February 28, 2012

Calm Waters?

It's been rather calm in the stock market lately.

For the past couple years, the euro zone debt problems and the "will we or won't we relapse into a recession" worry have been on center stage. Now, Europe's immediate liquidity issue has been patched and the U.S. economy seems to be on firmer footing. Accordingly, the stock market has responded to these developments and, last week, the S&P 500 index closed at its highest level in more than 3½ years, according to The New York Times.

Fear has declined, too. The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, ended last week at about 17. That's down from 48 reached last August and well below the 22-year average of 20.6, according to CNBC and Bloomberg. A low VIX suggests investors are less fearful of near-term market volatility.

Are there any worries on the horizon that could upset this calm?

Oil prices are one thing to keep an eye on. They rose 6 percent last week and closed at nearly $110 per barrel. Geopolitical tensions in the Middle East contributed to the rise as Iran is reportedly within sight of creating a nuclear bomb. That, of course, creates major headaches not only for the Middle East, but for the world in general.

On top of that, "There's also an oil pipeline dispute between Sudan and South Sudan in northeastern Africa; unrest in Syria, Yemen, and Nigeria; varying levels of tribal infighting in Iraq and Libya; and the possibility of leadership issues in Venezuela, where the president is undergoing his third surgery for an undisclosed type of cancer," according to The Milwaukee Journal Sentinel.

So far, the stock market hasn't flinched in the face of these flashpoints. However, an unexpected turn for the worse in any of these areas could trip the markets. And, since the S&P 500 index has more than doubled in value since the March 9, 2009 low, according to The New York Times, it might not take much to trigger a market correction.

As a financial advisor, we know that there is always something to worry about. Frankly, it's our job to worry about what could go wrong so you don't have to. The good news is, as a country we always seem to find a way to overcome whatever obstacle is thrown our way.

Secular Cycles

TRADERS TEND TO GET CAUGHT UP IN THE DAY-TO-DAY NOISE of the financial markets whereas investors know that markets often move in long secular cycles that can last more than a decade. For example, let's look at interest rates:

At the end of 1964, the 10-year U.S. Treasury note yielded 4.2 percent. Over the following nearly 17 years, the yield rose until it peaked at 15.8 percent in September 1981, according to Bloomberg. During that span, the yield fluctuated significantly (the noise), but the long-term secular trend was a rising interest rate environment.

Since that peak in September 1981, the yield on the 10-year Treasury has been in a more than 30-year long-term secular decline. In fact, the yield was a slim 2.0 percent last week - well below 1964's 4.2 percent. This decline was interrupted by numerous interest rate increases along the way (the noise), but the long-term trend was a decline in rates.

Turning to the stock market, it also exhibited significant moves during these two interest rate cycles.

From the end of 1964 to the end of 1981, the Dow Jones Industrial Average rose from 874 to 875. That's no misprint. Over that 17-year period, the Dow rose exactly 1 point. In other words, it went nowhere. However, during that period, it rose as high as 1,052 and dropped as low as 578, according to Bloomberg. Here, the long-term secular trend in the equity market was to move sideways with lots of noise in between.

Fast forward to 1982. From its low in August that year, the Dow Jones Industrial Average took off on a 17+ year secular bull market that saw the Dow rise 15-fold, according to Bloomberg. And, yes, there was lots of noise during that 17-year bull run including the 22 percent decline - in one day on Black Monday - October 19, 1987.

Here's the takeaway - markets are very noisy. While we monitor what happens in the short-term, we want you to focus on the long-term. Day-to-day fluctuations may top the headlines, but it's the long-term trends that you should pay attention to. Be an investor and not a trader.

Weekly Focus - Think About It

"Only put off until tomorrow what you are willing to die having left undone."

—Pablo Picasso, Spanish painter, draughtsman, and sculptor

Best regards,
Sean M. Dowling, CFP, EA
President, The Dowling Group Wealth Management

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