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There wasn’t much to ‘Like’ in the financial markets last week.

May 21st, 2012 | By Beau Mercer

There wasn’t much to ‘Like’ in the financial markets last week as stocks took a hit on another round of global worries. High on the list of concerns were:

This debacle points to three important investment lessons:

  • Continuing anxiety over Greece’s ability to avoid default and remain in the euro.
  • Rising borrowing costs for Italy and Spain.
  • Ongoing fears of an economic slowdown in China.
  • Loss of faith in the banking system due to JPMorgan’s $2 billion (and growing) bad bet.
  • A very tepid response to the highly anticipated stock market debut of Facebook.
    Source: CNNMoney

Investors are particularly frustrated that the European debt situation keeps popping up like dandelions. After two years and 17 euro zone summits, the issue is still not resolved. In fact, it might be worse than ever as Europe is quickly running out of road to kick the can down, according to BusinessWeek.

Greece is at the epicenter of this worldwide concern despite the fact that its population is less than the state of Ohio. Like the subprime crisis before it, investors are concerned that Greece may be the falling domino that kicks off a series of undesirable effects. If Greece has a disorderly collapse, it could spread to other weak European countries and then ripple out to the rest of the world.

Unfortunately, the time for easy solutions has long passed. Central banks and governments around the world have already added trillions of dollars to their balance sheets so they don’t have much room to maneuver. And, here in the U.S., we have a potentially bruising election and looming tax and fiscal matters to deal with by the end of the year.

When you add it up, 2012 is on track to be another dramatic year in world affairs.

Data as of 05/18/12 1-Week YTD 1-Year 3-Year 5-Year 10-Year
Standard & Poor’s 500 (Domestic Stocks)

-4.3%

3.0%

-2.9%

12.5%

-3.2%

1.7%

DJ Global ex US (Foreign Stocks)

-6.1

-2.8

-20.5

5.0

-7.4

3.7

10-year Treasury Note (Yield Only)

1.7

N/A

3.2

3.2

4.8

5.2

Gold (per ounce)

0.4

1.0

6.2

20.0

19.3

17.7

DJ-UBS Commodity Index

0.9

-3.3

-16.5

4.3

-4.7

3.2

DJ Equity All REIT TR Index

-6.7

6.0

2.7

27.7

0.2

9.9

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods

Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association
Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.

WOULD YOU GIVE YOUR MONEY TO THE U.S. GOVERNMENT

Would you give your money to the U.S. Government for 10 years and lock in a negative yield? Well, that’s exactly what happened last week as investors handed over $13 billion to the government and, in return, received 10-year Treasury Inflation Protected Securities (TIPS). These securities were sold at a record low negative yield of 0.39 percent, according to The Wall Street Journal.

TIPS are a bit different from traditional government securities because, “The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, you are paid the adjusted principal or original principal, whichever is greater,” according to the Treasury Department.

Now, why would anybody buy a TIPS with a negative yield when they could buy a traditional 10-year government security with a yield of about 1.7 percent last week? The answer lies in the difference between the two yields.

As reported by Bloomberg, the yield difference between a 10-year TIPS and a comparable 10-year Treasury security was 2.04 percentage points on May 17. Analysts call this the “break even inflation rate.” It means investors were expecting inflation to average 2.04 percent over the next 10 years. When you add the 2.04 percent expected inflation rate to the negative 0.39 percent yield of a TIPS, you get close to the yield of a traditional 10-year government security.

From an investment standpoint, if inflation averages more than 2.04 percent over the next 10 years, then owning TIPS might be a better deal than owning the traditional 10-year government security. Likewise, if inflation averages less than 2.04 percent over the next 10 years, then owning the traditional 10-year security might be better, according to The Vanguard Group.

With its built-in inflation protection component, TIPS are traditionally viewed as a hedge against inflation rather than a play on interest income.

As an advisor, it’s important for us to know the break even inflation rate that is embedded in TIPS. Knowing the market’s best estimate of inflation provides data we can use to help us value and analyze other investments that may be affected by changes in investors’ inflation expectations.

Weekly Focus – Think About It

“There is only one word in the English language with all five vowels in reverse order. Try to guess what it is before reading below for the answer. ”

http://www.byfaith.co.uk/paul2028.htm  

The answer is “subcontinental.”