Permanent Value

President’s Message

Bruce Doole
October 17th, 2011

UNCERTAINTY BREEDS VOLATILITY…

We are currently in a very uncertain economic environment.  Not many people would disagree with that statement.    While picking which way the market is going from day to day is next to impossible, we like to give you a long-term general sense of the market.   The recovery after the recession of 2007-2009 has been so slow in terms of economic and job growth,  and this is why it’s hard for investors to ascertain where markets are going so they can choose whether to participate in economic growth and or prepare for another recession (according to Warren Buffett, it is “very unlikely” the US economy will go back into a recession.)   That is why you keep seeing such volatility in stocks, bonds, gold, and currencies whenever there is another pronouncement from Europe or Washington.   

This past quarter the federal debt limit was a big part of the news.   There is a lot of misinformation about the debt out there so I wanted to give you a few facts about what is happening.  One of the issues that have to be addressed is not only the sheer size in dollar figures but also the debt as a percentage of our economy.   Authors Carmen Reinhart and Kenneth Rogoff have written a paper (“This Time is Different: Eight Centuries of Financial Folly”) on sovereign debt and its impact on a country’s ability to grow.  The authors conclude that a country’s growth slows substantially once the country’s level of public debt exceeds 90% of the size of its economy (source: Peterson Institute for International Economics, Harvard University).   The USA’s public debt is projected to be 71.2% of the size of our economy in 2012 (source: Congressional Budget Office) which led ulitmately to a downgrade of the Federal Government’s debt by Standard and Poors.   

So what impact does this have on our investments you might ask?   Since we invest in US Treasury bonds from time to time we thought we share a few numbers with you.  The yield on the 10-year Treasury note was 2.57% on 8/05/11, the day that S&P announced a downgrade of the USA from AAA to AA+.  Now 8 weeks later, the yield on the 10-year Treasury note closed last Friday (9/30/11) at 1.92% as funds around the world continue to buy US debt (source: Treasury Department).    Another result of the downgrade was a significant drop in the stock market over the past quarter and in fact the S&P 500* lost 7.0% (total return) in September 2011 [alone], its 5th consecutive down month.  The S&P 500 has experienced 5 consecutive down months only 3 times since 1990 including the negative stretch that ended last Friday (9/30/11).    This all took place in light of corporate profits being significantly higher than when the recession started in 2008.   In fact, the earnings projected to be generated by the companies in the S&P 500 stock index in calendar year 2012 are more than 6 times as large as the actual earnings of the 500 companies during calendar year 2008 (source: S&P).               

*The S&P 500 is an unmanaged index of 500 widely held stocks generally considered representative of the US stock market (source: BTN Research).   

What has a government that is set up to spend more than it saves (politicians don’t get elected on $ they save; they get elected on the $ they bring home to their districts/states) done about the federal debt you ask?    On 2/14/11 President Obama proposed $1.1 trillion of deficit reductions over the next 10 years.  On 4/13/11 he proposed $4.0 trillion of deficit reductions over the next 12 years.  On 9/19/11 he proposed $4.4 trillion of deficit reductions over the next 10 years (source: White House).  So forget about ten years, how is this year going to look?   Fiscal year 2012 (10/01/11 to 9/30/12) began a week ago Saturday.  The most recent projection (released on 8/24/11) for the fiscal year by the government anticipates $2.6 trillion of revenue, $3.6 trillion of spending, and a deficit of $973 billion (source: Congressional Budget Office).

All of this news requires us to be more vigilant than ever so that we can preserve, protect, and ultimately grow your money.  We look forward to meeting with you to discuss your strategy and make any year-end adjustments that will make your strategy more effective.