Grinding Through Gridlock

3Q 2011

The first known use of the word “gridlock” occurred in the early 1970’s, and is generally attributed to officials within the New York City Department of Transportation. In its original context, the noun refers to a traffic jam in which a grid of intersecting streets is so completely congested that no vehicular movement is possible. By extension, the term has since been applied to situations in which competing interests prevent meaningful progress. Whether it is Doves vs. Hawks at the Federal Reserve, Republicans vs. Democrats in Washington, Main Street vs. Wall Street, Unions vs. Corporations, or struggles between global leaders, this ongoing contentiousness continues to test increasingly fragile investor sentiment.

As it relates to markets and the global economy, there is a remarkably high correlation between depressed sentiment, heightened pessimism and/or fear, and increased volatility. Looking back at the previous 90-days, it’s notable that we witnessed average intra-day trading ranges of just over 2.4% for the S&P 500 Index. This kicked one minute, kissed the next pattern can be especially unnerving for investors. Thankfully, it’s a stretch at this point to begin comparing outcomes to late 2008 when both volatility and experienced loss were magnified by a factor.

Quarterly results for the diversified asset classes utilized to construct BAMG client portfolios are below:

• Domestic equities returned between -13.1% (Large Growth) and -22.2% (Small Cap Growth). Given troubling economic reports, a tenuous debt ceiling debate, and finally a ratings downgrade for the good ol’ U.S.A., the S&P 500 Index tested “bear market” territory by shedding 18.8% between July 7th and August 9th. Since that time, however, we’ve generally observed range-bound trading between 1,100 and 1,230.
• Consistent with past global panics, the U.S. dollar appreciated meaningfully versus a trade weighted basket of currencies. This provided a secondary hindrance for international stock categories, which remained under pressure given the illusiveness of a European resolution. Index performance ranged from -18.6% (Small Cap Developed) to -22.5% (Emerging Markets), and with valuation multiples compressed to 30-year lows we’ve focused our rebalancing efforts abroad.
• Within the alternatives space, global commercial real estate caught the broader market’s cold (-17.7%), while our managed futures benchmark (the S&P DTI) endured a more modest and less-correlated decline of 4.0%.
• Perhaps the most amazing observance for the quarter was the market’s verdict on the stability of U.S. Treasury obligations. At one point, the interest rate on the 10-year note dipped to an all-time low of 1.7%. The broad decline in rates helped the Barclay’s Aggregate Bond Index to record gains of +3.8.

There is an enormous amount of uncertainty in the world, and volatile markets can often drive investors to make emotional investment decisions. Indeed, the shoot first, aim later scenario we’ve witnessed has caused rational fundamental measures of value such as Price-to-Earnings Ratios, Tangible Book Value, or Earnings Yield to take a back seat to the daily media disturbance. Although silver-bullet solutions likely will not appear overnight, flexibility and adaptation through time offer a pathway to sustainable growth in both economies and markets. Ultimately, it’s mutual cooperation that solves for gridlock and delivers an enhanced benefit to all. We certainly appreciate the trust and collaborative efforts our clients exhibit in these trying times, and believe that through discipline, diversification, and understanding, goals can still be achieved.