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Public Stock and Bond Markets Uncertain
By Harvey Rowen, Starmont Asset Management, Keiretsu Forum Northern California Member
hrowen@starmont.com
Markets hate uncertainty. The stock and bond markets are no exception. Given the highly uncertain world in which we currently live, it has taken increasingly more effort to make money in those markets. This article will discuss the current state of affairs and describe some strategies Starmont Asset Management is using for its Clients which you can consider for your own portfolios.
2004 was to be the year in which the stock markets went up, propelled by a strengthening economy, and the bond markets went down, pushed by rising interest rates. In fact, just the opposite has occurred.
Equity Markets
As I write this article in mid September, the U.S. equity markets are down by almost any measure-- from NASDAQ’s down 6% to the Dow’s down 4% to the S&P 500’s down 1%. Foreign markets are doing somewhat better, with the EAFE (Europe, Asia and the Far East) index up 2%.
There are simply too many uncertainties for the markets to gain traction. We don’t know:
- If the "soft patch" in the economy is a soft patch, or a real slow down?
- What will happen with interest rates?—which will depend to a large extent on the answer to the economy question
- What will happen to employment?—which is also dependent on the economy. Employment effects consumer spending, which is a major component of GDP.
- What will happen to oil prices?—which will depend on terrorism in the Mid East, weather in the Gulf of Mexico, and politics in Russia and Venezuela. Higher oil prices are a drag on the economy
- What will happen with terrorism attacks outside of the Mid East?—fear of terrorism at the summer Olympics and at the Republican convention cast a pall on the markets over the summer, and fear of a Spain like incident before the Presidential election currently is a cloud over the markets
- Who the President will be, and whether that President will have a mandate?
Because of this uncertainty, Starmont has implemented a number of strategies to achieve our objective of obtaining better results for our Clients than market benchmarks, without adding significantly more risk to their portfolios. You may want to consider any or all of the following:
- Since there is no leadership in the market at present, all portfolios are broadly diversified between asset classes--between large companies and small companies; between companies that are growing rapidly and companies that are more staid; and between U.S. companies and companies in developed and developing countries outside the U.S.
- Around this portfolio core we have added holdings that add value and that are not highly correlated to the core holdings—such as a fund of funds that invests in commodities (which have had a strong year), foreign bonds (to hedge against the falling dollar), and Treasury Inflation Protected Securities (to hedge against inflation); and a long/short fund to protect against a substantial decline in the market should there be a major terrorist incident. This increases the likely return of the portfolio while decreasing the portfolio’s risk.
Bond Markets
Fixed income investments, usually in the form of bonds or notes, play a number of roles in a portfolio:
- They serve as a shock absorber in the case of a major disruption to the equity markets.
- They serve to dampen volatility in the portfolio, even absent a shock to the equity markets.
- They provide an income stream in the form of interest payments, that Clients can use as needed.
Bond prices hit 45 year highs in June of 2003 as interest rates hit 45 year lows following 11 consecutive rate cuts by the Fed. This year the Fed has begun to raise the Federal Funds rate (a short term interest rate), and we would expect long term rates to rise as well, sending bond prices down. Instead, the yield on the ten year Treasury note has gone from a high of 4.8% to under 4%, triggering a major rally in the bond markets.
With short term interest rates being pushed up by the Fed, and long term interest rates being pushed down by the market, the yield curve has flattened considerably. As a result, Starmont has shortened up on the maturity of the bonds we are purchasing for our Clients, since the reward offered by longer term bonds is not great enough to justify the risk of those bonds declining significantly in value when long term interest rates turn up.
Conclusion
We are in a very difficult investment climate at the present time. Investors in the public markets should focus on preserving their existing capital, and then attempting to grow their portfolios at better than inflation rates (preserving the purchasing power of the money in their portfolios) until more favorable returns become available. The strategies mentioned in this article are designed to accomplish this objective.
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