Posted by: Kim_Hamilton on 04/06/2011 12:39 PM
Updated by: Kim_Hamilton on 04/06/2011 12:51 PM
Expires: 01/01/2016 12:00 AM
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Investing In Times of Global Uncertainty~by Donna Stevenson of Pacific West Financial Group
In times of global uncertainty, making prudent investment decisions requires special diligence. When natural disasters strike and leading nations become embroiled in conflict, it can be difficult to find clarity amidst the barrage of disquieting headlines. This email is designed to help you find that clarity, and hopefully, sleep better at night......
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Donna Stevenson, Wealth Manager
"Investment Solutions"
Your Money: Investing in Times of Global Uncertainty
Investors have faced significant challenges during this new millennium. Starting in the early 2000s, we saw the burst of the dot-com bubble that riled markets from March 2000 until October 2002. During that same time period, the national tragedy of September 11, 2001 shook American confidence on many levels, with the corresponding aftermath introducing a six-day market close and the Dow's biggest one-day point drop of all time.[1] The two periods of recession bookending the 2000s led to a weak job market, a weak housing market, and a general lack of confidence.
The slow yet steady recovery from these events was again derailed during the financial crisis that began in 2007 and continued through 2009. This crisis stemmed from problems in mortgage-backed securities, which saw their values plunge as home prices went into their worst slide since the Great Depression and foreclosures soared to record levels. Today we continue to deal with a still-compromised housing market, the collapse of the sub-prime mortgage industry, and high unemployment.
We finally started to see solid returns in 2010, but the European sovereign debt crisis was looming. The Euro zone crisis began with headlines about the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) inflation rates, austerity measures, and bailouts. In May 2010, policymakers created an emergency financial package, funded by Euro zone states and the International Monetary Fund (IMF), worth 750 billion euros ($1 trillion) to protect the euro.[2] Amidst all this, United States' stock markets managed to hold their own, even advancing significantly for 2010, but have remained virtually flat for the first quarter of 2011.
The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq and is considered to be an indicator of the overall condition of the stock market. Indexes cannot be invested into. Chart is for illustration purposes only. Source: Yahoo Finance
In recent weeks investors have been further rattled by turmoil in the Middle East, as well as the catastrophic destruction in Japan. Given the history just outlined, you might be questioning what you should do with your investments. Should you stay in? Get out? Stay out? Let's consider some of the facts that may help you draw the right conclusion.
Euro zone
Europe's debt market worries are creeping up again as investors fret over how Portugal and Ireland will cope with austerity measures. Worries include the long-term solvency of the PIIGS, the stability of Europe's banking system, the implementation of austerity programs, and the widening gap between core members of Europe and those on the periphery. The European Central Bank has repeatedly warned that a default by any Euro zone member would have devastating consequences for the European financial system.[3]
The 17 countries that make up the Euro zone have agreed to increase the lending capacity of the bailout fund to 440 billion Euros ($621.7 billion) to help stop the bleeding, but many questions remain.[4]
Important Perspective:
While all this may sound daunting, the good news is that U.S. markets, recognized for their resiliency this year, have remained relatively unfazed by political and financial crises in the Euro zone. The initial anxieties sparked in the spring of 2010 have calmed, partially because trade between the U.S. and Europe is relatively small. Exports account for only about 12% of U.S. economic activity and 3% of GDP.[5]
While U.S. banks lend to their European counterparts and hold billions in investments, analysts agree that American banks have enough capital to withstand losses from a European crisis. U.S. banks' exposure to the PIIGS amounts to only 5.4% of loans and U.S. lending to Europe accounts for only 10% of total U.S. bank assets.
The Middle East and Oil
After the fall of dictatorial governments in Tunisia and Egypt, unrest spread throughout the Middle East, with conditions in Libya dominating the news over the past few weeks.
Initially, investors were alarmed by Egypt's position along the major trade route of the Suez Canal, and the uprising's affect on oil production. The same concern is echoed in Libya, despite its mere 2% contribution to world oil supplies.[6] Unrest has also spread to neighboring countries, including Yemen, Bahrain, Syria, and Saudi Arabia. Yet fears were eased slightly when Saudi Arabia increased its crude oil production to 9 million barrels a day to make up for supplies lost in Libya.[7]
Because these regions influence oil prices, U.S. drivers almost immediately felt the pinch at the pump. On March 18, the national average for regular fuel was $3.57/gallon, nearly 76 cents above last year's level. The same Lundberg survey found that 62% of participants cited rising gas prices as the biggest concern for the U.S. economy right now.[8] In general, every $1 increase in the price of oil costs consumers $1 billion over the course of a year.[9] And as gas prices rise it could affect consumer spending, thus slowing the U.S. recovery. Higher oil prices also weigh on the U.S. economy by increasing the costs of moving goods, thus transferring rising costs to manufacturers, wholesalers, retailers, and eventually the American public.
Important Perspective:
While acknowledging that a prolonged rise in oil prices could pose a danger to the economic recovery, Federal Reserve Chairman Ben Bernanke reiterated his commitment to keeping inflation low, and added: "I recognize that the increases in gas prices are very troubling... but they are not inflation per se. Inflation is an increase in the overall price level, which is very low. The inflation rate right now is 1.2% for all goods and services."[10] The drop in demand from Japan could also ease soaring gas prices.[11]
Significantly, oil fell from its highest point in more than two years in late March on signals that supplies are rising in the U.S. and concerns that the Middle East conflict will spread to Saudi Arabia eased. Futures slipped as much as 0.6% as Yemen's president agreed to hand over power by the end of the year and U.S. crude stockpiles grew for a third week.[12] As it relates to the conflict in Libya, it is also important to mention that our reliance on their crude oil exports is relatively low compared with other parts of the world, as shown by the chart above.
