Quartery Review: Third Quarter of 2011

By Steve Davis, CERTIFIED FINANCIAL PLANNER ™

I’ve been reviewing my clients' September 30 investment statements and I’m sure you have received your copies by now too. If you're a local reader and would like to review your accounts together or would like to recieve a second opinion from an independent financial advisor, please contact me. In the meantime, this post will attempt to provide perspective on the economy and financial markets over the past 90 days.


Tug-o-War

Growth vs. Sentiment

If there was one thing that jumped out at most investors during the third quarter, it had to be the huge swings in the market. Over half the trading days in the period saw the Dow Jones Industrial Average move more than 100 points in either direction. It was like a tug-o-war: On one side was the strongest quarter of economic growth this year and on the other side was increasingly negative investor and consumer sentiment.

Economic Growth: While the economic data doesn’t point to robust economic growth, the gross domestic product (GDP) is increasing. In the second quarter, GDP was up 1.3% and the third quarter is on pace to grow at a 2–2.5% rate, the strongest growth rate so far this year. Furthermore, the Index of Leading Economic Indicators (LEI) suggests continued slow growth and that a recession is unlikely. Still, the economy is expanding at a pace that is well below historical averages at this point in an economic recovery. 1

Investor and Consumer Sentiment: For some, the slow pace of growth probably feels like a recession. Despite the lack of recessionary indicators, consumer sentiment was at near 30-year lows and this pessimism overwhelmed the market in the third quarter. 2

  

Market Performance
The third quarter was ugly with extreme volatility and the sharpest decline since the first quarter of 2009. The main drivers of the decline seem to have been European debt worries and the waning confidence on both Main Street and Wall Street as analysts began to second-guess the recovery.

 

Below are results for key markets. These are in local currencies, so the effect of swings in the dollar is not reflected.

Source: MSCI


Looking Forward
So that’s what’s behind us – the key question is what’s ahead. What will have to happen to help this market climate improve in the coming months? There are three potential catalysts that might emerge.  

1. A decisive and truly unified effort by the EU to address the debt crisis.
2. A strong corporate earnings season featuring frequent, pleasant surprises.
3. A stream of data vouching that the economy is still growing.

Historically, the fourth quarter tends to be a very good one for Wall Street. Over the last 50 years, stocks have gained an average of 3.6% in the last three months of the year. 3 While the past is no predictor of future results, we can hope the historical pattern repeats in 2011.

Economic challenges and market volatility remain it is important to remain cautious.  But for those investors who need growth to achieve their long-term goals, it is equally important to take a longer view and know that fund managers are seeing many outstanding companies available at inexpensive prices.  For investors with cash on the sidelines, now may be the time to start putting some of that money to work. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult me prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.  The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
 1. Source: Bureau of Economic Analysis, Haver Analytics 10/02/2011 


2. Source: University of Michigan Consumer Sentiment Report 09/14/2011 
3. Source: usatoday.com/money/world/story/2011-10-03/world-markets-down/50640738/1 [10/04/2011]

Does the Stock Market Have You Worried?

Buy Low; Borrow Low.

By Steve Davis, CERTIFIED FINANCIAL PLANNER ™

The huge swings in the stock market last week may seem all too familiar. Perhaps you’re worried about a repeat of the 2008 financial crisis. Before you dump your holdings and run for cover, consider this surprising fact. According to the Employee Benefit Research Group, most retirement plan account balances have bounced back to pre-2008 levels. Account balances didn't recover entirely from the strength of the market -- those automatic paycheck deductions helped a lot too. Investors who cashed out and remained on the sidelines missed out on the profitable years since the crash. Still, the roller-coaster volatility we have experienced recently with the Dow dropping 600 points one day and rallying back 500 points the next is enough to cause some participants to consider getting out of their plans all together. For many people, this could be a big mistake.


Buy Low: Legendary investor Warren Buffett once counseled, "Be brave when others are afraid, and afraid when others are brave." If you want to heed Buffett’s advice, the best time to buy low is when everyone else is scared. It is their collective fear and the group-think selling that drives stocks to deeply-oversold bargain prices. History has shown that the rallies coming out of these oversold positions often occur quickly and are highly profitable.

