Market Update
The surge in oil prices is playing to investor's worst fears about inflation and recession. Risk aversion is back. The Dow Jones Industrial Average (DJIA) had its worst June since 1930 ending down 10.2% for the month. At halfway point for the year the S&P 500 Index is down 12.8%.
Our initial optimism for a second half recovery has been tempered by rising oil prices. Before oil jumped in June to record levels we concluded that the economy would pick up in the second half. The higher revision to the second quarter GDP number was early signs of a pick-up. I am still hopeful that the economy will continue to improve over the next twelve months based on a lengthy list of fundamental improvements: U.S. dollar strengthening, credit woes receding, inflation moderating, unemployment stabilizing, etc.
Bleak Headlines Create Long Term Opportunities
Today's headlines are bleak, but we see opportunities now that could pan out in 2009. Don't focus on the percentage decline at this point but on the steps that have been taken to strengthen the economy. The Federal response to the credit crisis has been unprecedented--and markets should feel the impact later this year. I understand that the current market environment is disconcerting, but uncertainty often breeds opportunity. The list of bargains in the market is growing and contrarian indicators are signaling that the market is either nearing a bottom or formed one last March.
The DJIA crossed over into bear market territory due to sky rocketing oil prices. I don't expect much progress on oil prices until after the summer. The price of oil must drop for the market to have a sustainable rally. There are two factors that can bring that about over the short term. Demand destruction which is occurring and a stronger dollar. I don't expect the U.S. dollar to rise until late fall.
How To Respond To Bear Market Readings
It takes twelve months to regain losses from a bear market. Historically the market bottoms before the economy bottoms. This time the economy looks like its bottomed but there is no hope for a strong recovery. Therefore, the typical rally from a bear market low is on hold for the time being. Here is what I am waiting on. The typical twelve month percentage gain in the DJIA after a Bear market ends ranges from the twenties to the fifties: 2000 (32.9% gain), 1990 (25.9% gain), 1981 (51.4% gain). The five year average annualized return of the S&P 500 index was 20.6% after multi-year low periods (captures bull market returns for 5 years after bear market since 1932). I don't expect that kind of progress for five years but certainly the first twelve months.
It's easy to stay invested when your account balance is growing. It's a fact, however that the market will suffer unexpected dips and your account balance will go down. At those times it's important to maintain a long term perspective. In investing, patience and perseverance can have its rewards.
Take, for example, a hypothetical $10,000 investment in the unmanaged Standard & Poor's 500 Composite Index. If, over the past 10 years ended December 31, 2007,* you had:
- Stayed in all 2,514 market days, your investment would have grown to $15,131.
- Tried to time the market and ended up missing just 10 of the best market days, your ending account value would have been $9,534, or more than $400 less than your original investment.
*Results are based on the S&P 500, excluding dividends. Figures shown are past results and are not predictive of results in future periods.
Some things take time. Focusing on long-term results can help smooth out the effects of short-term market fluctuations over time.
Imbalances Affecting The Market Takes Time To Fix
The imbalances built up through cheap money and leveraging by businesses and consumers will take time to fix. When they do the returns should be positive. I believe the commodity price inflation will fix itself. Even in spite of the floods in the Mississippi the corn crop should set a record this year and next year's crop is expected to break the old record. There isn't a shortage of farm land to plant corn, soy, rice, etc. Supply eventually will catch up with demand at these prices.
Oil is a completely different commodity when it comes to adjusting supply. I blame that on the policy makers in Washington. There are many ways to fix the longer term oil crisis if policy makers get their act together and show some bi-partisan leadership.
Our country's current energy policy is constraining domestic energy production and has made the US dependent on foreign oil. A new policy that allows fast construction of nuclear power plants, subsidizes renewable energy immediately, and permits drilling quickly in known offshore locations would combat the worst case scenario of $186 oil in the future.
Oil has doubled in twelve months from $70 to $140. The value of OTC commodity derivative contracts rose from $1 trillion in 2004 to $8.4 trillion in December 2007. There seems to be a bubble. We might have hit peak demand for US Gas consumption in 2007. But not oil. World demand is 85m barrels per day which is approximately one million above current supply. In response to high demand, the Saudi's are increasing supply by 500,000 barrels and capacity to 12.5m barrels. China, Taiwan, Malaysia, Indonesia have cut gas subsidies which aims to reduce consumption. Demand is decreasing one half million barrels per day. Oil, gas, distillates inventories are gradually building. Why isn't the price of oil falling? Iran, Nigeria, ECB rate hike, hurricane season threatening Gulf oil production, and potential Israel Iran conflict are offsetting any good news.
