The Cornerstone Late August 2011 “Let’s not do that again…” What a month it’s been, and, I think it’s important to discuss a few things: First, we all recognize the market changes that have occurred since the end of July and want to know what happened, why it happened and what this means for our portfolios. What – happened is that we had a confluence of 3 main events: The issue with the US Debt limit, the worries about the European economies and the worries over the US economy – and while they don’t look like extreme events when looking in the rear-view mirror, I don’t think it is the sum of the events as much as it is the product of them. So how big of deal was the Debt limit? Well my first comment is that it is certainly disgraceful how the congress has acted over this, especially when you consider this is an action to pay the bills we have already rung up, and the money congress has already decide to spend. Unbelievable. The damage done is simply irresponsible. I understand the feelings behind the desire to stop spending more money than we’re taking in, and in general I agree with that sentiment, but that discussion belongs in forward looking budgets. I don’t necessarily agree with S&P’s downgrade especially when it turns out their numbers were a trillion or so dollars off and the decision making turned to subjective items in the future and the issues with congress instead of the ability of the US to make its payments. Still, it happened and we have to deal with it. The worries of a European contagion affecting the US and indeed world markets bubbled up again and are, I think, well over-done. It appears that the biggest issue was the mistake made by the European Central Bank (ECB) in not purchasing enough Spanish and Italian debt in order to allay the fear of defaults there. In the meantime, they have stepped up purchases– actually to the point where interest rates are quite reasonable – in the 5% area in both countries. There are still questions about banks and political structures, but there’s nothing new there and it is unlikely that we’ll see another explosion of yields in the near future. (By the way, how many governments has Italy had since WWII? Guess! 20? 40? No, try over 60. In contrast we American have had only 44 in over 200 years! What amateurs!) The US economy, as we all know, has been bumping along the bottom since coming out of our recent recession, and stayed there since the beginning of the year. According to the US Dept of Commerce, we have had a downward revision in our 1st quarter GDP numbers to just .4% from .7%, and a second quarter number of just 1.0%. So the economy is slow, but cash on hand, in corporate accounts is close to 1.7 trillion according to some government reports. So, is this the chicken/egg routine as it pertains to the financial markets? Does corporate America hire more employees which will inspire confidence in workers, and cause them to spend? Or will the government have to prime the pump a bit more – probably with stimulus and a jobs bill, then people buy, then the private sector hires? Bottom line in all three scenarios’ above is that CONFIDENCE is what’s needed, and I think that the best way this can happen is by good leadership from the president and congress. At least we can hope. The question arises on how we could have had such a fast sell off when the economics and fundamentals were not that poor, and with many investment managers on holiday? Well over the years there have been a few structural changes to the US markets that may have helped that along. First, we now have a 24 hour global market – with reactions to any news, good or bad happening in a flash. This is a “traders” market, not an “investors” market and one that you don’t play in if you want to keep your money and sanity. For several years I have suggested to clients that they avoid the TV talking heads, and I believe the overblown reactions we have seen to news items have been amplified by these daily business shows. With the advent of these markets also comes high frequency traders (HTF) and electronic communications networks (ECN), both of which are supposed to help with the increased liquidity needs and to supplement/supplant the exchange specialists who for decades have been the buyers and sellers of last resort, thus keeping the markets stable. They disappeared when they were needed the most in these last downturns, not at all accomplishing the stability that was necessary. When we had the high volume swings in 2008, there was a genuine threat that the US economy was unraveling with the meltdown of Lehman Brothers, Bear Sterns, and the collapsing real estate market – but where is the calamity now? I don’t see it. So is there any defense for us, the investor, when this severe volatility hits? Probably not, but we can use these occurrences to look at historical data and consider that this type market – when the Treasury yields, consumer sentiment, and P/E ratios of all US corporation are at near all time lows, that this is the time historically when buying equities has proved to be very profitable (JP Morgan Asset Management 8/22/11). I hope this has helped shed a little light on the process. Please call us if you have any questions or concerns, and Thank You for Your Business. Phil The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. * Stock investing involves risk including loss of principal.