The comedian Brian Regan has a great sketch about going to see the doctor. He says doctors never talk about "pain." They use the word "pressure" instead, as in, "you might feel a little pressure" just before they hit you with something that really hurts. As Regan says, "If a doctor tells you you're about to feel some pressure--buckle up!"
Equity investors definitely felt pressure in the third quarter. The S&P 500 index sank nearly 14% in the quarter, its worst quarterly return since the end of 2008. And although that was terrible, the rest of the world fared even worse. Greece led the parade with a decline of almost 47%; Italy, Russia, France and Germany each lost about 30%
What's up with Greece?
The chart to the right shows why the pressure on Greece is justified. In short, Greek public finance is a disaster. The chart maps three dimensions of the European debt crisis: growth (vertical axis), public debt as a percent of GDP (horizontal axis), and relative borrowing costs (the size of each circle).
In terms of these measures, Greece wins the triple crown: slowest growth, highest debt-to-GDP, and highest interest rates. It is hard to imagine a more poorly run economy than Greece.
In fairness to the Greeks, however, they don't have the highest debt burden in the world. According to the International Monetary Fund (IMF), two other countries beat Greece for that honor: the tiny Caribbean nation of St. Nevis and Kitts, with debt-to-GDP of 205%, and Japan, with debt-to-GDP of about 234%.
By the way, if you want to read an interesting and entertaining book about the roots of the European debt crisis, I highly recommend Michael Lewis' new book, Boomerang: Travels in the New Third World. But be careful, the final chapter, aptly called "Too Fat to Fly", makes the pointed case that California is not so very different from Greece. Forewarned is forearmed.
Signs of life?
An uptick in economic activity late in the third quarter seems to be working against the notion that the U.S. is slipping back into recession. While job creation remains virtually non-existent, retail activity and growth in business inventories are improving, causing Ryan Sweet, a senior economist with Moody's Analytics, to increase his tracking estimate for third quarter GDP to 2.7%. As Sweet noted in his summary of the data, "This bodes well for growth in the final quarter of 2011; another decent gain could help restore business confidence and fuel stronger hiring." That would be sweet indeed.
A case of relative value
According to the Investment Company Institute, more than $173 billion flowed out of domestic equity funds during the first 9 months of 2011, while $339 billion flowed into taxable bond funds. I admit I don't get it. I mean, I understand how uncomfortable market gyrations can be, but if I'm a serious long-term investor (and we take investing very seriously), why would I choose to shift my money from stocks to bonds at these levels. It would be the ultimate case of buying high (bonds) and selling low (stocks). The chart to the right gives a sense of what I'm talking about. Yields on 10-year government bonds are trading at historically low levels while dividend yields on stocks are very healthy. In fact, I can buy stocks with dividend yields above government bond yields. Unless I have no tolerance for price volatility or have a very short time horizon, it makes no sense to favor bonds over stocks in the current environment.
The point of all this is that despite the pressures in the market, we continue to see outstanding investment opportunities. Our disciplined investment approach is focused on capturing these opportunities, a process which we are confident will bear fruit over time. In the meantime, while the pressure is on, we invite you to sit back and enjoy a little dose of Brian Regan. Just what the doctor ordered.