face of this risk, rising seemingly every day and often without much of a reason. This phenomenon, however, is also due to the ongoing distorting effects of monetary stimulus on stocks. Put simply, the stock market becomes artificially inflated when liquidity is being injected into the financial system. But the problem with this distortion is that the stock market quickly collapses once this artificial support is removed. This was why the stock market corrected so sharply starting in late April 2010 and again in late July 2011. In both instances, stocks were detoxing from the withdrawal of monetary stimulus.
At present, the stock market is once again elevating behind the influence of monetary stimulus, but this may not last for much longer. This is due not only because stocks are now vastly overbought, but also due to the fact that stocks have shown the increasing tendency over the last year to decline swiftly and sharply even when they are still receiving the support of monetary stimulus. Last year around this time it was Libya, Egypt, rising oil prices and the Japanese earthquake that sent stocks for a ride lower over several pullbacks in the spring. This year, the unfolding situation in Greece may be the catalyst to spark the latest sell off.
So what can we reasonably expect from investment markets in the event that Greece actually goes into default in the coming weeks? The answer here is far more nuanced than might be expected.
If Greece defaults, the initial stock market reaction is likely to be fairly muted. An immediate sell off followed by an equally quick recovery is a very likely possibility. It would not be surprising after the immediate reaction to even see stocks gradually rise in the subsequent week or two. This is due to the fact that the financial system is prepared for a Greek default. This is the event that everyone is watching and anticipating. And it is directly around the Greece situation where all of the monetary levees have been placed.
Instead, it is in the aftermath of the Greek default where the true danger lies. This is due to the fact that when a major market dislocation like a Greek default occurs, the spark for contagion typically arises from unexpected sources in the end. When Lehman failed back in 2008, stocks did not collapse immediately. Although they thrashed about in the initial days, it took three weeks before they started to fully cascade lower. When Credit Anstalt failed back in 1931 during the Great Depression, the stock market sliced back and forth for over a month before falling off a cliff. In both cases, this delay was due to the fact that the problems that eventually pushed the stock market lower emerged from sources well removed from what was perceived by policy makers to be the primary areas of concern. And given the magnitude and complexity of the current crisis in Europe, there is no reason to expect anything different this time around with Greece. Stocks may not go down immediately, but they may eventually get pulled sharply lower once the true fallout effects eventually start to surface.
Fortunately, the market is made up of a variety of asset classes outside of the stock market, and each will have its own unique response to a Greek default if it were to occur. U.S. Treasuries would likely rally strongly as investors seek a safe haven from the crisis. U.S. TIPS, Agency Mortgage Backed Securities (MBS) and Utilities Preferred Stocks would also likely rise under the same influence, albeit at a more measured pace than nominal U.S. Treasuries. Precious metals such as Gold and Silver also provide a degree of portfolio protection. If history is any guide, they would likely rally immediately on the default announcement, pullback sharply once the mass liquidation activity gets underway, and then rally even more sharply once global central banks intervene with even more aggressive monetary support in an attempt to address any fallout.
Of course, European policy makers may eventually relent in the end and postpone the inevitable Greek default to yet another day. This is the reason to maintain stock exposures in the face of such risks even with a stock market that is already overbought. For as long as global policy makers continue to pour more money into the financial system, stocks have the potential to continue rising far beyond reasonable expectations until the policy support is finally removed or the next crisis flashpoint (military action in the Middle East?) rises to the surface. And just as the numerous categories outside of stocks provide support during a crisis event, most also stand to participate to varying degrees if stocks continue to move to the upside.
These remain interesting times. And while 2011 was an eventful year, 2012 may be even more memorable when it’s all said and done. It should be interesting to see how it all unfolds in the coming weeks.
Thursday, January 5, 2012
Outlook 2012: Year of Reckoning
As the calendar turns to 2012, it is worthwhile to look ahead at what we might expect from investment markets in the coming year. While a variety of meaningful challenges will carry over from 2011, how these events play out will also bring the potential for attractive new opportunities as we move through 2012.
Investment markets have been in a state of flux since the outbreak of the financial crisis several years ago. Periods of government stimulus fueled euphoria have been followed by phases of unsettled reality that the underlying problems have yet to be fully addressed. At the root of the ongoing uncertainty are the financial excesses that were accumulated during the prolonged economic expansion from 1982 to 2000 and then compounded further in the years since the bursting of the technology bubble at the turn of the millennium. Put simply, there is far too much debt in the financial system today. And the time finally arrived a few years ago where markets began the process of cleansing itself of this debt and moving toward getting back into better fiscal shape. While this process has played out in some areas of the market, most notably the corporate sector and selected households, debt deleveraging has not been allowed to fully run its course to this point. Instead, global leaders and central banks have engaged in policy acrobatics since the outbreak of the crisis to postpone this debt unwinding. While these actions have provided time for the financial system to stabilize, global markets will remain volatile until this cleansing process is finally allowed to play itself out.
