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Market Commentary


June 2012
Greetings!
Recently, I walked into a quaint general store in the Berkshires.  I saw a sign that read, "Tough times don't last forever, Tough people do". At the same time, the radio was playing "Gravity is Gone" by Mike Cooley.  It goes like this:
 
"I'll meet you at the bottom if there really is one.
They always told me when you hit it you'll know it.
But I've been falling so long it's like gravity's gone and I'm just floating."
 
As if CNBC didn't spook me enough, now I'm seeing ominous reminders of the stock markets action everywhere I look.
 
After Friday's sell-off, we wanted to send you this note regarding the current market, share some fascinating perspectives from Warren Buffet and Peter Lynch, and commentary on Europe and Greece.
 
At WH Cornerstone, we understand market declines and corrections are scary, but, we will continue to be "optimists". Its important to put worldly events in perspective and look at the positive signs in the economy.
 
For starters, consider the "election-year indicator". In November, our presidential election will take place. During election years, the stock market has risen by an average of 11% dating back to 1928. June, July, and August are the best-performing months during an election year. Stocks have only had three negative years over the past 21 election cycles. Why? During election years, it's in the best interest of the current administration to do everything in its power to prevent stocks from going lower. Americans vote with their wallets. Expect the current administration to throw everything including the kitchen sink at the economy.
 
On Friday, it was reported construction spending, personal spending, and personal incomes all rose, all good signs.  The rise in personal spending indicates consumers are still contributing to economic growth despite the subpar economy.
 
So why the 2% drop on Friday?  As JP Morgan once quipped, "stocks tend to fluctuate".  Friday's market drop was a continuation of the worst month of the year for the major indexes. The financial media reported that bad employment data (unemployment edged up to 8.2%) created the sell-off.  Also, the Institute for Supply Management reported that the manufacturing purchasing managers' index for May dropped to 53.5.  It's important to note a reading above 50 suggests that the economy is still growing.
 
Let's put this in perspective; the market was down over 6% in May.  However, the market is still in the black for the 2012 (S&P 500 at 1.62% YTD).  The market screamed forward in 4th quarter of 2011, and continued in to the 1st quarter of 2012.  It's normal for the market to pull back especially since we are witnessing some negative economic news.
 
Our main concern right now is a market "panic" brought on by a potential domestic recession and a Eurozone crisis.  These are real issues that must be watched closely. We believe these issues will put pressure on the Federal Reserve, the Obama Administration and Congress to stimulate economic growth.  Currently, we are not making any recommendations to change course.
 
What's Warren Buffett thinking? At the annual Berkshire Hathaway shareholders meeting, Buffett and his right hand man, Charlie Munger revealed some interesting logic.  It appears Mr. Buffett and Munger don't waste time worrying about Europe. Buffett bought eight European stocks last fall. And he said simply of the crisis in European sovereign debt, "I don't know how it plays out in Europe...but I would totally avoid buying medium- and long-term government bonds, our own or other countries."
 
Even more interesting, Buffett and Munger also revealed that they don't waste time worrying about any macro concerns (except one - inflation). Buffett said that in the 47 years he and Munger have been running Berkshire, "We've never talked about macro stuff." Never!
 
Legendary investor, Peter Lynch of Fidelity, once famously said, "I spend about 15 minutes a year on economic analysis. The way you lose money in the stock market is to start off with an economic picture."
 
Greece...
Greece has very poor economic infrastructure. The public sector is huge.  Corruption is apparently rampant, and the tax collection system is non-existent. To say the Greek government runs large deficits is an understatement.  It spends way more than it takes in.
 
What may happen?
Greece may leave the European Union.  Greece may also default on its remaining debt. If that happens, Greek and other European banks would take large losses. The current Greek banking system would likely fail. The entire Eurozone banking system will be stressed from the losses on Greek debt.
 
Will Greece leave the Eurozone and create a new currency? No one knows what Greece will do. We speculate it is doubtful.  New currency and other transition costs would make the exodus an extremely large expenditure.
 
What's the impact to the United States?
It will create volatility in the capital markets, but the real impact will be minor.  Greece is a tiny country. Wal-Mart, for example, annually earns significantly more than Greece's gross domestic product (GDP). In fact, the 30 companies comprising the Dow Jones Industrial Index earn more than Greece. Greece is insignificant. Contagion is not. Investors are getting nervous about other Eurozone countries (notably Italy, Portugal and Spain). Borrowing costs of these countries are rising, making it more costly for them to borrow.
 
This past week, panic from Spain stole the headlines from Greece.  Spain's GDP is smaller than the assets of JPMorgan Chase, Bank of America, or Citigroup. Put another way, these three banks' assets are bigger than the productive output of one of the biggest countries in Europe.
 
Our guess is that life for the Greeks will get worse if they leave the Euro.  The rest of Europe will manage if a Greek exodus happens. Obviously, markets will get volatile with this type of uncertainty.  US and Europe are trading partners.  Some pain from there will ripple across the pond, albeit a lot less pain for the United States than Europe.
 
Our summary for the month of May: millions of people woke up, read bad news, heard more bad news and concluded a distressed Greece and a depressed Europe will threaten the profits of the 30 most consistently profitable, growing, highly competitive companies in the world--the Dow.
 
Market declines and corrections are scary. But, this too shall pass. Europe's problems, recessions, volatility are nerve-racking. We do not mean to minimize these issues, but we want to keep them in perspective.

Special thanks to our friends over at Stansberry & Associates.  Their research and data is always insightful.
If you need assistance navigating the often confusing world of personal finance, please let us know. We work with small business owners and individuals to provide sound, visionary stewardship of their assets.

For our clients, please advise us promptly if there are ever any changes in your financial situation or investment objectives.

 

Feel free to give us a call if you want to discuss anything further.

 

Cheers, 

Mike & Jenn married
Bill Harris, CFP

WH Cornerstone Investments