Don’t you just love a bargain? I was recently shopping at the Borders book store at Mansfield Crossing. Activity was brisk and I can’t begin to tell you how many customers were leaving the store with stacks and stacks of books, all purchased on sale. Often times when we read about the Dow Jones Industrial Average dropping, or watch the TV news anchors emotionally-charged segments about Wall Street, we worry and think that these market corrections are always a bad thing. If you’re young and have many years before retirement, however, market drops can be a very good thing indeed. When else can you purchase your mutual funds on sale?

Another consequence of the turmoil in the stock market is plunging interest rates. Last Tuesday, the US Federal Reserve pledged to keep interest rates at an “exceptionally low level” until the middle of 2013. This news could be a boon for families looking to buy or refinance their homes.

Borrow Low: "There’s a huge increase in mortgage applications," said Jerry Maguire, Senior Mortgage Advisor at Province Mortgage Associates, a local mortgage lender. With rates on conventional 30-year fixed-rate mortgages falling near, and in a few cases below, the 4 percent level, homeowners locally have been rushing to refinance in recent weeks. You’ve probably heard the old rule of thumb that says it only makes sense to refinance your mortgage if the new interest rate is at least two percentage points lower than your current one. “Not true” says Maguire. “Many people worry about their adjustable rate mortgages resetting at higher rates in the future. Even if you can’t lower your monthly payment by refinancing, many families can benefit by exchanging the uncertainty of a floating rate loan for the certainty of a fixed one.” Additionally, today’s low rates may allow some families to reduce the term of their mortgages from 30-years to just 15 or twenty years and potentially save thousands in interest costs.



Of course, everyone’s situation is different. As a financial advisor with more than twenty years experience, I’ve been down this road before. I understand that the number one question on the mind of most investors is, “What should I do now?” The answer to this question is the same for everyone: Talk with your advisor.

Oh, and if you’re worried that this is 2008 all over again? It’s not; there are major differences between then and now. Yes the equity markets have experienced recent losses, but today’s economic growth, while weak, is still positive. The banks in the United States are in much better shape than when the housing market collapsed. And corporations are producing solid earnings even in a weak economy. As an investor, I find that reassuring.


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This article was written by Steve Davis and appeared in the column "Talking with Davis about Money Matters" found at http://mansfield-ma.patch.com/articles/does-the-stock-market-have-you-worried





The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Financial Lessons from Driver's Ed

By Steve Davis, CERTIFIED FINANCIAL PLANNER ™ 

The Dow Jones industrial average dropped over 600 points Monday in the first day of trading after Standard & Poor's downgraded the United States' credit rating.  Skittish investors, already concerned about the economy, struggled to work out the implications of last week's downgrade.  With so much attention and angst focused on the debate in Washington over the US debt ceiling these past few weeks, it is no wonder the financial markets continue to bounce around. It seems that TV financial experts and entertainers (financial “expertainers”) often exaggerate events in the marketplace and thus excite the emotions of investors who are swayed by fear. This emotional ping-pong game results in illogical investment behavior, such as buying at market highs and selling at market lows. The wise investor learns to look past the colorful adjectives that describe daily market swings and instead keeps his or her eyes focused on long-term trends.


The Long View

My 16-year old son is currently taking his Driver’s Ed course at Driver’s Choice Driving School. Do you remember the first time you got behind the wheel of your mom’s station wagon? For me, I remember staring at the road immediately in front of the hood rather than looking 20 or so yards ahead. Quickly, it became apparent that it was next to impossible to drive safely with such a short-sighted approach to my surroundings. Even with a straight road, little traffic and perfect driving conditions, it was next to impossible to drive in a straight line when I only focused on the 3 feet of roadway immediately ahead of the front bumper. When I learned to look further down the road -- taking the long view – I discovered that maintaining a straight line of travel was not only easier, but much safer too.

