The Markets
Both the Dow and the NASDAQ ran into significant roadblocks on Friday putting an end to four days of gains. With oil, gold and wheat all trading at record highs, a re-emergence of inflation concerns is not what the markets need right now. A report Monday that S&P had reaffirmed its AAA rating for bond insurers MBIA Financial and Ambac Financial helped, and through Wednesday the blue chips had advanced by nearly 3.3%. Despite these temporary gains, the Dow snapped a two week winning streak as it lost 115 points (-0.9%) to close at 12266.
The NASDAQ also advanced early in the week as it gained 2.4% through Thursday. But in typical bear-market fashion the so-called growth index continued to underperform other dividend paying indexes, giving back all of its early-week gains. For the period, the NASDAQ lost 32 points (-1.4%) settling at 2271. It should be noted that the NASDAQ is still more than 56% below its high way back in 2000.
Of utmost concern right now are the surprisingly large year-to-date losses in the municipal bond market. In theory, as the stock market tumbles municipal bonds are supposed to offset some of that weakness by going up in value. This time around has been quite different, with these traditionally low-risk vehicles coming under significant pressure this year. For many high-net worth individuals, the reality is that right now practically everything in their portfolios is down for the year. Yikes!
The Appleton Group Composites™
Bear market, what bear market? So far this year, our clients have been significantly insulated from the quickly deteriorating market environment. While we’re still calculating performance through the end of February, generally speaking our managed composites continue to perform admirably. As one of the only (if not THE only) asset allocation disciplines that systematically adjusts the asset mix of the portfolio in real time as market conditions change, we offer the flexibility that so many other disciplines lack. Over the past week we have adjusted our posture to be slightly less defensive than we had been, systematically converting some of our bear-market and cash positions back toward the equity markets. I’m a firm believer that “buy-low, sell-high” works well, and while there might be additional weakness down the road, there’s enough institutional support right now for us to ease back towards neutral. The severe declines that many investors in buy and hold portfolios have experienced already this year (and have also experienced over the past eight years!) could take many months to recoup. As many of our portfolios are either up on the year or experiencing low single-digit losses, the comfort of being largely insulated from severe market shocks like these is really wonderful!
Looking Forward
Depending on who you ask, the markets are either severely undervalued or severely overvalued. With interest rates as low as they are right now, the earnings potential of the market puts the S&P 500 almost 40% below fair market value. That’s exciting! But the flip side of that coin is that no one can really determine what those earnings will be in six months or even a year. This gives the markets a whole lot of anxiety because without this important piece of information determining fair value is quite difficult. Later this month, we’ll start to get a feel for whether corporate earnings are stabilizing or not. The “or not” part is the wildcard.
One last issue that needs to be discussed is the severe decline in the dollar versus both the euro and the yen. This gets a bit technical, but the big picture is this: we’re at a severe tipping point, which isn’t a good place to be. If the Fed continues to lower interest rates to fuel growth, the dollar will continue to slide, pushing up the price of oil, gold, wheat and other assets that are commonly purchased in dollars. It will also give an artificial boost to the profits of those companies that export, which is a good thing in the short run. But at some point if inflation gets away from us (as it truly appears is happening) the Fed will have to raise rates. This will have a negative effect on corporate profits, and could lead to one of the most severe and painful deteriorations of market valuation that we’ve witnessed in many decades. Tipping points can be quite dangerous and the unwinding of the extreme devaluation of the dollar is something that can’t just be ignored.
Please visit www.appletongrouponline.com to learn more about The Appleton Group Composites™.
