Fall 2011 Market Update

FALL COMMENTARY

 

Recently we witnessed the Dow Jones collapse from 12,500 to below 11,000. As I predicted, once the Federal Reserve stopped propping up the markets with Quantitative Easing investors realized there were absolutely no fundamentals justifying their high risk investments.

Economist Paul Krugman called it a “Wiley Coyote moment”. Wiley motors across the desert at top speed straight over a cliff with legs still spinning until he looks down and realizes there is only air beneath him. The stock market was indeed being supported by a lot of hot air.

Two things happened at the beginning of August that resulted in the ratcheting down of the entire world economy.

  • First was the disgusting display in Washington by our Congress.  While the debt ceiling was raised at the last possible moment, the debacle led to a lowering of the U.S credit rating by S&P from AAA to AA. This signaled to the world that the most stable economy, government and currency (that it had relied on for the last 50 years) was now dysfunctional and could not be relied on to fix the world’s economic problems.
  • Secondly, GDP numbers started coming in showing a significant drop off of what little growth there had been across world economies, including emerging markets. The reality started to sink in that there was no recovery and, in fact, never had been. We are on the cusp of another recession or another leg of an ongoing depression.

Ben Bernanke confirmed this outlook by stating that the Federal Reserve did not expect to raise interest rates until at least 2013. The bond market responded by drawing an influx of buyers driving interest rates to their lowest levels in 60 years. The ten year treasury now yields below 2% and a two year treasury yields only .15%

Why did this drop in rates occur?  Several reasons; foremost, if there is no growth in the economy the Fed does not need to worry about inflation. The cure for inflation is raising rates.  Bernanke saying he doesn’t see the need to raise rates until 2013 is CONFIRMING THE NO GROWTH FORECAST.  Also, if there is no growth in profits; stocks will not be going up. Therefore the bond market does not have to offer high yields to attract investors away from stocks and, of course, there is the safety issue.  Bond yields are expected to continue to decline.   

I have avoided money markets for reasons that played out over the last few weeks.   As you may remember from my previous discussions, money market funds frequently loan money to high risk entities like Lehman Bros and European banks. The headlines have been full of stories recently that one of the causes for concern in European banks is “who will lend them money” if American money market funds will not.  This is NOT where we want YOUR LIFE SAVINGS.

These are very tough times for investors. I am trying to eke out every possible dollar of return with the smallest risk and locking funds in for the shortest possible time just in case yields do rise. Combined with patience this should get us through. There are really no other alternatives.

Hope you are enjoying the beautiful fall weather.

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