Asia
Coincidentally, differing circumstances have taken a toll on the world's second-largest and third-largest economies - China and Japan, respectively. China's government has tightened their economic policies three times this year, raising lending rates in an effort to curb inflation.[13] Despite ordering banks to set aside more cash, inflation remains a threat as China attempts to avoid a disintegration of their housing market.[14]
China's currency (the Yuan) is widely seen as being at least 20% artificially undervalued, which has driven up Chinese exports and amassed a U.S. trade deficit of $227 billion in the last year alone.[15] This trade deficit has been felt throughout the U.S. political system. The House of Representatives has already passed a bill that would give the administration power to penalize countries judged to be manipulating their currency values to gain a competitive edge in international trade.
The world's third-largest economy has recently been dealt a triple blow. On March 11, 2011 an 8.9 earthquake rocked Japan and generated a 30-foot-high tsunami that devastated the country's northeastern coast. On the heels of this devastating news were reports of several damaged nuclear reactors that continue to be a media feature.
Almost immediately, Japan's recession-burdened stock markets dropped.[16] Many of the nation's industries, including Honda and Nissan, were forced to halt operations. These shutdowns come at a time of strong recovery in global consumption (U.S. auto sales clocked their strongest pace in 18 months in February).[17] Several carmakers, including Toyota, Subaru, and GM have postponed production at their North American assembly lines because of a lack of supplies.[18] Americans should likely prepare for higher prices on Japanese cars and other products in the months ahead.
Japan's hold on the global electronics supply chain is also an area of concern - every major computer and consumer electronics maker relies on components that directly come from Japan (See chart).[19] Sony, producer of about a fifth of the world's computer chips and exporter of $91.3 billion worth of electronic parts last year, will close or cut output for the rest of March due to parts shortages.[20] Similarly Apple is contending with the natural disaster's affect on iPhone and iPad2 components. With wait times for iPads stretching to four to five weeks in the United States, investors have begun to worry about Apple's ability to keep up with customer demand.[21]
Important Perspective:
Despite many uncertainties in Japan, their recovery has the potential to reward savvy investors.* Since experts are optimistic that the earthquake's impact will have a relatively mild long-term effect on Japan's economy, a cross-section of investors are watching the Japanese market with the intent to invest - viewing the Nikkei's sharp drop as the best time to get in. In fact, a whopping $956 million flowed into Japanese equities in the week ending March 16 alone, according to data from Thomson Reuters Lipper service.[22]
U.S. commodity industries will likely benefit from exporting necessary goods to Japan. Over the long term, producers of building materials and construction equipment will gain from Japan's reconstruction effort. The U.S. will also likely assume production to supplement lost capacity in Japan, increasing demand in the U.S. automotive and electronic industries. U.S. goods exports to Japan made up just 0.4% of GDP in 2010, and Japan accounted for less than 5% of total U.S. goods exports. At the same time, U.S. exports to China have grown almost eightfold.[23]
What about Investors?
By and large, rational people don't like uncertainty. Especially when it comes to our investments, we generally prefer predictable, consistent returns. Realistically though, we must acknowledge that the world we live in is filled with uncertainty. Just a few months ago, who could have predicted the uprising in Egypt, the earthquake in Japan, or the no-fly zone over Libya? The answer is obvious.
And so, as investors - and as financial professionals - we are presented with this challenge: Where and how should we invest to achieve the highest possible return with the least amount of risk? This is not an easy challenge to meet, and it's one of the reasons we encourage you to seek professional advice when investing. For your reference, here are a few of the strategies we use to help our clients meet their goals.
* Diversification: In general, when crisis erupts in one region, areas of opportunity exist in others. While no single asset class does well all the time, a mixture spread across multiple asset classes can help smooth out highs and lows.** This approach may not provide the best (or worst) return, but in environments like we are currently facing, it is important to diversify. This is why we work very hard to help our clients select a mix of asset classes that will be right for them personally, but that will also help them achieve their financial goals.
* Active Management: Just because something is a good investment today doesn't mean it will be a good investment tomorrow. This is why we choose to engage the human element - in the form of a single manager, co-managers or a team of managers - when making investment decisions. Active managers rely on analytical research, forecasts, and their own judgment and experience in making investment decisions on what securities to buy, hold and sell. Both at our firm and at most of the investment companies where we place our clients' assets, an active management strategy is employed.
* Insurance: In addition to traditional investments, our firm also utilizes a variety of insurance products to help our clients prepare for the unexpected. Our combination of licenses, registrations, and special education qualify us to work with all types of investments. There is virtually no investment vehicle we cannot utilize if the circumstances call for it - simple or complex.
One of the biggest challenges investors face is resisting the urge to make emotional, knee-jerk reactions. Not too long ago, the September 2010 business section of USA Today read "Shell shocked investors quit the market." The S&P 500 then gained +20.6% over the last four months of 2010.[24] Can you imagine how disappointed you would be to miss out on that rally?
When their investments are rising, people tend to feel overly confident and are motivated to invest. Conversely, when investments are declining, investors' nerves can easily get the best of them, prompting them to pull out. Often, this trap causes investors to buy high and sell low, the exact opposite of what they desire to do.
We understand that it is hard to have peace of mind about investing when you've been through the upheaval of the last decade. If you are uncomfortable with any of your current investments or have questions about how you are allocated, we are always happy to discuss your personal situation. Simultaneously, we also want to assure you that we are diligent about making investment decisions that we discern to be in your best interests - both in the short-term and the long-term. If you have questions about anything you've read in this paper, please don't hesitate to give us a call. It is a pleasure serving you!
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Pacific West Financial
(209) 785-4660
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