A Brief Update
It is hard to believe we are already two months into 2012. Most stock markets around the world have rallied from the lows set last October. Actually, every asset class we track is up for this year, stocks and bonds alike. Sadly, most world stock indexes are still down significantly over a 1-year period, with the exception of the U.S. stock markets. Go U.S.A.! However, in spite of the U.S. stock market’s relative outperformance, as of early March, the S&P 500 is at nearly the same level where it peaked in April of last year.
Back on November 1st of last year we anticipated the ECB would lower rates at their November 3rd meeting, and that the ECB would behave more like the U.S Federal Reserve. We wrote, “We believe it is likely that on November 3rd, the ECB will lower rates between 25-50 basis points. This reversal of policy would come as a shock to most…Our assumption is that the ECB will behave more like the U.S. central bank and start to blur the lines of monetary and fiscal policy…What are the implications? In the short term, the euro debt and stock markets could react favorably ….. Longer term, however, it would alienate the Germans and other Northern European nations (ex-Irish) and further divide the region.” The ECB did not conduct an outright QE through direct bond purchases, but they did lend out over $1 trillion in 3 year loans through its Long-Term Refinancing Operations (LTRO), which accomplished virtually the same result of providing temporary liquidity to the European banking system and sovereign bond markets. Liquidity injections of this massive size alone can drive market returns in the short term, yet do little to address Europe’s underlying structural problems of too much debt, too little growth, and the lack of a fiscal union.
Our philosophy at Vigilare is always to protect first and then grow. Our belief is that we will accomplish good investment returns for our clients over full economic and market cycles by having flexibility in our investment allocations and through rigorous security selection. This means that on some occasions we may not fully participate in particular market rallies, and may lean more toward conservative investments or even cash positions. At the other extreme, when we view the risk/reward trade-off to be more favorable, which may coincide with an elevated level of fear and investor anxiety, we will add judiciously to those riskier asset classes. There will be a comfort level with increasing risk if we have been successful at protecting wealth on the downside. A more stable “pattern of returns” is even more important than just looking at the average rate of return over a time period. Put another way, we do not want you to endure the “white knuckle” ride that a buy-and-hold strategy has experienced over the last decade. The S&P 500 hit 1350 in February of this year; the first time the S&P breached the 1350 level was in April of 1999. Astonishing!
The current market environment is especially unusual because nearly all of the asset classes appear overvalued in our estimates. A combination of very adroit companies (especially U.S. multi-nationals), unprecedented global monetary easing policies, and unprecedented accommodative U.S. fiscal policies has contributed to the strong rally of late. All three of these factors alone will not keep the market buoyant for too long without significantly better global growth prospects and/or a willingness to address structural problems (too much debt everywhere, government tax and spending policies, regulatory and tax uncertainties). Today, the growth argument is ambiguous at best. To be clear, we still consider stocks a superior investment class relative to bonds, and believe that in spite of recent challenges posed to stocks, bond investors will be the ones extremely disappointed over the next decade. We will continue to add to our stock allocations as we gain more clarity on the global macro-economic picture and/or we observe more attractive valuations.