Letter to Clients – US Downgrade/Global Debt

8/8/11

Dear Client,

At Monday’s market close the Dow Jones lost more than 6.5% in value. This was not  a result of the S&P downgrade of US issued debt. US treasuries were actually the safe haven of the day, pushing the US Bond Aggregate index up .5%. Today’s sell off in stock was an emotional response to what is happening in Europe and a potential recession globally and here in the US.

Stronger European nations such as Germany, France and the Netherlands are showing signs of an economic slowdown. In addition to weaker economic indications these same countries also hold Greek, Irish, Portuguese and Spanish debt. Greece recently received a second bailout, only to now need a third in order to pay its bills. Last week Italy took the spotlight in that it is rapidly approaching a situation where it will not be able to meet its debts obligations. This situation is slightly different in that many believe that Italy is too large for the European Central Bank (ECB) to completely bail out. Italy’s Government is playing down its financial situation stating that their banks are well funded and that its citizens as a whole save well. This is not reflected in their 10 year treasury bonds, which yield 6%. Comparatively the currently healthy German 10 year treasury yields 3%.  A 10 year US treasury yields 2.6% and a two year note yields 0.336%.

Last Friday the ECB announced that it would begin purchasing Italian and Spanish debt, helping the countries raise additional capital. This is very similar to what the US did here in 2010 when the Fed purchased long term US Treasury Bonds from the bond market. The US stock market has sold off simply because of the uncertainty of the situation. The last large scale treasury bond default we saw was in 1998 when the Soviet Union defaulted on its bonds. The markets worldwide traded down then recovered a few weeks later.

The United States of America no longer has a long term AAA bond rating. What does this mean? Economically in the short term this rating really means nothing, in fact other rating agency’s still maintain US debt at AAA. This was proven on Monday as even after the first trading day after the downgrade the 10 year US Bond traded up in value as investors flocked to safety. In the long term this means that our country must stop the overspending. The S&P said in their report “Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden.”

The Wiser Portfolio’s are built to be held long term. Short-term market volatility is certainly mentally draining.  No one likes to lose, especially money, even if it is just on paper. In times such as these, investor behavior is more important that asset allocation.  Diversification and overall portfolio risk are important, but at this point your portfolio should already be built based on these objectives. Selling and going to cash emotionally feels like the right thing to do, but history shows that this is absolutely the wrong approach. In the chart below we see the market with a bar chart overlay of fund inflows and outflows. You can see as the market peeked in 2007 investors were adding large amounts of new money to the stock market.  In 2009 as the market bottomed out, investors were selling large amounts out of the stock market. This buy high sell low approach is not a winning solution for investing. To make matters worse these investors were selling bonds at their lows to buy stock at their highs in 2007 and then selling stocks at their lows to buy bonds at their highs in 2009. Buy and hold investors will have a long-term higher rate of return, especially when building portfolio’s using index funds.

 

 

 

 

 

 

 

 

Over the next few weeks’ European governments will be forced to make tough economic decisions. As these decisions are made the market will become more stable and economic valuations easier to determine.

Assuming that your portfolio is built for your long-term objective, your best action is to ignore the emotional market and do nothing. If you have any changes to your personal financial situation give us a call so that we can reevaluate your personal investment strategy.

Casey T Smith, President, Wiser Wealth Management, Inc

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