Investment markets will be coping with the threat of crisis early next week.  On Tuesday, the Greek parliament is set to vote on a new austerity program that is required for the country to receive the latest round of bailout funds from international creditors.  While the approval of this vote remains the probable outcome, the failure to pass these measures could result in a severely negative reaction from investment markets.  As a result, maintaining a close watch on portfolio risks and working to capture any potential opportunities will be particularly important over the coming days.

The situation in Greece remains critical.  This is due to the fact that the country has billions in debt and interest payments coming due in July, and they don’t have the money to make these payments.  As a result, Greece needs the latest round of bailout funds totaling 12 billion euros from the European Union (EU) and the International Monetary Fund (IMF) in order to avoid bankruptcy.  The key to getting these funds is the austerity vote on Tuesday.  If the Greek parliament fails to pass this latest round of budget cuts and tax hikes, the EU and IMF have stated they would withhold disbursing these funds.

If Greece were to default on its debts, it has the potential to spark a market crisis similar to the Lehman collapse in 2008.  While Greece itself is relatively small, a key risk associated with a Greek default is the uncertainty over exactly what financial institutions are exposed to the resulting final losses and to what degree.  European banks would be particularly at risk, and the spillover effects could impact U.S. banks as well.

Given this crisis risk, it is important to determine how portfolios can be allocated to both sidestep any potential chaos and capture upside opportunity.  The following are the asset classes that would be poised to gain in the event of a new crisis emanating from the Euro Zone:

U.S. Treasuries
U.S. Treasury Inflation Protected Securities (TIPS)
Non-Financial Preferred Stocks

Fortunately, portfolio allocations are already heavily emphasizing these asset classes.  This is due to the fact that the U.S. Federal Reserve’s latest stimulus program known as QE2 is set to end on Thursday just two days after the Greek parliamentary vote.  And all of the categories listed above are also among those expected to perform best once QE2 comes to an end.  As a result, portfolio allocations have already been shifted toward these asset classes well in advance of current events.  One additional point – while positions such as Gold continue to represent long-term investments, other allocations like U.S. Treasuries are more likely to remain in place for the short-term until current risk conditions start to fade.

In the end, it is probable that the Greek parliament will end up passing these austerity measures and will push their debt problem down the road a few more months.  But “probable” is far from “certain”, so monitoring these events closely through the weekend and into early next week will be important.  I’ll keep you updated.

And with the end of the quarter coming on Thursday, I’ll also be checking back soon with a preview for what we can expect in the upcoming third quarter of 2011.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

June Swoon

The post QE2 stock market correction is now underway.  Although the U.S. Federal Reserve’s stimulus plan is not set to end until June 30, a definitive move to the exits in stocks has already begun on June 1.  This shift lower in stocks in advance of the end of QE2 has long been expected, and the good news is that many other asset classes beyond stocks are filling the void with solid results.

Stocks are down over -5% thus far in June. While a snapback rally cannot be ruled out over the next few weeks with a final $56 billion dose of Fed stimulus still on its way between now and June 30, the breakdown in several fundamental, technical and behavioral indicators suggest that the recent downturn in stocks will likely have much further to go as we move through the summer:

The Economy:
Recent readings on the U.S. economy have been increasingly weak, which does not bode well for stocks in an environment where stimulus is about to disappear.  In addition, the situation in Greece continues to deteriorate, with potential fallout effects that could impact both the European and global economy.

Technical Chart Patterns:
During the entire QE2 rally since last August, stocks had been firmly holding various support levels.  But since the beginning of June, stocks have been cutting like a hot knife through many of these important support levels including its 50-day, 100-day and 150-day moving averages and its previous low on April 18.  While several levels of major support still exist including the 200-day moving average and the March 16 lows, it has been notable how decisively the market has plunged through previously bulletproof support levels over the course of just a few days in June.

1st Day of the Month Effect:
Since the aftermath of the financial crisis, stocks have typically rallied on the first day of the month.  For example, stocks have risen by nearly +1% on average on the first day of the month since the Fed launched QE2 last year.  This trend is driven by mechanical reasons including the flow of retirement plan money into the market as well as sentiment factors such as portfolio managers positioning for return opportunities to start the new month.  On June 1, stocks dropped by -2.28%, signaling investor concern about the outlook.

1st Day of the Week Effect:
Over the same time frame, stocks have also tended to perform well on the first day of the week.  Sometimes referred to as Mutual Fund Monday, this effect is driven by capital flows into mutual funds that are put to work in the market on Mondays.  Although this indicator has been deteriorating for months, the -1.08% decline on June 6 was one of the worst Monday outings for stocks in a QE supported market.  This coupled with the fact that volume was notably low indicates reluctance by mutual fund managers to put fresh cash to work in stocks.

