One of my favorite times of the year is from mid-March through early April. This period hosts the NCAA Tournament, Opening Day for Baseball, and The Masters golf tournament. CBS sportscaster, Brent Musberger, popularized the term “March Madness” back in 1982 to describe the frenzy associated with the NCAA Tournament. While locally we enjoyed the “March Madness” of watching our own Buckeyes advance to the National Championship game, the financial market also experienced its own version of “March Madness”.
What happened in the market place during the first quarter of 2007 can best be described in basketball terminology as “forced tempo”, with lots of “alley-oops” and a few “backdoor plays”. There is no other way to describe the first quarter market except to say that is was "Mad". Here are a few reasons for the volatility -
"Shanghai Surprise" - The initial market shake-up during the first quarter was on February 27th – one of those days that we all would have been better off staying in bed. First, the Shanghai Market was down 8.8% - the worst one-day sell off in a decade; then, there was news of a suicide bombing attack at the entrance to the main U.S. military base in Afghanistan during a visit by Dick Cheney; and finally, the former Fed Chief made comments in response to a question about the “possibility” that the market could fall into a recession. With all of these issues occurring on the same day, there was extremely heavy market trading activity, which contributed to the Dow Jones computer system locking up. At one point the Dow Jones fell by 179 points in one minute. The day ended with the market being down by 414 points, making it the single worst day in the stock market since September 17, 2001 – the day the markets re-opened after 9/11. While it was the worst day we had experienced in over five years, from an overall historical context, it was not that bad. Since January of 1987, it was only the 22nd worst day, and in the history of the market, it was only the 57th worst day. In addition, the February 27th market started at a much higher point than in the past, making the percentage decrease of the Dow much less significant than bad days in the past.
Corporate Profits - This has long been cited as the best indicator of how the market is truly faring in our country. For the 4th quarter of 2006, the posted cumulative corporate profits were at an all-time high. While there are now concerns over some accounting irregularities, we can feel confident that our country’s business and industry is going strong. When experts forecast recessions, the major factors to consider are the unemployment rate and the strength of business and industry. While the unemployment rate is slightly up over December 2006, the continuing corporate growth is a very good, if not, overriding factor.
Oil Prices - The price for oil and gasoline has become front-page news over the last few years. That trend has certainly continued from the mid-point of 2006 and now into 2007. In mid-2006, we saw oil prices fall dramatically which led to gas prices dropping to less than $2.00 per gallon. During the second half of 2006, the price of a barrel of oil slowly increased. Then, just as startling, in early 2007, oil prices fell dramatically again, and gas prices were back under $2.00. The harsh winter that followed, combined with the ongoing conflicts in the oil producing countries such as Iran and Iraq, has pushed oil prices back on the rise, shooting up by 16% for the month of March.
All indicators suggest that oil prices will continue to climb as we head into the summer months. While we may not enjoy paying higher prices, the current oil and gas prices have increased by only a very small margin on an overall cumulative basis since 1980. While the margin change has been minimal, we are feeling the effect so strongly because the majority of the increase of oil and gas prices over the last 25 years have taken place within the last 24-36 months.
Given all of the “Madness” taking place during the first quarter of 2007, including the spikes up and down in the marketplace, we should be relieved that the market finished the first quarter at breakeven. While that may not seem exciting, with just the events of February 27th, it is a positive sign that we ended the quarter in the same shape in which we started.
So, the next question is, what kind of “alley-oops” and “backdoor plays” will be coming down the court? My advice would be: proceed with caution. With that said, I am encouraged by a couple of indicators in the marketplace and foresee a modest market increase during the second quarter. The first encouraging sign is the continued strength in business and corporate earnings and we expect that bell curve to continue its upward ride. Secondly, in analyzing the stocks within mutual funds, it is clear that they still have room for growth. While many analysts have expressed concerns about today’s market and cite the similarities to the market of 2000 as the source of such worries, I disagree with their reasoning. There is a great difference between these two markets in that the stocks in the 2000 market were almost at their high point while stocks in today’s market clearly have room to grow. (For example, on 3/31/00 the S&P 500 Index funds had a P/E Price to Earnings Ratio of 31, while on 3/31/07 the P/E Ratio of the same S&P 500 Index Funds is 17).
As we look beyond the 2nd quarter, and into the summer months, we are expecting a “Summer Slowdown”. There are several different factors to consider. First, minor corrections are expected to be posted to adjust corporate profits from the 4th quarter of 2006. Second, and one of the most concerning factors for the summer months, is what I would term "The Sub-Prime Story". This term summarizes all aspects of the residential real estate markets. While the inventory of homes is already at an all-time high, it is going to continue to increase significantly. This increase is due to the Adjustable Rate Mortgages (ARMs) and Interest Only Mortgages re-setting to a rise in interest rates. What occurred is that homebuyers over-extended themselves when purchasing their home, and now the costs are adjusting higher as interest rates have increased. This problem coupled with an overall tightening of mortgage standards to acquire or refinance a loan may have us looking at a historic number of foreclosures later in 2007 and beyond. The third and final factor to consider is the overall volatility of the market or the VIX. The VIX measures the Volatility Index. In a good market year like 2006, the VIX was at approximately 10. On February 27th, the VIX shot to beyond 20 and is currently residing at 16. This indicates that we are in a volatile market climate and must proceed with caution.
As we prepare for what could be some tough summer months, our overall market outlook is still good. Through it all, experts are still predicting decent returns for 2007. With the continuing volatility of the market, this is a good time to remind everyone to make sure his or her portfolio is well diversified. We have stressed the importance of having a portfolio that does well in good markets and protects your savings in bad markets. This is not to imply the return will always be positive, because in some markets this is not possible; however, we believe in designing portfolios that will minimize the fluctuations. For our AdviseMe!® portfolios, we will be making a change to reflect the volatility of the market. Our objective will be to "lower the Beta" or lower the overall risk associated with the portfolios we are managing.
It is and has been the intent of Pension Advisors and AdviseMe!® to do everything within our power to help put you - the participant – in the best possible position to face retirement. In offering AdviseMe!®, we have always had a plan and have had great success in sticking to this plan. The power of AdviseMe!® is a program built to reduce and control risk. When the market does well, the AdviseMe!® portfolios also do well. However, when the markets are performing poorly, that’s when we shine! During the 1st quarter of 2007, while the market was extremely volatile, our Portfolios were much steadier and outperformed their respective benchmarks.
In writing this commentary, I often get concerned that people get too excited when things are good and too down when times are bad. The reality is that right now we are not doing badly, nor are we doing great; we are merely playing a “zone defense” through what has been truly “March Madness”. If there is anything that we can do to help you achieve your retirement or investment goals, please do not hesitate to contact us. We appreciate your continued support and look forward to working with you.