by Jason Norris, CFA Senior Vice President of Research
What a Long, Strange Trip It’s Been In the early spring of 2010, things were starting to look up. We were a year into the stock market recovery and had witnessed the popular equity indices almost double from their March 2009 bottom. Unemployment had started to improve and GDP was accelerating. Retail investors were getting comfortable with stocks again, which resulted in positive inflows to equity mutual funds.
Those “green shoots” wilted two years ago this week, when the flash crash hit the markets and the Greek “crisis” began to unfold.
The advent of these two events had major ramifications on the psyche of individual investors. The crisis in Greece unveiled the major structural problems of European economies. Their reliance on ever-increasing levels of debt and taxes to meet their welfare needs became unsustainable. The Greek crisis created a “domino effect” that forced austerity measures needed in their country as well as Ireland, Italy, Portugal and Spain. The recent elections in Greece and France have made it clear that the populous position is resistant to spending cuts and living within their means. Only time will tell how this will play out, but these political and economic events have increased volatility in the global equity markets and increased uncertainty regarding the European Union and Europe growth.
Dark Shadows The flash crash occurred on May 6, 2010, when the Dow Jones Industrial Average fell almost 1,000 points intra-day and recovered most of its loss before the close. This “crash” was the result of selling pressure from quantitative investors, as well as high-frequency trading that fed on itself. Having only begun to recoup the losses of 2008, investor confidence in the markets was rattled by this volatility. Over the last two years, individual investors have sold $260 billion worth of equity mutual funds, while investing over $360 billion in bond funds (even as interest rates were falling to historic lows). Though stocks are up roughly 20 percent over this time, there is a growing suspicion among investors that the “game was rigged.”
While we cannot control what happens in Europe, we (investors and industry participants), can provide input to improve transparency into our market structure and alleviate some of the fears the investing public has. While short-term volatility may continue, we believe there has been considerable structural market innovation since May of 2010, and for long-term investors, short-term volatility may provide opportunities.
The CFA Institute held its annual meeting earlier this week, and a focus of the meeting was to lighten the “dark shadow” over the equity markets. While most professional investors are highly ethical, some have given the profession a bad name—most recently MF Global. While some may argue that a lot of the trading (high frequency, dark pools, etc.) has increased volatility, it has also meaningfully decreased the cost of transactions and increased liquidity. For long-term investors, this is a major improvement.
Two Strikes We saw two large negative corporate events this last week. First, Cisco Systems stated they are seeing customers becoming somewhat more cautious in there spending patterns, primarily due to uncertainty in Europe. We believe Cisco is well positioned going forward, and while seeing some near term headwinds, we are positive on the stock for long-term investors.
Second, JP Morgan (JPM) announced late Thursday that it had major losses in its credit portfolio. The company is considered one of the best at managing credit risk and if they are facing challenges, we anticipate less sophisticated players may also be having issues as well.
Our Takeaway for the Week
- It’s never a dull moment in the markets, and we would anticipate continued volatility in the months ahead
- In the long term, we believe equities offer great value; however in the near term, interest rates may continue to decline, which will benefit fixed income positions