Wealth Management

Market Review - Third Quarter 2011

The third quarter began on a positive note. Investors were optimistic that the second half of 2011 would usher in stronger economic growth and continued gains in the equity markets. Yet by mid-July, sentiment turned decidedly negative, volatility spiked, and a flight to quality reminiscent of 2008 ensued. The quarter was punctuated by global economic and political developments that undermined investor confidence and created an environment of fear and uncertainty. In response, markets around the world swooned resulting in their worst third quarter since 2008.

Throughout the quarter, technical indicators overshadowed fundamental analysis as investors intently watched key technical levels in the S&P 500, gold and the VIX, for a clue as to how the markets would trade on any given day. The selling was fierce. Markets moved violently from day to day; exemplified by 29 days in the third quarter where the DJIA rose or fell by more than 1%.

By the end of September, no corner of the market was immune from the indiscriminate selling. The Dow Jones Industrial Average fell 11.5%, its largest decline since the first quarter 2009. The S&P 500 declined 13.9% for the quarter, and now stood at a negative 8.7% year to date. The more volatile small and mid-cap markets fell even further with the Russell 2000, the small cap market proxy, falling 21.9% and the S&P Mid-cap 400 losing 19.9%. European markets experienced their biggest quarterly losses since 2002 and gold lost its luster, falling 12% in September after posting record highs in August.

The macro backdrop for the sell-off began in late July as the debt ceiling debate intensified and the market reacted negatively to the stinging realization that partisan gridlock could damage our country’s economic future. With Congress failing to create a viable long term deficit reduction plan, the United States AAA credit rating hung in the balance. The credit rating agency, Standard & Poor’s, reacted quickly and on August 5th downgraded the U.S. sovereign debt rating from AAA to AA+; a decision that rocked financial markets.

Meanwhile, the European sovereign debt crisis raged on. As the odds of a Greek default increased, investors feared it could threaten the stability of the entire European financial system. Bourses across Europe experienced significant declines. The German, DAX, and the French, CAC 40, each declined more than 25% in the third quarter. Selling pressure quickly spread across the globe. In Asia, the Japanese NIKKEI declined 10.7% and the broader emerging markets plummeted 22.6%.

The anticipated impact of the S&P downgrade was a large scale sell-off in the bond market that would result in increased borrowing rates for the government, corporations and consumers. Such a result never materialized. To the contrary, the yield on the 10 year Treasury, a proxy for the bond market, fell to levels not seen since the 1940’s. By the close of the quarter, the flight to quality pushed the yield on the 10 year Treasury to 1.9%, well below the 3% level it stood at in early July.

As we begin the fourth quarter of 2011, investors can find a few reasons to be optimistic. Economic data points are  improving, valuations are compelling and corporations continue to report strong demand.

Looking ahead, we will closely monitor monetary and fiscal policy initiatives as well as global policy initiatives designed to create clarity in an environment currently plagued by uncertainty. We are cautiously optimistic that as each  layer of uncertainty is removed, markets will breathe a sigh of relief and refocus on the fundamentals, which is the cornerstone of our process.

Finally, during these uncertain times, we remain committed to our consistent process that identifies well run, financially strong companies with significant free cash flow and stable earnings across all market caps. We believe the market’s decline will present compelling opportunities to add good companies to our focus list at extremely low valuations.

Michael S. Kiceluk, CFA®, Chief Investment Officer (mkiceluk@capecodfive.com)
Rachael Aiken, CFP®, Senior Investment Officer (raiken@capecodfive.com)
Edward R. Eastman, III, Senior Investment Officer (neastman@capecodfive.com)
Kimberly K. Williams, Senior Wealth Management Officer (kwilliams@capecodfive.com)

The facts and opinions presented herein are provided solely for the information of Cape Cod Five Trust and Asset Management clients. The information presented has been compiled from sources believed to be reliable and accurate, but we do not warrant its accuracy or completeness and will not be liable for any loss or damage caused by reliance thereon.

Investments are NOT FDIC INSURED, NOT DIF INSURED, NOT BANK GUARANTEED and MAY LOSE VALUE.