Fear and frustration dominated investor psyches during August and September as backlash from political gridlock in the U.S. and worries of European contagion dominated action in volatile investment portfolios. Elevated 9.1% unemployment and a sluggish recovery in the U.S. also led populist Occupy Wall Street protesters to flood our nation’s streets, blaming the bankers and the wealthy as the cause for personal misfortunes and the widening gap between rich and poor. However, in the face of the palpable pessimism, economic Halloween treats and greedy corporate profits scared away bearish naysayers like invisible ghosts during the month of October.
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While many investors stayed home for Halloween in the supposed comfort of their inflation-losing savings accounts and bonds, those investors choosing to brave the chilling elements in the frightening equity markets were handsomely rewarded. Stockholders tasted the sweet pleasure of a +11% October return in the S&P 500 index, the largest monthly advance in 20 years.
Of course, as I always advise, investors should not load themselves to the gills in stocks just to chase performance. Rather, investors should construct a diversified portfolio designed to meet one’s objectives, constraints, risk tolerance, and liquidity needs. Within that context, a portfolio should also periodically rebalance by selling pricey investments (i.e., Treasuries) and redeploy those proceeds into unloved investments (i.e., equities).
Glass Half Full
There is never a shortage of reasons to be fearful and a one-month rally in equities is not reason enough to blindly pile on risk, but there are plenty of reasons to counter the endless pessimism pornography peddled by media outlets on a continuous basis. Here are some of the “half-full” reasons:
- Euro Plan in Place: After months of conflicting headlines, European leaders reached an agreement to increase the European Union’s bailout fund to one trillion euros ($1.4 trillion) and negotiated a -50% debt reduction deal with Greek bondholders. In addition, European officials agreed on a plan to increase bank reserves by 106 billion euros to support potential bank losses due to European debt defaults. This plan is not a silver bullet, but it is a start.
- Bulging Corporate Profits: With the majority of S&P 500 companies now having reported their actual third quarter results, profit growth is estimated to exceed +16% for the three month period ending in September. Expectations for fourth quarter earnings are currently forecasted to top a respectable +11% growth rate (Data from Thomson Reuters).
- Tortoise-Like Growth Continues: Even though it’s Halloween, the double-dip recession boogeyman is still hiding. U.S. economic growth actually accelerated its growth to +2.5% in the third quarter on a year-over-year basis, up from +1.3% last quarter. The growth in Gross Domestic Product was primarily driven by consumer and business spending.
- Jobs Still on the Rise: The unemployment rate remains stubbornly high, but offsetting the ongoing decline in government jobs has been a 19 consecutive month spurt in private job creation activity, resulting in +2.6 million jobs being added to the economy over the period. This doesn’t make up for the 8 million+ jobs lost during the 2008-2009 recession, but the economy is moving in the right direction.
- Consumers Opening Wallet: Consumers can be like cockroaches in that they are difficult to kill off when it comes to spending. Consumers whipped out their wallets in September as retail sales advanced at a brisk +7.9% pace (+7.8% excluding auto sales).
- Dividends on the Rise: While nervous Nellies park money in money losing cash and Treasuries (on an inflation-adjusted basis), corporations flush with cash are increasing dividends at a rapid clip. According to Standard & Poor’s rating agency, dividend increases rose over +17% during the third quarter of 2011. As of October 25th, the indicated dividend for the S&P stood at a decent +2.20% rate.
I am fully aware that equity investors are not out of the woods yet, as the European debt crisis has not been resolved, and the structural deficit/debt issues we face in the U.S. still have a long way to go before becoming disentangled. As a matter of fact, fear is building as we approach the looming deficit reduction Super Committee resolution (or lack thereof) later this month – I can hardly wait. If a $1.5 trillion bipartisan debt reduction agreement can’t be reached, some bored Occupy Wall Street protesters can shift priorities and take a tour bus to Washington D.C. to demonstrate. Regardless of the potential grand European or Washington debt plans that may or may not transpire, observers can rest assured fear and greed are two emotions that will remain alive and well when it comes to Wall Street and “Main Street” portfolios.
Wade W. Slome, CFA, CFP
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in JPM, or any other security referenced in this article.