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Market Commentary
Economic Updates
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Weekly Commentary
June 28, 2010
The Markets
Can world governments "cut"
their way to prosperity?
It's no secret that many countries are
incurring large--and unsustainable--budget deficits. What's interesting is the
approach each country is taking to try to lower their deficits to a manageable
level. Britain, Japan, Germany, and Greece, for example, are focused on cutting
government spending, according to Bloomberg, June 22. Conversely, the U.S.,
while concerned about government spending, seems more focused on keeping the
stimulus spending alive and raising taxes until (hopefully) the economy can
catch fire and grow on its own.
Who's right?
According to Harvard University
professor Alberto Alesina, "There have been mountains of evidence in which
cutting government spending has been associated with increases in growth, but
people still don't quite get it." In addition, a study by Ben Broadbent and Kevin
Daly of Goldman Sachs Group, Inc. as reported by Bloomberg on June 22, "discovered
that reducing expenditures by 1 percentage point a year boosted average annual
growth by 0.6 percentage point. Raising the ratio of taxes to GDP by the same
margin cut growth by an average 0.9 percentage point." And, from a stock
market perspective, the same report said, "The equity markets of the
countries that sliced spending beat those of other advanced nations by 64%
during a three-year period."
Like many things related to finance and
economics, we won't know "who's right" until time passes and the
market delivers its verdict. Between now and then, expect the vigorous debate
on spending cuts versus stimulus spending to continue among academics,
investors, and world leaders.
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Data as of 6/25/10
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1-Week
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Y-T-D
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1-Year
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3-Year
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5-Year
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10-Year
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Standard & Poor's 500 (Domestic Stocks)
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-3.6%
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-3.4%
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17.0%
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-10.4%
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-2.0%
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-3.0%
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DJ Global ex US (Foreign Stocks)
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-2.0
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-8.6
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13.9
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-11.7
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1.9
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0.4
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10-year Treasury Note (Yield Only)
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3.1
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N/A
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3.6
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5.1
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3.9
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6.1
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Gold (per ounce)
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-0.2
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13.6
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33.8
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24.4
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23.3
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16.0
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DJ-UBS Commodity Index
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0.2
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-7.5
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3.1
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-8.9
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-4.2
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2.1
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DJ Equity All REIT TR Index
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-3.0
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11.7
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65.9
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-6.7
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1.7
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10.6
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Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index
returns exclude reinvested dividends (gold does not pay a dividend) and the
three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR
Index does include reinvested dividends and the three-, five-, and 10-year
returns are annualized; and the 10-year Treasury Note is simply the yield at
the close of the day on each of the historical time periods. Sources: Yahoo! Finance, Barron's, djindexes.com, London
Bullion Market Association. Past
performance is no guarantee of future results.
Indices are unmanaged and cannot be invested into directly. N/A means not applicable or not available.
ARE
THE FINANCIAL MARKETS "NORMALLY DISTRIBUTED" and
should you even care? Consider this. The average height of an American male is 69.4
inches, according to the National Center for Health Statistics, October 22,
2008. If we randomly chose 1,000 American males and calculated their average
height, we would likely come up with a number close to 69.4 inches. Now, in an
un-random fashion, let's assume we found an 8-foot tall man--who is clearly an
extreme outlier--and we have him join the previous group of 1,000. By
recalculating the data, we now find the average height of this group of 1,001
men jumps by a very underwhelming
0.03 inches. In other words, adding an extremely tall outlier to this group of
average height men had very little effect on the overall average height of the
group. Without getting too technical and assuming "tall outliers" are
just as likely to be found as "short outliers," we can say the height
of men follows a "bell curve" or a normal distribution.
By contrast, let's consider the average
net worth of American households. According to the Federal Reserve, February
2009, the average American family had a net worth of $556,300 in 2007. Like
above, if we randomly chose 1,000 families, this group would probably have an
average net worth near $556,300. However, for fun, let's add Warren Buffett--and
his $40 billion net worth--to the group. Recalculating the data, we find the
average net worth of this group of 1,001 Americans jumps to $40.5 million!
