The Day After The Downgrade

It was quite a day in the stock market, which plunged by -6.7% as measured by the S&P 500 Index.  Given the events of the day, I wanted to provide a brief update on the markets and portfolio performance.

I’ll begin with the bottom line.  portfolios ended up for the day.  Although gains for the day were modest at less than +1%, this result was favorable given the considerable downside pressure coming from stocks.  Portfolio gains were supported primarily by precious metals such as Gold (+3.3% today), Silver (+1.7%) and Agnico Eagle Mines (+1.4%).  U.S. Treasuries also posted another strong advance, with government debt reaching new highs across the yield curve including TIPS (+1.2%), 3-7 Year Treasuries (+0.6%), 7-10 Year Treasuries (+1.6%) and 20+ Year Treasuries (+3.2%).  As a result, the hedging strategies in place to protect portfolios against major downside stock market events had a positive net effect today.

One fact coming out of today was notable.  Given that S&P, which is one of the three major credit rating agencies, downgraded the United States from AAA to AA+, it might have been reasonable to expect that U.S. Treasuries would have declined substantially today.  Instead, they traded sharply higher. 

This highlights an important point.  The sell off in stocks today had little to do with the U.S. credit downgrade.  Instead, it had much more to do with the ongoing financial crisis in Europe.  Over the weekend and into today, European leaders worked to try and resolve what is a rapidly deteriorating situation in Spain and Italy.  Despite their latest efforts to address the problem, financial markets remain unsatisfied and are starting to become impatient.  Hence the sell off in stocks today and the move to Gold, Silver and U.S. Treasuries, which are all still considered safe havens during times of market uncertainty.  Highlighting the fact that Europe remains the key overhang for the market, European financial preferred stocks were down between -10% to -20% today alone.  These types of moves in preferred stocks are highly unusual and help isolate the source of market stress. 

As for the U.S. credit rating downgrade, it will likely continue to do its part to add to market uncertainty and volatility, but its impact is currently secondary.  However, any unanticipated fallout effects from the downgrade will likely only begin to become apparent after a few weeks or longer if at all.  I will be watching this very closely and will keep you updated if I begin to see such effects beginning to boil to the surface.

Looking ahead, the stock market is now well overdue for a meaningful bounce higher, as it hasn’t been this oversold since late 2008.  But the fact that it is oversold does not mean that it won’t decline further.  After all, it was also oversold when the S&P was at both 1250 and 1200 just a few days ago, and today it closed at 1119.  And any bounce higher in stocks will likely be short lived – perhaps a few days to a week or two at most – given the weakening global economic outlook and the ongoing financial challenges in Europe. 

The one caveat to this stock outlook is the potential for action by global central banks including the U.S. Federal Reserve (Fed) or the European Central Bank (ECB).  For example, if the Fed were to announce another round of stimulus (QE3) either at their FOMC meeting tomorrow or at Jackson Hole at the end of the month, this could be the catalyst for a new rally higher in stocks.  Another example would be unprecedented steps by the ECB to finally try to get ahead of the crisis in Europe.  Once again, I will keep you updated on any developments on this front.

In the meantime, the emphasis will remain on keeping hedging strategies in place including positions in precious metals and U.S. Treasuries in working to generate further portfolio upside amid stock market turbulence.  Taking the opportunity when it presents itself to selectively add high quality stock names that have been pulled lower along with the broader stock market sell off will also be a priority in the coming days.

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.

Thursday’s Stock Decline

Thursday was a tough day for stocks to say the least.  Overall, stocks as measured by the S&P 500 declined by -4.71%, which marked the worst one day performance for stocks since before the March 2009 lows.

The primary driver for the sell off was the situation in Europe.  In recent days, Spain and Italy, which both rank among the twelve largest economies in the world, have come under increasing pressure due to their government debt problems.  The European Central Bank held a meeting today where it was hoped that they would provide some clarity on how they would address the problems in these two ailing countries.  Instead, they managed to perplex the market with several policy decisions that were widely inconsistent with recent actions and out of step with the views of Eurogroup leaders and the International Monetary Fund.  This sparked market concerns that confusion and lack of coordination among European leaders may result in the current crisis eventually growing out of control.  From there, the stock market rout was on.

