This year’s financial markets are imitating the volatile roller coaster ride we experienced in 2011. Like last year, the large majority of forecasts for the 2012 economy were optimistic, as most of Wall Street believed the worst of the global banking crisis was behind us. As we saw in 2011, U.S. stocks moved higher in the beginning of the year. However, the volatility we have seen return over the last month is reminiscent of last summer. Today, U.S. stock markets are essentially breakeven for 2012. Pacific Wealth Management’s bond investments, and in particular U.S. Government bonds, continue rising in price, allowing us to post positive portfolio returns thus far this year.
As we have been emphasizing over the last few years, the European Debt Crisis is far from over and remains at the forefront of Pacific Wealth Management’s radar screens for 2012. Although disputed by most of Europe’s finance ministers as recently as January of this year, the Eurozone economy is now officially in recession. The sell-offs in stock markets around the world are taking Wall Street by surprise and many investors, without effective risk management, are experiencing abrupt declines once again.
A financial market truism suggests the most anticipated event is the least dangerous. The world is watching Greece in a slow motion train wreck and heading for their ultimate exit from the European Union (EU). Although the Greeks just voted to stay in the EU, we believe it unlikely they will remain so over the long term. A less quantifiable and significantly more dangerous question remains; how will Greece’s challenges impact Portugal, Ireland, Spain and Italy’s ability to manage their crushing levels of debt? Although Angela Merkel continues to tow (talk up) the German “austerity” line, many of Europe’s political winds seem to be shifting toward more “growth” and less austere strategies. For the EU to survive, Germany’s inflation nightmare may eventually become a reality, as Europe will ultimately need to print an enormous amount of €uros to perpetuate their version of “Quantitative Easing”. We expect Germany’s desire to keep the EU together will ultimately supersede their insecurities about inflation. Our belief is the EU’s “monetary” union, which was created with a shared €uro currency, has to evolve toward a fiscal union, where EU member countries stand behind the government debt of one another or, minimally, a newly created €uro-bond.
The United States has its own “deficit reduction” political cross road looming in the fall elections. We will see whether our country’s elected and appointed leaders have the political will to tackle our homegrown deficit challenges before we begin to look like Southern Europe. The U.S. economy is growing slowly but remains fragile, as highlighted by the recent rise in unemployment. We believe America is vulnerable to the ongoing European challenges and the next chapter in the banking crisis. Corporate CEOs are reluctant to spend their very large reserves of cash until they see more clarity on taxes and the economic outlook. Pacific Wealth Management portfolios remain very well diversified as our Proactive Asset Management™ discipline continues to effectively manage risk. Over the last 18 months, we have purposely under-weighted allocations toward stocks, as we have perceived risk levels remaining high.
Although uncertainties are ever-present in global economies and financial markets, we believe the precarious nature of Europe, a percolating Middle East, and the volatile domestic and international political landscape, combine to make prudent risk management vitally important. As always, Pacific Wealth Management portfolios remain built for wealth preservation.