[dropcap]S[/dropcap]tocks finished down after a second week of intense volatility, nearing yearly lows. The big drop came on Thursday – seemingly the result of a weak Philadelphia area manufacturing activity report leading investors to believe double-dip recession is now the most likely outcome. Existing home sales dropped. Fears escalated around European banks ability to meet obligations after it was reported US regulators were investigating their US divisions for capital adequacy.
Treasuries and gold rallied, with the 10 year Treasury bond briefly dropping below 2% for the first time since 1954, and gold hitting all-time highs.
Tuesday – Summit between German and French leaders Merkel and Sarkozy is viewed largely as a disappointment, with no new major initiatives announced.
Wedesdsay – Core CPI (consumer inflation index) came in at 0.5%, above expectations.
Thursday – The Fed Philadelphia Manufacturing survey came out well below expectations. It is worth noting that the survey was conducted during the exceptionally volatile week of August 8th.
Thursday – Hewlett Packard reduced forward looking sales and earnings estimates and announced it is exploring spinning of its PC unit as well as the potential $10 billion acquisition of UK based software company Autonomy. Shares fell 20%
With 2008 a fresh experience, there is a high “freak-out” factor in the markets. Recent economic news has been, on balance, disappointing. The markets seem to be pricing in a certain recession, but we don’t view it as certain at all. There have been positive indications as well, including the most recent jobs report and continued strength in corporate earnings.
The S&P 500 is trading at just 11 times estimated earnings. This means current valuations could probably support a mild recession. Therefore, our guess is that the real risk the market is highlighting is not the US economy, but the threat of sovereign European debt contagion.
Recent market activity has highlighted the benefits of a diversified multi-asset class portfolio, but those who are completely giving up on stocks may find regret if the worst case scenario doesn’t play out. Just as stocks can sometimes reach bubble status, so to can “safe” assets such as government bonds and gold. We don’t know when the ride will end for Treasuries and gold, but we urge investors not to forget that what goes up can come down, regardless of whether it is considered a risky asset.
Craig Birk, CFP®
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