World energy use is expected to surge 50% from 2005 to 2030, largely due to an expanding population and rapid economic growth, according to the Energy Information Administration (EIA). Demand for new energy is led by the developing world, EIA said. While developed countries are expected to see a 19% rise in energy use, demand for energy in the developing world is expected to surge 85%. Oil prices are expected to range from $113 to $186 a barrel.
Record Oil Prices Are The Most Worrisome Factor Weighing On The Market
You can breathe a sigh of relief because the worst of the credit crunch is behind us. The Fed's taking on the role of lender of last resort by bailing out Bears Sterns helped the credit crisis move beyond its worst point. Although the road ahead could be bumpy, with companies still writing off bad investments and lending below normal levels, many portfolio managers think the current volatility and "risk aversion" is creating "contrarian" opportunities especially in the financial sector.
We are not out the woods just yet. The Federal Reserve said "tight credit conditions, the ongoing housing contraction, and the rise in energy prices are likely to weigh on economic growth over the next few quarters." Economy is weak due to tight credit, weak housing, high energy prices, lower consumer spending, and rising unemployment is abetting lower consumption. Unemployment tends to drop for eleven straight months before a rebound. I've tallied four already so hopefully in the first quarter of 2009 unemployment may stabilize. The most recent report showed an up-tick in employment but that may be transient given the weakness in the economy. Fed officials also said they expect inflation to moderate later this year.
Lastly, my outlook is very vulnerable to oil prices remaining above $130 for the rest of the year. Consumer spending is likely to pullback further in the face of $130 plus oil. Persistently high gas and oil prices would only serve to further dampen consumer sentiment which is extremely pessimistic at this point. Lower sentiment begets lower spending which means lower economic growth. The worst spike in energy prices on record must subside somewhat in order keep consumer spending above recession levels. My worry is that future economic growth won't support the projected seven percent earnings growth for 2008 that the market requires to move higher by year-end. That means waiting for the market to turn around in 2009. In 2009, the economy and market should be on more stable ground as far as year-over-year changes in unemployment, inflation, housing, economic growth , and earnings growth are concerned.
At This Point I Strongly Advise Investors To Stay The Course
Maintain your strategic allocation. Over the long term you're likely to do better by maintaining a suitable strategic asset allocation than market timing into cash. What has not done well recently eventually could do well. And what has done well may not do well later in this cycle. Don't chase performance in areas of the market that have experienced explosive returns. Just the same, don't abandoned the worst performers without doing your homework on future earnings growth potential first.
Please call me at 203-226-5733 if you have any questions. Thank you for the confidence you have placed in us.
Enjoy your summer!
Yours truly,
Patrick T. Byrne, Market Strategist
The opinions expressed are those of Patrick T. Byrne as of July 2, 2008, and are subject to change. There is no guarantee that the forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. Investment involves risk. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. Information and opinions are derived from proprietary and non-proprietary sources. Index performance is hypothetical and is shown for illustrative purposes only. You cannot invest directly in an index. S&P 500 is a registered trademark of The McGraw-Hill Companies, Inc. Nasdaq is a registered trademark of The NASDAQ Stock Market, Inc.Risk Managed Portfolio Program. IT SHOULD NOT BE ASSUMED THAT RECOMMENDATIONS MADE IN THE FUTURE WILL BE PROFITABLE OR WILL EQUAL THE PERFORMANCE OF THE SECURITIES IN THIS LIST. Past performance is no guarantee of future performance. There is no guarantee that participation in the Aspetuck Financial Management's RMP - Risk Managed Portfolio Program will protect you against loss of the money you invest.The mutual funds available in the RMP account incur fees and expenses (including investment management and administrative fees) that are in addition to the fees you pay to participate in the RMP account. Those fees and expenses are reflected in performance numbers. Please call us at (203) 226-5733 for a prospectus on any mutual fund being offered by the Program. Prospectus contains more complete information about the fund including all fees and expenses and should be read carefully before you invest. In addition, ask us for our latest ADV, Schedule F, and Schedule H statements. Read them carefully before investing. Investors should be aware that there are risks inherent in all investments, such as fluctuations in investment principal. Advisory services offered through Aspetuck Financial Management, LLC, a registered investment advisor.Securities offered through TD Ameritrade Inc, a registered broker- dealer. Member NASD/SIPC. Securities offered through Charles Schwab & Co., a registered broker- dealer. Member NASD/SIPC. Aspectuck Financial Management, LLC is an independent firm not affiliated with TD Ameritrade or Charles Schwab & Co.
Aspetuck Financial Management, LLC
email: aspetuckfinancial@sbcglobal.net
phone: 203-226-5733
(c) Aspetuck Financial Management, LLC
http://www.aspetuckfinancial.com/ |
