Company's 401(k) Plan.
01 October 2011
There is no method available to put a good spin on the third quarter's equity market performance. Highs for the period were posted by most broad equity indices during the first week of July. From there an initially slow decline set in that culminated in a sharp sell off during the second half of August before and around the time of the S&P downgrade of US sovereign debt. After a modest recovery from late August through early September prices again declined significantly as the latest rescue package for Greece appeared to be unravelling. While the situation in Europe now appears to be under control in the short term, longer term problems remain unresolved. Recent estimates of the costs of a long-term bailout that would allow for the elimination of Greece and perhaps Italy from the Eurozone continue to rise well beyond the scope of current rescue funds. The path to a permanent resolution of the crisis remains unclear.
In the US, a steep selloff by the commodity markets developed late in the quarter after the Fed announced completion of its second round of Quantitative Easing (QE2). In retrospect, it would seem fair to assert that the most visible result of the action was to funnel large sums of speculative cash into the commodity markets and to create downward pressure on the dollar in the foreign exchange markets. Both these trends have reversed in the past several weeks in the wake of the completion of QE2 inflows. The stated goal of bolstering credit creation to support economic activity, judging by recent GDP and unemployment statistics, appears so far to have not been attained.
For the quarter, all major US equity indices posted double-digit losses in the worst quarterly performance since the fourth quarter of 2008. The Dow Industrials lost 12.1% for the period with the broader based S&P 500 off 14.3% and the broader still DJ Wilshire 5000 down 15.7%. Small capitalization issues were particularly weak with the Russell 2000 losing 22.1% for the quarter. It is interesting to note, however, that during the late quarter weakness in mid-September, while most indices declined sharply, all held at or slightly above the levels reached in early August. Whether this implies a full discounting of the implications of the US debt downgrade, political uncertainty in the domestic arena or the ongoing debt crisis in Europe is not a conclusion that we can reach. Those who point to current events and purport to be able to predict future market performance or "appropriate tactical" allocation patterns to address these events and uncertainties have at best a 50/50 chance of accuracy.
The US markets delivered disappointing results in the third quarter of 2011 but foreign developed and emerging market equities performed signficantly worse. The broadest measure of world equity prices, the DJ World ex-US index, was down 20.2% for the quarter with the similarly broad based Defined Emerging Market index sliding 25.7% over the same period.
US Treasury instrument yields fell sharply during the second quarter, particularly after the US debt downgrade in early August. Yields on maturities across the curve declined to record or near-record lows in what appears to be a case of investor preferance for the "best of a bad lot." Auctions of several EU countries' debt instruments, particularly Portugal, Ireland and Italy, have been poorly received by creditors of late. Lenders are increasingly demanding record high rates of return to assume the potential default risks of these borrowers.
As noted above, prices in the commodity markets have declined significantly from their highs in the mid and late summer. Gold, which reached an all-time high of roughly $1925 per ounce in early September, is currently trading around $1650 per ounce. Similarly, crude oil prices, which peaked at just under $115/bbl in early May, have trended steadily lower and are currently at their lowest levels in more than a year at roughly $78/bbl.
Staying invested has been a recurring theme in these letters and the present issue is no exception. It's only human nature to look at the wake of a sharp decline and ask why it wasn't obvious that cash would have been preferable to investments in view of "upcoming events." The answer to that question is twofold. First, market reactions to perceived risks are not always in line with the conventional wisdom. For example, who was predicting that the prices of US Treasury instruments would soar after the country's credit rating was lowered? Some of the most influential and highly regarded fixed income managers on Wall Street have been predicting the demise of US Treasuries for more than three years against a backdrop of prices that repeatedly rise to new highs.
Second, and perhaps ever more important, if tactical decisions call for an exit from the equity markets in anticipation of a period of negative performance, what guidelines will be used to determine a re-entry point? As we have discussed and witnessed, the sharpest and most demoralizing declines are often followed immediately by strong recoveries that recoup significant portions of performance over a very short period of time. The bottom line is that whether or not to be invested in equities is not the real question; the important aspect of investing is to shoulder only the amount of risk (volatility) with which you can be comfortable. Declines are inevitable. Panic is not. Determining and implementing an allocation with a level of volatility designed to accomodate your personal tolerance is perhaps the single most important component of developing and maintaining the discipline necessary to stay invested. Staying invested is in turn one of the most important determinants of investment success.
Return data provided by Thomson Reuters