Market Commentary – September 22, 2011 Executive Summary Investors Aren’t Dancing the Twist Today Big declines in the stock market or changes in bond yields can often be traced to news on the economy or policy decisions. Today’s drop of over 400 points in the Dow Jones Industrial Average as of early afternoon, and fall in Treasury yields to record levels for the postwar period, is not one of them. Yesterday, the Fed announced what observers have called "Operation Twist" – an attempt to reduce long-term interest rates by buying $400 billion of long-term Treasury securities out of its portfolio and selling an equivalent amount of short-term securities. (Treasury bond yields move inversely to bond prices.) The idea is that a decline in rates on mortgages and corporate bonds, which usually follow Treasury yields, will encourage home buying and business investment. The announcement of "Operation Twist" was widely anticipated: 69% of the respondents to a September 19 CNBC survey of money managers, strategists, and economists thought the Fed would announce such an operation at its September meeting, and that it would be close to $400 billion in size. So why was the Fed’s announcement greeted with such a large and negative market reaction?
Some might attribute the market’s move to disappointment that the Fed did not announce a new massive bond buying program that would flood the markets with more liquidity. The most recent such program, nicknamed QE2 (for Quantitative Easing II), launched in November 2010 and ended at the end of June 2011, was accompanied by an 11% rise in the Dow. But surveys suggest that only a minority of market participants expected the Fed would embark upon such a program yesterday. A more plausible explanation is that the announcement made after yesterday’s meeting of the FOMC, the Fed’s policymaking body, contained more language about slow economic growth than previous statements. That the global economy is weak is hardly news to the markets, but the Fed’s willingness to say so is an official acknowledgement that growth is a concern, and as such, can be viewed as underscoring, if not accentuating, the market’s unease.
With the markets volatile, and disappointment at the policy paralysis on both sides of the Atlantic widespread, investors who have exited the stock market will be relieved that they have preserved principal. But it is worth pointing out that the slow economic growth, which is now the consensus view among economists, is not the same thing as a recession, which many in the markets seem to expect. Recessions typically follow periods of excess, in which firms are left with large inventories of unsold goods, and occur after a tightening of credit conditions. That does not describe the current situation. In our view, rather than exiting the stock market altogether, it would be better to maintain an allocation to equities (the size of which should vary with the risk tolerance of each investor), but stay defensive. This means favoring stocks that pay high dividends and the traditionally more defensive sectors of the market such as consumer staples, health care, and utilities, all of which have tended to outperform in periods of slow economic growth. In bonds, it makes sense, in our view, to be in investment-grade corporate bonds, which offer a return in the form of a spread over Treasury securities.
The act of making some positive portfolio moves, even if they are not large, might itself be rewarding enough to help ease the pain of days like today.
This information is compiled by Cetera Financial Group from source material obtained or provided by US federal and state departmental websites, equity index sponsors Standard & Poor’s, Dow Jones, and NASDAQ, credit ratings agencies Standard & Poor’s, Moody’s Ratings, & Fitch Ratings, domestic and foreign corporate issued newswires and press statements, and from referenced compilations and index readings by Bloomberg Professional. The information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The information has been selected to objectively convey the key drivers and catalysts standing behind current market direction and sentiment.
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