Week of August 13, 2007

The Markets
 
“All’s well that ends well.”  So wrote Shakespeare 400 years ago and it seems an appropriate description for the stock market last week.

The market started last week on a tear.  The Dow Jones Industrial Average rose 476 points in the first three days, which was the Dow’s best three-day rally since March 2003, according to Barron’s.  But on Thursday, investors had a change of heart and the Dow posted its second worst loss of the year, according to The Wall Street Journal.  By the time Friday morning rolled around, nervous investors continued selling.  However, the Federal Reserve stepped in and helped calm the markets by injecting $35 billion into banking systems, according to MarketWatch. This added some needed liquidity and confidence to the markets and the Dow ended the day down just slightly.
 
The Fed’s intervention raises an interesting issue.  If investors start thinking that the government or the Federal Reserve will intervene in the markets every time there’s a potential problem brewing, this could make investors less “disciplined” and cause markets to not function properly.  For example, if investors figure that the government will step in and prevent significant losses, they may take bigger risks, which could lead to bigger bubbles.

Walking a fine line between letting markets function in a capitalistic system and intervening if things get way out of kilter is a delicate balancing job for the Fed and the government.  Based on the markets response last Friday, the initial reaction was the Fed made the right move by adding liquidity to banking systems.

As the markets showed us last week, we may not like what happens in the middle “innings,” but ultimately, the score at the end of the game is what really matters.  And so far, all the numbers in the box below are showing positive returns.

Source: Yahoo! Finance, Barron’s Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly. Three-, 5-, and 10-year returns are annualized.  Assumes dividends are not reinvested.

AMERICANS HAVE TENDED TO CONSTRUCT LARGELY DOMESTIC PORTFOLIOS, but in the last few years, U.S. investors have begun to expand their worldview.  According to the Investment Company Institute (ICI), of the $160 billion of net new money investors added to equity portfolios in 2006, portfolios investing in foreign companies raked in a record $148 billion, up from $105 billion in 2005.

Additionally, a new Spectrem Perspective report, “Meeting The Affluent Investors Needs Through International Investing,” released in early May, notes that trend is strong among affluent Americans.  In fact, 40% of affluent households, defined as having more than $500,000 in investable assets, say they are likely to invest or continue investing internationally.  Nearly one-third (31%) say they are investing more internationally than in the past.

Are investors chasing performance or is this an attitude adjustment?  It may be a little of both.

While the traditional benefit of international diversification has been to lower portfolio risk, today U.S. and foreign markets seem to move a little more in lockstep than in the past.  Of course, this could reverse in the future.  For now, some investors are pursuing “global opportunity” as the primary reason to invest overseas.  Simply, the U.S. is a smaller piece of the world economy.  Today, if you want to invest in the dominant pharmaceutical company or automobile manufacturer, you need to cast a global net.

As the world becomes flatter, our investment choices become wider.

ARE INEXPERIENCED MONEY MANAGERS more likely to be swayed by the euphoria of investing bubbles?  In a recent paper titled, “Inexperienced Investors and Bubbles," Harvard Business School’s Robin Greenwood and Stanford University’s Stefan Nagel compared the returns of young and older money managers during and after the technology stock bubble.  The results show that inexperienced money managers, those under age thirty-five, exhibited trend-chasing behavior that produced over-investment in tech stocks.  According to the authors, the “trend-chasing behavior of young managers reflects their attempts to learn and extrapolate from the little data they have experienced in their career.”

The research showed older managers were less likely to take the bubble bait.  Why?  As Professor Greenwood commented in a Q&A with Sean Silverthorne, “First, they have had more market experience, and know that past returns do not imply future performance. Second, they may have lived through some years of particularly bad returns.  This tends to make investors more cautious.”

Greenwood noted further that “managers older than forty—just old enough to have lived through the 1987 crash—were particularly unlikely to bet on technology stocks relative to their younger counterparts.”
 
It goes to show there’s no substitute for experience.

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Best regards,

Fredrick J. Livingston, CLU, CFP

Securities offered through LPL Financial, Member NASD/SIPC

* The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.

* The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. 

* The Nasdaq Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System.

* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods.

Brain Teaser Answer:  It contains the numbers one to nine, in alphabetical order.