Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  N/A means not applicable or not available.

THREE KEY IDEAS FROM STEVE JOBS

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  N/A means not applicable or not available.

WHAT TO WATCH IN THE FOURTH QUARTER

Here are a few things that made the headlines in the third quarter and may affect the markets over the final three months of the year:

The S&P 500 index dropped 14.3 percent in the third quarter and is now down 10.0 percent for the year.

What to Watch: Third quarter corporate earnings will start rolling in soon and investors will scour them for any sign of weakness. For the past few quarters, strong earnings helped the market recover from the Great Recession. While some earnings weakness may already be priced in the market, we have to wait for the actual earnings to see how the market reacts.

Commodities and precious metals experienced significant price movements during the quarter. Gold prices finished the quarter up 8 percent, while silver dropped 14 percent, according to MarketWatch. Oil prices declined 17 percent for the quarter, while copper dropped a stunning 26 percent. On the agricultural side, corn prices finished the quarter down 25 percent from their June 10 all-time high, according to The Wall Street Journal.

• What to Watch: Recent declines in oil and copper prices are particularly noteworthy because they may presage a slowing worldwide economy. If the declines continue, it may not bode well for stock prices.

The housing market is still weak and that puts a significant drag on economic growth. According to the most recent S&P/Case-Shiller Home Price Indices, housing prices around the country are back to where they were in the summer of 2003.

What to Watch: Mortgage rates are at a record low yet the housing market is still in the doldrums, according to Bloomberg. Any sign that housing is turning the corner could bode well for the economy and the markets.

Interest rates on U.S. government securities dropped significantly in the third quarter as the flight to safety continued. The yield on the 10-year Treasury note recently hit a paltry 1.67 percent — the lowest yield since the 1940s. While low rates are good for businesses and our indebted government, it’s bad for savers who rely on interest income to support their living expenses.

What to Watch: If interest rates keep dropping in the fourth quarter, it may suggest investors are still in a fearful state. Ironically, it could be a good thing to see interest rates rise– as long as it’s due to economic growth and not due to money printing by the Federal Reserve.

Sovereign debt woes in Europe and budget wrangling in the U.S. weighed on the financial markets in the third quarter.

What to Watch: Continued bad news here could be very problematic. However, if there’s any concrete resolution to the Euro-zone debt problems or a credible bi-partisan budget solution in Washington — look out. The financial markets could rally strongly on that kind of news.

With the above issues looming, you can see why the markets are a bit nervous. Yet, even if the market swoons in the fourth quarter, it could make valuations so compelling that it sets the stage for the next bull market.

Weekly Focus – Think About It

“I wanted a perfect ending. Now I’ve learned, the hard way, that some poems don’t rhyme, and some stories don’t have a clear beginning, middle, and end. Life is about not knowing, having to change, taking the moment and making the best of it, without knowing what’s going to happen next. Delicious Ambiguity.” –Gilda Radner

The Federal Reserve did “The Twist,” but the financial markets ended up in “A Knot.”

In a much anticipated action dubbed “Operation Twist,” the Federal Reserve announced last week it would reshuffle its balance sheet by selling $400 billion of shorter-term Treasury securities and use the proceeds to buy longer-term securities. The Fed said it hopes the action will lower longer-term interest rates and, “contribute to a broad easing in financial market conditions that will provide additional stimulus to support the economic recovery.”

So far, as it relates to interest rates, the Fed’s action has worked. The yield on the 30-year Treasury bond declined from 3.2 percent the day before the Fed’s announcement to 2.9 percent just two days later, according to data from Yahoo! Finance. That’s a rather dramatic decline for such a short period.

Unfortunately, the stock market failed to respond positively to the Fed’s announcement as the S&P 500 index lost 6.4 percent for the week. The market’s drop, though, went beyond disappointment in the Fed’s action. The following also contributed to the market’s red ink:

• Intensified fears of a Greek default.
• Rising concern of a world-wide financial crisis, with sovereign debt at the epicenter.
• Growing signs of sluggish economic growth in China, which had been one of the few countries immune to economic turmoil.
• A 13 percent drop in the price of copper on Thursday and Friday of last week, which is concerning because the price of copper is often viewed as a proxy for worldwide industrial growth.

Sources: Wall Street Journal, MarketWatch, Bloomberg

With the market’s blood pressure rising, it reminds us of what flight attendants often say, “Ladies and gentlemen, the Captain has turned on the fasten seat belt sign. We are now crossing a zone of turbulence. Please return to your seats and keep your seat belts fastened. Thank you.”

Likewise, as your “Financial Captain,” we know there may be market volatility along the way, but, as always, we’re focused on trying to help you arrive safely at your financial destination.

