QE3

- 2012 3rd Quarter


As we head into the last quarter of 2012, we are on the summit, or apex, of the Market year. In the 3rd quarter the market rallied and was up 6.35%, and 16.4% for the year.1 In addition, the S&P 500 Index for the 1-year period ending 9/30 is up 27%. The Markets are not only at 52 week high, they are at a 4-year high. While we certainly have reason to feel good that the Markets have recovered from their losses, history tells us that upcoming events will have a significant impact on the Market.2 (BTN Research)

2012 has been, by all accounts, a very surprising year. The year began with the best 1st quarter the Market has seen in 14 years. Volatility was very low and forecasted problems in Europe did not develop which resulted in a Market gain of over 12%.

The 2nd quarter did unfold as expected with problems in the Eurozone increasing volatility resulting in the domestic Markets suffering a loss just shy of 4%. After a disastrous May, the worst month the Market has experienced in more than 2 years, a very funny thing started happening. The Market very quietly started moving and gaining in the right direction. Unemployment numbers dropped to 7.8% (the lowest number in 5 years), housing market turned a corner (posting its first annual increase in five years) and the companies that make up the S&P 500 posted better than expected earnings. In mid-August the VIX, the CBOE S&P 500 Volatility Index3, also known as the “fear index,” dropped to 13.45, the lowest level since May 2007, more than five years ago, and more than six months before the recession started in December, 2007. Investor fear in the stock market has been consistently subsiding, and market volatility is now back to normal, pre-recession levels.

To start the 3rd Quarter, QE3, the Federal Reserve’s third attempt at quantitative easing, was announced with the purchase of $40 Billion dollars in mortgage backed securities4. The initial impact was seen as a gain in the financial markets and a loss as our shaky dollar becomes weaker. Many believe that the Fed’s actions are dangerous, with the QE3 being an unconventional monetary policy used by central banks to stimulate the national economy when conventional monetary policy has failed. It will be some time before we feel the impact of the QE3, but many believe it may be one step forward with the potential of going several steps backwards.

While the QE3has helped the Market move forward, in the weeks and months ahead we are facing a historical event which will shape the Market for months, and maybe years, ahead. On November 6th, less than 4 weeks away, the United States Presidential Election will be held. Most believe that this will be the closest election since the 2000 race between George Bush and Al Gore. What hinges on the election is the potential of a “fiscal cliff”.5 Both an Obama Victory or a Romney victory will have positive and negative effects on the Market. For those that fear the “Fiscal Cliff,” the odds still favor the view that Washington officials will eventually take action (likely in overtime) to temper its impact and the Fiscal Cliff may turn out to be just a bumpy hill that can be navigated.

With the upcoming election, fiscal cliff concerns and the Eurozone issues, Market volatility is a given. However, if we understand the effect of such volatility we can make wiser investment decisions. In this graph note that in the last 2 years as the Market has recovered from the Great Recession of 2008, there have been 5 times the VIX was low and the S&P 500 Index hit a new high on its road to recovery. In the previous 4 times that the S&P 500 hit its new peak, it went through a market correction within 2 months of doing so, which varied between 6-19%6. The 5th such time period occurred in late August. With the events of the election, and issues in Europe upon us, it is realistic that even with QE3 to expect a double-digit correction between now and year-end.

While it is not the intent of this commentary to suggest or recommend that you, as a participant, make changes to your portfolio we think it’s important that investors understand what is happening in the Marketplace so that you can make an informed decision. I have often used the analogy of running a marathon as a way to think of planning for retirement. Marathons are long and grueling challenges, and to do so successfully, you must have a game plan. Once you have established the best pace for you: stick with it. You may see a runner sprint by you but rest assured your steady pace will take you past that sprinter on the way to the finish line. In planning for your retirement, there will be times when the Market goes down, and in turn rises again. Stay the course and you will succeed. If you believe you were investing too aggressively in 2008 & 2009 but rode it out to avoid locking in your loss, now may be the time to re-allocate your portfolio for the future. We are available at any time for individual consultations and look forward to meeting with you. Please do not hesitate to contact me directly at (216) 595-0700.

1 As of 9/30/2012
2 This Market Commentary is not intended to predict the Market or to be used by participants to time the Market. The most successful portfolios are those that are built for the long-term which are able to sustain and overcome any bumps in the road.
3 One of the most important but under-reported financial indicators is the CBOE’s Volatility Index (^VIX), which measures the market’s expectation of future volatility in stock prices (over the next 30 days). When it drops below 30 percent, it will be a strong indication that the market correction is complete and we’re back to business as usual.
4 While keeping the interest rates at zero percent until 2015 with the promise to make additional purchases if the unemployment picture didn’t improve
5 The Fiscal Cliff is the potential $600 billion in adjustments that are set to unfold on January 1, 2013 due to the expiration of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Action of 2010 and the spending reductions (“sequestrations”) under the Budget Control Act of 2011.
6 A market correction is usually a sudden/ temporary decline in stock or bond prices after a period of market strength. Market corrections are short-lived, lasting a few days to a couple of weeks before the market turns upward again.


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