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The Strategic Outlook |
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Strategic Group · 4380 SW Macadam Ave, Suite 260 Portland, OR 97239 · (503) 222-9737 · www.InvestwithStrategic.com |
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Strategic Group’s e-update |
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June 2010 |
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Does anyone know if Dramamine works on stock market induced queasiness? Up, down, up, down – I haven’t felt this much motion sickness since a cruise I took that passed through a storm front. The absence of any concrete proof that the economy is not going to return to the Great Recession has caused many investors to steer clear of the market or to jump at every whisper of a potential problem. That isn’t to say the problems aren’t real, but the possible consequences are laid out in worst case scenarios. Some could occur while others are remote at best. And the ones that could occur probably won’t occur within the next few weeks, which is what one would assume given the volatility of the market.
The two biggest concerns seem to be a double-dip recession or a failure of the Euro. On a long-term basis, the threat is that the U.S. will go the way of Greece because of ballooning debt. We will grant you that these are serious concerns, but without being too much of a Pollyanna, we don’t see any of these occurring in 2010.
Estimates of U.S. GDP growth for 2010 are about 3 to 3.5%. For a recession to occur, GDP growth would have to be negative for two consecutive quarters. Given that earnings for Q1 were by and large much better than last year’s first quarter, we don’t see a recession looming on the horizon, at least at this point. What is important to note is that the earnings were not just from cost cutting. Most companies showed growth in revenues as well. As part of the 1st quarter earnings conference calls, many companies gave an outlook of their expectations for the near-term future. Since investors hate being negatively surprised when earnings are announced, it is not unusual for companies to notify investors if their outlook was too rosy well ahead of their next earnings report. Over the course of this market downturn, at least for the stocks we watch, there haven’t been any reduced expectations from companies. Even if you assume that the analysts have unrealistic valuations, the key point is that positive GDP growth at some level seems to be more likely than another recession. On a related note, the U.S. Treasury yield curve is sloping upward meaning that short-term yields are less than long-term yields signaling a normal environment on the horizon. If the yield curve were inverted, this would indicate that trouble “may” ensue, which is not the case right now. This indicator has been particularly accurate over the last century at predicting recessions.
Getting back to the point, we need robust growth to generate jobs. At the current GDP growth level, employment would be created at a level that would just keep up with population growth and would not significantly reduce unemployment. But, in today’s news there appears to be some hopeful data. For the first time in 15 months, over the last three months the number of people quitting exceeded those being laid off. A larger number of people are feeling more secure about giving up an existing job than at any time over the last year. This could be because the average hours worked has been increasing. From a low in October 2009 of 33.7 hours per week, May’s preliminary number was 34.2. To put that in perspective, the range for 2007 was a low of 34.5 and a high of 34.71. As mentioned in an earlier newsletter, an early sign of an improvement in the employment picture would be employees voluntarily leaving jobs. Employees eventually get tired of working long hours and look for employment elsewhere. In order to keep good employees, employers are forced to raise pay and add workers.
Last month’s newsletter discussed Eurozone concerns, so we won’t rehash that topic. But, in June, Germany, Portugal, Spain, Austria, Belgium and the Netherlands were able to sell bonds which may mean that credit for the Eurozone is still available without tapping the $1 trillion bailout established last month. Also positive was the news that German unemployment fell more than anticipated in May.
The pace of government spending is troubling for everyone (well, maybe except for government). It is important that the government get a handle on spending in a way that doesn’t sabotage the fragile recovery. It is a balancing act that may be beyond the current group of legislators, but it is doubtful that 2010 will see the United States default on its debt. To fix the deficit, citizens of the U. S. will need to accept less from government – that too is a problem. Many are dependent on government programs and would struggle to survive without assistance. For those not already dependent, the European-like austerity necessary to reduce government spending could be very painful. Are you ready to make some difficult sacrifices?
These three problems aside, there are many other things weighing on investors: earthquakes, volcanoes, oil spills, healthcare, jobs, politics, and VOLATILITY. Volatility alone may have you yearning to get off the ship. Although we have reduced risk in the portfolios, be sure to let us know if you need to revisit risk tolerance in your portfolio. Although 2010 probably won’t see a major market collapse given the combined efforts of the Fed, European Central Bank, and countries around the world, that doesn’t mean that 2010 will be smooth sailing. We fully expect that 2010 will be a volatile year. The pain of the Great Recession, long-term unemployment, and global issues are all guaranteed to produce more up and down motion than many will be comfortable enduring. In our view, the confidence needed to calm the markets will take time. Time will show whether the economic data both in the U.S. and in Europe continue to improve. Time will show whether earnings will continue to grow and unemployment decrease. And in the absence of positive news, the whispers will move the market. So, if Dramamine isn’t an option, we urge you to contact us if you want to reduce risk.
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After Black Monday 1987, the major stock exchanges established rules to halt trading to prevent a market free-fall. Those rules are modified from time to time. The current circuit breaker is set on the first day of the quarter for that quarter. Prior to the Flash Crash on May 6th, the NYSE circuit breaker established that a 1050-point decline in the Dow Jones Industrial Average would halt trading for 1-hour, 30-minutes, or not at all depending on the time of the fall. The circuit breaker did not kick in for two reasons: the DJIA did not drop more than 1050 points and the Flash Crash started about 2:40 p.m. The circuit breaker rule stated that there would be no halt after 2:30 p.m.
Recognizing that the rules need to be modified again, the SEC is implementing new rules that state that if any S&P 500 stock rises or falls 10 percent or more in a five-minute period, trading in that stock will be halted for 5 minutes between the hours of 9:45 a.m. and 3:35 p.m. which encompasses the majority of the trading day (9:30 a.m. to 4:00 p.m.). Trading in the affected stock is to be halted across all venues – a problem that may have exacerbated the market decline on May 6th. The new rules will apply to U.S. exchanges.
This six-month pilot period will end on December 10th. The pilot period is to be used to review the process and to determine if other securities including ETFs will be included. |
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Flash Crash Results in Changes in Market Rules |
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Getting Queasy from the Market Volatility? |