September Economy and Market Viewpoint

September 23, 2011
Economy and Market Viewpoint
by Michelle Mabry

“Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”

-Sir John Templeton

Last week I attended a retirement planning symposium where one of the speakers was Bob Doll, who is the Chief Equity Strategist for BlackRock.BlackRock is the largest money manager in the world with assets under management of $3.66 trillion. Mr. Doll shared some interesting thoughts on the economy and equity markets.

He said that the financial world as we know it is not going to end.  There is no doubt that economic growth is pitiful and the Fed reminded us of that this week.As a result, the markets were down drastically Wednesday and Thursday. The S&P 500 is down more than 18% from its April high to its most recent low.

We also have the situation where all eyes are on Europe now.Within the EU, we have seen several sovereign debt downgrades and there is the possibility of a Greek default.Will the EU bail out Greece, and will Greece make the necessary changes to stay bailed out?

The answer to the first question seems to be maybe and to the second, no.  Greece has failed to meet the requirements laid out, essentially daring the EU to cut it off.As a member of the German parliament said, “Greece has been having a party for years, they never invited us to the party, and now that the party is over, they want us to pay for the party.”

German certainly doesn’t want to write checks, but it has been because if Greece defaults, what happens next?  Greece is a small economy and it could default with acceptable collateral damage, but the market will then take a look at much larger economies– Spain, Belgium, Italy and France–and continue bidding up their rates until they default as well.

While a Greek default could be absorbed, Spain and Italy are too big.If the large sovereigns default, the European banking system will go into crisis.  If the solvent countries stop paying, the game will end immediately, and the consequences could be severe, which would affect Germany since they rely heavily on their exports.

Splits among the governmental elite are becoming more apparent with a German member of the European bank resigning on Friday, September 9, in protest of Central Bank policies.The endgame is coming, one way or another.

So the question is, how can we protect our downside risk?  We have been steadily reducing our exposure to Europe by selling investments with a higher weighting in the Eurozone and replacing with investments that have less exposure to Europe and the Euro.  We are also buying investments that hedge their currency exposure.We will continue to keep our eyes on this situation and let you know more as it unfolds.

The European situation has also contributed to the recent volatility we have seen here at home.  But for the longer term, there are some reasons to be very positive about stocks.  The S&P 500 is trading at less than 12x earnings.  The last time that happened was 30 years ago, and the 10-year US Treasury was at 8%.The historical average is 16x earnings; in other words, stocks are cheap, and bonds are expensive.  Corporate earnings were up 17% for the first half of the year and cash on corporate balance sheets is at 11% which is double where it was a decade ago.

Yields on the 10-year Treasury note were trading around 1.75% on Thursday.  For the first time in 53 years, the S&P 500 yielded more — roughly 2.25% — than the 10-year Treasury. That has us believing that many of our clients who need income may want to be looking more than ever to use dividend-paying stocks to deliver that income.

In summary, we will likely continue to see large swings in the market and high volatility as we are at an extreme in uncertainty, but we are also at an extreme in valuations.We believe the US economy has what it needs to grow out of this downturn, but a few people are panicked.  I opened this article with quote from Sir John Templeton and I believe we are in the skepticism stage and are positioned for growth.  The best position to take is a balanced approach and remain focused on your long-term goals.


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