As we approach the end of summer, the overall market sentiment seems to be positive. However, we still need to see clarity on the main issues which include:
1) The European Debt Crisis – how they handle the immediate shortfall in Greece and will the ECB keep building a better firewall? (update below)
2) U.S. Presidential and other elections – will Congress avert the fiscal cliff by extending the Bush Tax cuts in some way?
3) China is seeing a slowdown – they are likely to ease monetary policy again…will it keep the growth engine moving forward?
These are the main issues that worry investors and business leaders. Clarity on any of these over the next few months will impact confidence levels. The S&P 500 is up over 11.5% for the year but the Flow of Funds data still shows that fear is still prominent in the psychology of investors. Year to date, investors have added $201 Billion to bond funds and have taken $68 Billion out of equities funds (note: these figures do not include hybrid funds). While the flow out of equity funds does not have a direct correlation to the true demand for equities, it is still a little hard to believe that equities funds continue to have outflows while the market continues to rise. What typically happens though, is institutional investors make the first move to reposition assets while the masses wait until the fear subsides. This usually happens after the markets have moved significantly higher.
A rotation of money out of Treasury bonds into higher yielding investments could be one of the largest catalysts for stocks in the near future. With the yields in treasuries being so low, it seems this movement is being held back by a lack of clarity on the issues mentioned above. In 2008, we saw a period of “panic selling” where investors sold good companies and bad companies, regardless of the price, because the fear levels were so high. There is an argument that if confidence is restored and investors start rotating assets out of low yielding Treasury Bonds, CDs and Cash, we could see a period of “panic buying” in other asset classes such as dividend paying stocks. The reason I bring this up is that every day we hear about how the global economy and markets could suffer under various scenarios (i.e. upcoming elections, Europe, etc.), but rarely do we hear about what the outcome would be if we actually get some of the macro issues addressed positively. Many commentators are going on financial shows and talk about what stocks they recently bought now that the market is up. These are the same “experts” that said the world was going to end two years in a row and that we were going into a depression as recently as last fall…. My point is that no expert or economist can predict the outcome in Europe or the U.S. elections. However, what we can focus on is the operating results and balance sheets of the companies and funds we own at Paradigm. From that perspective, things look a lot better than they have in many years and explains one factor that has driven the market higher in 2012.