Premarks: Market Post S&P Downgrade

I spent some time yesterday thinking about what has occurred over the past few weeks {it helped that it rained} which culminated with Friday's S&P downgrade of US debt. As I'm trying to write this more or less on the fly please excuse if it's a bit more disjointed than normal.

Anyone who says they really know what is going to happen today is either naive or lying. I will take a stab at a guess though. As I'm writing this the market futures are pointing to a lower opening of somewhere between 1-2%. As I previously mentioned, I think the market would be down today even without the weekend downgrade. It is impossible to know how much more this will add to the decline. I think there is a high probability that stocks will experience some sort of rally either later today or tomorrow. It would not surprise me to see markets end this week either even from where they opened today or higher. I also think there could be a higher level of volatility this week as markets try to find some equilibrium. Then it wouldn't surprise me if we go to sleep (meander aimlessly for a few weeks}.

Markets are now down about 7% for the year and 13% since their most recent July highs. This-believe it or not-is within the normal volatility range that markets can expect during the year. Stocks are nearing a 12.4 Price/Earnings ratio which is near the trough experienced in March 2009. Stocks were a pretty good buy then and are looking cheap today. Markets are basically pricing in a recession at this point. However, economic conditions: labor, lower corporate inventory levels, and consumer confidence aren't at the elevated levels that are normally associated with a recession. Also the dividend yield on the S&P 500 is approaching levels near that of the 10 year U.S. Treasury. The last time that occurred was also in March, 2009.

What markets worldwide have experienced is a massive loss of confidence. This will take time to repair. I'll stand by what I said regarding trading on Friday. That post is the 2nd one below this, entitled "What is it About August Anyway?"

Regarding what we might do for clients, I believe markets have become very cheap based on what we currently know. I think there is a risk of perhaps 5% to the downside {from Friday's close} buttressed by the potential for a 10-15% gain, possibly by year end. I also think that from these prices stocks now have the possibility of rising 20-25% over the next 12-18 months. While it is possible that some event will cause us to change this outlook, current facts suggest that the risk reward ratio is becoming more attractive for equities. That being said I will look for markets to stabilize before putting to work more of the cash we have on the sidelines. Also I'm willing to change my mind in the event that I am wrong. In this regard we will let our indicators be our guide.

After reviewing our portfolios, I am comfortable with most of what is held. Depending on styles and client risk/reward parameters we are in general holding healthy levels of cash {again realizing that for many investors in these times no cash level is comfortable unless it is 100%}, higher yielding ETFs, certain other defensive ETFs as well as investments in basic index related ETFs. It is at times like these that I believe that investing in ETFs really shows its merits. Unless Armageddon occurs it is unlikely that these will go to zero. Depending on how events unfold it is likely that we will put a tranche of this money to work sometime this week. Again I would refer you to the post of Friday for how this might pan out.

Finally let us consider that much as friends might stage an intervention for somebody with a substance abuse problem, we must consider the possibility that the government debt downgrade could lead us as a nation to a series of steps that could put us on a sounder economic footing down the road. That road while likely painful and full of pitfalls. However it could place the U.S. in a better future economic position which would be very optimistic not just for equity investors but the American public. More on this possibility at a later time.

*Long ETFs related to the S&P 500 in client and personal accounts.

**Please note that the above reflects solely the opinions of Lumen Capital Management, LLC. As such it is designed solely for the clients and friends of our firm. Since we do not know the investment parameters of casual readers of this blog, they are advised to consult their own investment advisors or do their own homework. Nothing in this posting should be construed as a recommendation or a guarantee of any sort. Better yet, hire us and we'll show you how our work is done!!!