Weekly Commentary August 15th, 2011

The Markets

If there was ever a week for investors to be on vacation and “off the grid,” last week was it. By being unplugged, you would have missed the following wild ride:

·         Monday: The S&P 500 index plunges 6.7 percent partially in reaction to the U.S. losing its triple-A credit rating. By the end of the day, about 99 stocks out of every 100 close lower -- the biggest rout since May 13, 1940 when Germany was beginning its invasion of France, according to CNBC.

·         Tuesday: The index soars 4.7 percent as the Federal Reserve announces it will leave its benchmark interest rate at a record low for at least two more years.

·         Wednesday: The index tumbles 4.4 percent as concern about the health of the European banking sector and France’s triple-A credit rating sends investors to the exits.

·         Thursday: The index skyrockets 4.6 percent as calmer heads prevail and investors swoop in to buy perceived bargains.

·         Friday: The index closes higher in a relatively uneventful day.

·         For the week, the Dow Jones Industrial Average rose or fell at least 400 points on four consecutive days -- the first time that’s ever happened.

Sources: The Wall Street Journal, Bloomberg, CNBC

Yet, remarkably, after all the volatility, the S&P 500 index lost only 1.7 percent for the week.

As mentioned above, the U.S. lost its coveted triple-A credit rating from Standard & Poor’s on August 5. However, in the irony of all ironies, rather than seeing U.S. interest rates rise on this bad news, rates actually dropped dramatically. The interest rate on the benchmark 10-year Treasury dropped from 2.56 percent on August 5 to 2.24 percent last Friday, according to data from Yahoo! Finance. It turns out that the stock market volatility had some investors fleeing to the perceived “safety” of U.S. Treasuries.

But wait, there’s more. In another irony, the value of the much maligned U.S. dollar was virtually unchanged last week, according to MarketWatch. Despite the downgrade of our credit rating, people still felt our currency was worth holding relative to other currencies such as the euro.

While the major headlines were scary, some good news occurred last week, too. The Commerce Department said retail sales rose a solid 0.5 percent in July and first-time unemployment claims dropped below 400,000 in the week ended August 6. That was the lowest level for unemployment claims since early April, according to MarketWatch.

With markets dropping and volatility rising, some pundits are now comparing the current market environment to the 2008-2009 financial crisis period. And, while there are some similarities, The Wall Street Journal pointed out a glaring difference in its August 13 edition.

The panic in 2008 represented a crisis in markets. What's happening now seems to be a crisis in government. In 2008, the world's richest countries embarked on a series of unprecedented interventions to stop financial markets from seizing. Today, the tables are reversed: Financial markets have lost confidence in politicians' ability to master their problems. In 2008, countries united in response. This year has been marked by tensions and misunderstanding, including those between the U.S. and Europe over the continent's response to its debt crisis.

This “crisis in government” has led to a “crisis in confidence” in consumers. According to the Thomson Reuters/University of Michigan preliminary index of consumer sentiment, U.S. consumer confidence dropped in early August to the lowest level since Jimmy Carter was president in May 1980. This extremely low confidence level may be a headwind for the economy.  

At times like this, it is very important to maintain perspective. While the markets are swinging wildly, the S&P 500 index still closed last week more than 9 percent higher than a year earlier, as shown in the box below.

As investment managers and investors, we can’t let short-term gyrations derail us from our long-term objectives. 

Weekly Focus – Think About It

“Courage is fear holding on a minute longer.” --George S. Patton, U.S. Army General