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  N/A means not applicable or not available.

AN OFTEN OVERLOOKED ASPECT OF SUCCESSFUL STOCK INVESTING is the importance of dividends. In bull markets, investors tend to focus on price appreciation, meaning, they look for stocks that can increase in price. In heady times like the late 1990s, investors feasted on stocks that would double or triple in a matter of months. Watching a stock go from $20 a share to $40 or $60 a share is exhilarating and makes for good cocktail party chatter. On the other hand, watching a stock sit at $20 a share for several years while you collect and reinvest a 3 percent dividend is rather boring and not worth sharing on the social circuit.

However, just like the old story about the tortoise and the hare, the slow and steady growth of dividends plays a very important role in making money grow over time.

The past 10 years is a great example of how dividends have helped improve the returns of an otherwise disappointing stock market. Here’s the data:

• For the 10 years ending September 23, 2011, the S&P 500 index had a positive average annualized return of 1.3 percent excluding reinvested dividends.
• For the 10 years ending September 23, 2011, the S&P 500 index had a positive average annualized return of 3.6 percent including reinvested dividends.
• As shown above, receiving dividends and reinvesting them added 2.3 percentage points per year to an investor’s return compared to the return generated by price appreciation alone of the underlying stocks in the S&P 500.

Sources: Morningstar, Yahoo! Finance

In today’s environment of low returns, finding a way to possibly eke out an extra 2.3 percentage points of return per year is attractive.

Over a longer period, receiving dividends and reinvesting them has accounted for one-third of the total return of the S&P 500 index over the past 80 years, according to Standard & Poor’s.

Standard & Poor’s also points out the following benefits of dividends:

• When bond yields are low, like they are now, dividend paying stocks might be a way to enhance an investor’s current income.

Just like any other investment, though, you need to figure out how dividends fit within your overall investment strategy. Are you looking for dividends to provide stability, income, or growth within your portfolio? Or, perhaps it’s some combination of all three.
Considering how dividends fit within our clients’ portfolios is just one more way that we’re trying to add value.

Weekly Focus – Think About It
“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

–John D. Rockefeller

The Markets

Are the world’s economic leaders focused on solving the wrong problem related to Europe’s sovereign debt woes?

As you may know, Greece and several other European countries are in debt up to their eyeballs.  Much of their debt is held by European banks and there’s a big worry that if Greece or some other countries default, then some European banks may face major write-offs that could severely jeopardize their viability.

Unfortunately, what the powers that be in Europe are doing is akin to you going to the doctor and being treated for severe back pain with a heavy dose of pain medication.  Rather than “heal” your back, the pain killer simply “masks” the pain.

Last week, five of the world’s leading central banks announced a coordinated action that made it easier for European banks to borrow U.S. dollars to help fund their loan needs, according to The Wall Street Journal.  This move addresses the “liquidity” of European banks, but not the “solvency” of them.  In other words, it helps ease the symptoms of the problem without actually solving the problem.

Simply put, a liquidity problem means you are short on cash and unable to meet current payments due.  Typically, it’s a temporary situation that’s resolved by a loan or selling an asset to raise cash.  By contrast, a solvency problem is much different.  It means you have a structural defect and you revenue/assets are not high enough to support your expenses/liabilities.  In effect, your business model is unsustainable.  Frequently, it leads to a restructuring or bankruptcy.

In Europe, Greece has bath a liquidity problem and a solvency problem.  And, by extension, the banks heavily exposed to Greece and some of the other weak euro zone.  Until they make the tough decisions, we may b stuck in this volatile market environment.

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  N/A means not applicable or not available.

“BEWARE OF GEEKS BEARING FORMULAS.” Warren Buffett

On October 19, 1987, the Dow Jones Industial Average went into a free-fall that was exacerbated by computerized “portfolio insurance” trading strategies.  By the end of the day, about $1 trillion of market value evaporated, according to CNBC.

In the fall of 1998, hedge fund Long_term Capital Management imploded and had to be bailed out by a consortium of investors orchestrated by the Federal Reserve, according to Investopedia.   The fund was led by Nobel_Prize winning economists and employed sophisticated computerized trading strategies that eventually ran amuck.

During the week of August 6, 2007, as the subprime mortgage crisis was gathering speed, several large hedge funds employing quantitative investment strategies “blew up” and lost billions of dollars in just a few days, according to Scott Patterson, author of the book, The Quants.

A “Flash Crash” on May 6, 2010 wiped out $862 billion in market value in a matter of minutes and was triggered by a computer-driven sale, according to Reuters and Bloomberg.  Within four days, the entire loss was recouped, according to data from Yahoo! Finance.

