Stock market performance was awful in the third quarter with the S&P 500 moving down -14.3%.The S&P is down -8.8% for the year so far.However, our portfolio allocations continue to do better than the market during this period.
3rd Quarter analysis and our strategy:
The 3rd quarter had its worst performance since the first quarter of 2009.The broad market sell-off was a result of concern about the European sovereign-debt crisis, a U.S. economy flirting with a double-dip recession, and signals that former fast-growing economies, such as China, are slowing down.Even some famed safe haven investments failed to perform as gold tumbled toward the end of the quarter after hitting an all-time high of over $1,800 an ounce in August.
The slew of bad news, coupled with periodic flashes of optimism, led to one of the most volatile periods ever for stocks.The DOW moved by more than 200 points 18 times during the quarter.In August, it swung by more than 400 points in four consecutive days. Many investments from U.S. stocks to crude oil had their worst quarter since the frightening days of the Lehman Brothers collapse in 2008.There were consistent worries about the health of banks, this time primarily in Europe and a continued loss of confidence in the financial markets.Financial stocks were among the hardest hit during the quarter with many banks falling 25% or more.Morgan Stanley shares were down more than 40% amid rumors that the bank is exposed to debt of troubled European nations. Wall Street strategists have reduced their forecasts for growth and company earnings, and investors have lowered their expectations for the stock market this year.Ominous signs abound.Economic data out of China, the key engine for the world economy is increasingly bleak.China’s manufacturing sector appears to have shrunk in September.Leading indicators for the world’s economy such as China’s stock market, copper and crude oil prices have tumbled. The third quarter began on a positive note but quickly turned negative.Economic data in early July showed the U.S. recovery was slowing and politicians took the country to the brink of default in early August by waiting to the last moment to raise the debt ceiling.Then Standard and Poor downgraded the U.S credit rating, sparking a rush out of U.S. stocks. Meanwhile, Europe’s debt troubles escalated, and more recently, signs of China’s slowing down emerged, raising doubts about future demand for commodities and other goods.Investors fled to the safe haven of U.S. Treasury debt which had its best quarter since early 2008.The yield on the 10-year note slid below 2% meaning that the returns for this investment are negative when you take into consideration inflation is over 3%.
Is there any positive news?
Historically the third quarter is the worst performing quarter of the year.The fourth quarter historically is the best.Investors are now turning their attention to corporate earnings which have been pretty much overlooked over the last three month period.Earnings are expected to increase 11% over the same period last year.If this turns out to be better than forecast, the market should respond positively.We expect the economy to move along at a 2% rate of growth which eliminates the fear of a double dip recession.
Portfolio allocation remains the key
To outperform the equity markets consider the allocation we have employed. GNMA bond funds gained 3% during the quarter.The Vanguard Healthcare fund remains positive for the year.Small-cap stocks, normally the riskiest of investments had the worst performance during the quarter with mid-caps following and large caps performing the best of the group.As markets rebound, small-caps will outperform large- caps as they have done over the last two and a half years.
I mentioned last quarter that bonds would provide safety if the stock market fell.This again proved to be the case as bond funds had nice gains during the quarter. Allocation remains a positive as we move through this difficult time, and I believe that the stock market will make a comeback in the fourth quarter.
Especially in this environment, I recommend reviewing portfolio allocations to provide some volitility protection. If you would like some advice in this area, please give us a call.
Bruce A. Kraig, CFP, MBA October 2011
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