After four frenetic days, today seemed almost calm by comparison. Monday through Thursday marked the first time in stock market history that the Dow Jones Industrial Average changed by more than 400 points on four consecutive days: in order, -634, +429, -519 and +423, for a net decline of 301 points. Today’s rather placid 126-point gain reduced the week’s loss to a mere 175 points, masking the excitement from those not privy to the daily roller coaster ride.
The intra-day swings were even more dramatic with much of the action unfolding into the close. Approximately half of Monday’s massive decline, about 300 points, disappeared in the session’s last 45 minutes. Tuesday saw a rise of about 640 points in the last hour and half, turning a big loss into an even bigger gain. That late-day enthusiasm was reversed by a 300-point decline on Wednesday’s opening, and the day concluded with a 370-point loss in the final two hours. Thursday looked great all day until the market shed 160 points during the last 15 minutes. On this late-summer Friday, as floor brokers were making an early exit for the Hamptons, the market limped to an anticlimactic close.
While receiving far less publicity, the bond market was equally volatile. As stocks bounced up and down like a hyperactive rubber ball, massive amounts of money fled to safety in U.S. Treasury bonds, notes and bills. From last Friday’s close through late Wednesday, the yield on the U.S 10-year Treasury plummeted from 2.56% to 2.09%, an amazing three-day decline. By week’s end, the yield had risen part way back to 2.24%. While yields were declining and prices rising on top quality bonds, junk bonds–euphemistically called high yield bonds–headed the other way. On a panicky Monday they lost 5.4% of their value in a matter of hours. The ultimate in safety, the three-month Treasury bill, demonstrates dramatically how worried big money is. The three-month bill closed the week with an annual yield of one-half basis point. In other words, if you loan the U.S. Government $1,000, the government promises to return your $1000 three months from now with a return of one and one-quarter cents. This is the quintessential example of the desire for the return of your money rather than the return on your money.
Despite the well-chronicled reduction of the U.S.’s debt rating by Standard & Poor’s, the primary concern facing the markets and the world economy is the growing danger of sovereign defaults in Europe and the resultant danger to the banks that hold that increasingly risky paper. Governments and central banks worldwide are doing their utmost to offer reassurances that they have solutions and will exercise them as necessary. It’s possible that they will succeed–at least in “kicking the can down the road”–but the probability of warding off default indefinitely and restoring these countries to economic good standing is unlikely in several cases and impossible in others. Whether they can succeed even in deferring potential defaults will depend upon their ability to maintain investor confidence. That’s looking increasingly unlikely.
The environment remains fraught with danger. How highly unpredictable events unfold over the weeks and months ahead will largely determine the course of both equity and fixed income markets. As others have stated, these are markets to rent, not own. To protect and grow assets, we are continuing to boost portfolio yield with risk-free income while looking for strategic opportunities in both the equity and fixed income markets. In a low-yield, high-risk environment, it is essential to keep capital properly protected.