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MARKET COMMENTARY
September 2, 2010
As everyone knows, the current investment environment is vexing. The stock market is extremely volatile and had one of the worst Augusts on record driven by concerns over a potential double-dip recession and investor sentiment which is as low now as it was in March of 2009 when the market hit its low point. Problems remain but unlike then, our banking and financial system is in reasonably solid shape, corporate earnings are good, companies are sitting on huge amounts of cash and banks are starting to lend, although loan demand remains low as paying down debt has become the priority. Unfortunately, unemployment will remain high and come down only slowly as companies use new technology and operate leaner than before.
The stock market’s behavior caused a “flight to quality” which is part of the reason that stocks have struggled and interest rates have declined to historic lows as a result of this and the efforts of the Federal Reserve. The economy continues to grow but at a slower pace than originally thought. So is this a normal slowdown which typically occurs, or is it something more, and what is an investor supposed to do?
If we are in a normal slowdown, the stock market will move up long before economic reports confirm this, and the move will be sudden and sharp. If one is completely out of the market, most of the upside will be gone before the cash on the sidelines can be put to work. On the other hand, cash is “king” if we are going back into a recession.
The alternatives to stocks as a practical matter are money market funds or bonds. Money market funds and 1-2 year treasuries are paying virtually northing and with rates on the ten-year treasury bond at about 2.50%, there is a considerable principal risk in bonds if rates rise in a recovering economy since the price of a bond moves in the opposite direction to interest rates, declining in value as rates move up.
In emotional and volatile times like these, it is important to maintain focus on long term objectives. Allowing caution to override the reality of inflation by investing solely in safe, low-return investments like CDs, money market funds and treasury bills which will not keep up with inflation over the long haul is a bigger long term risk than owning stocks.
In this treacherous environment, we have tried to position our accounts to be as safe as possible while still being in a position to take advantage of any rise in stock prices. It is for this reason we have chosen to avoid chasing yield, keeping the maturity schedule of our bond portfolio short so we can take advantage of the higher rates which should be available in any recovery. Our gold stocks should act as a hedge against future inflation and the uncertainty in the world economy, as should our large cash position, while the lower than normal exposure to stocks provides some safety and the opportunity for gains if and when the stock market turns around.
To this end, we are in the process of putting together a fund to capitalize on the price bubble we see coming in gold and interest rates. This fund will have greater flexibility and be able to react more quickly to changes in the market and various asset classes than is possible in individual portfolios. For those who are interested, it will not involve any new money, but rather taking all, or a portion of the money in the portfolio invested in these areas and putting it into the fund which we believe will provide a greater degree of security, while affording enhanced appreciation potential. If interested, please give us a call and we will provide the details.
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