Permanent Value

Weekly Update: August 23-27, 2010

Michael La Salle
August 27th, 2010

Stocks Fall on Disappointing Economic News

Stocks closed the week out lower as the Dow Jones Industrial Average fell 0.62% and the S&P 500 lost 0.66%.  A rally was ignited Friday as Fed Chair Ben Bernanke stated the Fed is not “impotent” and ready to defend the U.S. economy.

In economic news, existing home sales fell 27.2% in July to a 3.83 million annual rate for the lowest level since 1995.  Expectations would have placed the annual rate at 4.65 million for July.  Despite the extremely slow pace of sales, prices only were down 0.2% for the month.  New home sales for July also fell to a new record low as the annualized rate dropped to 276,000.  Durable goods orders also disappointed this week as new orders were up 0.3% for July, significantly below expectations of a 2.5% jump.  Better news came later in the week as jobless claims surprised on the upside as the new claims level rose to 473,000, well below the anticipated 495,000 level.  Gross domestic product also came in higher than expected as the, although low, quarter over quarter growth was 1.6%.  Expectations were set at a growth rate of 1.3% for the second quarter.

In earnings news, an extremely slow week was highlighted as Barnes & Noble disappointed as the specialty retailer reported a loss of $1.02 per share, well below the expected loss of 80 cents per share.  Burger King Holdings, on the other hand, surprised on the upside as the company posted earnings of 36 cents per share, 5.88% higher than analysts’ estimates.

What opportunities are ahead?

Investing in today’s economic environment can be very confusing.  Many investors jump around from investment to investment with little thought of the implications of the trades they place.  Without a sound investment strategy to follow many investors see returns that are inconsistent and surprising.  Since the most common reason for investing is to create a source of income by having money work for you, it is not in the investor’s best interest to have a portfolio that is scattered and unpredictable.

When developing an investment strategy, it is imperative to understand the tradeoff between risk and return for each individual investment and the effects it will have on the entire portfolio.  Although we all know the old disclaimer, “past performance is not an indication of future results,” there is no reason we cannot use historical information to give us an idea of how certain investments react in certain market environments and how they move in relation to each other in these environments.

Using certain tools, investors are able to perform a “stress test” on their portfolios.  Just like when you go to the doctor and they hook you up to a few machines and have you run on a treadmill, a portfolio “stress test” will also give you an idea of how your investments will hold up when it is under market pressure.  Using a Monte Carlo Simulation, which provides a sophisticated method to analyze the risk of your portfolio, you are able to see what you can realistically expect from your portfolio in many different market conditions.

After analyzing the information gathered by the Monte Carlo Simulation you should be able to reasonably predict the best, worst, and a median return that can be expected with its current allocation.  In addition to the possible returns your portfolio may return, the Monte Carlo can also give you information like the Sharpe Ratio, which is a measurement of the expected return per unit of risk, in other words, is the return you are expecting from good investment decisions or from simply taking more risk.

Without a sound investment strategy investors are often guilty of making emotional decisions that are not in line with their long-term objectives for their portfolio.  By developing a strategy and putting your portfolio through the ringers of a “stress test” you can give yourself the best chance of realizing your financial goals.

If  you or someone you know would benefit from having a stress test done, contact us for our complimentary Portfolio MRI.

Market Returns

This Week Year to Date Last Year Last 5 Years
S&P 500 -0.66% -4.53% 3.26% -11.66%
Dow Jones Industrial Average -0.62% -2.66% 5.95% -2.37%

Next Week’s Economic Releases

August 30 – Personal Income & Outlays

August 31 – Consumer Confidence

September 1 – ISM Manufacturing Index

September 2 – Jobless Claims, Pending Home Sales

September 3 – Employment Situation