The mounting crisis in Europe may finally bring global markets to this reckoning phase in 2012. Europe faces the following dilemma. Seventeen countries across Europe share the common euro currency. To join the currency union, each country ceded control of their monetary policy to a central authority in the European Central Bank. As a result, each country only controls its fiscal policy. Since the outbreak of the financial crisis, a growing number of countries across the region are increasingly buckling under the weight of too much debt. First, it was smaller peripheral countries like Greece, Ireland and Portugal. Now it is much larger core countries like Italy, Spain and even France. But none of these countries can take the traditional steps of devaluing their currency to stimulate growth and manage their debt because they share the euro with other countries. Thus, the only other option is to engage in austerity, which is to raise taxes and cut spending to increase revenues to service their debt. But the problem with austerity is that it stifles growth, which leads to reduced tax revenues over time to service the debt. So investors lose confidence that these countries will be able to continue to make debt payments in the future. Consequently, the value of this debt falls since investors no longer want to own it. This increases the borrowing costs for these countries, as they have to pay a higher interest rate so that investors will still buy their new debt. The result is that less money left over to service existing debts, pushing the value of this debt down further. Adding to the problem is the banks, which are the primary holders of the debt of these countries. With the value of this sovereign debt falling, the capital levels at these banks effectively evaporate, which threatens their ability not only to lend money but also to even stay in business. And this is where the threat of another 2008 Lehman Brothers type crisis begins to take hold. Putting all of this more simply, European banks are facing bankruptcy from holding the debt of European countries facing bankruptcy, and the primary place for these European banks to go for support are the European countries that put them into this bind in the first place. As this circular dilemma spirals, it appears increasingly likely that we may finally enter a reckoning phase as we move through 2012. Several countries warrant particularly close attention in this regard. These include Italy, Greece and Hungary, all of which are leading candidates at the moment for unexpected shocks that could lead to a contagion episode in the financial system.
The fact that global financial markets may finally be forced to face these debt demons in 2012 would be positive from a long-term perspective. Certainly, any debt unwinding episode will likely come with a fair amount of short-term market turbulence. But until markets are forced to fully engage this debt cleansing process, we will continue to experience persistently wild and unpredictable volatility. Once this deleveraging process is finally allowed to play itself out, however, the economy would be refitted and the basis would be formed for the start of a new secular bull market (think 1945 or 1982). Once the turbulence subsided to arrive at this end point, this would be a very positive outcome moving forward.
Given the prospects for a reckoning event in 2012, the question becomes how best to position portfolios for such an episode. At the same time, portfolios must also be positioned to benefit if global policy makers continue to act aggressively to further delay the inevitable deleveraging process. Thus, the focus in portfolio construction is on asset classes that stand to benefit from either outcome. Leading among these are four primary categories.
The first is U.S. Treasury Inflation Protected Securities (TIPS). If a contagion event were to occur, U.S. TIPS would likely benefit from investors flocking to safe haven Treasuries for protection. However, if monetary policy makers continue to successfully delay the deleveraging process through further aggressive stimulus, U.S. TIPS would also benefit from the asset inflation that would likely accompany this additional money creation.
Next is Agency Mortgage Backed Securities (MBS). During a crisis event, Agency MBS would also benefit due to the fact that these securities are now essentially backed by the U.S. government. The fact that they offer a higher yield relative to comparable U.S. Treasury debt is also a plus. On the flip side, if monetary policy makers inject more stimulus, Agency MBS would likely be a direct beneficiary as the U.S. Federal Reserve has openly stated that this area of the market would be the main focus of any further asset purchases (QE3) in an effort to lower mortgage rates even further.
The third is Utilities Preferred Stocks. If a financial crisis were to erupt, these securities are among the best protected given the fact that regulated utilities will continue to receive the steady cash flows from customers that will still pay to keep their lights on. Conversely, further monetary stimulus to delay the debt unwind would consist of keeping interest rates near zero, and since these securities have yields in the 5% to 8% range, these securities would remain particularly attractive from an income generation and real returns perspective.
The fourth is Precious Metals including Gold and Silver. A European crisis would put the survival of the euro currency, which is the second largest currency in the world, into serious doubt. As a result, demand would increase for alternative safe haven currencies, and both Gold and Silver are appealing in this regard given their hard asset characteristics. And if policy makers instead act with aggressive monetary stimulus to thwart a crisis, the resulting currency devaluation and associated potential for inflation would also support strong demand for hard asset protection.
