It was another week with Europe dominating the headlines. The Dow rose 1.4%, the S&P climbed 0.9%, and the Nasdaq returned -0.3%. Gold continued to bounce around but settled near the $1,800 an ounce level, up 1.8% for the week. Sparked by concerns of a nuclear Iran, oil popped higher by 5.0% to $99 per barrel.
Source: MSN MoneycentralThe markets rose nicely every day this week except for one, and unfortunately that day was a doozy. The markets recovered nicely late in the week, though, to eventually move back into positive territory.
Again this week, the market was driven by big changes taking place in Europe with a change in leadership in both Greece and Italy. We opened the week with news that the Greek Prime Minister was stepping down and a new government would be formed.
Catching us by surprise, Italy, the 3rd largest economy in the Euro, also grabbed headlines as their financial condition weakened. Bond yields in the country continued to rise, meaning it would cost them more to borrow money. Italian Prime Minister Berlusconi was also in jeopardy of losing his position after nearly 20 years of service.
We figured the uncertainty created by these stories would send the markets lower, but they climbed higher Monday and Tuesday. It wasn’t until Wednesday that the worries came to a head.
Bond yields rose above 7% in Italy, a level many refer to as “the point of no return.” The chance of default becomes very high, even if meaningful steps are taken to remedy the problem. This was the yield level that lead to bailouts in other Euro countries like Ireland, Portugal, and Greece. A bailout in Italy is more problematic, since they are much larger than any of these other countries and the costs would be enormous.
Investors were spooked by the news, with banks taking the brunt of the hit due to their potential exposure to Europe. By the end of the day, the Dow had fallen 3.2%, the 6th biggest drop for the year.
Conditions moderated for the remainder of the week and the markets climbed back higher, eventually erasing the Wednesday losses. Italy announced plans to boost growth and cut their debt and the markets gave the plan a thumbs up.
The leadership picture in both Greece and Italy improved, as well. The new Prime Minister in Greece, Lucas Papademos, has a economics background with a PhD in Economics from MIT. The likely new leader of Italy, Mario Monti, also has an economics background. Since the problems facing these countries are economic in nature, their background makes them decent fits - for the time being, at least.
Back at home, we saw an improvement in employment that helped push the markets higher. Initial jobless claims have been hovering around the 400,000 level for weeks, but dropped to 390,000 this week. Though still troublingly high, it is a welcomed improvement. Consumer confidence levels showed a gain this week, as well.
Next Week
Next week will be another busy one. Corporate earnings will be lighter, but there will be many economic data releases. We will info on housing, retail sales, productivity, and leading indicators. We will also get inflation data with the PPI and CPI releases.
Europe will also be a focus due to all the changes that occurred this week. The markets seemed to like the changes, but there are many questions that remain unanswered. The volatility will likely continue into next week.
As we approach November 23rd, the Congressional supercommitee will become more of a focus. The lack of a compromise will likely be seen as a negative. They need to cut $1.2 trillion over the next ten years, which, if you average it out, would be $120 billion a year. The fact that it is difficult to agree to just $120 a year is troubling, since massive amounts of cuts will be needed in the future.
Investment Strategy
Again, no change here. We are still cautious due to the questions surrounding Italy, Greece, and the rest of the Euro zone.
Corporate earnings have been good, with over 80% of companies beating their estimates according to Factset. Normally that would help the markets, but as we have mentioned, Europe has been the market driver. When everything goes up or down together, it makes stock picking almost a futile effort.
If we were to put new money to work, in equities we are focused on large cap higher-quality stocks, particularly companies with operations overseas. Smaller and little-known stocks with low correlation to the market are also promising, since correlation is high at the moment. We like commodities and were encouraged by their recent strong performance. A slowdown in China, who has been a major driver of commodity prices, has us worried in the longer term, though.
TIPs are important as we still expect inflation to increase while U.S. Treasuries are a sector we are very bearish (pessimistic) on. We think yields will increase over time, but that has yet to happen due to the unprecedented intervention from the Fed. However, we feel that this level is proving a good time to short again. Municipal bonds are important and there are some nice yielding bonds out there now (try to avoid muni funds and buy the actual bond if possible).
Finally, international stocks are facing many headwinds, most notably slower growth and inflation. Still, if we had to put new money in, we favor developed international markets as opposed to emerging.
These day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
This commentary is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing. Past performance cannot guarantee results.
