When I began writing, the S&P 500 had just dipped into bear market territory (see chart below).  At the same time, Ben Bernanke is in front of Congress and on my television screen saying that the Fed is ready to take further action to spur growth.  If history is any guide, it’s fair to say that stocks like Fed stimulus, so Bernanke’s comments today shouldn’t be taken lightly.

Is this a good time to invest?  Either we dip into a recession or we don’t.  Valuations look pretty good if the economy continues to grow even at a slow pace.  However, if we do slip into a recession, the market’s valuation does not look so great because earnings estimates are likely too high.

I can’t predict the short-term moves of the market, but I promise that the market will move higher before sentiment or the economy turns up.   For younger investors with a long-term time horizon, I feel more comfortable saying that today represents a decent opportunity to add to your portfolios.

For older investors with shorter time horizons, I think your focus should be on staying disciplined with the investment plan you created with your advisor.  Don’t suddenly jump in or out of stocks. Don’t suddenly sell the losers of the past quarter for the recent winners.   As the great Wayne Gretzky once said, “I skate to where the puck is going to be, not to where it has been.”

Whew, that was quite a digression.  On to the September Recap…

Investors fled from stocks in September, wiping out about $4 trillion from global equity markets, with much of the volatility related to the European debt crisis.  The MSCI All-Country World Index of stocks lost 8.9%, dipping into bear territory from its May 2011 peak.

The volatility was mostly related to the European debt crisis.  European policymakers seem to be in denial of their long-term solvency issues, opting for temporary fixes that have done little to shore up confidence.  Making matters worse, the banking system is also infected by the sovereign debt issues and could face a liquidity crisis.  A regional recession in Europe seems increasingly likely given the weak backdrop for growth in the eurozone and the need for dramatic deficit reduction.  The eurozone region accounts for nearly 20% of global GDP; a breakdown in economic growth or their banking system would be felt globally.

Meanwhile, disappointing economic data in the U.S. across manufacturing, labor, and confidence gauges indicate that the U.S. economy is sluggish and vulnerable to recession itself.  In response to the wavering economic outlook and market turbulence, the Federal Reserve announced a program known on Wall Street as “Operation Twist” that lengthens the average maturity of its bond portfolio with the goal of lowering long-term interest rates.  They will also reinvest maturing housing debt into mortgage-backed securities, which the Fed hopes will support the mortgage market.  This action comes on the heels of the Fed’s earlier promise to keep interest rates at record lows until at least mid-2013.

Large Cap stocks (-7.03%) outperformed their mid (-10.59%) and small cap (-10.3%) counterparts, while value continued to perform worse than growth.  Utilities (+0.19%) posted the only gain among S&P 500 sectors in September.   Investors find Utilities attractive during times of economic turmoil due to their more “recession-proof” revenues and high dividend yields.

The worst performing sectors were Materials (-16.36%) and Energy (-12.54%).  These sectors were hurt by fears of a slower global economy and falling commodity prices – the S&P GSCI Total Return Index of 24 commodities slid 12.17%.  Commodity declined can also be attributed to gains in the U.S. dollar, which rose 6% in September, topping the performance of the most-traded global currencies for the first time in more than three years.    Crude oil dipped 10.82%, while gold registered a 10.67% loss.

Domestic stocks outperformed international and emerging market stocks.  The MSCI EAFE Index of developed international stocks was weighed down by poor European market returns – no surprise there.

The MSCI Emerging Market Index also had a nasty month.  Emerging economies were already facing slower growth, but the slowdown in the U.S. and Europe threatens to deal an additional blow to many of these nations that rely on exports.

Treasurys added to their already big gains, largely because traders anticipated the Fed’s “Operation Twist” well ahead of its announcement.   The yield curve, which measures the extra yield investors demand to hold longer-term debt – continues to flatten, which has historically been a very bad sign for the economy.  The 10-year note finished the month yielding 1.92%, while the 30-year bond finished at 2.91%. 

Thanks for reading,

Peter Lazaroff

St. Louis, MO

Acropolis Investment Management

www.acrinv.com