May proved to be a rough month for the bulls as the global markets suffered their worst monthly percentage losses since February 2009. Coming into the month, all major market segments were continuing to produce slow steady gains. But it was largely downhill for the month as the markets closed lower on fourteen of the last nineteen trading sessions. Volatility is back as well, with the Dow Jones Industrial Average experiencing fourteen triple-digit gains or losses during the month, including a +3.9% advance on May 10th and a -3.6% decline on May 20th. The highlight of the month occurred on May 6th, however in what has become known as the “Flash Crash” when the Dow fell nearly 1,000 points intraday before settling with a 348 point decline. For the month, the Dow posted a loss of -7.9%, ending at 10,137.
In a change of pace for 2010, the NASDAQ composite underperformed the Dow. For the month, the NASDAQ lost -8.3% closing at 2257. Most other at-risk assets also declined in value including U.S. real estate (IYR, -5.52%), commodity-based equities (XLB, -9.53%) and emerging international markets (VWO, -9.33%). High quality fixed income assets fared much better, with yields on the ten-year U.S. Treasury Bond dropping to 3.28%.
Despite the volatility, most common major averages remain close to breakeven for the year, with the Dow down only -2.8% while the NASDAQ has lost only -0.5% of its value.
The Appleton Group Composites™
All in all, the markets are demonstrating the normal ebb and flow of rising and falling prices, with only a few positions having reached the point at which they must be adjusted. All three of our firm’s core managed portfolios have seen a reduction in at-risk assets, and consequently an increase in investable cash and bear-market positions. We continue to hold invested positions in large-cap value, large-cap growth, real estate, and a reduced position in high-yield bonds. As of the close of the markets today, we have eliminated positions in our international emerging markets index and our basic materials index. For these positions in the PLUS and Tax Managed Growth strategies, we have replaced each with their bear-market equivalent, which are designed to produce the opposite daily performance of their normal index. Should the downward trend continue uninterrupted in these markets, the bear-market positions we own would rise in value, creating profits in these positions and offsetting a portion of the losses that may be experienced from the other positions we own. It is the same strategy that we’ve employed in these disciplines for more than ten years. Should the markets find their footing and begin to trend higher, we will eliminate these bear-market positions in due course and reposition the portfolios for that renewed rising trend.
While the market deterioration in May has been quick, it has been largely normal for most of the positions we use and within the experience of our trend-following strategy over the past ten years. The markets are clearly concerned about the sustainability of the year-long recovery, which is showing up in the deterioration of markets that are especially sensitive to slowing growth. Price is everything, and the investment adjustments of tens of millions of market participants will eventually produce some kind of a sustained trend, either downward or upward. The more time spent on the right side of these trends the better, and it is our goal to maximize time spent being invested during sustained rising trends and minimize time spent fully invested during sustained declining trends.
What a difference a month makes in the expectations of the markets. At the end of April the markets were convinced that the Federal Reserve and the U.S. Treasury would be successful at engineering a sustained economic recovery, as evidenced by slow and steady market advance of the first four months of the year. But the issues of a slowing economy later in the year and continued high debt by countries such as Greece, Spain (and possibly the U.K and the U.S) will be with us for a while. The trillions of dollars spent so far to prop up the global economy have certainly been effective, but what will happen when that stimulus wears off? That’s been the source of the volatility seen over the past few weeks and will be the big question for the remainder of the year. A second round of economic stimulus appears unlikely given the political climate and the upcoming election cycle in the fall. And with extended unemployment benefits being left to expire, workers may feel it necessary to return to the labor force at any price. This is bad news for wage growth in the long run, but may be wholly unavoidable.
On the positive side, corporate profits and guidance remain strong, mortgage rates are still at all-time lows, and the recent strength of the U.S. dollar could serve as a catalyst for a strong market rebound as soon as Europe begins to fix its budget problems.