June 27, 2011
Just a brief update this week as our annual board meetings are in progress - it's notable that despite the brief reprieve of market concerns Thursday on tentative agreement over Greek aid, we actually saw very little change in the value of Greek debt. While there is a great deal of short-term attention on day-to-day developments on this front, credit spreads effectively indicate expectations of certain default within a roughly 2-year window, but very small risk of near-term default. Until we observe a firming in market internals (which have deteriorated markedly) and in leading economic measures (which have also weakened), we expect that enthusiasm about Greece may provoke short-lived market spikes and short-squeezes, but little of durable effect for the stock market.
For our part, we continue to focus on our measures of valuation and market action, both which are unfavorable at present. An improvement in the quality of market action could allow some latitude for a constructive market exposure, but with the recent advance past both the median extent and duration of cyclical bulls within secular bears (which I continue to believe is the appropriate characterization), the risk of significant market losses should not be underestimated. Presently, we estimate the prospective 10-year total return of the S&P 500 Index at about 4.2% annually, based on our standard methodology. This is better than we observed in May, but the modest improvement since then should be some indication of the limited extent to which the recent decline has restored appropriate valuations.Strategic Growth and Strategic International Equity remain well-hedged. In Strategic Total Return, we slightly increased our duration to a still limited 2.5 years, primarily by adding to 3-5 year maturity Treasury holdings. Our primary risk exposure at present remains in the precious metals area, where the Fund has a roughly 18% position in precious metals shares. In contrast to the fairly dismal set of market conditions we observe in the equity market, the conditions we observe relating to precious metals shares have historically been associated with fairly strong returns, on average, even in the absence of much strength in the underlying spot gold price. Still, precious metals shares are associated with significant volatility, so we view an 18% position as material (though not aggressive). Given that we already observe negative real interest rates, falling long-term yields, positive inflation trends, and a very high ratio of spot gold to the prices of gold shares, we would observe the most favorable set of conditions we monitor if the ISM Purchasing Managers Index moves below 50, but I don't expect that sort of weakness in the upcoming report. Suffice it to say that I believe our present exposure in precious metals shares appropriately reflects expected return/risk prospects here.
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