Bernanke Effect:
Since the beginning of the QE era in March 2009, stocks have typically rallied when the Fed Chairman makes a major speech.  Even if he says nothing of consequence, stock investors have usually found a way of gleaning something positive from his words to rally higher.  But when the Fed chairman took the podium on Tuesday, June 7, markets immediately rolled over and dropped by nearly -1% in about an hour.  Once again, this price movement had little to do with anything Bernanke said – much of his speech had already been leaked into the market earlier in the day.  Instead, this market response was likely a signal to the Chairman of investor concern that without more Fed stimulus (QE3), stocks will lack the fuel to continue to rally higher.

It has been expected for some time that stocks would begin to weaken in anticipation of the end of QE2 on June 30.  And portfolio allocations have been adjusted for months in preparation for this eventual turn in stocks.

Many of the asset class categories that are expected to perform well during a Post QE2 stock market correction are off to a good start.  Leading among these are U.S. Treasuries, which are up nearly +1% for the month.  Selected non-financial preferred stocks have also jumped roughly +1%.  In addition, Treasury Inflation Protected Securities (TIPS) are up +0.5% in June, while other categories such as Investment Grade Corporate Bonds and Gold are holding steady near breakeven so far for the month.

Looking ahead to the coming week, the next few trading days will be important in signaling whether one last rally in stocks is coming before QE2 draws to a close on June 30.  Otherwise, the pace could begin to pick up to the downside.  Stay tuned.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Looking Beyond QE2

The post QE2 path for the economy and markets is becoming increasingly clear.  It was known from the beginning when the U.S. Federal Reserve’s launched its current $600 billion stimulus program late last year (widely known as “the second round of quantitative easing” or QE2) that it would come down to two possible outcomes in the end.

The ideal outcome:  Economic growth picks up and becomes strong enough to support asset prices inflated by Fed stimulus along the way including stocks and commodities.  In other words, the economy would eventually grow up to support higher markets.

The deficient outcome:  Economic growth remains sluggish despite Fed stimulus, placing inflated stock and commodities prices at risk for a meaningful pullback.  More simply, higher markets are left to fall back to the weak economy.

As we enter the final days before the end of QE2 on June 30, it is becoming increasingly clear that the deficient outcome will be the most likely.  Recent U.S. economic data has been disappointing to say the least.  Not only is the pace of growth sluggish at best, the economy is actually showing signs of slowing down with many readings coming in below expectations.  Beyond the U.S., the economic situation in Europe remains no better than it was a year ago at this time.  Instead, it is actually quite a bit worse.

With the deficient outcome most likely after QE2, what can we expect from markets?

First, stocks and commodities are likely to enjoy at least one more rally in the days leading up to the end of QE2 regardless of the fundamentals.  Today was another classic example of what we’ve seen throughout QE2.  Despite a day filled with lousy U.S. economic data, stocks rallied sharply higher on the news that Greece was set to receive another bailout and would avoid bankruptcy – for now.  No matter that Greece will simply be unable to repay its debts – they already can’t pay their current loans back, so lending them even more money isn’t going to solve the problem.  But while a market that can celebrate the can being kicked further down the road is certainly dubious, it does provide an ideal environment to gradually transition portfolios into the expected post QE2 winners.

So which categories are these expected winners.  They are listed below:

Likely post QE2 winners:
Selected Defensive U.S. Large Cap Growth Stocks
Selected Defensive U.S. Mid-Cap Growth Stocks
Investment Grade Corporate Bonds
High Yield Corporate Bonds
Non-Financial Preferred Stocks
U.S. Treasuries

This list comes with precedent – all of these categories either held steady or posted solid gains when the deficient outcome occurred after the end of QE1 last summer.  And many if not all are set up well to repeat this performance a second time around.

Of course, many market segments are likely to struggle under the deficient outcome.  The list of likely post QE2 losers are shown below (many of these have been winners in the current environment):

Likely post QE2 losers:
Most U.S. Stock categories – Cyclicals and Financials in particular
International Stocks
Emerging Market Stocks
Industrial Commodities – Copper, Oil, etc.
Agricultural Commodities
Financial Preferred Stocks
Non-US Sovereign Bonds
Emerging Market Bonds

What about the wild cards?  Preparing for the unexpected is critical, particularly in today’s markets.  While there are too many to mention in this e-mail, two particular events bear close watching in the coming months after QE2.  The first is the arrival of QE3 – just as they did last summer, the Fed could eventually step back in with another round of stimulus.  This would be a signal to potentially shift allocations back to the current “post QE2 loser” list.  The second is the situation in Europe – if things begin to really come apart in the Euro Zone, this would be a potential shock that could narrow and change the “post QE2 winner” list above quite a bit.  Stay tuned on both of these items – I’ll keep you updated.

The priority over the last several weeks and continuing in the coming weeks will be to gradually shift allocations away from the expected post QE2 losers and reallocate toward the anticipated post QE2 winners.  Closely monitoring the potential wild cards will also be important along the way.  Through it all, the focus remains on generating positive absolute returns, managing risk and seeking to capitalize on positive return opportunities regardless of the overall market environment.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.