September Review-September wrapped up a thoroughly forgettable quarter as the Standard and Poor’s 500 lost 7.0%, including dividends, for the month and 13.9% for the quarter. Foreign markets fared even worse as the MSCI EAFE index lost 9.5% during the month in dollar terms and 19.0% for the quarter. As a result, panicked investors withdrew more than $87 billion from U.S. mutual funds, the most outflows since the depths of 2008. According to Ned Davis Research, since World War II, quarterly price declines in excess of 14% are followed by a gain in the following quarter 89% of the time. The average gain in such quarters has been 5.3%. Any further signs that the U.S. might manage to avoid a new recession should limit the downside to a market that had fallen nearly 20% at its nadir. It helps that the U.S. is not burdened with liquidity demands or tight fiscal policies and, since we are only a little more than two years removed from the worst recession since the 1930’s, there isn’t much in the way of economic excesses built up that need correcting.
The ongoing distress in Europe trumped any concerns about U.S. debt levels and credit quality and investors continued to flock to the safe haven of the U.S. Treasury market in September forcing the yield on the 10 year Treasury bond down to 1.93% at month-end. Since bond prices move up when yields decline, it was a very good quarter for bonds, particularly Treasury bonds. According to “Barrons” it was the best quarter for Treasuries on record. The 10 year Treasury bond produced a 2.8% total return during September and 11.9% for the quarter. According to data from the Federal Reserve Bank of St. Louis and Yale professor Robert Shiller, the yield has never been below 1.95% on a monthly basis and has been at 2.0% or lower only 0.2% of the time since 1871! Based on history, the probability of the yield going much lower would seem to be remote, but then we have never had a Fed so determined to keep the yield low. With the Consumer Price Index having advanced 3.8% over the twelve months ending August, the real yield on the 10 year Treasury ended the month at -1.87%. As we invest for the long-term, not just a quarter, and we are extremely uncomfortable committing client assets to an investment that is highly likely to produce a negative return after inflation, we will continue to favor corporate, mortgage-backed, select foreign bonds and, where appropriate, municipal bonds for the fixed-income portion of our portfolio allocations.
Outside of the continuing European drama, the biggest event in September was the Federal Reserve’s announcement of “Operation Twist.” Under this program, the Fed will sell securities from its portfolio that have maturities of 3 years or less and use the proceeds to buy maturities between 6 – 30 years. The goal of the program is to lower long-term rates in order to incentivize risk taking and support the mortgage market as mortgage rates are tied to longer term Treasury rates. The program was widely anticipated but is more extensive in a few aspects. The market anticipated a $300 billion but the Fed announced a $400 billion program. The allocation to the 20 – 30 year maturity range is bigger than expected. The announced allocation amounts to about 90% of the planned new issuance of the 30 year bond, though the Fed won’t buy more than 35% of any given issue. Finally, they surprised market participants by announcing that principal and interest payments from the Fed’s mortgage-backed securities portfolio will be reinvested in mortgages rather than Treasuries as had been the practice.
The key to investment success in the immediate future remains in Europe. Investors’ actions have been driven by headlines and rumors and will continue to be guided by how they think the situation will unfold. Probably, the best that we can hope for is that the European authorities can somehow navigate the Byzantine rules, regulations, and political realities of the Eurozone and stabilize the sovereign debt crisis, get the countries back on track for economic growth in the subdued range of 2%-3%, all while developing achievable plans to reduce government debt going forward beyond the crisis. Until then, it is likely that we will continue to experience violent daily swings in market prices as investors continue to be torn between reasonably valued stocks and the uncertainty caused by Europe’s debt contagion and the wide range of possible policy responses.
The following is not intended to reflect any specific investment portfolio managed by WheelerFrost Associates, Inc. or to provide investment advice. Investment recommendations made by WheelerFrost Associates, Inc. are given only on a client by client basis in conjunction with a specific investment plan.
- We are maintaining a cautious outlook toward stocks, given the uncertainties arising from the ongoing economic stresses in the U.S. and the sovereign debt crisis in Europe.
- Developed countries appear attractive versus the U.S. on valuation criteria.
- Emerging countries appear attractive versus the U.S. on growth criteria.
- Favor commodity exposure as a hedge against commodity induced inflationary pressures.
- Corporate and mortgage-backed bonds are favored over Treasuries.
- Municipal bonds have rallied substantially from panic induced levels earlier in the year but remain relatively attractive compared to Treasuries.
- Favor State General Obligation municipal debt as well as essential services issues.
- Higher oil prices due to Middle East turmoil and emerging country demand.
- Debt contagion to other core European countries.
- Potentially over-stimulative Fed policies and rising commodity prices are inflationary threats.
- Debt levels and budget deficits in developed countries pose threats to sovereign debt.
- Credit conditions remain challenging for individuals and small business.
- Inflation concerns in emerging countries are forcing monetary tightening that could lead to slower global growth.
This review is compiled from various research sources and nothing presented herein is or is intended to constitute investment advice, and no investment decision should be made based on any information provided herein. While WheelerFrost Associates, Inc. has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability or completeness of third party information presented herein. Information provided reflects WheelerFrost Associates, Inc. views as of a particular time. Such views are subject to change at any point and WheelerFrost Associates Inc. shall not be obligated to provide notice of any change.