Market Commentary

Chasing One Rabbit

January 2012

"If you chase two rabbits, both will escape" – Spanish proverb

The sun is shining, poppies are blooming, and the line at the ice cream store is out the door.[i] This warm and sunny spell in the middle of winter is truly enjoyable, and we are making the most of it. The same might be said for the recent few weeks' relief from the dramatic volatility of the summer and fall: as we write, stock volatility measures are less than half where they peaked last August through October.[ii] .

When do the storms come? Like the weather forecasters, we don't have good predictions for a few weeks from now. Still, we can coherently explain that over a season's full cycle or a market's full cycle, certain patterns hold and they are generally though not exactly predictable. Storms do come in winter.

We are heartened that the U.S. is enjoying a few stronger than expected economic readings for a period of time and that investors have returned to a period of somewhat calmer sentiment. On a larger scale, however, the biggest problems of our economy still persist, and they continue to stand out in sharp relief against these smaller, brighter readings. Even as corporations are reporting record profits, the largest challenge is the bolstering of public and personal solvency. Public solvency is in question; states, municipalities, and our nation are fragile vis-a-vis our polity's ability to meet our financial obligations. Solving this part of the economic problem takes a political solution, and we have a political system that seems increasingly dysfunctional. Unfortunately, we are not sanguine about constructive nor especially creative outcomes to the problem of public solvency in the coming couple of years.

Of course, personal solvency is also a widespread issue, driven by high unemployment and an economy that is no longer strongly led by ebullient consumers. The excess of consumer debt acquired during the years of the credit and housing booms will take many years to revert to regular levels. Recently, the personal savings rate in the United States has gotten as low as it's been since December 2007.[iii] Without sustained job growth to support the increased spending we've seen lately, economic growth is once again coming at the expense of our own piggy banks, and is not viable in the longer term. The sun is shining during a stormy season, but we don't think that is indefinitely sustainable.

In Europe, the situation is much more clearly negative. We expect the path of monetary and economic union to be bumpy for quite awhile, and Europe is entering recession. As in the U.S., Europe needs to produce economic solutions that are also political in nature; the road to those solutions will be difficult and volatile. There is no easy fix. We have recently been reading that the U.S. has become a relative island of stability in an otherwise stormy sea, but we believe the problems in Europe will again ‘sneak up' on us and impact our economy and stock market, much like they did last summer and fall.

The broad measure of U.S. stock market performance was up slightly last year, while stocks outside the U.S. were down in the double-digits. Your portfolios, somewhat underexposed to stocks, ended the year in negative territory. You have heard from us time and time again that we are cautious and defensive in our orientation, so why is this so? Three reasons. In the aggregate, stocks were off worldwide, and your stock-oriented holdings were slightly down. Second, we chose to add to gold and gold-related investments in your portfolio mid-year last year, and those investments are down in the short term. Over the next several years, however, we continue to see this as a prudent move, bringing gold exposure in your portfolios from a range of about 4-5% of your portfolios to about 8-10% of your portfolios in many cases. This offers an important layer of portfolio stability when things get rough.

We also continue to hold significant international bond investments in your portfolio, in addition to significant international stock exposure, and those were down in the near term too. Overall, we think it is prudent with all the uncertainty around the globe, including in this country, to have your bond positions include a significant proportion of shorter-term debt in countries in very sound economic shape. We are willing to live with a period of underperformance, after a two-year period of outperformance, because we see the manager of your international bonds using the dislocations in the global bond and currency markets to prudently buy good investments at cheap prices

Meanwhile, your stock portfolio continues to be balanced overall across the globe in stocks of companies that are in more defensive industries, in extremely good financial shape, and trading at reasonable prices.

As for the larger weather pattern, we note with a degree of caution that in the year 1999, the 15-year real trailing return of the S&P 500 peaked at 15% per year; right now, in this long bear market, it's at 3% per year. In the last cycle of 15-year returns, however, this number went negative before it became positive again.[iv] The larger pattern and all the significant economic problems in front of us give us cause for continued caution. We continue to emphasize opportunity with yield and income in your portfolios, and won't go off chasing other rabbits at this time.

This is a general assessment of client portfolios and does not reflect the specific circumstance of every client.

i[i] On 1.7.2012:

[ii] See



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