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Written by Lewis Wealth Management

May 26, 2010 at 7:21 pm

Posted in Uncategorized

Market Perspective – May 26, 2010

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Dear Clients and Friends:

The stock market officially reached correction territory and there has been a lot of volatility, which is obviously a cause of concern. The market opened sharply lower yesterday and recovered. This morning the market opened sharply higher. I thought it would be helpful to put some context around what is happening in the markets.

The Euro-Zone.

The European Union has 27 countries, all with different political and economic systems, but tied together by treaty under one currency, the euro. Some countries came through the 2008 crisis better than others. In particular, Greece, Spain, Portugal, Ireland and Italy have not fared well. These countries are burdened by very high deficits and weak, inefficient, and in some cases corrupt economies.

Recently, Greece was having some difficulty rolling over its debt. When it went to the market to issue new debt, there were not enough interested buyers. Greece was on the brink of default.

Fortunately, the European Central Bank (ECB) and the International Monetary Fund (IMF) put together a financial rescue package in exchange for some very tough austerity measures that Greece must impose upon its economy. These austerity measures will be very painful and difficult to implement in the years ahead.

Spain seems to be the next economy in distress. Earlier this week, the Bank of Spain seized control of CajaSur, a savings bank controlled by the Roman Catholic Church. Cajas are savings banks that fall under the influence of regional Spanish politicians. Spain recently suffered its own housing bubble collapse and this exposed corrupt lending practices in the Cajas. As a result, Spain initiated a process to reform these banks and merge then into the larger commercial Spanish banking system. This seizure is seen as an acceleration of that process, which is a good thing.

The IMF recently sent a mission to Spain and it appears that the IMF will recommend a wide range of reforms for the Spanish economy (like Greece).

Here are the risks.

First, European banks hold a lot of sovereign debt (like the bonds of Greece and Spain). They will be financially weakened if there are any defaults and they will be unable or unwilling to continue to make loans – creating a credit crisis in Europe that could trigger a second recession on that continent. This could be similar to our credit crisis of 2008.

Second, if the European economy struggles that will hamper growth here at home as multi-national companies based in the US will do less business in Europe. That will have a downward drag on our markets.

Third, the markets are having a very difficult time pricing in these problems. Both Greece and Spain have defaulted on their debt before, and they also have very volatile political systems. But what makes this crisis unique is that they are now members of the EU – which is tied together under one currency. This makes it more difficult to predict what might happen. How far will the countries of the EU go to preserve the union? We just don’t know at this point and markets hate uncertainty. Don’t be surprised if more rocks are thrown on the streets of Athens and general strikes paralyze Madrid.

On the positive side.

The size of the current European crisis is much smaller than the problems our banks faced in 2008. Since our own credit crisis, the capitalization of our banks has improved substantially.
The European economies at the most risk (Greece, Spain, Portugal, Ireland, and Italy) are a relatively small part of the EU’s overall economic pie.

It is encouraging to see the ECU and the IMF vigorously defend the euro by creating a fund that can assist Greece and other struggling Euro-zone economies.

There is a lot of economic data pointing to recovery in the US, but headwinds and risks are still present.

Recommendation.

There will be continued volatility in the markets. The question is whether there are any facts present to trigger a substantial change in investment policy. I believe the answer to that question is no.

There is only one real strategy to deal with this type of volatility and that is to have some downside protection already in your portfolio (which all clients already hold). Your alternative is to try to time the market, which does not work and actually increases the risk to your overall portfolio and your financial plans.

While it is difficult to watch the headlines, keep in mind that we are long-term investors and only a portion of your portfolio is invested in the stock market, and there are other assets in the portfolio that are providing downside protection.

Regards,
Austin Lewis, JD, MBA, CFP®
Lewis Wealth Management

Caveat – This is an educational blog expressing an opinion only.  It cannot not be relied upon until your individual situation is taken into consideration by an experienced advisor.  This blog is not designed or intended to give you individual investment, tax or legal advice. I strongly recommend that you consult with you own financial/tax advisor and/or legal counsel for information and advice concerning your particular situation.

Written by Lewis Wealth Management

May 26, 2010 at 2:59 pm

Posted in Uncategorized