Week 37: Five days of Gains . . . and yet, no conviction.

September 16, 2011 – After weeks of writing about the dismal state of affairs in the economy, it would be natural to anticipate that the markets would continue to deteriorate, but Week 37 serves as a reminder that the markets are not as predictable as one might think, and they can easily be altered by current events.  This is one of the reasons why timing the market can be such a precarious investing strategy. 

This week’s current event was that the world’s banks rushed to the rescue of European banks in need of U.S. dollars and provided loans  thereby averting – at least for now – a potential liquidity crisis.  It may seem odd that European banks might be in need of U.S. dollars to avert such a crisis; however, many European banks make their money by lending abroad and those loans tend to be issued in dollars.  Before the concerns of debt issues in of the governments in Portugal, Greece, and Italy (to name a few), these banks would simply have obtained dollars by selling short- term loans to the U.S. money market funds.  But as concerns of European nations’ defaulting has grown the money market managers have pulled back on buying these bonds – leaving European banks without a source of dollars. 

To stem the potential lack of liquidity, the Federal Reserve agreed to extend loans to the European Central Bank as well as other European banks.  The move was orchestrated along in conjunction with the central banks of Britain, Switzerland and Japan:  the action relieved nervous investors who feared that if the crisis continued, it would result in the deterioration of European economies and negatively impact the profits of those who do business in Europe. 

The reaction of the markets seems to have overshadowed the foreboding news that the U.S. economy is continuing to slow down.  The latest report from the Department of Labor on unemployment noted that a total of 428,000 people joined the jobless rolls, which is 11,000 more than the previous week and above the 400,000 level that economists believe is necessary for the nation’s 9.1% unemployment rate to decline. 

As the outlook on the economy has darkened, those sectors in the market most affected by a potential downturn have taken it on the chin:  material stocks are down 10.6% YTD (year to date) and industrials have fallen 9.2% YTD, while the non-cyclical utility stocks have shown an almost 8% gain for the year.  One need only to look at the financial sector to realize how the European crisis, the depressed U.S. housing market, and our slowing economy have impacted them:  the sector is down 21% YTD. 

With such uncertainty about the future in the market, it is no surprise that the Volatility Index (VIX) has recently shot up.  Increased volatility can mean that those investing in the market have greater uncertainty about the future direction of things.  This, too, has added to investors’ concerns as they continue to watch a see-sawing market, not sure what to deduce.  One would think that after a week of solid gains, investors would have some conviction as to the future direction of stocks, but as mentioned above, predicting the market is precarious.

Week 37 Market Data            
    Market Close                    % Change
  12/31/2010 9/9/2011 9/16/2011   Weekly YTD
DJIA 11,577.51 10,992.13 11,509.09   4.7% -0.6%
S&P 500 1,257.87 1,154.23 1,216.01   5.4% -3.3%
NASDAQ 2,652.87 2,467.99 2,622.31   6.3% -1.2%
Crude Oil ($ per barrel) 91.4   87.96   - -
Sources: Thomson Reuters; WSJ Market Data Group