Portfolio Management Update Third Quarter 2011

Transcription

1 Portfolio Management Update Third Quarter 2011 Rick Grimshaw, CPM CIMA or First Vice President Portfolio Management Director 10-year US Treasury Yield: 1.74% Branch Manager DJIA: S&P 500: 1124 October 10, 2011 Commentary [10/4/2011,source: Thomson Financial] [See Important Disclaimers at the end of this Commentary] I think I have writer s block. That s pretty uncommon for me. First, some background. Prior to starting in the investment profession, I spent some years as a reporter and news anchor for several radio stations post-college. I was writing a lot reporting on events I had covered, rewriting wire copy, investigative reporting and more. Writing came easy. Now, its time to reflect on the third quarter, 2011 just concluded. The quarter was marked by excessive volatility and lots of pessimism, starting with the U.S. government s debt crisis in July and early August, followed by continuing concerns about the Eurozone, bank balance sheets and the strength of entire countries. Add a serious lack of political cooperation and the result was one of the worst quarters in recent years, judged by performance, for the Standard and Poors 500-stock index [source: Thomson Financial]. I still believe in the longer-term ability of equities to provide annual returns, net of taxes and inflation, which can assist in providing for our retirement, college education for children and grandchildren, making a major purchase or simply staying ahead. Frankly, the quarter just ended reinforced my belief, as a number of observers beyond this writer have commented that new bear markets in stocks have historically not started from environments like these with low interest rates for U.S. government bonds, extreme public pessimism about stocks, and corporations with lots of cash on hand which appear to be valued in the markets at very reasonable price/earnings ratios.

2 But the 3 rd quarter of 2011 tested my belief. Temporarily. Resulting in writer s block. I have found the solution to my problem usually comes in two ways rereading some of my earlier commentaries, and seeking out the opinions of those I respect. So that s where we will go with this quarter s report to you. I started with my first quarter, 2011 commentary, which talked about the historical definition of a bull market in stocks. I was drawn to Item #6 in Charles Dow s summary, reproduced here: 6. Trends exist until definitive signals prove that they have ended. Dow believed that trends existed despite "market noise". Markets might temporarily move in the direction opposite to the trend, but they will soon resume the prior move. The trend should be given the benefit of the doubt during these reversals. Determining whether a reversal is the start of a new trend or a temporary movement in the current trend is not easy. Dow Theorists often disagree in this determination. Technical analysis tools attempt to clarify this but they can be interpreted differently by different investors. [Grimshaw Portfolio Management Commentary, 3/23/11] Next, I checked on the work of Scott Grannis, who publishes an economics commentary regularly. Scott is the former chief economist for Western Asset Management, a major fixed income institutional money manager. He recently commented on equity valuations as follows [10/4/11], in a report titled Back to 08 Valuations :

3 This chart [above, from Grannis post] shows Bloomberg's calculation of the S&P 500's P/E ratio using 1-year forward consensus earnings estimates. By this measure, the market today is only a shade less pessimistic about the future than it was towards the end of 2008, when a multi-year global recession/depression was widely expected. What this tells me is that if you are still bearish about the stock market's prospects, then you must also believe that the future is going to be even worse than a global recession/depression. If the global economy ends up experiencing anything less than what is almost a nightmare scenario, then stocks are selling for bargainbasement prices. 1 My final outside perspective comes from Rod Smyth, Chief Economist for Riverfront Investment Group, writing in his Weekly View: We believe stocks in the U.S. and overseas likely hit their lows for the year last Monday [10/3/2011]. We urge investors who are contemplating selling to reconsider, and those who have atypically large amounts of cash or shorter term bonds to add to stock weightings. We are extremely aware of the problems facing the global economy and have written about them relentlessly for several months, but we think a point of maximum pessimism was reached and that stocks will continue to rally, albeit with continued high volatility, from last Monday s low. 1 [Weekly View, Riverfront Investment Group] What factors could lessen the uncertainty toward investing in stocks, and lead to more investor confidence? There are three major issues in my view, which, if resolved favorably could provide some fuel for stock market gains. First, the ongoing questions from Europe. A broader, EuroZone solution or plan to provide capital to bank balance sheets, and the legislative approval of a Greek bailout plan from the 17 sovereign goverments, could help. Second, corporate earnings. We are embarking on the quarterly earnings report season for U.S. corporations. Positive surprises could reduce concerns about earnings growth in this still-sluggish economic growth environment.