Last week, Goldman Sachs announced that it was closing one of its well-known hedge funds that relied on computer-driven trading strategies after it racked up substantial losses this year.   At its peak, the fund had $12 billion in assets, according to CNBC.

Despite the occasional headline-grabbing failure of computerized high-frequency trading, it still accounts for roughly 50 percent of all trading volume in the United States, according to Bloomberg.  Based on complex mathematics, computer-driven trading is defined as, “A technique that relies on the rapid and automated placement of orders, many of which are immediately updated or canceled, as part of strategies such as market making and statistical arbitrage and tactics based on momentum,” according to Bloomberg.

With this technology takeover of Wall Street, a new element of unpredictability has entered the financial markets.  The above examples show how volatile things can get when computer models go haywire.

So, some of the volatility we see in the markets these days may be exaggerated by computerized trading  both on the upside and downside. While we may not like it, we need to get used to it.

Weekly Focus — Think About It

“Interest on debts grow without rain.”  Yiddish Proverb

The Markets

Are we heading toward a “currency war?”

When there’s turmoil in the stock market or in the geopolitical environment, investors sometimes flee toward perceived “safe havens” in the hope of protecting a portion of their assets. While there’s no guarantee that any investment will be free from risk, the following assets have sometimes been on the receiving end when times get tough:

• U.S. dollar
• Swiss franc
• Japanese yen
• U.S. Treasury securities
• Gold

Sources: Goldline.com, U.S. Census Bureau

For example, Europe’s debt woes have soured investors on the euro (the European common currency) and pushed investors to the Swiss franc. This flight to the franc has been so strong that in early August, the franc hit a record high against the euro, according to The Wall Street Journal.

Unfortunately for the Swiss, the high value of the franc created countrywide economic problems. The Wall Street Journal said the soaring franc, “pushed some weaker Swiss exporters into bankruptcy, and sent others scrambling to slash prices to hold onto business.” In addition, “Tourists, an important source of income for the Swiss economy, now find it more expensive than ever.” Essentially, the strong franc created domestic havoc.

Well, last week, the Swiss National Bank decided enough was enough. The bank announced that it would cap the value of the soaring franc and, “buy euros in ‘unlimited quantities’ whenever the single currency fell below 1.20 francs,” according to The Wall Street Journal. Within minutes of that announcement, the value of the franc plunged 8 percent against the euro, according to Bloomberg.

Without getting bogged down in the details, this was an extremely bold move by the Swiss and could lead to, “a currency war, in which a growing band of countries seek to lower the values of their currencies to protect their economies,” as reported by The Wall Street Journal.

Dramatic currency intervention like this adds one more wrinkle to the uncertain worldwide economic environment. While we can’t control situations like this, it’s on our radar and we’ll monitor it and adjust for it on your behalf as best we can.

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable or not available.

9/11 – 10 YEARS LATER

The past week was filled with remembrances of that tragic day 10 years ago when we lost nearly 3,000 of our loved ones and the country lost its feeling of peace and security. We will never forget the grief, the heroism, and the pulling together of the nation as we all tried to heal in the days and months following that fateful event.

Much has changed since then and, in a way, we all lost some of our innocence and perhaps some of our optimism. But, as Americans, we are a resilient nation. We’ve endured tragedy and war before and we always found the strength and the courage to overcome. The pain of the terrorist attacks is still with us, the images still vivid, the effects still lingering, but persevere we do and prevail we will.

While it pales in comparison to the human toll of 9/11 and its aftermath, the U.S. financial markets and the economy have been relatively weak in the years since that day. Here are some examples:

• Over the 10 years between September 10, 2001 and September 9, 2011, the S&P 500 index rose only 5.6 percent — that’s a compound average annual return of only 0.6 percent excluding dividends.Source: Yahoo! Finance
• Over the 10 years between September 10, 2001 and September 9, 2011, the price of one ounce of gold rose 581.8 percent — that’s a compound average annual return of a whopping 21.2 percent. The rise partly reflects inflation concerns, currency debasement, and a general flight to safety. Source: London Bullion Market Association
• The U.S. experienced two recessions since 2001. Source: National Bureau of Economic Research

From the terrorist attacks and their aftermath to the sluggish economy, it’s been a difficult 10 years for our country. And, just like it has taken time to process the 9/11 tragedy, it will take time for our global financial system to deleverage and cleanse itself. As this unwinding continues, there will be setbacks. But, over time, our human spirit will strengthen, our economy will improve, and the world will be a better place.

Weekly Focus – Think About It

“Enjoy the little things, for one day you may look back and realize they were the big things.”

–Robert Brault