Pleasant surprises aren't always that pleasant.
The soft patch in the U.S. growth outlook that emerged as the year got under way took economists by surprise. Since then, many have lowered expectations for key economic indicators, and that lowered bar has led to some better-than-expected data readings. The danger as the second half kicks off is that these prove to be head fakes.
The degree to which economists missed the economic slowing was captured in economic surprise indexes. These are meant to disclose bouts of excessive optimism or pessimism among forecasters. A move into negative territory shows economic data came in below consensus expectations, and vice versa.
Starting in February, these gauges compiled by banks like Barclays Capital and Citigroup collapsed into negative territory. The extent to which data missed expectations was on a scale not seen since the financial crisis. Forecasters then changed tack; expectations for June data are now down sharply from earlier levels. Yet the lowered expectations bar sets the stage for positive surprises. Any positive surprises, though, may obscure the fact economists have been slow to cut gross-domestic-product growth projections for the latter part of 2011.
After a tumultuous second quarter, investors could certainly be forgiven for feeling dazed and confused.
While the Dow Jones Industrial Average ended the quarter up 0.8%, the positive result belies the whipsaw nature of trading through many financial markets. As the third quarter opens, typically a sluggish trading quarter, investors face the prospect of continued volatility.
The oft-repeated trading term "risk on, risk off" is again dominating, with stocks, currencies and commodities moving in response to macro events—rising and falling as investors became alternately optimistic and despondent about global economic growth, Europe's debt woes, and the impact of Japan's earthquake and tsunami. When they do buy, individual investors have been shunning U.S. stocks in favor of bonds. Markets are seeing quicker turns in sentiment, making it harder for investors to find trends to ride. Though trading volumes on the New York Stock Exchange and NASDAQ were down more than 30% in the second quarter, from 2010, the headline effect is of extensive volatility in the market which shakes the nerves of traders and individual investors alike, and in turn causes more trading volatility without fundamental cause.
For the Dow, that meant an April rally of nearly 4% was followed by a collapse that lasted through mid-June; other markets also saw sharp reversals. Crude oil on the New York Mercantile Exchange slid 16% from an April 29 high to finish down 11% for the quarter at $95.42. The yield on the 10-year Treasury note swung from 3.57% in early April, down to 2.87% on June 24 before climbing to 3.16% at the end of the quarter. The dollar was on its own roller-coaster against the euro between $1.38 and $1.49.
On June 30, the Federal Reserve ended its $600 billion bond-buying program, termed QEII. Some traders believe that without the steadying hand of the Fed, volatility could be on the upswing. Sentiment swung from optimism about the global expansion in the first quarter, to worries about the extent of an economic
soft patch that followed a rise in oil prices and the disaster in Japan. During late May and much of June, the markets were buffeted daily, and sometimes hourly, by conflicting headlines about the Greek debt crisis. In the currency markets, most strategies had a tough quarter, traders say, thanks in large part to a rally in the euro despite the renewed concern about the Greek debt crisis.
Since the financial crisis, there has been a "behavioral trauma" among individual investors. There's an absolute focus on principal protection and capital preservation, with the desire to derive returns almost exclusively from income. When investors have typically turned to stocks, dividend payers have been in more recent favor, a change from 2009 and 2010, when stocks were led higher by companies seen as lower quality.
Some of our clients are now asking about the possible U.S. default as Congress sits at an impasse in budget negotiations. As we have seen in our political system in the past, this is a game of political football with both Republicans and Democrats in the first of a series of battles over taxes and spending, the next of which is due after the 2012 election. Republicans want everyone to know they resisted tax increases until the last moment so Democrats get blamed; they seem to be succeeding. Democrats want to campaign on the idea that they protected Medicare and Social Security from Republicans, and see little reason to surrender that talking point unless Republicans are implicated in tax increases.
What does all this mean for our clients? It means that we are managing your portfolios prudently, watching for fundamental strengths and weaknesses in the global markets and not reacting with the whipsaw approach that is causing such extreme volatility in the markets. Our approach, as always, relies on careful asset allocation between stocks and bonds as appropriate to each client’s financial situation. We are looking for real opportunities in the markets without exposing you to excessive risk or volatility.
That said, JCFA portfolio performance has been exceptional this quarter. With many portfolios holding 45-50%, or more, in bonds and the bond market benchmark returning 2.6% - many JCFA portfolios have been up well over the relevant benchmarks. We are proud of our long run of superior risk adjust returns.
The strong partnership between Joyce and Priscilla allows us to add new clients, many of whom have been referred by our existing clients- always a welcome event. We are happy to have clients in any location.
We hope you are having a wonderful summer enjoying a relaxing change of pace from your usual routine. We always enjoy hearing from you.
Joyce and Priscilla