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Welcome! Today is
2011 - More Volatility and Uncertainty
Markets around the world had another volatile year. Here in the U.S., the S&P 500 index outperformed every major developed market and nearly every developing market – by ending the year flat! For a little perspective, let’s review 2011 via the S&P 500 index. The index was up 2.3% in January and by the end of April was up 8.4%. However, by early August the S&P 500 was down 11.0% for the year. From August 17 through the beginning of September, the S&P 500 was down almost 20%! In September and into October, the index was on a tear regaining ground it had lost over the summer and early fall. At year end, we were right back where we started at the beginning of the year. 2011 was a year of highly correlated and extremely volatile trading action. Fundamental factors were overshadowed by the uncertainty of global macro developments that drove outsized, news-driven movements in the markets.
Here are some of these developments:
Middle East. Tensions in the Middle East escalated and evolved into Arab spring. This actually began in late 2010 with an incident in Tunisia and picked up steam in January/ February of 2011 with Egypt. Civil uprisings grew and spread to other countries as well. Libya was a dramatic, longer-lasting revolution, which saw all-out war between Gadhafi and the rebels. Gadhafi would eventually be killed by rebel forces. Insurrection has now spread to Syria and a protracted fight is going on between Assad and rebel forces as we write. The hope that these countries will adopt democratic governments is a positive, but the uncertainty in the largest oil-producing region in the world temporarily sent oil prices dramatically higher. This lead to fears of higher oil prices/additional tax on the consumer/decrease in consumer spending which hurts already anemic economic growth, and so, the markets declined. Oil prices eventually came down, but Middle Eastern issues were one of the major volatility events of 2011.
Japanese Earthquake/Tsunami. As the debt situation in Europe was worsening and Middle East tensions were rising, the massive Tohoku earthquake and tsunami hit Japan on March 11. It was reported as the most powerful earthquake in history to hit Japan, and the nuclear power plant crisis that resulted led to a global scare, and volatility increased as a result. Japan’s economy was hit hard and there was a negative impact on the global economic recovery as well.
European Sovereign and Bank Debt. Our biggest concern for 2011 was Europe, and it did not disappoint. It was the biggest factor of the year that created ongoing uncertainty and volatility. Capital market concerns started with Greece and then moved to Ireland, to Italy, to Spain and even to France. EU leaders, in the fall, could not get any consensus around crafting a solution that would prevent a systemic bank crisis. The fighting in the Eurozone had a major negative effect on the U.S. market along with our own debt crisis. Currently, European debt yields have come off their highs, but yields on Italian and Spanish debt remain at historically high levels. These countries will find funding their debt at even these current levels problematic. The austerity measures being asked of European countries, to curb their prior years lavish spending, will/already has led to a recession in the Eurozone. The depth of that recession is currently unknown, but will certainly have an impact on the fragile economic recovery here in the U.S.
U.S. Debt Downgrade. The U.S. debt deadline in August was well known ahead of time and had not been a problem in the past as the debt ceiling had been raised along with our debt levels. Initially, the markets gave our politicians the benefit of the doubt that a solution would be reached; however, the partisan bickering and drawn-out nature of the negotiations led to a loss of confidence in our government officials. A temporary “deal” was reached, but Standard & Poor’s downgraded the U.S. credit rating to AA+ from AAA on August 7. S&P’s opinion that accompanied the downgrade was that “the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what would be necessary to stabilize the government’s medium-term debt dynamics.” The historic downgrade caused a global sell-off in equities – yet another round of volatility in 2011.
China’s Economic Issues. On the back burner for most of the year, but very important to global growth is China’s economy – will they engineer a soft or hard landing? As we discussed in our last newsletter, China has been the engine of global economic growth. Their demands for food, oil, and other commodities has raised the economic well-being of many countries. China’s rapid growth has led
to what some believe is a property bubble. The Chinese government has been trying over the last year to “cool down” their property market, and also inflationary pressures which have risen to unsustainable levels. A hard economic landing would surely slow global growth. The outcome here is still uncertain.
Occupy Wall Street. Social discontent is a problem when you have large and growing disparities between “the haves and the have not’s”. Bleak future prospects for employment and living standards have caused protests to spread around the world. At first the movement was not taken seriously, but many have become sympathetic to the messages of anger and resentment that this movement symbolizes. Social media networks enable instant communication of these issues and disenfranchised groups can form and demonstrate with lightening speed. Encampments have broken up or quieted down for now, but the swiftness with which their voices can be heard again should not be discounted or dismissed going forward.
In Closing. The issues that created so much volatility and uncertainty in 2011 have not gone away because we have started a new year. The U.S. economy has shown signs of gaining some steam in the last few months, but whether this will continue into 2012 is a big unknown. Deleveraging of governments, the private sector and individuals is a multi-year process and economies take time to heal. Our current belief is that our economy will vacillate between acceleration and deceleration, but the growth spurts will be sluggish. We are still bullish for the longer term, but for now, we are erring on the side of conservatism. Our portfolios consist of some cash reserves, high-quality stocks and investment grade bonds. While we are optimistic for the future, investors will need to ride out periods of high volatility and have lots of patience.
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