Market Commentary by Paul R. Touchstone, CFA Senior Investment Strategist and Portfolio Manager
San Francisco, Calif. (May 25, 2011)– Stone & Youngberg, a leading financial services firm and the nation’s top underwriter of California and Arizona municipal bonds over the past five years1, is pleased to share the following market commentary from their Asset Management Group regarding the Elevated Financial Risk and European Sovereign Debt Problems.
Equity and commodity markets are giving back some gains in May after strong, high single-digit returns in the first four months of the year. During the month, Emerging Markets are leading the decline -5.9% while the S&P 500 is off -2.0%. Gold is off -3.2% while Silver is down over 25% for the month.
The US Dollar is up 3.3% during the month against the basket of G-7 currencies and up 4.0% when compared directly to the Euro.
The price correction in global markets comes on the heels of recent economic reports out of the US, Europe and Japan that are detailing softer growth while the emerging market’s main cylinder (China) has been aggressively raising short-term interest rates and its Reserve Requirement Ratio (RRR). After six straight months of increases, the RRR now stands at a record high 20%. The RRR forces banks to keep more money in their coffers while rising short-term interest rates are intended to discourage borrowing.
The market correction, so far, has been orderly as noted in the muted reaction in the broad equity market VIX (“fear gauge”). Credit spreads seem to be holding together and are not indicating broad signs of market stress.
The Credit Default Swap (CDS) markets in Europe are the exception where renewed fears of debt contagion continue. The European debt problems are complicated at best due to the political nature of their economic union and serve as a constant reminder as to how over indebtedness and leverage remain significant global issues.
The markets are protecting against default at the sovereign level (see Portugal, Ireland, Spain, & Greece in the table below) more so than at the corporate/banking level. Intuitively, this makes sense in the current environment as the sovereigns would be the first to default. But unless properly “back-stopped” by central banks a domino effect of defaults within European financial institutions would likely follow resulting in another crisis similar to Lehman’s bankruptcy in September of 2008.While we do not expect this to happen, the European Central Bank has been unsuccessful at quelling market fears and tail-risk scenarios remain elevated.
As such, we are closely monitoring the CDS markets on the largest 12 European banks for signs that this crisis could spread into something more meaningful. As of now, markets remain orderly.
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On the positive side:
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According to the American Association of Individual Investors, Bullish Sentiment is at its lowest level since August 2010 (typically a contrarian indicator)
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The Economist/FT survey of global business confidence continues to climb and is in positive territory +20 vs. -37 in September 2008 (typically a coincident/leading indicator)
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Availability of jobs in the US stands at 3 year highs -- 3.1 million jobs available
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US Federal Reserve data shows that bank lending & demand for loans is rising – we’ve been waiting for these indicators to turn positive for a couple of years
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Monetary policy is ultra loose & accommodative across the developed world
Summary & Investment Implications
Despite near-term risks associated with Europe, we anticipate that the global economic growth story has a good chance of picking up pace in the second half of the year. Market participants should return their focus toward solid earnings reports, resilient consumption reports, and positive implications from the rebuilding efforts in Japan & renewed pace in bank lending.
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Broad diversification and balanced portfolio strategies are essential in this market environment
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Within Equity Allocations:
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Overweight US stocks (particularly large cap names)
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Underweight developed International stocks
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Selectively buy commodities & Emerging Markets on pullbacks
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Continue to build core positions in liquid, non-correlated assets
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We are seeking to add to our Managed Futures strategies as they are essentially “long” tail risk. (more on this in coming communications)
About Stone & Youngberg Asset Management Group
As a complement to our fixed-income brokerage services, Stone & Youngberg offers fee-based asset management to individuals and institutions. Our approach relies on reducing volatility and managing exposures to risk. This is designed to increase the probability of meeting our investors’ financial objectives. Disciplined risk management, planning, and communication are essential in formulating long-term, successful investment strategy.