I received this today from my fee-only wealth management advisors........
August 5, 2011
Overview of Current Market Correction
“We simply attempt to be fearful when others are greedy and to
be greedy only when others are fearful” ‐ Warren Buffett
At the start of this week the U.S. government found itself facing down the barrel of the debt ceiling crisis. They were under pressure to act under the premise that inaction would lead to some serious repercussions for the global investment markets. They were able to agree to a last minute compromise to avert the crisis – but despite the conventional wisdom it would provide at least short‐term support for equity markets – the global investment markets embarked on a serious decline this week anyway.
The primary causes for this decline? A continued deterioration of the view on global economic growth – or lack thereof – along with concerns of growing systematic risk in Europe due to the spread of their sovereign debt issues. Before we delve deeper into those issues, let’s first put in context where we are right now. The domestic stock market has experienced a 12% correction and is down about 4% year‐to‐date. Let’s recall that just last year the domestic market declined about 17% and was down nearly 8% at mid‐year and then experienced a strong rally in the second‐half of the year. Market corrections are a normal part of any market cycle and historically have presented great buying opportunities. However, it’s easy to spot these opportunities in hindsight as opposed to the middle of a correction, when the fear factor is at
its highest. The question this morning is whether the current market correction is just part of a longer term bull market offering a buying opportunity or are we on the cusp of a new bear market driven by the issues mentioned above.
Global Economic Slowdown
Based on the depth of the recent financial crisis, the ongoing deleveraging process of both consumers and governments and the depressed state of the U.S. real estate market, we have fully expected to be in a protracted slow growth environment. When growth is slow, any soft patch in economic data will be enough to spark fears of a double‐dip recession or, by this time, a new economic recession. The current fears of recession are the same fears that drove the market correction in 2010. At this time, our research sources are still indicating that they do not see a new economic recession in the face of slower growth, due to the continued stimulative policies instituted by the Federal Reserve. What they do so see is a continued slow growth cycle with sluggish growth occurring in the developed markets of the U.S., Europe and Japan balanced by stronger growth occurring in most Asian regions and the emerging markets.
European Systematic Risk
Similar to the recession fears, this issue also has a sense of déjà vu as this concern helped spark the market decline in mid‐2010 as well. The fear is that sovereign issues in Greece, Ireland and Portugal will spread to the much larger economies of Spain and Italy and then to the European banks. Issues with the European banks could lead to additional liquidity issues worldwide based on exposure to these banks by other global institutions. While some degree of interconnected risk does exist, our research indicates that this is primarily a European issue and the impact will be slow or negative growth from Europe adding an additional drag to overall global growth. The reason for this rationale is these issues have been well known and thoroughly discussed for the past 12 to 18 months so global financial institutions have had time to understand and prepare for this issue. This is different than the Lehman Brothers failure that froze global markets in 2008. That failure occurred in a matter of weeks with most people still not believing it would occur until its failure was announced.
Conclusion & Trading Strategies
We currently believe the current correction bears more similarities to April 2010 rather than October 2008. The positive U.S. jobs data that was reported this morning helped reinforce those thoughts. Based on the relative low equity valuations enhanced by the recent decline, combined with the strength of corporate earnings and balance sheets, this correction more likely represents a time to buy rather than a time to get more defensive. With that being said, events in Europe and the weak patch of economic data, cannot be fully discounted so while the probability of a new bear market is low we must assign a higher chance or likelihood to it than we previously thought. It is also likely that we will experience a continued high degree of volatility over the next month or so as the market works through this uncertainty, so be prepared for that volatility to occur both on the upside and downside.
Our actions today include eliminating emotion and continuing to implement our investment strategies. This includes taking some risk off of our current long positions within our alternative strategies, maintaining our current short or defensive positions, but also maintaining a longer‐term bias towards the upside as we think that global economic growth and higher equity prices will not be completely derailed by these current issues.
We hope this correspondence provides you with more insight to our tactical investment approach and how we are focused on using the current environment to benefit our clients’ portfolios as well as protect those portfolios during all market environments. As always, please do not hesitate to reach out to us to further discuss or ask any questions you may have.
The Veros Wealth Management Group
317-781-9300