Fortunately, portfolios were prepared for today’s events.  While money was draining out of stocks, it was flowing into U.S. Treasuries.  As a result, a heavy portfolio weighting to Treasuries added considerable value.  For example, longer duration U.S. Treasuries (maturing in over 20 years) gained +3.56% today, and other areas of the Treasury market also rose +1% or more.  This helped meaningfully offset the impact of the stock market decline.  And although Gold sold off today, its decline was only -0.53%.  In total, any declines in portfolio value were limited to considerably less than -1%.

Looking ahead, today’s stock drop had the feel of liquidation selling by financial institutions and hedge funds, which was a common occurrence in late 2008 and early 2009 during the days following the outbreak of the financial crisis.  Supporting this idea was the fact that several stocks were actually up in the late morning, but ended the day down -5% or more.  Such volatile price activity is a sign of sellers being forced to liquidate into a stock market where there’s not enough buyers to pick up the slack.  And when such liquidation selling gets underway, it’s unpredictable to say exactly when it’s going to end.  But the stock market is now oversold – it has gone down too far, too fast – and many high quality stocks are now considerably less expensive today than they were just a few weeks ago.  Thus, this sell off should provide the opportunity to add selected high quality names once the stock market finds some stability.  The only question is whether this stability comes at 1200 on the S&P where it closed today or at an even lower level before its all said and done.  The next few trading days will tell us a lot in this regard.

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.

Beyond the Debt Ceiling Debate

The recent national drama is drawing to a close.  After weeks of intense negotiation, it appears that politicians in Washington have come to an agreement to raise the debt ceiling.  Investment markets are cheering the news, as stocks are signaling a strong opening when trading resumes tomorrow.  The relief rally is only likely to last a few days, however, as far greater challenges lie ahead in the coming weeks.  As a result, the priority is to keep portfolios focused on the investments that have been rising while stocks have been struggling.

Although the media was transfixed with the debate, the debt ceiling issue and the risk of the U.S. defaulting on its debt was never much of a concern for investment markets over the last few weeks.  If it had been, we would have likely seen a major sell off in Treasuries with yields spiking higher.  Instead, the Treasury market has been in rally mode, gaining +3.2% for the month of July including +1.3% last week in the final tense days leading up to the ultimate resolution.

So what explains why stocks have been struggling over the past few weeks?  Certainly, the uncertainty resulting from the debt ceiling debate has not helped stocks, but this has been an ancillary reason at best.  Instead, three factors have had stocks under increasing pressure, and these challenges will still remain once the debt ceiling debate goes away.  They are the following:

1.  The Economy is Slowing
A growing economy is the primary fuel to sustain higher stock prices.  But nearly all signals suggest that the economy is weakening with each passing month and recession risks are on the rise.

2.  Fiscal and Monetary Stimulus is Spent
A primary driver of the market rally over the last two years has been the massive support from government spending and Fed stimulus programs like near zero interest rates, QE1 and QE2.  But a key takeaway from the debt ceiling debate is that any additional government spending to boost the economy is highly unlikely going forward.  And the Fed’s QE2 program came to an end on June 30 with no talk of QE3 coming any time soon.

3.  The European Crisis Keeps Getting Worse
Euro Zone leaders announced a major rescue package on July 21 that was supposed to provide the continent six months to a year to regroup and stabilize.  But problems are already starting to resurface after only a week.  And although the issue is in Europe, it has the potential for major negative spillover effects on the global banking system including the U.S.  Looking ahead, Spain and Italy are the countries that are likely to garner the most media attention for their problems in the coming weeks.

So while we’re likely to see stocks rally strongly over the next few days in celebration of the debt ceiling debate finally ending, they’re likely to soon falter and begin struggling once again primarily for these three reasons.

Fortunately, a variety of asset classes perform very well in such economic environments like we have today, and portfolios have been positioned to benefit.  These include bonds such as U.S. Treasuries and precious metals such as Gold, both of which are considered safe haven investments during times of uncertainty.  Both of these categories have been performing very well over the past several weeks and portfolios have been meaningfully weighted to both Treasuries and Gold to capitalize.  Treasuries are up +6.8% for 2011 year to date including a +3.2% advance in July, while Gold is up +14.1% for the year including an +8.4% gain this past month.

In the coming days, the debt ceiling relief rally should provide a good trading opportunity to lock in gains on selected stock positions.  And the accompanying safe haven sell off may also provide the potential to add to existing bond and precious metals positions on the dip, as these are the categories that are likely to continue to perform well in the coming months as markets work to navigate through ongoing economic challenges.

I will continue to keep you posted as events unfold.

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.