4 Third, the work of the U.S. Congress so-called Super Committee. There are deadlines imposed by the August debt-ceiling legislation coming up in the 4 th quarter. Should the committee not come up with a further plan to cut spending, automatic reductions kick in [source: Bloomberg]. If details about a revised spending plan leak out in my opinion, leaks from politicians and/or their staffs are more likely than not the markets may react favorably as uncertainty is reduced. Since volatility seems to be on many investor s minds, I wanted to add my thoughts. First, simple mathematics. I keep, framed on my wall in my office, some notable newspaper clippings from The first, from the Wall Street Journal of January 9, 1987 has the headline Breaking the Barrier: Dow Jones Industrials Top 2000 Mark. The second, from the New York Times of Tuesday, October 20, 1987 has the front page headline: Stocks Plunge 508 Points, a Drop of 22.6%; 604 Million Volume Nearly Doubles Record. I find these framed clippings provide a nice reminder and constant historical perspective for me. Today, 508 Dow Industrial Average points is about 4.5% of the DJIA s value [508 divided into = 4.7%]. We have swings of 200 points from the intraday high to intraday low more often than not. The Chicago Board Options Exchange [CBOE] Volatility Ratio, or VIX, finished on October 3, 2011 at 45.5, versus a December, 2009 level of 21.7 and a reading of 49.7 at the March 9, 2009 market bottom [source: Morgan Stanley Smith Barney Global Market Data Daily, 10/4/2011]. Part of the reason for such volatility, I believe, comes from the decimalization of stock prices. Richard Grasso, former Chair of the New York Stock Exchange, recently called going from fractions to pennies [or less] in stock prices a major factor in higher volatility [8/11/2011, on CNBC]: _Trading_Grasso*. There now appears to be a movement to regulate such trading, as reported by the New York Times recently:

5 So where does all of this lead us as investors? I believe we need to see through all of this daily fog and continue to ask ourselves where money may be treated best. I remain convinced that equities can provide above-average returns over time versus bonds and cash in the current environment of uncertainty and fear. I ve repeated in commentaries like this one the ability of the markets to frustrate the majority of people at the same time. Today s frustration with equities, especially after a negative return for the Standard and Poors 500 during the most recent quarter, could be replaced with better investor sentiment should the three concerns I mention be alleviated. There could also be other news events which could surprise investors. In short, my view remains that we are still in a bull market for stocks that began in early March, Comparing the January, 1987 WSJ headline from my office wall [ Dow Industrials at 2000 ] -- and calculating returns from that point over two decades ago, to the 10,808 level referenced above -- results in an average annual gain of 7.13% over more than 24 years. That s price appreciation alone, without dividends. We have certainly learned in the 3 rd Quarter of 2011 that it can be a bumpy ride. But the result may likely justify investor patience. So much for writer s block. Rick Grimshaw, CPM CIMA Morgan Stanley Smith Barney First Vice President 1701 SE Columbia River Drive Portfolio Management Director Vancouver, Washington Branch Manager rick.grimshaw@mssb.com * Please be advised by clicking on a third party URL or hyperlink, you are not going to morganstanleysmithbarney.com. Morgan Stanley Smith Barney LLC is not implying an affiliation, sponsorship, endorsement with/of the third party or that any monitoring is being done by Morgan Stanley Smith Barney of any information contained within the web site. Morgan Stanley Smith Barney is not responsible for the information contained on the third party web site or your use of or inability to use such site. Nor do we guarantee their accuracy and completeness.

6 Sources for all facts: Reuters, Bloomberg, Wikipedia, Thomson Financial. Research Sources: Morgan Stanley Smith Barney LLC., Scott Grannis, Riverfront Investment Group, CNBC. If there is a specific fact you d like a more detailed citation for, please contact us and we can provide the source. 1 Scott Grannis and Rod Smyth are neither employees nor affiliated with Morgan Stanley Smith Barney LLC. Opinions expressed by them are solely their own and do not necessarily reflect those of Morgan Stanley Smith Barney. The information set forth was obtained from sources we believe to be reliable, but we do not guarantee its accuracy or completeness. Past performance is not a guarantee of future results. The views expressed herein are those of the author and do not necessarily reflect the views of Morgan Stanley Smith Barney or its affiliates. All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results. This material does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The strategies and/or investments discussed in this material may not be suitable for all investors. Morgan Stanley Smith Barney LLC recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor s individual circumstances and objectives. S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market. An investment cannot be made directly in a market index. Dow Jones Industrial Average is a price-weighted index of the 30 blue-chip stocks and serves as a measure of the U.S. market, covering such diverse industries as financial services, technology, retail, entertainment and consumer goods. An investment cannot be made directly in a market index. Portfolio Management is an advisory program in which the client s Financial Advisor invests the client s assets on a discretionary basis in a wide range of securities. Morgan Stanley Smith Barney LLC. Member SIPC. CRC Reference Code