August 05, 2011

Miller/Russell’s Perspective

Following Thursday’s decline of 4.8% on the S&P 500, equities ended the day down 9.1% since June 30th, and 12% since the April 29th high. Furthermore, the volatility index, a measure of the market\’s risk, which has been hovering between 16 and 20 for the past six months, spiked 35% on Thursday to 31. What does this all mean, both for our economy and your portfolio?

It is important to determine why the market has declined and ask what actions should we take? We believe the markets are continuing to reflect economic data which, as we said in our August 3rd communication, has been negative. With the expectation of reduced expenditures and/or increased taxes in the future, continued slow growth is implied for the broad economy. As a result, many investors are responding by flooding to Treasuries which is driving yields to their lowest level in years. This is why you own bonds.

Should you invest only in bonds? Absolutely not! In fact, equities are beginning to look attractive. Keep in mind a few points:

75% of companies beat earnings estimates last quarter.
Adjusted after-tax corporate profits are at an all time high.
Household debt obligations (rent, credit card bills, car payments, etc., divided by income) are at their lowest since 1992.
The S&P 500, which historically trades at a price-to-earnings ratio of 15-16, is currently trading at 12, nearly a 20% discount.
History has taught us that the best protection against volatile markets is a well-diversified portfolio. While the equity markets are down more than 9% since quarter-end, Miller/Russell\’s average Fixed Income allocation is up 1.3% for the period, and our average Multi-Strategy allocation is only down 1.1% for the same period. Diversification significantly offsets large equity movements!

It is vital to recognize that markets do not always reflect reality. Markets are driven by both data and emotion and because of this fact, we may see further deterioration. However, now is the time for discipline, not panic. Although the U.S. economy may be slowing, this is not true of all economies. 60% of earnings from S&P 500 companies are from outside the U.S. Because of this, Miller/Russell has put 40% of our equity exposure outside of the U.S., mostly in countries with strong balance sheets and strong GDP growth. We believe our current portfolio structure is well-positioned to manage equity market pullbacks and benefit from their eventual recovery.

Miller/Russell & Associates