It seems to me that the same logic applies to investing. Losing sight of the long term and thinking that you can time the market by selling at the peak and then re-entering the market once it hits bottom is a big mistake. Timing market shifts is nearly impossible and requires two correct decisions: when to sell and when to buy back in. While making modest adjustments can add value, investors who make wholesale market timing bets usually lose. The biggest potential pitfall in trying to time the market is missing the days it’s “up.” For example, during the 10-year period after the 1973-1974 stock market decline, an investor who missed just 10 of the market’s best days would have also missed out on more than 50% of the market’s price return.1 Imagine that! And trying to figure out when those 10 best days would occur would have been an impossible task when you consider that none of the days were consecutive, four of the days occurred in a single year, and six of the years didn’t have any of the best 10 days.2 Perhaps the folly of market timing can be illustrated with another lesson from Driver’s Ed.

Route 3 Traffic to the Cape
The left hand lane of the highway is referred to as the passing lane while the right hand lanes are called the travel lanes, right? In theory this seems correct, but on a Friday afternoon in the summer, all lanes heading to the Cape would probably be better referred to as “parking lot lanes”! How many times when sitting in traffic do you find yourself wanting to switch lanes? We’ve all done it; the lane next to ours starts to move so we put our blinker on, scan the rearview mirror and move into the line of cars that are making progress down the road. And as soon as we do it, our new lane stops and the one we were previously sitting in starts to move again. So, if you have a long-term investment horizon and are tempted to get out of the market and move entirely into cash because of short-term events, you may be wise to remember the story about Cape Cod traffic jams.

Financial Lessons
While the debt ceiling debate has grabbed the headlines and is currently the most significant risk to the market, the underlying strength of the global economy remains solid. Company earnings continue to be very strong as corporate America continues to benefit from a resurgent business reinvestment climate and a resilient consumer. On the other end of this self-imposed debt ceiling crisis stands an economic climate where businesses are earning near record profits, employment is improving, housing has stabilized, and consumers are once again revisiting the malls to spend.



Enjoy the Ride
As we enjoy the beautiful warm nights, think back to the summer shortly after you received your driver’s license. What joy and freedom we experienced when we used to cruise the streets with the windows open listening to our favorite songs play on the radio. One of my favorite songs from those days was by The Doors. Jim Morrison sang, “Keep your eyes on the road, your hands upon the wheel… We’re gonna have a real good time.”

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This article was written by Steve Davis and appeared in the column "Talking with Davis about Money Matters" found at http://mansfield-ma.patch.com/articles/financial-lessons-from-drivers-ed




The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Tick, Tick, Tick: Our National Debt and How it May Impact the Economy and Financial Markets

By Steve Davis, CERTIFIED FINANCIAL PLANNER ™

The clock continues to tick towards the August 2, 2011 deadline when the United States debt ceiling limit will be reached. While the newspapers and TV are full of stories about this situation, I thought you might find it helpful to hear some of my thoughts as it relates to your investments and the market in general.


Overview: The debt ceiling limit is a key element of U.S. Government financial management. The U.S. Government is expected to receive about $175 billion in tax revenues for the month of August, but has $310 billion in monthly obligations that it needs to meet. As a result, the $135 billion in monthly shortfall is usually borrowed via the issuance of U.S. Treasury bonds. However, once the debt ceiling is met, the U.S. Government will not be able to issue new debt and will therefore, have to make significant decisions as it relates to what $135 billion or 44% of its “bills” it will delay payment on. That is, of course, if the debt ceiling limit is not raised by Congress and signed into law by the President.

Politics: While the rhetoric coming out of Washington has certainly transitioned from compromise to contention, it should not be overlooked that the divided parties are aligned on a few very important criteria that should bring a resolution closer to happening—namely that spending cuts should be enacted and that a more responsible government spending policy should be put in place to get a handle on the nation’s soaring national debt. In addition, both sides seem to now understand that the polarizing political view of revenue increases (the Democrats’ wish) and significant entitlement reform (the Republicans’ wish) are too significant a gap to overcome over the short term and are now virtually off the table.

