There has been plenty of discussion about the Old or New normal since the start of the recovery. We believe the recent dramatic market activity could be a sign that the markets are now pricing in a "new" normal - one in which uncertainty, weaker growth, poor policy effectiveness, and diminishing confidence in our leaders are the norm. In fact, it seems that this serious lack of confidence in leadership acted as a catalyst for the recent abnormal market activity.
I’ve spent some time speaking with my trusted peers and we agree that the last two months have been very abnormal. Just consider the combination of high corporate earnings, low consumer confidence, and increasing levels of market volatility and political self-interest. It reminds me of a scene from Mel Brooks’ classic movie Young Frankenstein. In the scene, Dr. Frankenstein sends his assistant Igor to fetch a brain to be used in Dr. Frankenstein’s monster. After accidentally dropping Albert Einstein’s brain, Igor selects a brain labeled “Abnormal – Do Not Use”.
Our Previous Comments
At the start of the year we suggested investments for a “slow but growing” economic environment. As we pointed out in June, a market downturn of approximately 14% happens almost every year. If you have not read our June article, please do so and look at the accompanying chart, one of our favorites. It displays calendar year returns and the negative drops experienced during each year. 2010 saw a market decline of 17% when the economy was much weaker than it is now and still finished the year positive. In fact, since the 1930s there have been 30 market declines of 15% or more, but only two predicted a recession. It would be rare for a recession to begin at a time when corporate earnings, reported just weeks ago, are likely to surpass their mid-2007 highs before the end of the year.
No Confidence
The votes have been cast in the global financial ballot box. The global voice has spoken. America’s and Europe’s incoherent and unfocused economic policies have convinced many investors to expect much slower growth and the possibility of a new recession. Many believe the policy responses have been too little and too late. Despite an agreement on the debt ceiling, our political leaders have essentially only kicked the can down the road.
Come November, the debt ceiling Super Committee will meet in another attempt to provide a sound solution to what many consider one of our country’s greatest problems. While we are hopeful that more long term measures will be put in place to help control our deficit, we would not be surprised to see more of the same political bickering.
Downgrade Not a Surprise
We were not surprised about the downgrade after witnessing the “abby normal” amount of political back-and-forth. As S&P stated, a main reason for the downgrade was the lack of confidence in our leaders and their ability to truly come together and address our issues as leaders should.
To paint a historical picture, there have been 11 sovereign downgrades in the last 25 years. In eight of those, equity markets increased an average of 17% within the 12 months following the downgrade.
Markets Hate Uncertainty, and Now We Have More
In addition to the lack of faith in our political leaders, much of the recent decline can be attributed to an abnormal amount of uncertainty around the globe. The ongoing European sovereign debt issue seems to evolve on a daily basis with no clear path forward and has an increasing affect on the market’s direction. Other events generating uncertainty include the “Arab Spring” in the Middle East, inflation worries in the Far East and Latin America, longer-term effects of the US downgrade, and the media broadcasting the risk of another recession.
This uncertainty could cause consumers and businesses to delay future spending. These ramifications are significant because consumer and business sentiment help forecast trends in economic activity. While our leaders have the tools available to help manage recent events, it is imperative that they regain our confidence by doing instead of talking.
Weaker Growth, but Still Growing
The US economy is still growing as shown by recent economic reports, albeit slowly. Updated GDP figures for the past few years show that the recession was more severe than previously thought and that the recovery was not as pronounced. Since the summer of 2010, there have been slow yet positive improvements in the growth of money, velocity of money, job growth, and loan growth. The S&P 500 hit new post-2008 highs at the end of April despite troubles in Japan, European debt issues, a struggling jobs market, the debt ceiling debate and other abnormal events.
Second quarter earnings are up 18%, with 75% of companies exceeding expectations by an average of 5%. 72% of companies have beat revenue expectations. In terms of cash on hand, nonfinancial corporations are holding around 11% of their balanced sheets, the highest level in 60 years. If the S&P 500 companies put all their cash to work in the form of M&A, they would be able to buy 56% of the market cap of the Russell 2000 index! Many of these same companies are returning cash to investors in the form of increased dividend payments. Finally, mortgage rates are much lower and should help increase refinancing and home purchases.
