posted on February 9th 2015 in Market Commentary with 0 Comments /

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Volatility is a word analysts throw out frequently when markets gyrate sharply over a short period of time. One day it’s sheer ecstasy and the next day if feels like despair.

Investopedia defines it this way: “Volatility refers to the amount of uncertainty or risk about the size of changes in a security’s value… this means that the price of the security can change dramatically over a short time period in either direction.”

Or take a quick peek at Dictionary.com. For our purposes, the fourth definition offers us the best explanation: “(of prices, values, etc.) tending to fluctuate sharply and regularly: volatile market conditions.”

That is what we witnessed during January. Using data provided by the St. Louis Federal Reserve, the Dow Jones Industrial Average rose or fell more than 100 points during 14 of the 19 sessions last month. Nine of the 14 were negative, while the remaining 5 saw the best known market average finish higher.

The best and worst: An advance of 323.25 points on January 8 helped offset a decline on January 5 of 331.34.

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Source: Wall Street Journal, MSCI.com *Annualized **USD

Investors are trying to digest a number of events, including the soaring dollar, falling oil prices, a lackluster global economy, and more aggressive monetary policies from a number of central banks around the world.

Take a recent comment by George Soros, who is known as the man who “broke the Bank of England” in the early 1990s. Given his foray into U.S. politics, just the mention of his name can create sparks. But let’s not discount his investment expertise.

Soros noted at a conference in Davos, Switzerland last month that financial markets and international affairs have become more closely linked than in the past.

“This has greatly increased the level of uncertainty, volatility, and unpredictability… and has made the job of hedge-fund managers hellishly difficult,” Soros said.

We are not a hedge-fund managers nor are we eliciting any sympathy for them. Their goal is to use a high degree of leverage and take plenty of risk in the hopes of generating large returns. Sometimes they win, and sometimes they are left licking their wounds.

But Soros recognizes that markets are going through periods of increased volatility.

We never let a moment pass that would allow us to preach on the virtues of diversification. Markets can and do fluctuate sharply from time to time. While investing cannot eliminate risk, it can be managed with proper portfolio techniques.

We always caution against putting all our eggs in one basket. Yes, it is a cliché, but it helps to paint a visual and put you on a path toward your long-term financial goal.

In the end it’s about allocating your portfolio among stocks, fixed income, and cash. And within those categories, we advise a strategy that diversifies you within those asset classes.

The goal is to reduce risk while keeping you focused on the long- term. By keeping our yes on the prize, we need not get overly concerned when markets fluctuate.

About that big oil price tax cut

You can’t help but notice the steep drop in gasoline prices. After hitting a high last year of $3.71 per gallon in late April (Energy Information Administration – EIA), the average price of regular gasoline in the U.S. sits at just $2.07 as of February 2. No one saw that coming.

Given that analysts estimate each one cent decline equates to $1 billion in annual savings, consumers are reaping a windfall at the pump, and it’s a windfall that should be a boon for the economy. Think of it like a tax cut–at least that is how it’s being portrayed.

It has been a windfall for consumers. Regular gasoline in the U.S. averaged $3.48 from June 2013 thru June 2014 (EIA). Even if prices drift higher as we head toward the summer driving season, we are collectively saving an enormous amount of money that is set to boost spending and economic activity.

Two closely-followed measures of consumer confidence, the University of Michigan’s monthly survey and Conference Board’s index have recently surged and are back at levels that would be normally be associated with an economic expansion (St. Louis Federal Reserve, Conference Board, Bloomberg). That’s a strong tailwind for consumer spending.

Yet, “We haven’t seen the extra savings from lower gas prices translate into additional discretionary consumer spending,” Ajay Banga, chief executive of MasterCard said on an end-of-January conference call (Wall Street Journal).

An early January survey by Visa suggests that consumers are banking or paying down debt with 75% of their savings and spending the rest on minor purchases (Wall Street Journal).

Moreover, Howard Schultz, Starbucks president and CEO, pointed out in a January 23rd interview on CNBC that consumer behavior is slow to change, and he’s not seeing gasoline savings roll into his stores.

It’s highly anecdotal, but after paying $27 to fill up the gas tank instead of say $50, a $3-$4 latte would seem to be the obvious choice! Apparently, it’s not.

Pain in the energy patch

One thing that’s certain, we’re seeing cutbacks in spending and layoffs among energy firms.

Occidental will slash its 2015 capital budget by 33 percent to $5.8 billion (Reuters), ConocoPhillips said it would cut capital spending

by 20% to $13.5 billion (Wall Street Journal), and Shell will dial back its spending by $15 billion over the next three years (Reuters).

It’s not just the majors. Oil-service firms are also slashing budgets, including oil-service giants Schlumberger and Halliburton. So are the smaller players that have spearheaded the shale revolution.

That’s cash that is no longer fueling economic activity.

“The Energy sector accounts for roughly one-third of S&P 500 capital spending and nearly 25% of combined capital spending and R&D spending,” writes Goldman Sachs’ Amanda Sneider.

We expect total Energy capital expenditures will collapse by 25% in 2015…, dragging total S&P 500 capital expenditure growth into negative territory,” Goldman Sachs’ David Kostin said.

It’s not that the fall in gasoline prices is an overall negative for the U.S. economy. It isn’t, but some of the early enthusiasm has been overdone, in our opinion.

The initial price drop to roughly $80 per barrel may have been the sweet spot – a nice price break at the pump but not enough to dampen growth in the energy industry. But current prices don’t support energy exploration.

In a way, the drop in gasoline really isn’t a tax cut. Instead, it’s a transfer of wealth from producers to consumers. It may take time for consumers, who still bear the scars of the Great Recession, to spend their windfall.

 

What does all of this mean?

The one thing experience in the industry has taught us: few can accurately predict where the economy will be in one year, and even fewer can accurately call the peaks and valleys in stocks.

One favorite quote comes from baseball legend Casey Stengel, “Never make predictions, especially about the future.” It’s one reason why we talk so much about diversification and the longer-term.

Your core portfolio holdings should include both large- and small- company stocks. And let’s not eschew international holdings. There will be times when U.S. equities outperform global markets, as they did in 2013 and 2014.

But there are also times when international markets will lead. For example, emerging markets have been beaten down and may offer a more attractive value proposition when compared to prices that are more fully valued at home.

Though we won’t try to guess where the U.S. and emerging markets may be in five years, for many investors, they should be a part of core holdings.

Bonds not only provide income, they have historically “anchored” a portfolio.

Bonds have historically been less volatile than stocks. Add bonds and reduce the percentage of stocks and history tells us we can reduce the overall volatility.

 

The fixed income component will likely prevent us from matching an all stocks portfolio when stocks soar, but we are unlikely to follow the market into the depths when the inevitable bear market returns.

Besides, be careful about chasing return. Remember the moral from the tortoise and the hare? Our recommendations are based upon a client’s financial goals, and much will also depend on their particular situation and tolerance for risk.

Finally, cash rounds out the portfolio. It reduces risk and provides funds in the event of an emergency.

We hope you’ve found this review to be educational and helpful and remember to keep your eye on the prize and not let short term volatility knock you off course.

about the author: WorthPointe Wealth Management

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