Stock Market in 2011 and beyond

27 September 2011

Back last December, the U.S. Federal Reserve announced a plan, commonly called QE2 or the second round of quantitative easing, to loose money control to stimulate the American economy and employment hiring. With the stimulus, most economists forecast a good recovery for 2011, although a few warned a correction to the stock markets. In the beginning of 2011, the market was slower than 2010 but fared still steady. In mid-March, a very powerful earthquake hit northern Japan. Japan was ready to absorb this disastrous earthquake but not to stand the ensuring tsunami. The disaster and a related nuclear accident not only inflicted about $300 billion of damages to that island country but also disrupted the supplies of some critical components to the production of some global industries.

In May, the capital markets were badgered by the European sovereign debt crisis. In early summer, most still bet the global economy could be in a better shape in the next half year. Unfortunately, the economy actually went luffing in a slowdown in the summer. To compound the instability, the market was affected by the political rankling about debt ceiling and spending budget in the United States. After repeated hints, Standard & Poor's, a leading rating agency, finally downgraded the once-solid U.S. government long-term bonds from AAA to AA+, while affirming the A-1+ ratings on U.S. short-terms on 5 August 2011. The sensitive stock market instantly responded by plunging into a deep dive, though the drop steadied a little bit in early September.

QE2 ended in June 2011 but apparently did not reach its objective as the American unemployment did not come down significantly. In fact, the American economy now stalled. Some people began talking about a double-dip recession, even though official statistics stated a positive territory for the first half of 2011 in the United States. In September, the U.S. government put forward several proposals to bolster the flagging economy - a $450 billion stimulus bill, a bill to tax the wealthy, and a monetary plan to switch short-term and long-term securities. The latter, named Twist Operation, aims to flatten the yield curve of securities in order to increase the cash supply for small businesses and housing market. Immediately after it was announced, the capital market nevertheless responded by sending the stock market in another plunge.

The market is now clouded with more uncertainties and threatened by a new recession. So, the present economic situation seems to be very gloomy and unstable. From talks of money seminars, one may conclude the outlook for 2011 and 2012: 1. A slow growth, 2. Low interest rate, 3. Low inflation rate for non-core consumption, and 4. A likely continuation of uncertainty and instability in the market

My Own Portfolio as a Back view

My portfolio has been following a dumbbell strategy - a big base of diversified stable high-yield dividend stocks and a smaller bell of growth/cyclical stocks, basically of small and medium Canadian caps. The growth stocks were held in short position and traded without option trading. The strategy seemed to work well from 2009 to the first quarter of 2011. In April 2011, the portfolio grew 70% using margin leverage and the low interest rate; the net cash flow increased about 40%. Some blue-chip stocks were added to the portfolio; however, these stocks were found not immune to market swings. The portfolio now followed the broad drop of the market from the March peak of 2011 to the present.

Quarterly Performances (%)

The % of the account is calculated by my broker with the consideration of deposits, withdrawals, accrued interest and market values.
                  2011         2010           2009          2008
Quarter 1          5%           9%           -14%               
Quarter 2        -17%          -7%            20%               
Quarter 3         N/A          10%            19%               
Quarter 4         N/A           6%            13%               
Year End            -          19%            47%          -34%

Before-tax Investment Earnings (Trading+Dividend-Interest)

(quarter-to-quarter change, using 2009 as the reference)
% Change          2011       2010        2009 
Quarter 1         177%       272%        100% 
Quarter 2          56%       115%        100% 
Quarter 3        -214%       -35%        100% 
Quarter 4          N/A        50%        100% 

2011 Year-to-date Benchmark Comparison against Indexes

Portfolio                        -28%
Canadian T-Bill                 0.64%
SP/TSX Composite index         -3.52%
SP/TSX 60                      -3.93%
S&P 500, C$                    -3.28%
DOW, C$                         0.58%

The portfolio basically reflected the market - a dip in March 2009 followed by a sharp rebound, a slow-down in the Summer of 2010, the decline since March 2011. The net worth of the portfolio has been steadily eroded since April, 2011 - a drop of about 25% from May to September. Some of decreases were turned into realized loss by selling losing stocks and turning them to cash and other safer stocks. Thus, the trading turned into negative in August and September. For the time being, the net earnings for 2011 is still positive. Nonetheless new strategies or tactics are needed to protect and improve the portfolio.

Future Plan

Over business news in the internet and the TV, some money managers said they have turned very defensive for months by liquidating the major part of their holdings into cash while expecting the unexpected events in the market. When the market really dropped, some analysts, particularly the academics, asked the investors not to sell at a panic and advised a long-term view as the unrealized loss would become a realized loss and the loss would not be recouped when the market rose again.

Between these two different approaches to the recent demise of the market, others suggested a prudent and flexible approach to keep the exposure to the market by switching some assets to defensive stocks, ETFs or mutual funds, while increasing the cash reserve. They also advised solid large caps would generally fare better than small caps. Considerations of the stock selection are: lower PE multiples, positive earnings per share, good book value per share, and a stable or rising track of prices ( 3 - 5 years). Some of blue-chips are Coca Cola, Kraft Food, Kellog in the U.S. and BCE and Enbridge in Canada. Some also commented on the importance of dividend yield of stocks in this uncertain environment. Adding gold-backed index ETFs and funds and the use of options might also add more protection to a portfolio. For a large portfolio, another alternative came up is the use of future contracts to hedge the portfolio, although a future expert is needed to set up the contracts.