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Last Quarter Round-Up
My outlook last quarter was one of concern for both the U.S. and global economies. For the U.S., I suggested the end of round two of quantitative easing (QEII) could downshift our economy to an even lower gear. For the globe, the worry was Europe and how its sovereign debt crisis might unfold. As it turns out, at least one of these concerns had an impact on the market with the S&P 500 Index down 14.3% for the quarter. While I was skeptical the end of QEII would have significant impact on the economy, we won't have a sense of that until we see third quarter Gross Domestic Product (GDP) levels. Reported second quarter GDP was low at only 1.3%, although that is good compared to first quarter GDP, which was only 0.4%. The Eurozone has continued to "kick the can down the road," but that little game cannot last forever. I believe much of the market volatility we saw in the third quarter was related to the Eurozone sovereign debt situation. Concerns about Europe shifted beyond a Greek debt default, which at this point is fully expected, to a potential banking crisis caused by the capital losses from said default. The logic continues that if a Greek default spills over to other at-risk countries, the losses and potential bank crisis become exacerbated. These concerns are legitimate given the extent of European bank exposure to the sovereign debt of these at-risk countries.
Current Quarter Outlook
My sentiment for the coming quarter is very similar to last quarter. I believe the U.S. economy is trudging along. Growth is slow, but we are not in a recession and I don't think we will enter one. That said, with Gross Domestic Product (GDP) readings as low as they are the economy still "feels" like it's in recession. Consumer and business confidence levels are both very low. For most people, the difference between slight economic growth and slight economic contraction are just terms bounced around by the media and politicians. The U.S. is in for a protracted economic malaise. Even the Federal Reserve Board has hinted at such. Thus, I see no major market drivers for the U.S. this quarter. However, all of that changes if something develops in the Eurozone. Europe is the 800 lb gorilla in the room. Global impact from the Eurozone could be substantial, and could move markets in either direction. I believe last quarter's losses reflect the market expectation of bad Eurozone developments. But if leaders in Europe are able to coordinate an orderly Greek default and avoid contagion, the markets could respond very positively. The European debt situation is very complex and the countries involved seem stubborn, but I believe the cost and risk of not working together are far too great. I expect a coordinated effort with help from the International Monetary Fund and other nations. Still, the potential risks are high enough that taking some defensive positions makes sense. My equity strategy for the quarter is to reduce equity exposure, especially in European holdings. For fixed income, I intend to add to cash and hi-yield bond positions.
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