Once again, the markets over the past several months have provided an interesting ride. After a slow start during the first quarter, volatility returned particularly when the nation of Greece began having economic issues.
This comes after most prognosticators at the beginning of 2010 encouraged investors to buy international stocks and avoid U.S. investments. Despite this, U.S. investments have outperformed international ones thanks to small company stocks - typically the most risky investment alternatives - which have been up more than 15% so far this year.
Indeed, there has been a major correction in the markets over the past couple of weeks, but this is hardly cause for alarm. Such movements have been common occurrences during major bull markets throughout the history of trading. Consider this: The domestic market has rallied more than 80% since March 2009.
That said, we have been receiving a lot of questions from clients lately, so let's delve further and evaluate the current landscape.
For 2009, bank debt was the big concern; today, it's government debt. No doubt, government debt levels have gotten astronomically high - the United States debt is expected to reach 90% of GDP at some point this year. The core investment lesson remains: There are no riskless investments.
But at Redwood, we have developed a portfolio that has successfully avoided much of the risks that have surfaced in recent years. Sure, someone who holds a significant number of Greek bonds should be concerned, but Redwood clients do not keep any of these bonds in their portfolios. In regards to stock holdings, Greece represents 0.36% of our entire stock portfolio - barely a blip on the radar screen. Compare it to the moments when investment houses such as Lehman Brothers, Washington Mutual, and Bear Stearns went bankrupt and minimally impacted the Redwood portfolio because the bulk of our investments lay elsewhere.
In addition, the Euro- Zone represents 10% of your equity portfolio dominated by the larger and more financially stable countries of the region. Are countries like France, Germany, and Italy going to file bankruptcy? Very unlikely.
The issue revolves around Europe and whether the larger nations will support the bailout of Greece. Part of the current fear is that the contagion of Greece might move to Spain and Portugal and, thus, put pressure on the European heavyweights to contribute more money. Such a scenario has not been an easy sell to the German people and politicians in particular, who are especially sensitive during election time. Comments last week from former German Chancellor Helmut Kohl failed to alleviate fears in his country of bailouts even as he explained that the conversion to the Euro was just as much a peacekeeping measure among participating nations as an economically convenient one. But the truth is, peace in Europe is more likely to continue when everyone is connected via a common currency.
Even if a scenario arose where the Euro failed and each nation of the European Union reverted to its original sovereign currency (not a likely event but not out of the realm of possibility), it would hardly mean financial ruin across Europe. These countries survived long before the Euro and will continue to survive after.
Here at Redwood, we believe the Greek crisis stands as just another crisis in the long list of events that have rattled markets over the past 100 years. Markets endure and trading continues. In the coming years, a financial crisis could affect Russia or China or even the United States again.
So the bottom line is: How do you react?
The simple response: Stay calm. Stay diversified.
Having invested with Redwood, you can be assured of diversification. Our equity portfolio is invested in more than 10,000 different companies representing more than 40 countries. We avoid the "timing game," where investors might attempt a quick sale of Greek stocks and pull in investments in Chinese or Indian companies. And then as the markets turn, they simply switch the entire buying-selling game around. Such strategy is typically a losing proposition.
If we invested that way, we might as well take an annual field trip to Las Vegas and put the entire portfolio on a single number on the Roulette Wheel and see where the spin takes us. Truly, there is no shortage of gamblers out there trying to win just that sort of game. And like Vegas, such odds are woefully against you.
No surprise. Interest rate forecasts are all over the place.
Experts at PIMCO, the largest bond manager in the world, contend that inflation is inevitable and, thus, so are higher interest rates. Conversely, BlackRock, No. 2 in bond management, argues that inflation is not likely in the near term and that interest rates will go even lower. One firm favors bonds maturing within the next 3 years, while the other prefers ones with much longer terms.
Oh, and it doesn't stop there. Economists at Goldman Sachs recently released a forecast saying the 10-year treasury will drop to around 3%, while those at Morgan Stanley provided a forecast of 5%.
What does Redwood think?
The key to a good offense is a good defense, so we are somewhere in the middle. We have a good mix of short-term and intermediate-term bonds across all sorts of sectors - corporate bonds, treasury bonds, and, of course, inflation-protected securities. Our portfolio invests in nearly 5,000 different types of bonds, all with very high credit ratings. Thus, like our stock portfolio, our bond investments puts the chances of you losing your money in our bond portfolio at very slim and any sudden increase in interest rates will have minimal impact.
Inflation has dropped off the radar lately, since there have been no signs of prices increasing significantly.
As we have mentioned several times in our investment committee meeting, the best indicator of future inflation are wages and capacity utilization. With unemployment as high as it is, it will be virtually impossible for employers to raise wages and manufacturing plants are nowhere near full capacity.
Still, inflation remains on our radar here at Redwood, so we plan to maintain our investment in short term bonds and Treasury inflation-protected bonds.
That's the "State of the Markets" for now. As always, feel free to call or e-mail us with any questions, concerns, or comments.
