A Delicate Balance
In order to fully understand the strength in the stock market, it is important to consider the role of central banks throughout the world. During this tepid economic recovery where GDP is barely growing at 1%, how is the stock market able to sustain such an advance as it has this year? The reason for this is the worldwide commitment by central banks to relieve economic stress by maintaining a very friendly monetary policy.
For the US, this means that our Federal Reserve buys government securities through its current QE3 mandate. These purchases flood the system with liquidity. Added liquidity throughout our whole financial system “trickles up” to the stock market and pressures stocks into going higher.
Outside of the US, central banks stand ready to assist in bailing out debtor nations like Spain and the other fiscally strapped European countries. China is looking for ways to spur its own faltering economy. Worldwide, central banks are pulling on the same oar with the end result being inflation of asset prices, like stocks.
These concerted efforts by worldwide central banks make stock markets flourish. As long as these policies continue, investments in stocks or bonds promise to do very well. The slogan, “Don’t fight the Fed” provides an actionable mandate.
The problem is that eventually, these concerted efforts reach their endpoint.Deeply indebted countries have severe limitatons on what they can do to bolster their economies. Governments cannot afford to allow further escalating deficits. Amidst a slowing worldwide economy, we will eventually reach a point at which no stimulus will work.
Investors need to navigate this uncharted path. For the time being, it is better to be invested in this mild recovery and participate in the torrid growth in the stock market like we have seen this year. The stock market can easily reverse course and head lower when central bank easing is no longer effective. It will be crucial to recognize the signals of the inevitable downturn and act on those signals.
In August, renowned bond fund manager Bill Gross proclaimed “the cult of equities is dead”. My favorite investment pro is Ray Dalio, who runs the hedge fund, Bridgewater. If you Google “Ray Dalio” and “Foreign Affairs”, you can hear his description about our economic circumstances. He also predicts that stocks will do poorly in the months ahead.
In our work, we need to gauge when the positive affects from central banks will become exhausted. The Fed and its brother and sister organizations throughout the world will soon run out of productive tools to spur economic growth. When this does happen, stocks will most likely correct. Staying in the market and staying defensive at the same time is the “Delicate Balance”.
3rd Quarter Overview
The S&P 500 shook off its 2nd quarter loss and climbed 6.40% in the third quarter. That moved its 2012 gain to 14.48%. This is a remarkable gain given the muted economy and mushy indicators of business activity. Most recently, in October, the Dow, S&P, and NASDAQ finally moved beyond their highs for 2012 set back in April. The S&P is still about 8% off its peak value in 2007.
The recent gain in the stock market is being fueled by the likes of Google, Goldman Sachs, IBM, Wal-Mart, and, despite the decline in October, Apple. This bullish tone affected most industry groups.
Anyone looking to get a steady rate of return on bonds was not disappointed in the third quarter. Barclays Aggregate bond index rose 1.60% for the quarter and is still up 4.01% for the year. Most people fear that interest rates will rise. This spells peril for bonds but in fact, bonds have shrugged off this fear and given a solid and stable performance. It is worth noting that bonds have outperformed stocks for the past 10 and 30 year periods.
Most companies report earnings in October. The initial take is not good. Bespoke Investments forecasts a 1.1% decline in earnings which would be the first year over year decline and the worst performance since the financial crisis in 2008. It will be interesting to see how reporting companies’ stock prices do amidst a disappointing earnings season.
There is ample coverage devoted to predicting the market in the face of the elections and the looming fiscal cliff. Other than a brief, short lived move, these events probably will not serve to materially push the markets.
Peregrine Returns and Strategy
Peregrine Equity and Balanced Composites gained almost 3% for the third quarter of 2012. Our Equity Composite is up 9.71% for the year and our Balanced Composite is up 7.38%. This performance lags our benchmarks. Due to the susceptible economic weakness, we are cautious about carrying a heavier equity weighting for our clients. Our effort centers on the work that it takes to find stocks that can truly outperform the market even in the face of a potential market correction. Analysis shows that there are many companies that have the “torque” that can contribute to a growing portfolio.
Past performance is no guarantee of future results. Investment management involves the possibility of losses. Significant general stock market moves up and down can influence the performance of client portfolios. Composite returns are based on client portfolios of over $100,000. Not all clients are included in the composites. All returns include the reinvestment of dividends. All returns are net of fees. Composite returns are derived from aggregated, time-weighted returns for clients of Peregrine Asset Advisers. Individual client returns can deviate from the composite returns. While Peregrine uses the S&P 500 as a benchmark, Peregrine does not attempt to mimic the structure of this index. Individual client portfolios vary. The number of securities held also varies per client.
Do you have questions or would you like to know more, contact Dan Botti.