Consider underweighting stocks with a significant revenue base in economically troubled European countries.
The S&P 500 Index closed at 1402 on March 15, 2012, the first time the index closed above 1400 since June 5, 2008.1 The latest upward progression began in October 2011 when the debt crisis in Europe showed signs of receding and economic reports in the United States began displaying a more positive outlook. Between October 3, 2011, and March 23, 2012, the S&P 500 gained 27%, and U.S. investors have been riding a wave of mostly good news.
- Economic activity in the manufacturing sector, including new orders and production, expanded in February 2012 for the 31st consecutive month.2
- Real gross domestic product, a gauge of economic growth, accelerated 3.0% during the fourth quarter of 2011, compared with 1.8% during the third quarter of the year.3
- Although the unemployment rate remained high at 8.3% for February 2012, the rate declined from 9.0% in February 2011, creating optimism that the worst period of high unemployment may be over.
The question on the minds of many investors is: Will this momentum last, or is another crisis waiting in the wings? Risks remain, both within the United States as well as abroad. The European sovereign debt crisis appears to have stabilized, at least temporarily, thanks in part to the recent agreement among Greek private debt holders to accept a proposed restructuring of Greek sovereign bonds. If Europe is plunged into another crisis, Standard & Poor’s believes the fallout would affect U.S. business spending and equity prices.4
Domestically, the recent escalation in oil prices has the potential to curtail consumer spending, especially if prices rise further. Standard & Poor’s estimated that each $10 increase in the price of a barrel of oil subtracts 20 basis points (.20%) from growth in gross domestic product in each of the subsequent two years following the price hike, assuming the cost remains elevated.4
What Investors Can Do
Given questions that remain about the long-term health of the global economy, investors may want to consider the following:
- Consider overweighting equity holdings to U.S. stocks and emerging markets.5 This strategy could potentially avoid problems related to the euro zone. When analyzing potential holdings, review a company’s revenue sources to avoid significant exposure to Greece, Portugal, Italy, and other crisis-prone countries. In the United States, recent strong returns may create a scenario where the potential for future short-term gains is likely to be more muted.
- Keep bond holdings short term.6 Federal Reserve Chairman Ben Bernanke has stated that the Fed will continue to keep the federal funds rate low in an attempt to stimulate economic growth. But interest rates are likely to go up sometime, and when they do, bond prices are likely to fall. Consider keeping the majority of your bond holdings short term so that if interest rates increase unexpectedly, you will not be locked into long-term holdings that decline in value.
Investing in both stocks and bonds always involves risks, but avoiding securities associated with the euro zone and keeping bond holdings short term may help you avoid economic problems either in the United States or abroad.
1Source: Standard & Poor’s. Investing in stocks involves risks, including loss of principal.
2Source: Institute for Supply Management (ISM), Manufacturing ISM Report on Business , March 1, 2012.®
3Source: U.S. Bureau of Economic Analysis, February 29, 2012.
4Source: Standard & Poor’s, U.S. Economic Forecast Monthly Summary, March 2012.
5Emerging markets are generally more volatile than the markets of more developed foreign nations, and therefore, you should consider this increased market risk carefully before investing. Investors in international securities may be subject to higher taxation and higher currency risk, as well as less liquidity, compared with investors in domestic securities.
6Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
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