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Henry J. Herrmann
CEO
Chariman of the Investment Policy Committee
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Waddell & Reed Advisors Market Perspectives – August 2011
We have recently seen the most dramatic and rapid market movements since the financial crisis of 2008. The volatility is driven by several factors, and can be very unsettling. However, I want to assure you that the entire investment team at Waddell & Reed continues to review all market sectors, economic data and global events with an eye toward doing what is best for our investors. We meet every weekday morning to discuss events and ideas, we will continue to do so, and we are working constantly to be astute stewards of the assets you have entrusted to us.
This is among the most frustrating environments I have seen in a very long time. Economic fundamentals remain fairly sound, corporate earnings are strong, financial institutions have liquidity, yet various political issues in the U.S. and Europe have created tremendous uncertainty. Financial markets never like uncertainty.
The key events we’ve all been reading or hearing about – specifically the package Washington has put forth as part of its step to raise the debt ceiling, and the sovereign debt crisis in Europe – have created more uncertainty rather than helping to mitigate uncertainty. On top of that, Standard & Poor’s, a rating agency, cut its rating on long-term U.S. government debt for the first time in history. All of this has resulted in a perfect storm to rattle the markets.
It will take time to settle all of this and for rationality to return. I’d like to say this will go away quickly, but the truth is the markets are the victims of political governance failures. We need more leadership in Washington and in Europe. In time, however, certainty surrounding these issues will develop. Given that, I think it is important for investors to understand that now is not the best time to drastically change long-term investment plans, or sell securities at a loss. We believe it is better to retain a longer-term perspective, wait for sensibility to return and continue to monitor your asset allocation with the guidance of your financial advisor.
While we’ve all heard some predictions of an outright recession in the U.S. and a big decline in earnings, we do not believe that is likely to happen. The following quick review of the primary issues impacting the markets right now, and our impression of each, may help as you evaluate your situation.
First, if the market was truly worried about the U.S. defaulting on its long-term debt, you would not see the rush of money into U.S. Treasuries that we’ve recently witnessed. Over the last week or so, U.S. Treasury securities have seen their yields decline and their prices rise. This is not a sign of concern to us about default. U.S. debt securities remain among the safest in the world, and investors continue to recognize that.
The recent debt ceiling package, after much argument, blame and difficulty in Congress, solves the debt-ceiling crisis for the short run. But it comes with a timeline to get deficit reduction measures established; a timeline that runs nearly through the end of this year and has a high likelihood of failing. The financial markets simply don’t like this package because it is politically divisive and has yet to show that it can solve any of the uncertainty while clearly decreasing the U.S. deficit.
In Europe, the so-called resolution of the sovereign debt crisis that took place several weeks ago involves a number of commitments but doesn’t address several problems. In short, the European Central Bank (ECB) chose to buy the sovereign debt of Ireland and Greece, but specifically not the debt of Italy and Spain, which became the big issue after the package was announced. European leaders are taking too long to reach a decision on several different sovereign debt issues. There remains a great deal of disagreement among the key players as to who should bear what burdens.
Is this environment similar to 2008, and could we see similar prolonged market declines? Today we have a fundamentally different and stronger environment, as U.S. financial institutions have tremendous liquidity (unlike 2008), credit markets are functioning normally, consumers and companies have scaled back their debt, and corporate profits are strong. The complex investment instruments and systems in place in 2008 are largely non-existent, and the environment is much more tightly regulated. The issues we face today are entirely separate, and in some ways more easily solvable, though consensus and leadership will be required.
Over time, we believe that the message from the financial markets is certainly going to get the attention of the various government authorities. But how quickly they can get focused and gain consensus on credible plans for the deficit issues in the U.S. and Europe is unpredictable. However, we do believe that will happen and will happen reasonably soon.
The financial markets overall and individual investors and corporate leaders in particular, need more confidence in government and in the future. I think once some action is taken, confidence will improve and the underlying economic tone, which mostly is constructive, should calm the markets down.
During this difficult environment, we encourage you not to overreact. In the language of the successful investor, “it is never wise to sell low and buy high.” Remember, a strong financial plan is developed with a sense of clarity and perspective, with your long term goals in mind.
Our investment team will never forget that it is your money we are managing. Rest assured, we will continue to monitor the markets, and manage your assets with a profound understanding and appreciation for the trust you have placed in us.
Sincerely,
Hank Herrmann
Past performance is no guarantee of future results. The opinions expressed in this article are those of Mr. Herrmann and are current through August 2011. Mr. Herrmann’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed.
Waddell & Reed Financial, Inc. is the ultimate parent company of Waddell & Reed, Inc. and of Ivy Funds Distributor, Inc.