Two additional asset classes serve the purpose of weighting portfolios toward the potential for one outcome over the other.
Stocks would benefit in the short-term from the further delaying of the deleveraging process. But given the fact that global policy makers have been resolute in trying to squelch the debt unwind, the probability associated with this outcome remains meaningful. In order to help neutralize the risk associated with these stock exposures, it is worthwhile to emphasize the more defensive areas of the market including consumer staples such as food and household products as well as utilities. Not only will these categories provide the potential for upside if the stock market rises, but they also provide the best downside protection if the market were to plunge into decline. And if a financial crisis were to fully explode, the opportunity would eventually present itself to purchase high quality stocks at extraordinary discounts. Thus, maintaining a considerable cash allocation within this targeted stock allocation is worthwhile so that the powder is fully dry to capture these opportunities as they present themselves.
U.S. Treasuries would benefit most in the short-term if a crisis episode were to unfold. Although yields are already low and uncertainty remains about the fiscal outlook, U.S. Treasuries continue to provide an idea destination for safe seeking investors during times of crisis. For example, Long-Duration U.S. Treasuries gained +31% in the second half of 2011 versus the stock market that was down over the same time period. These securities also provide an ideal way to hedge against a rising U.S. Dollar and its associated impact on Gold and Silver, which is an added plus for maintaining positions to this area of the market.
It promises to be another interesting year in 2012. Financial markets may potentially reach a reckoning point that while difficult may finally put the current crisis behind us. At the same time, we are likely to witness a continuing wave of revolutionary change in many parts of the world including most notably the Middle East. The threat of new military conflict remains meaningful, particularly with Iran highlighted by recent activity in the Strait of Hormuz. And 2012 will also bring another Presidential election here in the U.S. These are interesting times, and 2012 promises not to disappoint in this regard.
Best wishes for a healthy and happy New Year.
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.
Investment markets have been in a state of flux since the outbreak of the financial crisis several years ago. Periods of government stimulus fueled euphoria have been followed by phases of unsettled reality that the underlying problems have yet to be fully addressed. At the root of the ongoing uncertainty are the financial excesses that were accumulated during the prolonged economic expansion from 1982 to 2000 and then compounded further in the years since the bursting of the technology bubble at the turn of the millennium. Put simply, there is far too much debt in the financial system today. And the time finally arrived a few years ago where markets began the process of cleansing itself of this debt and moving toward getting back into better fiscal shape. While this process has played out in some areas of the market, most notably the corporate sector and selected households, debt deleveraging has not been allowed to fully run its course to this point. Instead, global leaders and central banks have engaged in policy acrobatics since the outbreak of the crisis to postpone this debt unwinding. While these actions have provided time for the financial system to stabilize, global markets will remain volatile until this cleansing process is finally allowed to play itself out.
The mounting crisis in Europe may finally bring global markets to this reckoning phase in 2012. Europe faces the following dilemma. Seventeen countries across Europe share the common euro currency. To join the currency union, each country ceded control of their monetary policy to a central authority in the European Central Bank. As a result, each country only controls its fiscal policy. Since the outbreak of the financial crisis, a growing number of countries across the region are increasingly buckling under the weight of too much debt. First, it was smaller peripheral countries like Greece, Ireland and Portugal. Now it is much larger core countries like Italy, Spain and even France. But none of these countries can take the traditional steps of devaluing their currency to stimulate growth and manage their debt because they share the euro with other countries. Thus, the only other option is to engage in austerity, which is to raise taxes and cut spending to increase revenues to service their debt. But the problem with austerity is that it stifles growth, which leads to reduced tax revenues over time to service the debt. So investors lose confidence that these countries will be able to continue to make debt payments in the future. Consequently, the value of this debt falls since investors no longer want to own it. This increases the borrowing costs for these countries, as they have to pay a higher interest rate so that investors will still buy their new debt. The result is that less money left over to service existing debts, pushing the value of this debt down further. Adding to the problem is the banks, which are the primary holders of the debt of these countries. With the value of this sovereign debt falling, the capital levels at these banks effectively evaporate, which threatens their ability not only to lend money but also to even stay in business. And this is where the threat of another 2008 Lehman Brothers type crisis begins to take hold. Putting all of this more simply, European banks are facing bankruptcy from holding the debt of European countries facing bankruptcy, and the primary place for these European banks to go for support are the European countries that put them into this bind in the first place. As this circular dilemma spirals, it appears increasingly likely that we may finally enter a reckoning phase as we move through 2012. Several countries warrant particularly close attention in this regard. These include Italy, Greece and Hungary, all of which are leading candidates at the moment for unexpected shocks that could lead to a contagion episode in the financial system.
