Market Insights - September 2010

Fear, Greed…and Patience

Financial markets welcomed September with a whirlwind of optimism, and a good thing, since August had been a particularly trying month for investors.  Bonds and fixed income investments continued to perform very well, but stocks, both US and global, have shown increased volatility since the end of April.  Great expectations (and numbers) set the tone during the first quarter and through April, but these were dashed in May and June by fears of a EU debt meltdown, and a series of unhealthy employment and housing indicators, raising fears of a slowing almost stagnant recovery.  While consumer sentiment in August rose slightly to 53.5 from a dismal July reading, short term investor sentiment plunged to its lowest level since the stock market hit absolute bottom in March 2009. Fewer than 21% of individual investors have favorable expectations for the markets over the next six months, even as the Dow has gained nearly 55% from its low.  Fear and uncertainty are driving investor behavior today; and opportunity usually follows closely behind.

It can seem perverse, but these high levels of pessimism and despair very often precede a strong and significant rally in stock prices.  We’re certainly not saying investor gloominess is unwarranted. Lack of confidence in Washington, slackening job creation, the President’s falling approval ratings, mistrust of the banks and the financial sector …the list goes on. There are good reasons to feel bad about what’s happened, but not to justify such extreme pessimism for the financial markets going forward.

A much more positive underlying trend, we believe, will begin to outweigh short term concerns for investors with a time frame greater than the next 6 months. For one thing, the sheer size of the US economy, three times larger than our closest second, China, remains a potent factor.  It took a long time for the excesses in our system to become an asset bubble, and it will take some time for the problems to work themselves out.  For investors, patience will be rewarded.

Even with the slowdown in jobs creation, the economy has the potential to add 1 million jobs in 2010, twice that number in 2011, and more than 2.5 million in 2012. GDP growth, we think, could return to 3.5% plus next year and into 2012. Now this is not a given, and among other things, fiscal policy needs to focus on job creation, access to credit for small business, and a willingness to come to grips with the eventual deficit issues looming larger and larger.

The current gloom seems to discount the impact of rising corporate profits on share prices, as well as an extremely favorable Fed monetary policy. Additionally, valuation of stocks, measured by price earnings ratios, remains at extremely attractive levels.  Remarkably, during this first phase of market recovery, as the Dow surged by more than 50%, investors took billions of dollars from the stock market and stashed it away in bank accounts and money markets paying less than one percent.  We believe these massive reserves of liquidity will begin to flow into equity markets as conditions ease, fueling sustainable gains. 

What fundamental strategy will give confidence and provide a basic foundation for investors to wait out the end of this recession, collect dividends and interest, and participate in the eventual recovery and return to prosperity?  A written investment plan, and a portfolio based upon each individual investor’s circumstances, appropriately balanced among stocks bonds, real estate and short term investments, with broad diversification within these areas, and the ability to strategically rebalance and deal proactively with changing economic environments.

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