Weekly Market Commentary 9-6-11

Risk vs. Return in Low Growth Economy

Tim Phillips, CEO – Phillips & Company

There is plenty of economic data to look at every week, but between Ben Bernanke’s speech in Jackson Hole and the September FOMC meeting there are three major economic data points:

  • August employment (9-2-11)
  • Retail sales (9-14-11)
  • CPI (9-15-11)

Last week we had the first of the three come out and it suggests the recovery has hit a significant soft patch.

change in employment from period to period

Looking at some of the other economic data consumers actually spent more than expected and saved less despite this recent soft patch.

personal savings rate over time

According to a paper by Reinhardt & Rogoff titled, The Aftermath of Financial Crises, the average unemployment rises for almost 5 years with an increase in the unemployment rate of about 7 percentage points. If we use the date the National Bureau of Economic Research says the recession began, which is December of 2007 then that means we could have elevated levels of unemployment until December of 2012 (15 months away).

If we still have 15 months of elevated unemployment and a deleveraging consumer it could be hard to generate historical returns without assuming more risk. For example lower risk 10 year treasuries used to yield 3-4% and higher risk emerging market equities (based on the MSCI Emerging Market Index) used to return in the mid-teens.

In today’s slow growth and lower interest rate environment 10 year treasuries are now yielding less than 2% and emerging markets equity returns are flat to negative. We are being forced to accept either more risk or live with less return.

This is where blending asset classes to compose the right risk and return profile comes into play.

maximizing the power of diversification

As you can see from the graphic above, based on historical data when you increase your diversification you can generate a higher return and lower standard deviation over time. Maximizing the power of diversification can be an easy way to increase your return and lower your standard deviation in this current environment with more risk and less return.

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Tim Phillips, CEO – Phillips & Company


Research provided by:

Adam Gulledge, Associate – Phillips & Company