Quarterly Market Updates

MARKET UPDATE AND OUTLOOK : October 2011

What’s new at J.P. King & Associates, Inc.?

Last month marked the 30th anniversary of J.P. King & Associates, Inc. We were pleased to celebrate with so many friends and clients at the party we hosted September 30th at Round Hill Country Club. We hope everyone enjoyed themselves as much as we enjoyed having you. As a small token of our appreciation to mark this special occasion, we handed out embossed 30th anniversary stem-less wine glasses to our guests. Please be sure to pick up your wine glasses the next time you visit the office.

We continue to grow as a firm, and are pleased to welcome two new clients who joined us this quarter. We also added a new employee. Jonathan Gonzalez is a recent graduate of St. Mary’s College, and is joining our team as an administrative assistant.

Looking back

The third quarter was extremely difficult for global stocks. In fact, it was the worst quarter in most markets since the fourth quarter of 2008. The S&P 500 Index dropped approximately 14%, international stocks (VEU) dropped 22%, and emerging market stocks (VWO) dropped 26%. Selling was primarily driven by the escalating debt crisis in Europe along with spreading fears of a global recession.

Last quarter we said that 10 year treasury bonds yielding 3% didn’t appear to be attractive to us and weren’t likely to continue rising in price (falling in yield). We were wrong, as 10 year treasury bonds are now yielding 2%, meaning their prices went up almost 9% for the quarter. With the sell-off in global stocks and commodities, there was a flood of money into treasury bonds. As the money flowed into treasuries from all over the world, the U.S. dollar increased in value versus international currencies. This caused global bonds to suffer. The Templeton Global Bond fund, one of our larger holdings, declined roughly 8% for the quarter. The fund has large exposure to Asian currencies which suffered their worst month during the quarter since December, 1997.

In the Alternatives space, Gold (GLD) continued to move higher with a quarterly gain of just over 8%. It wasn’t a smooth ride, however. Through the end of August, Gold was actually up 25% for the quarter; then through September it dropped 12% from its high. We continue to view Gold favorably, but as it becomes more popular and prices continue to rise, the volatility is likely to increase. We will continue to monitor the value of our gold holdings in portfolios, planning to rebalance the position, so that it does not exceed our target percentages. Oil (USO) dropped 18% for the quarter after dropping 12% the previous quarter. This affected our Commodities holdings significantly. Concerns over a slowing global economy contributed to the decline. Our Long/Short and Market Neutral Funds had mixed returns for the quarter, with all of them at least outperforming the S&P 500 Index. The best performer was Hussman Strategic Growth, which returned over 7% for the quarter. As mentioned before, Hussman has been defensively positioned for quite some time, and that served the Fund well during the quarter. The AQR Diversified arbitrage fund was a decent performer with a loss of less than half a percent. The Marketfield fund did relatively well, losing less than 4% for the quarter. The Merger fund lost about 4% and TFS Market Neutral fund lost a little over 10%.

This was a difficult quarter for our portfolios. Global diversity was a detriment this quarter, as foreign investments sold off more than domestic investments. And the broadness of the sell-off affected most asset classes, not just stocks. We build portfolios around low-correlated asset classes, yet sometimes those correlations can change and converge in the short run, meaning things can all go down at once. This is what happened in 2008/2009, and this is what happened again this past quarter. Not only were stock markets down steeply, we saw global bonds go down, multi-sector bonds go down, and commodities go down. Gold and U.S. government bonds were about the only positives. Considering that worldwide stocks declined about 18 percent, our portfolio models were still able to meet or surpass their volatility targets, which is our objective.

We made portfolio adjustments this quarter that reduced exposure to risk. The changes that were made in August helped portfolio performance through September. The fund switches we made will help not just in the short run; these funds will be positive additions as we move ahead.   

Looking forward

Over the past few quarters we have talked about our expectation for the markets to moderate. We even used the saying “two steps forward, one step back”. Unfortunately, that step back was much larger than most people anticipated.   

We mentioned in our latest Investment Bulletin in August that we believe the odds of a recession have increased, possibly to as high as 40 – 50%. If we do get a recession however, we think a small positive is that it will likely be on the mild side. If we do not slip into a recession then the economy will probably continue with slower than average growth, both here and abroad.

We continue to evaluate portfolio changes and opportunities. We are currently most focused on income producing investments. If we are to continue in this slower-growth economic environment, then a strategy of “getting paid while we wait” makes sense to us. We are actively evaluating additional dividend yielding and income generating investments, and may introduce one or more into portfolios before year end. If so, we will inform you in advance via an Investment Bulletin.     

If the markets continue to decline much further we will reach a point where rebalancing becomes attractive. Rebalancing brings portfolios back into line with their target allocations. We would be selling some of the winners (over-weighted securities) in our portfolios to take advantage of buying stocks (under-weighted securities) at lower prices. 

We would enjoy discussing any of our comments with you in greater depth. We encourage you to call with any questions you may have, or to schedule an appointment for a more thorough review of your situation. Thank you for allowing us to assist you in managing your financial lives.

James P. King, CFP^®, Scott Horton, CFP^®