What Is It About August?

So what is it about August anyway? Once again the month brings us angst & misery, at least in the financial markets. Kids don't notice it though thankfully. To them it's that last fling of summer before school intrudes back into their lives. In most cases  schools today intrudes earlier in the summer and for longer periods each year!

Markets of course don't know or care about seasonal patterns. They will as the consigliere used to say, "Do what they have to do to prove the most amount of people wrong.". Markets did that this week by staging their worst daily & weekly performance of the year.

As of this writing {Friday}, stocks are down about 4% for the year and are down approximately 11% since starting to roll over around July 4th. There are three main factors that we think have contributed to this decline. The first was the messy and chaotic way the debt crisis was handled. That process unfolded mostly as we expected. {See here}. However, the final product was less than most investors wanted and reinforced the view among the public regarding Congress' ability to get anything of real productive value accomplished.

The 2nd issue has been the concern that the economy is slowing down to the point that a recession could be just around the corner. Yesterday's jobs report data which showed some upward revisions to job creation in the past few months and showed growth for the current period, would seem to lower this concern right now. However, it is likely that the economy will grow at a slower rate through the rest of the year than investors had previously assumed.  It is also likely that both business and consumer confidence has taken a hit during this period which could also help slow things a bit.

Finally the problems in Europe just seem to continue to get worse. Many of us assumed that the Europeans were on the way to fixing their issues of sovereign debt when they announced in July their debt program for Greece. Recent events in Portugal, Spain and now Italy suggest that if anything these problems have become worse.

The investment pictue using a longer term time horizon is perhaps not as dreary as the current outlook might suggest. Corporations are coming off a pretty good 2nd quarter earnings season. They are not only showing good profitability but also their balance sheets are collectively the best they have been since the 1970's. There is a sovereign nation debt issue in Europe but it so far doesn't seem to be morphing into the kind of banking crisis that we witnessed in 2008. Finally stock valuations are low based on midpoint earnings estimates going forward and finally investor expectations have declined to a point suggestive that much of what has occurred is likely baked into prices at this point.

I've said recently that we've had the defensive pages of the playbook handy.  Here's what it says and hence my thoughts regarding overall portfolio strategy. While nobody can say where for certain the bottom to this decline might be put in place, it is likely to be an event that occurs in fits and starts. That is there will likely be snapback rallies which should be ideal for repositioning portfolio assets or even raising cash. It is unlikely in my view that equities will form a "V" shaped bottom and march straight back to new highs. For one thing we have now fallen out of the trading range we were locked into since February and the 1260 level on the S&P 500 will now be resistance. So it is reasonable to expect a period of backing and filling between now and sometime in the fall. It is also possible that we could experience some further downside in stocks. While a lower probability event, we cannot dismiss the possibility that prices could fall another 5-7% based on current sentiment. However I think that for investors with intermediate time horizons (6-18 months) there are bargains being created by this current decline. We plan to review our portfolios and make changes accordingly in the coming weeks. In particular we will be interested in adding exposure to equities that are paying higher dividend amounts either by design or by accident because of this decline.

We have carried a fairly high cash position for clients both now and at various times during the year. While realizing that in this type of decline that no cash position under 100% is seen as enough, we think that we will be in an environment where we can constructively put some of that to work soon.

At this point we are leaving our 2011 target price on the S&P 500 unchanged at 1350-1400. If we had to guess however we would probably pick the lower end of that range as the likely target price for year end. That means that if stocks were to hit those targets then prices have the potential to rise 12-15% from where they are currently trading.  Accordingly and to reflect our thinking while we will leave the defensive pages of the playbook open and while we will leave our short term rating up to NET MARKET NEUTRAL. we are close to raising that short term rating a notch.  Not there yet but could be as early as next week if the markets respond the way we think they might.

*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!!!