Clearly, adding an extreme outlier to this sample dramatically changed the average
of the sample.
As it relates to the financial markets,
do you think their distribution of returns looks more like the average height
of American men (where an extreme outlier doesn't really affect the average) or
the average net worth of American households (where an extreme outlier could
have an extreme impact)? If you think the returns in financial markets look
like the average height of American men, but
it turns out they behave more like the average net worth of American households,
you could lose a lot of money. In fact, much of modern portfolio theory is
based on the assumption that financial markets follow a normal distribution,
i.e., they look like the average height of American men. Unfortunately,
experience suggests otherwise.
Warren Buffett-type outliers such as
the October 1987 stock market crash, the 2000-2002 bursting of the internet
bubble, the 2007-2009 bear market, the 2008 credit crisis, and last month's "flash
crash," suggest that the financial markets are subject to large outliers that
can significantly affect your financial well-being. Knowing that, we do our
best to try to limit the damage to your portfolio if one of these outliers occurs
during your investing lifetime.
Weekly Focus - Think About It
"In the business world, the
rearview mirror is always clearer than the windshield."
--Warren Buffett
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Warm Regards,
Jim Forcella, CFP®, CFS®
LPL Branch Manager
LPL Investment Adviser Representative
CA Insurance License #0635256
P.S. - Please feel free to forward this commentary to family, friends, or colleagues. If you would like us to add them to the list, please reply to this e-mail with their e-mail address and we will ask for their permission to be added.
Closing Reminders - Should your personal or financial situation change (i.e. Marital or employment status, beneficiary changes or income needs) please contact us at 530.222.6301 or 800.546.5573 for either a phone review, or an appointment. We want to ensure that your current financial objectives meet your personal circumstances.
Forcella Wealth Management Information - Are you receiving too much mail regarding your investments? You now have the option to receive your LPL Financial communications electronically! LPL Financial is pleased to offer the convenience of viewing shareholder communications, including the fund prospectus, annual reports, and proxy statements online. Visit the link below to be directed to a secure website where you will enter your LPL Financial account number and Email address. You will no longer receive shareholder communications information through the mail but can request a hard copy at any time. Please feel free to contact us if you have any questions regarding this form.
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Forcella Wealth Management
1600 Victor Ave ● Redding, CA 96003
Phone 530.222.6301 ● Toll Free 800.546.5573 ● Fax 530.226.1677
jim.forcella@lpl.com ● www.forcellawealth.com
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* This newsletter was prepared by PEAK.
* The Standard & Poor's 500
(S&P 500) is an unmanaged group of securities considered to be
representative of the stock market in general.
* The DJ Global ex US is an unmanaged
group of non-U.S. securities designed to reflect the performance of the global
equity securities that have readily available prices.
* The 10-year Treasury Note represents
debt owed by the United States Treasury to the public. Since the U.S.
Government is seen as a risk-free borrower, investors use the 10-year Treasury
Note as a benchmark for the long-term bond market.
* Gold represents the London afternoon
gold price fix as reported by the London Bullion Market Association.
* The DJ Commodity Index is designed to
be a highly liquid and diversified benchmark for the commodity futures market.
The Index is composed of futures contracts on 19 physical commodities and was
launched on July 14, 1998.
* The DJ Equity All REIT TR Index
measures the total return performance of the equity subcategory of the Real
Estate Investment Trust (REIT) industry as calculated by Dow Jones.
* Yahoo! Finance is the source for any
reference to the performance of an index between two specific periods.
* Opinions expressed are subject to
change without notice and are not intended as investment advice or to predict
future performance.
* Past performance does not guarantee
future results.
* You cannot invest directly in an
index.
* Consult your
financial professional before making any investment decision.
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Securities Offered Through LPL Financial Member FINRA/SIPC
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