Greetings!
Here is your newsletter for February 2010, including a market update and some thoughts on market corrections and speculative bubbles.
I am still scheduling Q1 review meetings for February, so if you have not yet made an appointment please contact the office at your convenience.
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| January Market Update |
 Despite a backdrop of solid earnings reports and favorable economic news (including a 5.7% GDC expansion for the fourth quarter) equities were unable to find any traction this month, and January went into the books with a loss for the third year in a row.
For the month, the Dow Jones Industrial Average lost 3.5%, the NASDAQ dropped 5.4% and the S&P 500 fell by 3.7%.
A "correcting" market (coming off a Q4 return in the S&P 500 of 6%) has been the subject of much chatter going back several months; while many in the financial press have predicted said correction (technically defined as a ten percent decline) it is important to recognize that, in-and-of-itself, a correction is not necessarily indicative of anything other than a response to rising prices. In any case, portfolio decisions made in anticipation of a correction would be ill-conceived: anyone can predict a correction; no one can predict the timing of a correction.
Meanwhile, it was reported last week that existing home sales for December fell by 16.7%, a shockingly large figure and one of the worst monthly drops in history. However, December existing home sales were 15% higher than December 2008, a solid year-over-year increase. Additionally, the median sales price of $178,300 was 1.5% better than the year ago selling price, the first such year-over-year increase since August 2007. Tax incentives for home purchases have been expanded to include all home buyers, and have been extended until April 2010.
Understanding Speculative Bubbles
One of the tell-tale signs of market turmoil is when financial commentators clog the media airways divining all sorts of market outcomes, mostly gloomy ones.
Chief among the prognosticators of late is The Economist magazine, which recently ran a cover story entitled 'Bubble Warning: Why Assets are Overvalued'.1
The argument of The Economist and like minded commentators is that 1) equities are currently overly dependent on lax monetary policies and unsustainable government stimulus, 2) the US equity market is still considerably overvalued, and 3) these excessive prices are being maintained essentially via the benefit of free money and the transference of private sector debt to the public sector.
"Investors tempted to take comfort from the fact that asset prices are still below their 2007 peaks would do well to remember that they may yet fall back a very long way," the magazine intoned in its January editorial.
To be sure, there is a lot of discussion in the media about new bubbles and the reckoning in store for us when governments and central banks begin withdrawing stimulus. The arguments can seem so convincing that you are left wondering why the individual commentators don't put some of their own money at risk and short the market: if it is so evidently a bubble, why not get rich from its inevitable implosion?
The quick answer to that question is that while these people are fairly sure their predictions will eventually be proved correct, they are not sure when.
In the meantime what are the rest of us supposed to do? A first step for the interested is to look at history.
A database search of The Economist going back to the early '80's reveals that they have made around two thousand mentions of "bubbles" in that time. (The magazine has a long track record of making pronouncements about unsustainable market trends.)
In April 1998 they ran a cover story about "America's Bubble Economy", citing the stock market's 65 percent surge over the prior two years as just one symptom of a "serious asset-price bubble".2 Perhaps it was, but that didn't stop the market (as measured by the S&P 500) from rising another 40 percent over the subsequent two years.
This notion of a self-generating speculative frenzy in the equity markets, taking prices well beyond what their fundamentals might suggest, is commonly accepted as the definition of a bubble. The bubble grows larger when traders and investors buy stocks in anticipation of further price increases, not because of a fundamental belief that the asset is undervalued.
The most frequently cited example of this would be the tech boom of the late '90's, when there was an intense appetite for any company associated with the Internet, regardless of the fundamentals or earnings prospects of the particular business.
But the mere act of publicly identifying a bubble does not mean prices will not inflate further. In the case of the Internet, there was a fundamental case to be made for the higher prices up to a point. Investors make decisions in real time based on the information available. The market can only work with the information it has at any given moment, and the fact that a bubble develops and inflates does not necessary mean that markets are inefficient.
Here in 2010, for every pessimist who thinks the rally in asset prices between March and December 2009 is built on easy money, there is an optimist who sees a fundamental under-pinning for the gains. Legg Mason chairman David Nelson sets the current valuation of the S&P 500 at roughly 1,350 (at the end of January it was at 1,073), whereas GMO's Jeremy Grantham says the index is inflated, pinning the fair value at around 860.
A survey released in January by Bank America Merrill Lynch found declining cash balances among money managers, and a 13 percent increase to 52 percent in the proportion of those surveyed who were overweight equities.3 "This survey is one of the more bullish we have seen and suggests that investors buy into the idea that this recovery has legs," a spokesman for BofA Merrill Lynch Global Research said in a release about the survey.
As you have read ad-nauseum in these editions, and as has been proven again and again, no so-called expert can predict the market reliably, and nobody guesses right consistently. There will always be risk and uncertainty in investing, which is why the critical element of an investment plan is to remain focused on elements within one's own control, such as building a diversified portfolio which matches one's appetite for risk, current life circumstances, and long-term goals.
This liberates investors from having to try to time the market and rely on forecasts, even from reputable publications like The Economist.
1The Economist magazine, Jan 9, 2010.
2America's Bubble Economy', The Economist, April 18, 1998.
3Survey Says Managers Bullish on Equities, Recovery', Pensions & Investments, Jan 19, 2010.
Research and selected content used herein was obtained from a recent Jim Parker article. |
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Milestone Financial Advisors, LLC
Ten Key Portfolio Considerations: |
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- Reduce Expenses
- Diversify Systematically
- Seek to Reduce Taxes
- Think Long Term
- Maintain Discipline
- Maintain Prudent Cash Reserve
- Own Low Cost Funds
- Maintain Asset Allocation
- Add to Portfolio Systematically
- Connect Goals to Investments
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