Permanent Value

Weekly Update: December 6- 10, 2010

Michael La Salle
December 10th, 2010

Stocks Up as Lawmakers Inch Closer to Tax Deal

Stocks were up this week as lawmakers continue to argue over new tax deal.  The Dow Jones Industrial average gained 0.25% and the S&P 500 jumped 1.28%.

In economic news, the December 4th week’s initial jobless claims were down 17,000 claims from the previous week.  Analysts were expecting a drop to the 425,000 level, but were surprised by the 421,000 level.  The overall U.S. trade deficit in October shrank to $38.7 billion from $44.6 billion in September, less than analysts’ projections of $44.0 billion gap.  The University of Michigan’s Consumer sentiment index for December came in at 74.2 versus November’s 71.6 as consumers are beginning to feel the effects of the improving economy.

In quarterly earnings news, Costco Wholesale Corporation beat analysts’ expectations by posting earnings of 71 cents per share.  National Semiconductor Corporation also surprised this week after posting earnings of 34 cents per share, 6.25% better than expectations.

Stress Test Your Portfolio

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 often 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.

Market Returns

This Week Year to Date Last 12 Months Last 5 Years
S&P 500 1.28% 11.24% 12.52% -1.51%
Dow Jones Industrial Average 0.25% 9.42% 9.65% 5.86%

Next Week’s Economic Releases

December 14 – Producer Price Index, Retail Sales

December 15 – Consumer Price Index, Industrial Production

December 16 – Housing Starts, Jobless Claims, Philadelphia Fed Survey

December 17 – Quadruple Witching, Leading Indicators