Market Overview & Update
Markets are again exhibiting extreme volatility on the downside. With today’s bounce, responding to hopeful news coming out of Europe, we thought we would share some observations with you. We will use a question and answer format to try to focus on the questions that may be the most interesting and important to you.
1. Is the (investment) world coming to an end?
This is a natural question when we see the stock market decline as it did last week. As you know, if you have read our other communications throughout this year, we have virtually no U.S. equities in our portfolio models at present – haven’t since late May. We do have allocations to other asset classes that have been negatively affected by various economic factors, and we will discuss a number of those asset classes separately.
While Silver Oak has been very defensive and conservative in our asset allocations, even the most conservative holdings have given back some of the gains we experienced earlier in the year.
However, even with those pullbacks, we are pleased to say that each of our portfolio models is in positive territory for the year. While not every client portfolio is exactly the same in composition and has performed exactly the same, we can say that as we look at the S&P 500 results (as of Friday September 23rd they were negative by over 10%), having positive portfolios means that we are substantially ahead of that index.
2. Do our portfolios still own gold and silver?
We certainly have looked upon these precious metals as tools to help us protect portfolios against a number of dire economic scenarios, and especially as a “no confidence” vote against the dollar. Silver has exhibited quite a bit more volatility than has gold, which has been a bit troubling. We therefore bought and sold silver twice so far this year. The following chart reflects where we bought and sold the silver ETF during 2011 for many portfolios, depending on the specific model and allocation to the higher risk bucket.
We continue to hold our allocation to Gold. There are many factors that will affect the price of gold. Aside from jewelry demand and large purchases by central banks, gold has tended to rise this year due to a number of crises including the Greek debt crisis and the political stalemate in Washington, D.C. over raising the debt limit.
This week, we are experiencing a countervailing factor that has caused the metal to lose some of its luster, specifically the strength of the U.S. Dollar versus the perception of the Euro. Should the situation in Europe stabilize soon, we expect the dollar to continue to weaken, having a positive influence on the price of gold. Should stabilization not be in the cards for Europe in the short term, thus keeping the dollar strong, we will be watching gold closely in its relationship to the dollar and in absolute terms to see how it performs.
3. Why do we see some of the bond investments declining?
Our portfolios contain many different types of bond investments for diversification purposes. Some of our bond mutual funds are internationally diversified and are denominated in foreign currencies. The recent strength of our dollar also has a negative impact on these bond funds. While we continue to like international and emerging market bonds as part of our long-term strategy, we are in the process of trimming some of those positions due to near-term weakness.
Our investment philosophy places most of our bond holdings in the lower risk bucket. Certain bond funds with more volatility due to wider currency swings are placed in our higher risk bucket. Our goal is to maintain a target rate of return of 5-6% in the lower risk bucket. While we have generally been on track with meeting this target, periods in which significant actions are taken by both our Federal Reserve and by central banks in foreign markets certainly make this goal more difficult. We will continue to monitor the global macro economic factors that impact bond prices and plan to adjust portfolio holdings as needed to maintain our return target.
4. What is going to happen next?
That is certainly the $64,000 question. If our crystal ball was working, answering this question would be a lot easier. All we can do is to continue to monitor the economic fundamentals and events as they unfold, and translate economic policy into portfolio holdings which offer investment opportunities at a reasonable level of risk.
As our Fed Chairman noted last week in his prepared remarks, there are “significant downside risks” to the economy of the U.S. At the same time, some say that a recession in Europe is likely and that the demise of the Euro cannot be ruled out. There are too many structural issues at play for us to feel optimistic relating to many higher risk assets. However, at some point, with faith in the continuing recovery of our economy and in our free-market system, we will eventually conclude that the prices of equities have reached fair valuations and that expected returns justify their inherent volatility. At such time, we will add equities again to our higher risk bucket.
As always, we welcome your questions, emails, and telephone calls. This is a very unsettling period, and we are here to answer any questions you might have regarding our “take” on the current and future investment climate.