Financial markets endured unprecedented volatility last week.

For example, the Dow Jones Industrial Average experienced four straight days of 400 point-plus moves — both up and down — for the first time ever. The stock market rose or fell 4 percent or more on each of these days.¹

That’s only the fifth time in the last 100 years that investors experienced such big sentiment swings within the same week. In spite of all the sound and fury of this day-to-day volatility, however, stocks didn’t move much for the full week.²

The Dow lost 1.5 percent and the Nasdaq Composite declined just 1 percent.³

Of course the question now on every investor’s mind is: Where do we go from here?

After a snap-back rally in recent days, some say the market may be in the process of finding a floor from which to launch a sustainable rally. After all, haven’t share prices corrected enough after slipping over 15 percent in just a few weeks? Others in the financial media warn this correction could easily have further to run. Instead of a floor under stock prices, they’re concerned about a trap-door.

Maintain Perspective in Volatile Markets

Of course, we won’t know the answers for sure until after the fact. In the meantime, we’re closely monitoring markets to help determine our positioning, but we’re also maintaining a long-term perspective on this short-term market volatility.

In terms of our asset allocation within core Banyan equity accounts, there are a few important points to consider …

First, we’re certainly more optimistic on the long-term outlook for US equities since share prices are cheaper now while, overall, profits continue to expand at a healthy clip.

Following more impressive results during the second-quarter earnings season, S&P 500 profits are on pace to reach record highs this year, north of $100 per share, exceeding the peak in 2007. Yet stock prices are still 30 percent below those peak levels. Valuations are clearly more attractive now.⁴

Second, our optimism for stocks is tempered by recognition that economic growth has slowed significantly more than expected. For this reason, we’ve raised cash levels to help cushion against further near-term volatility — and we also want to be ready to take advantage of attractive buying opportunities that are presenting themselves daily.

As long-term investors, we understand that share  prices could slip lower near term, and we are willing to accept that risk based on the investment discipline we adhere to. Specifically, the  stocks we purchase on behalf of our clients are expected to outperform over the next two to three years … not the next two or three months.

Third, we’re proactively shifting our asset allocation to lower the risk profile in our equity portfolios. As part of this process we favor companies with a stable history of sales growth and profitability in both good and bad times.

Abbott Labs (NYSE:ABT), IBM (NYSE:IBM), and Johnson & Johnson (NYSE: JNJ) are just a few examples of leading global brand-name companies you’ll find near the top of Banyan’s buy list right now.

Keep in mind we’re not suggesting that it’s time to jump into stocks with both feet, but it’s certainly not the time to be selling in a blind panic either. We find attractive value in many high-quality companies right now. In this environment, the risk-off trade has regained the upper hand, as we pointed out in last week’s Banyan Market Letter (Issue 29 • Aug. 10, 2011).

Looking ahead, investors are right to be concerned about issues including the European debt crisis and our own deteriorating government finances in the US. And regrettably, it doesn’t look like much progress is being made on solving these issues.

This adds uncertainty to the outlook and negative headlines are grabbing the most attention as a result. The consequence has been more turbulence in financial markets.

We’re closely monitoring economic developments — especially conditions in emerging markets in Asia where inflation is a concern — and in Europe where recession seems the bigger risk. The direction of growth and inflation in these regions will certainly have important implications for US investors too.

Meanwhile, a key to riding out short-term volatility is to stay focused on your long-term investment objectives — the reasons why you’re investing in the first place.

Markets Overcome Uncertainty

In the short term, markets are driven largely by emotion — often irrational — taking the form of either fear or greed, which creates panic or exuberance. We’ve seen several cases of each in recent years.

Although it seems counterintuitive, history shows that what seemed like the absolute worst times to invest in the stock market — when judged by negative headlines — often turned out to be the best times to invest!

Over the last 85 years, the very best 5-year return for the S&P 500 began in May 1932 — in the midst of the Great Depression — stocks soared 367 percent over the next five years.

The second best 5-year run for stocks began in July 1982. Do you remember the phrase “stagflation” in the headlines? Interest rates, inflation and the unemployment rate were all in double-digits back then — yet stocks gained 267 percent over the next five years.⁵

And we all remember September 11, 2001, perhaps the most devastating blow to American confidence ever inflicted. As if it were yesterday I can recall being on the 10th floor of a downtown Ft. Lauderdale office building preparing for the stock market to open that Tuesday morning, but of course it never did.

The stock market remained closed four days in the aftermath of 9/11. When it reopened, stocks plunged 16 percent over the next five days. Investors have probably never felt such intense emotion or sense of uncertainty as we all did in those two weeks. I certainly never have — either before or since. 

But financial markets managed to recover. In spite of the uncertainty, this proved once again to be a good time to invest (or stay invested) as the S&P 500 went on to gain almost 50 percent over the next five years.⁶

Let’s face it, there’s no shortage of worries right now, and investors have every right to be concerned, but at Banyan Partners we expect markets to overcome these concerns too. In time, markets will overcome a slowing global economy, the European debt crisis, even a potential double-dip recession.

We’re confident our economy and financial markets will overcome these issues and recover just as we always have in the past. We may soon look back with the benefit of hindsight and realize this was also a good time to invest — or stay invested — in high-quality stocks.

Good investing,

Mike Burnick
Director of Client Communications
Banyan Partners, LLC

Banyan Partners and the advisory accounts that we manage may have positions in the securities mentioned in this report and may purchase or sell such securities without notice.  The aforementioned investments may not be appropriate for all investors and past performance is no guarantee of future results.  Investors must make their own decisions based on their specific investment objectives, risk tolerance, and financial circumstances.  This commentary is not a complete analysis of every material fact with respect to any company, industry or security mentioned in this report. This report is solely for informational purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.

¹ BlackRock: Weekly Commentary, 8/15/11
² Ibid.
³ Bloomberg data, 8/15/11
⁴ Standard & Poor’s, 8/16/11
⁵ Fidelity Investments: Viewpoints, 7/21/11
⁶ Ibid.
⁷ Bloomberg market data, 8/16/11