Recent Market Volatility

by Sergio Mariaca on Feb 4, 2016 9:30:00 AM |Share:

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The market events of January 2016 provide an opportunity to examine several questions important to investors and revisit some fundamental principles of investing in capital markets.

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2011 Review: Economy & Markets 1/11/2012

by Sergio Mariaca on Jan 11, 2012 12:29:00 PM |Share:

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The past year reminded investors that they should hope for the best, prepare for the worst, and be thankful when reality does not match their fears. Investors entered 2011 with hopes that the world economy would continue recovering from a long and painful deleveraging process. Equity markets had posted two straight years of positive performance, central banks remained committed to pro-growth monetary policy, and major developed nations were focused on reducing debt.

By mid-year, however, optimism faded as troubling events around the world dominated headlines. The devastating earthquake and tsunami in Japan, political unrest in the Middle East, rising oil prices, a US credit downgrade, the threat of another global recession, and an escalating debt crisis in Europe weighed heavily on markets. As stock market volatility returned to global financial crisis levels, investors faced a major test to their discipline and staying power.

Although US stocks experienced some of the highest volatility in years, the broad US market delivered flat performance in 2011. Developed markets logged negative returns, and emerging markets had mixed performance, with most countries also underperforming the US. The bright spots were in the fixed income arena, where a flight to quality triggered by the euro debt crisis and US credit downgrade boosted returns on US government securities, inflation-protected securities, and municipal bonds.

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The above headliner graph features some of the year’s most highly publicized events in the context of the Russell 3000 Index, a broad indicator of US stock market performance. These events are not offered as an explanation of market performance, but as an illustration that a volatile news environment can challenge even the most disciplined long-term investors.

The World Stock Market Performance chart below offers a snapshot of global stock market performance, as measured by the MSCI All Country World Index. Actual headlines from publications around the world are featured. Again, these headlines are just a sample of events during the year.

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Throughout the year, investors could find a host of reasons to avoid stocks and wait for more positive news before returning to the market. As these select headlines suggest, determining the right time to invest is a difficult task since the market anticipates news and quickly factors in new information.

The Year in Review

In 2011, global diversification proved as important as ever. Although diversification may not have prevented losses, investors with broadly diversified portfolios were better equipped to endure the uncertainty. Major themes during the year included:

European Debt Problems

The sovereign debt crisis intensified as European authorities struggled to avert a Greek debt default and alleviate fiscal pressures in Italy and France. But these restructuring attempts fell short of market expectations, which spooked investors and raised concerns of additional sovereign debt downgrades and a possible breakup of the Eurozone. The crisis also hurt European banks holding large positions in sovereign debt. To avoid losses, leading institutions reduced lending and dumped assets, which depressed asset values. Higher borrowing costs in the most indebted countries, combined with reduced government spending and revenues, raised more concerns that the Eurozone was entering a recession in late 2011.

Economic Uncertainty

Since the global financial crisis in 2008, central banks and governments have taken bold measures to fuel business activity and stabilize financial markets—and investors have eagerly awaited signs that economic recovery has taken hold. The economic signals continued to be mixed in 2011. Favorable US news included strong corporate profits and dividends, substantial levels of cash on corporate balance sheets, low interest rates and inflation, a booming domestic energy sector, continuing strength in auto sales, record-high share prices for some multinationals, and improved fourth-quarter numbers in manufacturing, exports, consumer confidence, and employment. Pessimists could point to the longstanding jobless trend, slumping home prices, tepid growth in retail sales, worrisome levels of government debt, and political gridlock at both the national and state levels.

Although emerging economies showed resilience, investors were concerned that another recession in Europe would impact its trading partners in emerging economies—and particularly in China, where high inflation and a manufacturing slowdown threatened to send its previously fast-growing economy into recession.

Rising Volatility

Investors in US equities had to endure a heavy dose of uncertainty for their moderate gains. The S&P 500 Index reflected this volatility by closing up or down over 2% on thirty-five days in 2011, compared to twenty-two days in 2010. By contrast, before the global financial crisis, the index did not have a single day with a 2% or more movement in 2005, and only two days in 2006.

Market observers also documented higher correlations among individual stocks and between asset classes. In 2011, there were sixty-nine days in which 90% of the S&P 500 stocks moved in the same direction, which is more than the combined total for 2008 and 2009. Higher correlations are common during periods of uncertainty, as macroeconomic forces overshadow the impact of a company’s business fundamentals on its stock price.

Falling Commodity Prices

In early 2011, commodities soared with expectations of improving economic growth around the world. Copper, cotton, and corn hit all-time highs in the first half of the year. Crude oil experienced double-digit returns in response to anticipated higher demand and threats of supply disruptions tied to political unrest in the Middle East. The Dow Jones-UBS Commodity Index peaked in April, then fell 20% as the global economic outlook faded. The index returned -13% for the year—its first negative return since 2008. The most notable exception was gold, which set more records in 2011 and peaked at $1,888.70 per ounce in August before declining in the fourth quarter to return about 10% for the year.

