The Goldilocks Effect
- 2006 4th Quarter
Posted by David Krasnow on December 4, 2006
As we said goodbye to 2006 and ushered in 2007, I contemplated what made 2006 such a good year in the market. There are a variety of factors that contributed to the S&P being up 15.8%, but I believe the single biggest factor was the Federal Reserve halting interest rate changes.
I recently read an article that said, “the Investment Man of the Year was clearly the new Chief of the Federal Reserve, Ben Bernanke”. This article went on to say that Bernanke, who took over in February for Alan Greenspan, did an admirable job of understanding the pulse of the market. The article jokingly referenced that he made sure the factors of the market “never got too hot” and “never got too cold” but ended up “just right” which resulted in the nickname, “The Goldilocks Effect”.
After reading the article, I have taken that quote and expanded upon it in my 2006 year in review and my thoughts for 2007.
- The Federal Reserve - As mentioned above, and in the past, this was the straw that was stirring the market, both positively and negatively. We experienced a period dating back to 2005 of 17 consecutive interest rate increases. This continuous rise hurt the bond market and made the equity market sluggish. In late summer of 2006, the Fed decided to halt interest rates. After a brief period of market indifference, the market went on an amazing run in the 3rd Quarter, and then finished the 4th Quarter up 6.7% and 15.8% for the year.
The thoughts on the Fed are that interest rates will remain unchanged for the short-term. While most believe the factors are right for a strong market year, there are signs of slowdown economically from the manufacturing and industry-based sectors. Many believe that when the Fed meets in May, there is a very good chance that they will lower interest rates. This will help provide a stimulus to the economy and to the market.
- Energy - It was a rollercoaster ride in the Energy sector in 2006. Energy prices went as high as $73 per barrel, and then late in the year dipped below $60 a barrel. As of the date of writing this commentary, the price is $61 per barrel. The effect or result in the drop of the price of oil is that we have seen a dramatic decrease at the pump. Gas is hovering around $2 per gallon, and in all likelihood, will continue dropping even further.
While we may personally enjoy the fact that the price of gas has decreased so much, from a market perspective, it is not a positive factor in the short-term. The energy sector was up over 35% for both 2004 and 2005, and was up again almost 20% in 2006. Most mutual funds have been investing very heavily in the energy stocks; therefore, we have enjoyed a sharp increase in the past three years. Now that energy has come back down, you should see an adjustment period during the 1st quarter of 2007. The result is that many mutual fund companies are shifting their positions out of Energy and into other sectors such as Technology and Real Estate.
- Natural Disasters - In recent years, we have had more than our fair share of natural disasters. The year 2004 was the worst cumulative hurricane season in over 25 years. Then in 2005, it continued with hurricane Katrina, which was the single worst natural disaster in over 100 years. As a country, we needed a break and were lucky enough to catch one in 2006. There were no hurricanes of any kind, making it the mildest hurricane season in 30 years. A hurricane season similar to what we experienced in 2004/2005 is a good thing from an economic perspective. The rebuilding efforts bring jobs and stimulation to the business cycle. Though, while the rebuilding efforts of the Gulf Coast area will go on for the next 10 to 20 years, the devastation, destruction and aftermaths of what took place make it extremely difficult to find a silver lining.
As we head into 2007, we have learned that we must expect the unexpected. Whether it is a tsunami, hurricane, earthquake, or whatever, we know that events we cannot control will occur both domestically and around the world. As investors, we need to learn to accept that, and not react emotionally to events that transpire around us.
- Geo-Political Issues - We are at a time in our nation’s history that we are susceptible to any type of terrorist attack. With our country’s ongoing involvement in Iraq and Afghanistan, as well as the escalating crisis in Iran, we as individuals must plan for the worst and be pleased when things turn out better than expected. It is amazing to think that September 11th occurred more than five years ago. At that time, people expected another event to happen sooner than later.
As I am often asked my opinion on Geo-political issues for 2007, my answer remains the same. At some time, I believe something will happen again. When other nations and cultures do not regard human life in the same way that we are accustomed to, there is only so much we can do. In the aftermath of 9/11, markets initially plummeted based on the shock of what had transpired. The experts say that our markets would drop if we had another attack, but not at the same level as what we previously witnessed.
The overall market outlook for 2007 remains strong. In a recent conversation with Dr. Ken Mayland, he believes that stocks are still priced extremely well versus earnings, which projects to a good upside. My analysis is that things are good, and all indications are we still have room for the market to grow and move forward. With the above said, I would also like to play devil’s advocate and state that the market is either at or close to all-time highs, depending on the close of the market on any given day. What that means to me is that while it is true that times are good, and appear to be good for the near future, things will not go up forever.
If you have not taken the time recently to review your investments, especially if you have not reallocated from when the market dropped from 2000-2002, and you believe you are too aggressively invested, this is a good time to review your portfolio.
For 2007, Pension Advisors' Education Campaign is “The Pursuit of Happyness”. Every person I meet has the desire to retire in comfort but often lacks the knowledge or fails to plan to fulfill his/her goals. In the 1st quarter, our challenge is simple - Set Your Goals. Think about how long you plan to work, what you envision your retirement to be, and ultimately where financially you will need to be to hit those goals. We will then work with you to fill in the blanks to help you achieve those goals.
Our other focus for the New Year is that we are asking everyone to increase his/her deferral percentage in 2007. In most instances, we have challenged participants to defer 6% percent of their pay. We are looking for 7% in '07.
As we say at the beginning and end of every education meeting, it is not our goal to make anyone into an investment expert or a retirement expert. If we can help you at any time with your investments, or any aspect of retirement planning, please do not hesitate to contact me. Please feel free to reach me at firstname.lastname@example.org or (216) 595-0700 with any questions or to schedule a free meeting and evaluation.
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