It was a tale of two markets this week, with stocks falling sharply early in the week before the resignation of Italian Prime Minister Silvio Berlusconi sent the averages rallying into the weekend. The Dow, S&P 500 and NASDAQ all finished marginally in the green for the week.
The latest domino to fall, or at least leaning in the wrong direction, is Italy, whose bonds yields continue to spike under unsustainable deficits and little economic growth. That’s a very big problem for two reasons.
Number one, higher yields mean higher borrowing costs. Higher borrowing costs in turn mean more debt and growing financial pressure. This is an absolutely vicious self-perpetuating cycle that 99 out of 100 times leads to insolvency.
Secondly, Italy’s economy is 10X the size of Greece. That’s right, you heard me, 10X, making it the 8th largest economy in the world. Who knew pasta, silk suits and leather boots were so profitable. That has many analysts calling Italy “too big to bailout.” And we all know how Greece has rocked the global economy for the last 2 years, so just imagine having 10 of those go off at once.
And as if that’s not problematic enough, Portugal is headed in the same direction, with its bond yields on the move too as it battles its own financial demons.
So that was the story in the front half of the week, investors were very concerned about rising bond yields out of the Euro zone.
Italian Prime Minister Resigns, Market Rallies
But right when stocks looked like they were about to fall off a cliff, with the Dow posting its biggest loss in two months on Wednesday with a near 400-point loss, investors found comfort in the resignation of Italian Prime Minister Silvio Berlusconi, providing hope that the country would find a way to pass extreme austerity measures and kick its balance sheet into shape.
But even though the outlook is a bit gloomy right now, here is a key takeaway. That absolutely doesn’t mean you shouldn’t be investing. Remember what Warren Buffet says; “Be fearful when others are greedy and greedy when other are fearful.”
And make no doubt about it; investors are scared right now, with everyone and their mother going full bearish in the last two weeks.
The fact of the matter is that there is just no way to predict how the Euro story will unfold, but If stocks find a reason to rally, whether that’s due to hyper inflation or sustained earnings growth, you don’t want to be on the sidelines when it happens.
And if you are a bit concerned about volatility, there are plenty of ways to reduce your risk without going into cash. Maybe that means trimming back on growth stocks and rotating into more conservative segments of the market like utilities and consumer staples. Or maybe you move out of small caps and go into large caps and dividend stocks. You could also buy some bonds, which usually gain in value when stocks fall.
Because remember, when your account’s in cash, you’re far from riskless. Your risk just shifts from the down side to the upside.
Updates:
We saw some sweet redemption from EZCorp, Inc. (EZPW) this week, reporting awesome Q3 results that came in well ahead of expectations that validate the strength of the company’s business in spite of regulatory concerns. That had been weighing on shares, falling from $38 in July to a short-term low of $25 in late October. But in spite of the solid 5% gain in the choppy market, shares still have tons of value trading at a sharp discount to its peers and the overall market.
The Blackstone Group (BX) was removed from the portfolio this week. Shares of Blackstone had actually been hanging pretty tough in spite of the company’s disappointing Q3 results. But here’s the key takeaway. The weak economy has been wreaking havoc on the number of deals this private-equity firm has been able to sink its teeth into, denting earnings and growth projections. But even more importantly, if the market takes a hit on further chaos in the Euro zone, financial stocks will be beaten like unwanted step children. So even though Blackstone is a top company in its field, the risk reward ratio looks tilted to the down side.
But in spite of concern about the global economy, crude rallied for most of the week, pushing prices just shy of the $100 mark and lifting PowerShares Long Oil (DBO) to a 4.23% gain. That gain definitely had something to do with the inflation trade heating up, where investors know the only way many of these developed economies (EU/United States) can emerge from their financial nightmares is to print their brains out and hyper inflate.
Bullish crude also showed up in Cimarex Energy (XEC) and Baker Hughes, Inc. (BHI), both gaining 4% on the week. PowerShares Double Gold (DGP) also gained on inflation concerns, also up 4% on the week.
And finally, with investors concerned about volatility, dividend stocks fell into favor, lifting CPFL Energy (CPL) to an outsized 6% gain. When you add in the company’s awesome 6.2% dividend, it’s easy to see why CPL remains an excellent choice for growth and income.
That’s all for this week, but until next time, here is a good article discussing the high expenses of owning a mutual fund. This report found that trading costs alone were about 1.44% annually. And when you add in management fees and other costs, mutual funds look like the high-priced, low support and relationship vehicles they are. Enjoy.
Your Investment Partner,
Mike