Investor Risk Aversion

The fragile world economy made markets particularly vulnerable to shifting investor sentiment. During the year, investors reacted to uncertainty by moving to asset classes they deemed more stable, including large cap stocks and government bonds. Despite the Standard & Poor’s downgrade of the US credit rating in early August, investors fled to US government securities as concerns mounted over the sovereign debt crisis in Europe and political stalemate over the US debt ceiling.

2011 Investment Overview

Most global equity investors experienced negative returns in 2011. After a strong first-quarter start, developed equity markets grew more volatile in response to discouraging news on the economy and sovereign debt crisis. Despite a brief rebound in July and during the fourth quarter, most equity markets logged negative performance for the year.

The US stock market was one of the few developed markets to experience positive returns. The S&P 500 logged a 2.11% gain (dividends reinvested), and the Russell 3000 returned 1.03% for the year. Despite strong returns in the fourth quarter, developed and emerging markets logged negative returns, with forty of the forty-five countries that MSCI tracks posting losses. The MSCI World ex USA Index returned ­12.2% and the MSCI Emerging Markets Index returned ­18.4% for the year. Ireland and New Zealand were the only developed markets besides the US to end the year in positive territory, and Greece was by far the worst performer. Indonesia and Malaysia were the only emerging markets that ended the year with positive returns, and Egypt was the worst performer.

The US dollar fluctuated but finished about 3% above where it started against most developed-market currencies. It sharply appreciated against the main emerging market currencies, especially against the Indian rupee and the Brazilian real. This relative strength negatively impacted dollar-denominated returns of emerging market equities. The euro remained stable during the year even as analysts began predicting the dissolution of the currency zone, and the Japanese yen and the Australian dollar both gained against the US dollar.

Along the size dimension, large caps outperformed small caps in the US, non-US developed, and emerging markets. Value stocks underperformed growth stocks in the US, but mostly outperformed growth among emerging markets and had mixed results in developed markets.

In the fixed income arena, US intermediate-term government securities and TIPS performed exceptionally well, returning over 9.4% and 14.5%, respectively. Real estate securities in the US had strong positive returns and excellent performance relative to other US asset classes; in other developed markets, REITs had sharply negative returns but still managed to have good performance relative to other asset classes.


Russell data copyright © Russell Investment Group 1995-2012, all rights reserved. Dow Jones data provided by Dow Jones Indexes. MSCI data copyright MSCI 2012, all rights reserved. S&P data provided by Standard & Poor’s Index Services Group. The Merrill Lynch Indices are used with permission; copyright 2012 Merrill Lynch, Pierce, Fenner & Smith Incorporated; all rights reserved. Citigroup bond indices copyright 2012 by Citigroup. Barclays Capital data provided by Barclays Bank PLC. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio. 
Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities.





Stampede into Bonds 12/1/2011

by Sergio Mariaca on Dec 1, 2011 12:55:00 AM |Share:

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U.S. Treasury debt had its best quarter since the first quarter of 2008. Treasuries maturing in 10 years or more returned 23% during the quarter, according to Barclay’s Capital index data. Not since 1995 have investors done so well owning longer-dated U.S. government debt. However, according to the Fed economists, expectations for interest rates, growth and inflation indicates 10-year notes are the most overvalued on record. (Source: WSJ, October 1, 2011 – Stocks Log Worst Quarter)

Yields on the U.S. Treasury 10-year note fell to 1.71%, the lowest yield since the 1940s. With overall inflation running around 3.6%, that indicates that many investors were effectively accepting a loss. And, in the case of U.S. Treasury bills, investors at times throughout the quarter bought securities that offered no yield at all. Essentially, investors were parking money with the U.S. Treasury, at least expecting to get back the same amount in 3 months. For many investors, all that mattered was certainty. (Source: WSJ, October 3, 2011 – Spooked Investors)

The Federal Reserve has promised to keep short-term rates low for another 2 years and it keeps the rate on 10-year bonds down by printing money and using that to buy the bonds. Artificially low interest rates may stimulate people to buy homes and use their credit cards, but they have the opposite effect on people with money in the bank. For example, widows used to live off the interest on their bank deposits. How can you do that when the yield is only about 0%? Many investors have their money in Treasury bonds because they are considered “safe.” They are safe only in the sense that you know what is going to happen. You know they’re going to make you slightly poorer.

Bullish Opinion 12/1/2011

by Sergio Mariaca on Dec 1, 2011 12:50:00 AM |Share:

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Corporate earnings have held up well throughout these problems and we are hoping for more of the same. Earnings are close to all-time highs, and more important, stocks overall are trading at the lowest prices since prior to the great Bull market in August 1982. Even amid double-dip fears, many analysts predict that earnings are likely to be higher this year and again in 2012. It appears that the stock market is hardly sailing off the end of the world!