What Happens Next: Now, the only things (and they are a big “only”) that the two sides have to work out are: where the cuts in spending should come from, how long they will take to implement, and how much money they will save. The reality is that the two divided sides are not as far apart on the terms of a deal as they are from an ideological and political posturing perspective. Said another way: the two sides sound and act a lot further apart than their competing plans actually are.

We expect that the debate in Washington will continue over the next few days as the game of political ideological “chicken” plays out. However, our base case is that a compromise will be forged over the coming days and will result in either a short-term extension of the debt limit or, more likely, an agreement to raise the borrowing capacity of the United States Government until well into next year.

More importantly, even if a bill is not agreed upon and signed into law to raise the debt ceiling by August 2, we do not foresee the United States Government defaulting on its obligations. A default will occur if the government failed to pay the interest due on its debt. For the month of August, the interest due on Treasury bonds accounts for only $29 billion, which is easily met by the $175 billion in tax revenues that are expected. However, while a default would be avoided, the significant impact of dialing back $135 billion that could not be borrowed for other Federal services and obligations would have serious economic impacts.

The Economy: While the debt ceiling debate has grabbed the headlines and is currently the most significant risk to the market, the underlying strength of the global economy remains solid. Moreover, several of the open-ended issues that have lingered for months are finally getting substantively addressed, including a plan for a second bailout of Greece, a stabilizing European debt crisis, and the re-emergence of Japan’s economic infrastructure from its terrible natural disaster in early spring. In addition, company earnings continue to be very strong as corporate America continues to benefit from a resurgent business reinvestment climate and a resilient consumer.

The Financial Markets: In the meantime, the current conditions support a cautious stance as the market is sin gularly focused on Washington. We expect that a resolution on extending the debt ceiling will ultimately be agreed upon, but not until the deeply divided government drags the nation and the market even further through the mud. But, on the other end of this self-imposed crisis stands an economic climate where businesses are earning near record profits, employment is improving, housing has stabilized, and consumers are once again revisiting the malls to spend. While the turmoil in Washington will invariably offer up several more nervous days as the debate lingers on, we believe that a relief rally for the market is around the corner once compromise replaces contention and unity trumps division.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult me prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
 The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.  The research in this letter has been prepared by LPL Financial.

Quarterly Review -- First Half of 2011

By Steve Davis, CERTIFIED FINANCIAL PLANNER ™

MANSFIELD, MA:  As I write this blog entry, the June 30 investment statements are starting to come across my desk.  I imagine that the US Postal Service has already delivered yours to you too.  You’ll see that the first half of the year has produced modest single-digit gains for most assets classes. 

Market Performance in the First Half
The first quarter of the year showed the markets registering solid gains, despite the effects of Japan’s terrible earthquake and tsunami. 

The second quarter was a different story, with concerns arising from growing inflation threats in emerging markets, debt worries in Europe and a downgrading of growth forecasts for the global economy.  Below are the first-half results for some key markets.

Source: MSCI
Note: Results are in local currencies; the effect of swings in the dollar is not reflected

Here at home, we saw U.S. stocks fall for the first time in four quarters.  The S&P 500 lost 0.39% in the second quarter, a period marked by worries over high gas prices and indications that the recovery was stalling.  Given the above, I want to share a few quotes which I think help us see things in perspective.

Quote #1
-- Warren Buffett, letter to investors published February 2011
“Money will always flow toward opportunity, and there is an abundance of that in America.”

In November of 2009, Berkshire Hathaway spent $26 billion to buy the 77% of rail giant Burlington Northern that it didn't already own. In interviews, Warren Buffett referred to this as "betting on America." Buffett has been consistent in his positive outlook for the U.S. economy, looking past short-term events to focus on America's ingenuity and resolve and its ability to attract the best and the brightest from around the world.

Buffett is consistently voted the greatest investor of all time. In the 46 years he's run Berkshire Hathaway, annual growth in book value has exceeded 20%, more than twice the gains for the U.S. stock market index. Even more remarkable, Buffett's numbers are after tax, while the index's gains are pretax. And while he had lagged in individual years, in his last letter to shareholders, Buffett pointed out that there has never been a five-year period where Berkshire Hathaway underperformed the S&P.