The fact that global financial markets may finally be forced to face these debt demons in 2012 would be positive from a long-term perspective. Certainly, any debt unwinding episode will likely come with a fair amount of short-term market turbulence. But until markets are forced to fully engage this debt cleansing process, we will continue to experience persistently wild and unpredictable volatility. Once this deleveraging process is finally allowed to play itself out, however, the economy would be refitted and the basis would be formed for the start of a new secular bull market (think 1945 or 1982). Once the turbulence subsided to arrive at this end point, this would be a very positive outcome moving forward.
Given the prospects for a reckoning event in 2012, the question becomes how best to position portfolios for such an episode. At the same time, portfolios must also be positioned to benefit if global policy makers continue to act aggressively to further delay the inevitable deleveraging process. Thus, the focus in portfolio construction is on asset classes that stand to benefit from either outcome. Leading among these are four primary categories.
The first is U.S. Treasury Inflation Protected Securities (TIPS). If a contagion event were to occur, U.S. TIPS would likely benefit from investors flocking to safe haven Treasuries for protection. However, if monetary policy makers continue to successfully delay the deleveraging process through further aggressive stimulus, U.S. TIPS would also benefit from the asset inflation that would likely accompany this additional money creation.
Next is Agency Mortgage Backed Securities (MBS). During a crisis event, Agency MBS would also benefit due to the fact that these securities are now essentially backed by the U.S. government. The fact that they offer a higher yield relative to comparable U.S. Treasury debt is also a plus. On the flip side, if monetary policy makers inject more stimulus, Agency MBS would likely be a direct beneficiary as the U.S. Federal Reserve has openly stated that this area of the market would be the main focus of any further asset purchases (QE3) in an effort to lower mortgage rates even further.
The third is Utilities Preferred Stocks. If a financial crisis were to erupt, these securities are among the best protected given the fact that regulated utilities will continue to receive the steady cash flows from customers that will still pay to keep their lights on. Conversely, further monetary stimulus to delay the debt unwind would consist of keeping interest rates near zero, and since these securities have yields in the 5% to 8% range, these securities would remain particularly attractive from an income generation and real returns perspective.
The fourth is Precious Metals including Gold and Silver. A European crisis would put the survival of the euro currency, which is the second largest currency in the world, into serious doubt. As a result, demand would increase for alternative safe haven currencies, and both Gold and Silver are appealing in this regard given their hard asset characteristics. And if policy makers instead act with aggressive monetary stimulus to thwart a crisis, the resulting currency devaluation and associated potential for inflation would also support strong demand for hard asset protection.
Two additional asset classes serve the purpose of weighting portfolios toward the potential for one outcome over the other.
Stocks would benefit in the short-term from the further delaying of the deleveraging process. But given the fact that global policy makers have been resolute in trying to squelch the debt unwind, the probability associated with this outcome remains meaningful. In order to help neutralize the risk associated with these stock exposures, it is worthwhile to emphasize the more defensive areas of the market including consumer staples such as food and household products as well as utilities. Not only will these categories provide the potential for upside if the stock market rises, but they also provide the best downside protection if the market were to plunge into decline. And if a financial crisis were to fully explode, the opportunity would eventually present itself to purchase high quality stocks at extraordinary discounts. Thus, maintaining a considerable cash allocation within this targeted stock allocation is worthwhile so that the powder is fully dry to capture these opportunities as they present themselves.
U.S. Treasuries would benefit most in the short-term if a crisis episode were to unfold. Although yields are already low and uncertainty remains about the fiscal outlook, U.S. Treasuries continue to provide an idea destination for safe seeking investors during times of crisis. For example, Long-Duration U.S. Treasuries gained +31% in the second half of 2011 versus the stock market that was down over the same time period. These securities also provide an ideal way to hedge against a rising U.S. Dollar and its associated impact on Gold and Silver, which is an added plus for maintaining positions to this area of the market.
It promises to be another interesting year in 2012. Financial markets may potentially reach a reckoning point that while difficult may finally put the current crisis behind us. At the same time, we are likely to witness a continuing wave of revolutionary change in many parts of the world including most notably the Middle East. The threat of new military conflict remains meaningful, particularly with Iran highlighted by recent activity in the Strait of Hormuz. And 2012 will also bring another Presidential election here in the U.S. These are interesting times, and 2012 promises not to disappoint in this regard.
Best wishes for a healthy and happy New Year.
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
Time To Derisk
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.
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.
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.
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