Many American companies, which have been accumulating cash while they wait for signs of a solid rebound, have some of the largest cash positions in their history, which should allow them to weather almost any storm. The Federal Reserve said that there was $2.05 trillion in cash and other liquid assets as of the end of June, the most since 1963, primarily due to better earnings and record profits in some recent quarters.

Recessions typically catch companies that are not as flush with cash. Tighter credit and declining revenues often deplete a company’s operating funds and prompt layoffs, which compound the economy’s pain and cause more uncertainty. That makes it even harder to get credit, further tightens cash availability and discourages companies from investing to take advantage of an eventual recovery. However, this time, “The cash should act as a shock absorber,” says John Lonski, chief economist at Moody’s Investors Service. “With more cash, companies would be less inclined to cut…capital expenditures and staff.” (Source: WSJ, October 5, 2011 – Companies $2 Trillion)

The U.S. economy is a highly complex and multifaceted mechanism. It is extremely difficult, if not impossible, to predict accurately, despite the fact that many economists make their predictions with great confidence. While third quarter earnings could potentially boost share prices, timing such a rally, if it does happen, is difficult indeed. Studies have shown over the years that investors typically pick the wrong time to sell and buy shares, especially when markets are so volatile. And another major problem is you have to get 3 things right: when to get out, when to get back in, and where to invest that money in the meantime.

wealth managementWhen a recession occurs, it is because of a slowdown in economic activity. Mr. Yamarone of Bloomberg Publications equates this to someone riding a bicycle. “If you pedal too slowly, the bike will tip over,” he says. Although they share many similarities, no two recessions are exactly alike. They differ in terms of severity and duration. The magnitude of a recession is also influenced by the degree of the prior expansion. For example, the 2008 Great Recession followed the greatest credit bubble of all time. In fact, the bursting of the bubble was so severe that we lost over 8 million jobs and are still more than 6 million jobs short of fully recovering. As economic activity slows, businesses begin to reduce their labor force in order to become profitable. This decline may be sparked by a decrease in consumer spending, which comprises about two-thirds of the GDP. As demand slows, layoffs increase and unemployment rises. As the unemployment rate rises, there are fewer wage earners to support the economy and spending falls. As spending falls, businesses reduce their labor force . . . and the self perpetuation begins. Before the economy can recover, confidence must be restored.

The National Deficit 11/30/2011

by Sergio Mariaca on Nov 30, 2011 2:00:00 PM |Share:

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American national debt held steady in the $2-3 trillion range for 3 decades until the early 1980s. It began to rise rapidly at that point, reached the $7 trillion mark in the late 1990s, and then took off again after 2000. In recent years, public debt growth has accelerated further, climbing up to $14.3 trillion by the spring of 2011. We are now dealing with the third-biggest deficit in U.S. history, after the deficits in 2009 and 2010. This staggering amount:

  • is nearly equal to our current dollar GDP
  • represents about 25% of all goods and services produced annually by the entire world
  • increased from around $20,000 per head (every man, woman and child in America) to $46,000 (while the median household income is around $50,000 before taxes)
  • reflects $0.56 in federal government borrowing for every dollar Americans paid in federal taxes
  •  is projected to equal 71.2% of the size of our economy in 2012 (Source: BTN, October 3, 2011)

During the last quarter one of the major debates was about raising our debt ceiling. Many Americans were strongly opposed to the idea and didn’t want to pass the debt burden down to their children. (Source: – Deferred Liability)

The fiscal year of 2012 (10/1/11-9/30/12) and the most recent projection (released on 8/24/11) for the fiscal year by the government estimates about $2.6 trillion of revenue, $3.6 trillion of spending and a record deficit of $973 billion, a shortfall of 38%. (Source: BTN, October 3, 2011)

As the chart shows, 2011 will be almost $900 billion more spending than in 2007. Total federal outlays will have increased by roughly one-third in only 4 years. This hasn’t happened since World War II. The government is trying to spend their way out of a recession, but where is the promised economic growth? (Source: WSJ, August 25, 2011 – What Austerity)

This is the real cause of our current deficit and debt woes. The 2011 deficit did not come from extraordinary spending to fight the recession; these expenses are due to increases in business-as-usual spending, mostly on Medicare, Medicaid and defense, as well as a variety of entitlements. (Source: Barron’s, October 3, 2011 – The Books Are Closed)

The main problem is that consumers aren’t spending, and consumer spending makes up about 70% of GDP in the U.S. Why aren’t they spending? Answers include:

  • They’re unemployed, or at least worried about it.
  • They’ve lost access to their “home equity ATM” (household equity is down about $8 trillion since 2006).
  • They feel less wealthy, less secure, due to the poor performance of the stock market over the past decade.

Recovery from these economic conditions is estimated to take a very long time.

Admiral Michael Molen, the chairman of the Joint Chiefs of Staff, claims our ever-expanding national debt is the biggest threat to our nation’s freedom. (Source: American Spectator, September 2011 – Biggest Threat) Many economists believe that real spending cuts, not small reductions and proposed increases, are needed to solve this national crisis.

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