Quarterly Summary

The Federal Reserve's efforts to jump start the struggling U.S. economy dominated the quarter's headlines.  In early August, the Fed announced it would hold short-term interest rates near 0% until at least mid-2013.  The Fed's move accompanied a downbeat forecast in which it noted a depressed housing sector and deteriorating jobs market.  The Fed acted again in September when it announced plans to sell $400 billion in short-term Treasury bonds in its portfolio by June 2012 and buy longer-term debt, a move aimed at further driving down long-term borrowing costs.  The Fed also said it would maintain its investments in mortgage-backed debt at current levels, instead of paring its mortgage holdings as it has done over the past year, in an attempt to boost the ailing housing market.  On a more negative note, the central bank noted "significant downside risks to the economic outlook, including strains in global financial markets."

At the end of August, the Commerce Department reported the U.S. economy grew at a 1.3% pace in the second quarter of 2011.  However, other indicators continue to point to a sluggish economy.  Job creation stalled in August, when the unemployment rate was stuck at 9.1% for the second straight month.  Consumer confidence fell to multi year lows, as consumer worries about the weak jobs market and falling stock prices escalated.

Investor uncertainty has increased markedly in recent weeks, but we see reasons to be cautiously optimistic. We believe odds of an outright recession are around 50%, despite growing talk that the U.S. is sliding into another downturn; although the ECRI has officially called for a US recession in 2012.  A more probable scenario is a "stealth growth recession" characterized by extremely low economic growth and high unemployment.

The situation in Europe remains a bit troublesome, as economic growth is slowing across the Eurozone, loan losses continue to pile up, and the risks of a banking crisis are growing. A Greek default looks increasingly likely; it seems to be just a matter of when.  However, European policymakers appear to have finally grasped the gravity of the crisis, and we believe the odds are favorable that they will take sufficient action to prevent it from spreading.

While the news over the past several weeks has been fairly negative, the one thing missing from the constant cascade of worrying headlines is any hint of deterioration in US corporate earnings, at least at this point.  Earnings estimates will need to be watched carefully in the coming weeks/months for signs of a slowdown.  So far this month most earnings reports have come in better than expectations, which is a good sign for continued profitability by corporations.  S&P 500 earnings estimates for 2011 are still hovering around $98.00 (up slightly from the first quarter); with continued expectations for roughly $108.00 in 2012.

   

Headline Risk

Over the past few months, there has been an abundance of negative press regarding the credit concerns over in Europe. These concerns triggered a nasty spillover effect here in the United States, leading to increased pessimism and greater negative sentiment within the markets. As a result, we’ve seen stock prices decline from late July/early August and have since been trapped in a volatile trading range. Meanwhile, more news continues to spread. Last week Fitch downgraded both Italy and Spain. We saw domestic activity similar to this back on August 5th when S&P downgraded the United States. Though it was a trivial act, the broad market sold off sharply. Over the next few days, we witnessed some of the most pronounced swings in market history which spawned even higher levels of uncertainty and negative sentiment among investors.

This is a classic example of headline risk that investors will inevitably face, (especially during volatile times like this). What investors need to be reminded of is the fact that nothing fundamental changed from one day to the next, and still the market went into a tailspin. This pertains to both the United States and Europe. A rating agency came out and offered their new “opinion” about a nation’s ability to deal with their current debt level. Keep in mind these are the same rating agencies that triple stamped mortgages for the majority of an entire decade only to help spawn the housing and financial meltdowns.

The point is that in situations like these, the cooler heads will often prevail. The “sell everything” mentality is nerve wracking and often shows up at just the wrong time. Emotions tend to get the best of us and acting on them, especially when it comes to investing, is never a prudent strategy. If a slight change or adjustment to your account is in order, keep it simple. Remember, it’s good to pay attention to what’s going on in the markets, but don’t let too many front page articles get the best of you or your investments.

Anti Wall Street Protests

Over the past few weeks, large numbers of young Americans have been gathering at Wall Street in NYC in an OccupyWallStreet movement.  Caroline Baum from Bloomberg News wrote a very interesting column this morning about the movement.  I think the movement addresses a number of concerns and the article is insightful is showing what we could expect in the coming weeks and months.  Link to article is below -


http://www.bloomberg.com/news/2011-10-07/anti-wall-street-protests-ignore-legitimate-gripe-caroline-baum.html#disqus_thread