Matters of Confidence

George Hosfield,CFA , is Ferguson Wellman's chief investment officer and Investment Policy Committee chair. 


"There is nothing more bullish than fear, nor more bearish than certainty" – John Mendelson, International Strategy & Investment 


Confidence is always a very delicate and precious thing. What we've experienced over the past 10 trading days is the result of a crisis in investor confidence. In our view, the resolution of the debt-limit debate and the preservation of the AAA credit rating of the U.S. was a longer-term positive. Unfortunately, it occurred in the context of a political environment that was so toxic that domestic and global investors lost faith in Washington… at least in the short term. 


If there is one piece of certainty amid all this uncertainty, it is this: Absent the immense powers of the Fed and a potential third round of quantitative easing ("QE3"), the U.S. debt ceiling precludes any material hope of fiscal or monetary stimulus before the next election. If you add to that mix a softening economy and the failure of European leaders to fully resolve their ongoing debt issues, what ultimately precipitated from this equation was a very sharp downdraft in just about all risk-related assets. Investors – both domestically and globally – are fleeing risk and seeking safety, principally in high quality bonds and precious metals.

Since the 2009 market lows, both corporate profits and the broad market averages have advanced nearly 100 percent. During that interval, we have endured several sharp corrections – the worst of which occurred in April of 2010 when by the market corrected by almost 16 percent. Note that following April's correction, the market advanced 30 percent. That said, it is hard to know how far the current correction will persist before it exhausts itself. We had been anticipating a rebound in economic momentum post what was a decidedly weak first half; however, recent data has served to temper our confidence in this forecast.

We now believe the markets are in the process of "pricing in" the prospect of a mild recession. Whether or not the economy contracts is really not at issue, since the market is now in a mode where it will discount first and ask questions later. Exactly at what market level we fully price in (or discount) a recession is difficult to pinpoint, but we expect this process to continue to unfold over the coming days and perhaps weeks. If the past is prologue, this process will continue to proceed with both high velocity and high drama. 


Given the nature of the issues of concern, we expect the market will first find a bottom and then begin a process of consolidation. That is, we anticipate we will enter a trading range that could last for a couple of quarters. 


We expect bond yields to remain lower for much longer than previously thought. We would prefer intermediate and longer-term bonds to cash. In fact, it is not inconceivable that we could see new all-time lows in the yield of some key Treasury maturities. We believe dividend-paying stocks will prove both defensive and attractive. Furthermore, we expect growth stocks to outperform more cyclically oriented names and as a result, we will continue to move toward more growth -oriented sectors and names. 


It is also likely that emerging-market stocks will provide an attractive entry point during this process, since most of the downdrafts of the past several years have bottomed before their developed market counterparts. As we have discussed before, emerging markets, tend to not share the debt-related concerns that are prevalent in larger, more developed markets. 


Economies can be fickle, and a little confidence can go a long way. That said, with all that has transpired in Washington, the past couple of weeks has hurt confidence and it is now feeding on itself. Investors, consumers and business owners alike are for the moment frozen, unwilling to part with their cash which is essentially putting "capital on strike." While stocks are inexpensive, history has demonstrated that "cheap" is not necessarily a catalyst. Though we are not liquidating at this juncture, in view of the aforementioned increased risk to the pace and sustainability of the economic expansion and the prospect of interest rates remaining low and perhaps even trending lower, we shall opportunistically reduce equity weightings to "neutral." Any proceeds would be used to increase the allocation to fixed-income securities and perhaps tactical assets.

This has been a painful and unpleasant market event. We have experienced many of these corrections in the past, and we expect to see many more in the future. The most important thing we can do for our clients is to make sure that we have correctly interpreted what's transpired, and reposition portfolios if necessary. 


Best regards,

George Hosfield,
CFA 
Chief Investment Officer 


The information provided herein is for educational purposes only and should not be construed as investment advice or as an offer or solicitation. Not all securities are suitable investments for all investors; therefore, Ferguson Wellman Capital Management will not necessarily implement any particular strategies discussed herein for all clients. We recommend that you discuss questions regarding your individual portfolio and investment strategies with your portfolio manager.