To put his record into dollar terms, $1,000 invested in the Standard & Poor’s index of U.S. stocks at the start of 1965 would have risen by the end of 2010 to $62,620. By contrast, that same $1,000 under Buffett's stewardship would have grown to over $4 million.

Quote #2
-- Bill Gross, Morningstar Fixed Income Manager of the Decade; June 7, 2011
“In terms of the stock market, there are amazing 0pportunities [compared to U.S. government bonds]; there’s a huge gap and a huge differential.”

As manager of PIMCO Total Return Fund, the world's largest bond fund, Bill Gross turned in a track record matched by few others and was named Morningstar Fixed Income Manager of the Decade. In part, this stems from his willingness to take contrarian views: in 2010, he went on record talking about the "new normal" of lower growth, higher inflation, and increased risk in holding debt of governments around the world.

In a June 7 interview on CNBC, he spoke about stocks and said, “Corporations are in the catbird seat. They've got cheap financing, cheap leverage. They've got cheap labor and the ability to move from one country to another at their will. And so corporations basically have done very well, and will probably continue to do very well.”

What this Means to Investors
In today's low-interest-rate environment, it's hard to make a compelling case for cash except as a portfolio diversifier and a source of liquidity.  As for bonds, Bill Gross represents the growing sentiment that the risk in bonds is rising as economies recover and interest rates start to rise.
This leaves stocks.  Whether you adopt the "lesser of two evils" view of stocks as opposed to bonds, like Bill Gross, or join Warren Buffett in embracing stocks more enthusiastically, there are clear values in high-quality stock market investing.

In Buffett’s annual letter, he encouraged his shareholders to see through the haze.  He wrote, “Commentators often talk of ‘great uncertainty.’  Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Human potential is far from exhausted, and the American system for unleashing that potential remains alive and effective.”
Here’s what I wrote last quarter, and I continue to believe this is the way forward:  We've always had unexpected events and always will. And despite these unforeseen events, economies have grown, companies have prospered, and stock markets have generated positive returns. The key to benefiting from this long-term growth has been to diversify so that no single event can create permanent damage to your portfolio.

I believe that investors with a balanced approach and a long-term view will be well rewarded. The approach to risk management I recommend may not be fun or sexy in the short term, but all the evidence at hand suggests that over time it will serve you well, getting you to your goals with the least amount of stress and distress along the way.

A Letter to Clients and Friends about the 1st Quarter of 2011

By Steve Davis, CFP ®


 
Dear Clients and Friends: 
You’ve most likely just received your investment statements and will be pleased to see that the markets have come a long way since 2008. In this letter, I will provide a brief recap of the first quarter, along with my thoughts about the importance of expecting the unexpected. Finally, I will encourage you to contact me to schedule a time to review your portfolios and discuss any changes to your financial plans.

First Quarter Review 

Following a strong end to 2010, the U.S. stock market, as measured by the S&P 500 Index, continued its march higher to begin 2011 with a gain of 5.9% in the first quarter. The Index’s first quarter gain was its best first quarter since 1998 and the third best first quarter of the past 20 years. Bonds hit some speed bumps in the first quarter, but a middle-of-the road return in the low-to-mid single digits by year-end still seems likely.

For stocks, it was a relatively smooth ride, higher in the first six weeks of the year through mid-February when the Index peaked at 1344, a gain of nearly 7%. March saw a setback and the earthquake and tsunami in Japan on March 11 took a dreadful toll on human life. The scope of the tragedy and its final impact on the economy may not be fully known for some time.

Learning to live with uncertainty 
Market analysts spend many thousands of hours each year looking at stock and bond fundamentals, economic forecasts and company earnings, among a cast of other data. Presently, solid consumer spending, a resilient global economy, healthy manufacturing data and better-than-expected earnings bode well for investors. But, even with enough time and data, the analysts can’t anticipate exactly how the markets will perform.

