The Federal Reserve met Tuesday and decided not to do anything. They were probably influenced by a slightly better employment report last week, but more than anything else they know that they basically have one bullet left in the chamber because all the rest have been fired. They won’t fire it (go to a QE3) until and unless the economy and stock markets are so weak they have no other choice. The upshot of non-action, as we saw Wednesday, was a sell-off in economically sensitive assets and currencies. Bonds and the dollar, the financial instruments the benefit from deflation, both had another very nice day. Gold was trashed (off $88, or 5.5%). Oil prices gave up more than $5/bbl. Technicians are saying that gold will fall to $1450/oz. minimum, and oil to the $85-87 range, in the first quarter of 2012. Remember that the more you hear that, the greater chance those markets are already at bottoms. Commodities tend to take the stairs up and the elevator down, so to speak, so big declines tend to occur out of nowhere, as opposed to when everyone expects them.
Oddly enough, stocks have on the whole been less volatile than bonds and commodities. Dividends have, so far, helped stocks hold up pretty well relatively speaking. With everything that has happened this year, for the S&P 500 to be down less than -1% is actually impressive (the Dow is actually up almost 4%). Note that the Russell 2000 is down -8% and EAFE is off a frightening -14.5%. U.S. blue chip stocks have that “safe asset” patina right now, relative to any other equity security in the world. If a global recession is coming, however, blue chips won’t hold up either. I’d certainly want to be underweight anything economically sensitive right now.
This is a difficult time for investors and advisors, because many of the rules of thumb and tools we use aren’t working right now. We are used to lower interest rates coinciding with strong financial markets. The assumption was that low interest rates stimulated the economy through increased borrowing, but as we have seen lately (and for the last 20 years in Japan), low interest rates only help if businesses and individuals use them to finance expansion. If they don’t, low rates only slow the rate of money transfer from spenders to savers. Also, as advisors, we are familiar with the concept of optimization (or using diversification to create an optimal portfolio for a given risk tolerance). Today correlations between asset classes and sub-classes are higher and far different than they have averaged over the past 25 years. If you are using traditional correlations, you are badly underestimating risk because you are assuming diversification benefits (low correlations between stocks and commodities, modest positive correlations between developed and emerging markets, for example) that don’t exist because those correlations are so much higher today.
Municipal bonds continue to make Meredith Whitney look bad. Munis are the best performing sector of the bond market outside of long treasuries this year. This is no surprise. They are long dated fixed income securities with a very low default rate and in many cases, better yields than taxable securities. With fiscal restraint taking hold in so much of America (just try getting a school bond referendum passed) and the national government and state governments less generous, fewer new projects means less issuance, which improves the supply-demand equation. I have been looking for the right time to move money from Legg Mason Municipal (SHMMX, Joe Deane’s old fund) to PIMCO Municipal Bond (PMLAX, his new one) since it takes a while to reshape a bond portfolio; think about that now.
I’ve been very disappointed with the Templeton Global Bond fund (TPINX) this year. Manager Michael Hasenstab has done a tremendous job with this fund over the past ten years. This is one he will want to forget. The fund is bullish on emerging markets and natural resource usage. Hasenstab has seen inflows because of his strong track record, and he has used those inflows to double down on his bets. While I wouldn’t bet against him over the long term, I am shifting my portfolios to a 60/40 combination of PIMCO Foreign Bond Unhedged (PFBDX) and Fidelity Emerging Market Bond (FMKAX). Those funds are handling the very challenging environment a lot better this year, and have the managers and long term track records to give me comfort.
Large cap growth trends have shifted over the past several weeks. Momentum oriented funds (those that are willing to buy very high P/E stocks as long as the growth trends hold up) have led the way most of the year, but they have been giving way to more defensive growth companies where the P/E is much lower and the growth rates lower but less subject to disappointment. Think about moving from Salesforce.com to Waste Management.
Past Performance is no assurance of future results
Trademark Financial Management, LLC (“Trademark”) is an SEC registered investment adviser with its principal place of business in the State of Minnesota. Trademark and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisers by those states in which Trademark. Trademark may only transact business in those states in which it is notice filed or qualifies for an exemption or exclusion from notice filing requirements.
This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. Any subsequent, direct communication by Trademark with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Trademark please contact Trademark at (952) 358-3395 or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov). For additional information about Trademark, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein. Please read the disclosure statement carefully before you invest or send money.