Markets under the Magnifying Glass

August 18, 2011 - 12:37 PM


Terror in the Markets! The latest "B" Movie?

The 1954 "B" movie, "Them" is based on the premise that irradiated ants in New Mexico grow to an enormous size and then threaten to end civilization.  While I have not seen the movie (and who really needs to?), the basis for many "B" horror movies is to take relatively small threats in ordinary life and put them under the magnifying glass so that they look truly terrifying on the big screen.

The US and European stock markets opened to an immediate sell-off this morning, down over 4% in the first 60 minutes of trading on US exchanges.  Why was there so much volatility?  It's usually hard to say if there was any one thing caused the initial drop, but fear usually magnifies whatever actual problems there may be.  The Labor department released data showing initial jobless claims rising by 9,000 to 408,000, though the four-week moving average dropped to 402,500; both relatively small changes.  Inflation numbers were mixed, slightly higher when including gasoline, but lower than expected when excluding food and energy.

Of course, European banks and sovereign debt are still looming issues, but S&P did reiterate France's AAA rating, still higher than the US.  However, 10-year US Treasury yields dropped below 2% briefly this morning, showing that investors, if not S&P, still view US government debt to be of the highest quality.  What will actually happen in the Euro-zone is still uncertain; nothing new there, either.

So, today's economic numbers are not improving, but neither did they fall off the cliff overnight.  The circumstances are still as uncertain economically and politically today as they were yesterday.

Markets Under the Magnifying Glass

I think most people recognized long ago that we are facing a host of difficult circumstances globally; problems that will not be resolved quickly.  Most of these issues have been known for many months, if not years.  The day-to-day and monthly numbers describing these problems are not dramatically changing.  So, the ongoing problems remain large and real, but these dramatic market reactions to short-term readings are like putting on magnifying glasses while looking at ants and then acting as though dramatically newer and larger threats exist, that didn't the day before.  This magnifying glass point of view causes some participants in equity markets to make and re-make what should be five- and ten-year decisions on each day's new data.

While running the risk of sounding like a broken record, a well-diversified portfolio with an adequate allocation to bonds and cash (e.g., 5-10 years of expenses for those contemplating retirement in the next few years) is built to weather the short- (1-year) and even intermediate-term (3-5 year) volatility of stock markets.  For investors with long-term goals, long-term strategies still make the most sense.  Yes, it's unnerving and discouraging to watch the reported daily values of our investments gyrate the way they have recently.  However, short-term reserves in high-quality bonds have held their values and continue to pay interest.  Stock dividend yields are actually rising above Treasury yields as prices fall, and long-term portfolios for those contemplating retirement still have the same amount of liquidity they had 30 days ago.  Maybe a trip to the movies for a romantic comedy is in order instead of another night of MSNBC, Fox News and CNBC with "Them"?

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