Future Growth Complications
We’re starting to see countries adopt spending cuts and austerity measures, more so in Europe although we wouldn’t be surprised to see them here in the US. These measures could be part of a “new normal” that we live with for several years. This decrease in spending has the potential to slow economic growth moving forward. The possibility of new taxes and the expiration of tax breaks may dampen consumer and business spending. Emerging economies such as Brazil, India and China are currently fighting inflation and trying to slow their red hot economies.
Unfortunately there are no new mega trends to guarantee high levels of growth. These could include a new discovery in the technology, energy or industrial sectors. We believe the main growth opportunity lies with the emerging global middle class. Some estimate the number at 2 billion strong.
No one has asked me, but here’s what I believe should happen. We have an opportunity to borrow money at ~3.8% for 30 years. This money should be used to help rebuild America by funding a massive new initiative that focuses on a new energy plan, transportation infrastructure, etc. Spending this money now on projects that actually produce instead of sending money to banks could be a huge benefit to our economy. I am not a big believer in debt, but money at 3.8% for 30 years seems like a pretty good deal. Let’s get our workers that truly want to work working!
What to Do Now?
Fundamentals are still positive, although weaker, and fear and negative sentiment are at heightened levels. As such, we are not convinced that the slow but growing bull market has ended. However we have noticed an increasing amount of investors looking to hire money managers with the ability to protect portfolios on the downside. Considering one of these money managers for a portion of your portfolio could help you partially avoid future market downturns and lower your overall risk.
WrapManager chooses from an array of different managers and philosophies to create a portfolio with your unique goals in mind. Imagine your portfolio as having two distinct areas: a set of money managers that represent your core investments, and a few satellite money mangers with more specialized strategies. These could include a dividend focused manager or a capital protection manager. Request your free proposal here to see the money managers we would choose for you and why!
Equities
We continue to believe that some of our 2011 manager recommendations have played out well so far. These included a money manager that buys dividend paying companies with a history of increasing dividends, and a manager that acts as a stock picker looking for the super growth companies across different asset classes. We still see these as two important and distinct investment choices in a slow but growing environment.
A third type of money manager to consider is one that can help protect your portfolio on the downside and potentially reduce your overall risk. We are seeing an increasing number of investors who are concerned with limiting losses during severe market downturns. This would be especially beneficial in the uncertain environment in which we find ourselves.
These three types of investments are important for the current market environment. Of course adjustments may need to be made if new economic data signals a shift from our current course and more abnormalities appear. Be sure to watch for future articles from us as new data is made available. Click here to request a copy of our 2011 Top Equity Money Manager Picks!
Fixed Income
Low rates will most likely be around for the near term future and we suggest staying diversified with many types of income producing investments. We would focus on short to intermediate maturities and sacrifice yield, with the expectation that global economies will show signs of recovery in the next two to four years.
Looking Forward
WrapManager will continue to watch the economic signs as they unfold. The economy could go into recession if we start to see sustained unemployment and several consecutive quarters of decreasing corporate earnings and consumer spending. While there are certainly several abnormal elements at play, only time will tell if the current market environment represents a “new normal.” Either way, there are certainly a few abnormal elements at play.
As always, please feel free to give your Wealth Strategist a call at (800) 541-7774 if you have any questions or would like to discuss your portfolio.
Disclosure
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of August 9, 2011, and are subject to change as subsequent conditions vary. The information and opinions contained in this material are derived from sources deemed to be reliable, are not necessarily all inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. No client or prospective client should assume portfolios presented (or any component thereof) serve as the receipt of, or a substitute for, personalized advice from WrapManager, Inc. or from any other investment professional.
The S&P 500 Index is a market capitalization-weighted index, composed of 500 widely held common stocks, including reinvestment of dividends that is generally considered representative of the US Stock Market. The Russell 2000 Index is a market capitalization-weighted index composed of 2000 stocks, including reinvestment of dividends that is generally considered representative of small US companies. Index information is shown for illustrative purposes only. One cannot invest directly in an index.
Information pertaining to money manager or WrapManager’s operations, services, and fees is set forth in each of their current disclosure statements, copies of which are available upon request. WrapManager, Inc. is an investment advisor registered with the SEC. The associated persons of WrapManager, Inc. may also be securities agents with Prospera Financial Services, Inc., a registered broker/dealer, member FINRA/SIPC. Securities offered through Prospera Financial Services and cleared through First Clearing, LLC, an affiliate of Wells Fargo. WrapManager, Inc. and Wells Fargo are not related entities.