What can’t be anticipated are developments that are by their nature unpredictable. We’ve had several of these events in the past year:

• Last April’s volcanic eruption in Iceland that caused the shut-down of 100,000 transatlantic flights, and cost the airlines $2 billion 1
• Last year’s explosion of the Deepwater Horizon oil rig that resulted in dramatically higher oil prices
• Recent street protests in Egypt and other countries that resulted in changes of leadership, and direct military action in Libya
• And, of course, the earthquake, tsunami and nuclear-reactor crises in Japan.

 In light of episodes like these, investors need to take away two key lessons:

  

Lesson One:
Expect the unexpected. The only way to deal with uncertainty and manage the impact of unforeseen events is to build strict risk controls into portfolios, similar to those used by the most sophisticated pension funds. While the risk of one-time incidents can't be eliminated, through diversification and risk management we can try to limit the damage when negative events occur—whether they be massive frauds such as Enron, sudden bankruptcies like Lehman Brothers, volcanic eruptions, oil rig explosions, or earthquakes.

By creating diversified portfolios, we help reduce risk to your investments. Different asset classes like stocks, bonds and cash equivalent investments don’t usually act in the same way at the same time. Investing in different geographical areas means that you aren’t subject to the same political events or natural disasters which may affect companies differently. While diversifying doesn’t eliminate risk it can help reduce the effects of volatility.

Next, your portfolios need to be rebalanced back to the target asset allocation, and some of the positions that have outperformed might be trimmed to stay within risk control limits. Some investors find this very difficult—after all, you're selling exactly those investments that have done the best. But remember, the objective is to buy low and sell high. Plus, it's the only way to stay truly diversified and control the risk that accompanies overexposure to any one stock, industry sector, or geographic region. And it's also the only way to get some protection from things that simply can't be anticipated.

Lesson Two:
Avoid overconfidence. Over short and mid-term time periods, rebalancing means that there will always be someone who's made a big bet that has paid off and who is doing better than you as a result. Rebalancing your portfolio as described above eliminates big bets and will seldom give you bragging rights on the golf course. Investors who take the big-bet approach typically have a high degree of confidence in their investments; after all, if you're absolutely certain about a company or industry, why bother to diversify? On the other hand, research by the University of Chicago's Richard Thaler has demonstrated that overconfidence is among the most costly traits an investor can have.

Look no further than the many employees in Silicon Valley during the tech boom. They were 100% confident about the future of their firms and often had all of their retirement accounts invested in the companies they worked for as a result. These investors saw sterling results for a while—right up until the tech bubble collapsed.

Mark Twain once said,

"It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so."

 In other words, the sources of trouble aren't the things we've identified as question marks and causes for concern. Rather, what causes portfolios to crater are the things that we're absolutely positive about right until unanticipated occurrences catch us by surprise.

We've always had unexpected events and always will. And despite these unforeseen events, economies have grown, companies have prospered, and stock markets have generated positive returns. The key to benefiting from this long-term growth has been to diversify so that no single event can create permanent damage to your portfolio.

I believe that we will work through the recent events and that investors with a balanced approach and a long-term view will be well rewarded. The approach to risk management I've described may not be fun or sexy in the short term, but all the evidence at hand suggests that over time it will serve you well, getting you to your goals with the least amount of stress and distress along the way.

Let’s talk  
Please give me a call to schedule a meeting to review your accounts. Should you have any questions in the meantime on your portfolio, the contents of this note, or any other issue, please give me a call. I'd be happy to deal with your questions on the phone or at our next meeting.

As always, thank you for the opportunity to work together.

1  "Airlines' Losses Top $2 Billion from Eruptions," Washington Post, 16 April 2010

Is it time to reevaluate your approach to investing?

By Steve Davis, CFP®


If you are like many investors out there, you may be watching key financial markets from a distance, still unsettled by the downturn of several years ago and left wondering about your investment strategy. This is not the moment to be passive—now is a great time to assess your situation, explore the current landscape, and make sure you’re capitalizing on available opportunities so they don’t pass you by.


Here's a brief video, which illustrates today’s investment environment.  The video was produced by LPL Financial, and I invite you to check it out.



Click above to watch the video



After you watch the video, contact me to discuss your situation, adjust your financial strategy, and put a plan into action that is right for you.