Market Commentary - 4.19.12
The Financial Markets' European Vacation
The first quarter was very good for investors as global equity markets rallied beyond most expectations. However, since the end of the first quarter, overnight news in Europe has driven sharp gyrations in these global markets. The recent market swings is reminiscent of a 1985 movie, National Lampoon's European Vacation. Coincidently, this movie offers an interesting parallel to today's markets and their reactionary nature to news out of Europe.
For those of you who have not seen the movie, the premise is pretty straightforward. The main character, Clark Griswold, takes his family on a vacation to Europe and experiences a series of mishaps before returning. The first quarter market rally, despite mixed economic data, debt concerns here and abroad, and rising geopolitical risks, was similar to the uneasiness that we felt after Clark Griswold's deadpan declaration that he was taking his family to Europe. This uneasiness was warranted as early movie scenes show Clark driving on the wrong side of road, destroying part of Stonehenge, and offending every non-American. Early in the second quarter, the financial markets also experienced uneasiness on news from Europe. No, it was not from an American tourist raising havoc on the roads of England, but instead from rising borrowing costs in Italy and Spain. In the first week of April, yields on Italian and Spanish government bonds surged after Spain saw demand for its debt fall in its first auction since presenting its newest austerity budget. Because this auction fell short of its target, it dragged on investor sentiment and sent global indices lower.
It was not all bad for the Griswolds in Europe. They learned to deal with adversity and bond as a family. (Warning: spoiler alert.) In an uplifting moment near the end of the movie, Clark rescues his wife from kidnappers and is the quintessential Hollywood hero. Similarly, later in the second quarter, global financial markets jumped on the combination of strong demand for Spanish debt and a better-than-expected investor sentiment reading in Germany. Unlike the prior Spanish bond auction, investors snatched up the bonds as bids exceeded supply by 2.9 times. The ZEW indicator of investor sentiment, which measures expectations among German investment professionals for the next six months, showed an unexpected increase in April, its fifth straight monthly gain. This combination of good news drove investor optimism about Europe and sent equity markets higher.
Looking forward, we unfortunately do not have a spoiler alert for European debt issues. While there has been some progress made over the past few months, we do not expect European debt issues to be solved anytime soon. Austerity measures still need to be enacted and adhered to, investor confidence needs to return and the magnitude of a European recession needs to be minimized. With that said, we do see some positives emerging including lower CDS spreads (basically a measure of the cost to insure against default) and the success of the European Central Bank to provide liquidity to European financial institutions. Furthermore, in an interesting analysis from Prudential Investments, the following table shows opportunities that could be used to potentially improve the European debt situation. Low household debt in Italy suggests higher income and sales taxes could be implemented in Italy to improve budget deficits. Low government debt offers Spanish leaders a way to increase spending measures to combat the effects of their current recession.
Data: As of March 31, 2012; Source: Prudential Investments
(% of GDP)
(% of GDP)
(% of GDP)
(% of GDP)
Much like the ups and downs during the Griswold vacation trek, investors for the balance of this year can expect events in Europe to drive market gyrations and elevate volatility levels. To mitigate potential market volatility, we continue to suggest an increased allocation to income solutions (such as corporate bonds and dividend paying stocks). Adding income-producing or yield-generating investments to a portfolio provides a consistent income component that is received regardless of underlying price movements and may help cushion downward market moves. We would also expand portfolio diversification through the use of alternative investment strategies. Because of their low correlation to traditional stocks and bonds, alternative investments have historically shown an ability to improve portfolio diversification. In other words, when markets move one way, alternative strategies have historically moved in the same direction to a lesser extent or have even moved in the opposite direction.
This information is compiled by Cetera Financial Group from source material obtained or provided by US federal and state departmental websites, equity index sponsors Standard & Poor's, Dow Jones, and NASDAQ, credit ratings agencies Standard & Poor's, Moody's Ratings, & Fitch Ratings, domestic and foreign corporate issued newswires and press statements, and from referenced compilations and index readings by Bloomberg Professional. The information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The information has been selected to objectively convey the key drivers and catalysts standing behind current market direction and sentiment. No independent analysis has been performed and the material should not be construed as investment advice. Investment decisions should not be based on this material since the information contained here is a singular news update, and prudent investment decisions require the analysis of a much broader collection of facts and context. All economic and performance information is historical and not indicative of future results. Investors cannot invest directly in indices. This is not an offer, recommendation or solicitation of an offer to buy or sell any security and investment in any security covered in this material may not be advisable or suitable. Please consult your financial professional for more information.
While diversification may help reduce volatility and risk, it does not guarantee future performance. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability, and differences in accounting standards.
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