"The Faith-Based Millionaire is a fresh approach to having an authentic and purposeful life."
-- Dan Miller, best-selling author of 48 Days to the Work You Love and No More Mondays
August 2011 is on pace to become the roughest and most volatile month for the stock market in almost three years. Where exactly will this correction bottom out? How long will buyers stay on the sidelines?
Two crucial questions await answers – but before turning to those questions, consider the developments that really hurt equities in the middle of August.
In the sports world, everyone knows defense wins Championships. Whether it is basketball, hockey, or football, the team with the strongest defense often has the best chances of going home with the gold trophy! It is much the same way with an investment portfolio. You may have a great strategy for when the markets are rising (buy and hold), but what happens when the markets fall apart? Are you defensively positioned?
In order to navigate the volatile waters of today’s stock market, investors need to be quick and nimble. They need a strategy for both the good and bad times. When the markets are rising, it pays to have investments that grow quickly. During the down times, it pays to have investments that can “weather the storm”. That is where an All-Weather strategy becomes handy…
It always feels like things can go MUCH lower… And they can, but legendary investor Warren Buffet recently nailed it, “The lower things go, the more I buy.” He detailed his strategy in an August 9th chat with Fortune. Buffett is a buy-and-hold kind of guy, and even if you don’t buy into his approach, you have to admit stocks are cheap in the wake of the recent correction. For many investors, a downturn like this means picking up quality stocks at markdown prices, including dividend-paying stocks.
Just how cheap are stocks in August? We have some compelling valuations out there. Just to give you some idea of where the broad market is at, the 12-month forward equity earnings yield of the MSCI World Index (according to Reuters) was just above 10% on August 12. This was the highest earnings yield since January 2009 – and more than five times the yield of the 10-year Treasury in mid-August.
Domestically, Capital IQ data from August 12 shows that stocks in the S&P 500 are trading at a forward price-to-earnings ratio of around 12. Historically, the forward P-E ratio for the S&P 500 has averaged about 16. Judging by that yardstick, we have a buyer’s market right now.
A few years ago, we set out to find a way for investors to get more income than the measly 1% savings account at local banks and with much less fluctuation than the volatile stock market. We were also concerned about the risk of the bond market as interest rates started to tick up. That is when we came up with the idea for the global income portfolio. Our goals were simple:
1. Find both foreign and U.S. investment opportunities.
2. Find high quality investments that meet our faith and values
3. Find lower risk investments that could stand up during tough times and rise during good times
As expected, a plunge. World stock markets swooned on August 8 in reaction to Standard & Poor’s downgrade of U.S. long-term debt. On Wall Street, the DJIA fell 634.76, the S&P 500 79.92 and the NASDAQ 174.42. It was the toughest day on Wall Street since December 1, 2008, when the National Bureau of Economic Research announced America had lapsed into a recession.
Investors endured a shock like this last year. In spring 2010, the S&P 500 pulled back 16% from a peak. At the close on August 8, the index was down 16.8% from its spring 2011 high.
Standard & Poor’s issued a historic downgrade of U.S. debt on August 5, sensibly waiting until the market week had concluded to send a shock wave toward global investors. It reduced America’s long-term debt rating – which had been AAA since 1941 – to AA+.
S&P felt Congress did too little too late. The credit rating agency had threatened to lower the boom if Congress passed any deficit reduction plan smaller than $4 trillion in scope. The Budget Control Act of 2011 “falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” an S&P statement noted. It also retained its “negative” credit outlook on the U.S.
S&P is also skeptical that the federal government can collect more money from taxpayers. Its analysts do not think the Bush-era tax cuts will sunset at the end of 2012 “because the majority of Republicans in Congress continue to resist any measure that would raise revenues.”
On August 5, S&P sovereign ratings committee chair John Chambers told Fox News that the new AA+ rating could be cut to AA within 6-24 months if the U.S. doesn’t arrange to slash $4 trillion from its deficit in the next decade. The implication: Congress better agree on more cuts by February.
On his 50th birthday, President Obama watched Wall Street cast a no-confidence vote in the economy he had been assigned to turn around. The Dow Jones Industrial Average sank 512.76 and experienced a correction Thursday, with the S&P 500 (-60.27) and NASDAQ (-136.68) also down more than 10% from spring peaks.
Developments overseas generated anxiety on Wall Street. Citing “renewed tensions in some financial markets in the euro area”, the European Central Bank abruptly announced a bond-buying program Thursday, a distinct reaction to fears that Italy or Spain might need a bailout from the European Union. ECB president Jean-Claude Trichet stated that “downside risks may have intensified.” The ECB didn’t detail what debt securities it would buy or the amount of the purchases. Early indications hinted that the campaign would be modest. The ECB broadened the scope of its lending to Eurozone institutions at its benchmark interest rate this week in a move to aid feebler banks; the Bank of England kept its key interest rate at 1.5% and the ECB held its key rate at 0.5%. These firefighting moves did little: the FTSE 100, CAC 40 and DAX all dropped between 3.4%-3.9% on the day.
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