Stocks under pressure in August but rebound at month-end
August was difficult in terms of equity price volatility, and it marked the fourth consecutive month that major stock indices lost ground. For the month, the S&P 500 Index (S&P 500) declined 5.43 percent, and the Dow Jones Industrial Average (the Dow) lost 3.96 percent. For the year, the S&P 500 is now down 1.77 percent while the Dow is modestly up 2.14 percent. Things could have been worse, however, but for the S&P 500 and the Dow moving higher at the end of the month, up 8.54 percent and 7.09 percent between August 22 and 31.

Market volatility soared in early August, with the VIX index closing at 48 on August 8. Daily price swings were large, including six days of more than 400-point moves in the Dow. Although the average monthly price swing in 2011 has been 72.82 points, in August, the average swing was 219.09 points.

The month was driven by strong technical factors, as average daily volume swelled on down market days. Some equity investors recoiled, causing domestic equity investments to experience $35 billion in outflows, according to Investment Company Institute data.

Challenges at home and abroad
There was no reprieve for international investors, as foreign markets traded lower on renewed concerns over the eurozone debt situation. The MSCI EAFE Index lost 9.03 percent for the month, leaving it down 6.02 percent for the year. The riskier MSCI Emerging Markets Index lost 9.19 percent in August and is now down 10.27 percent in 2011. Debt fears seemed to drive much of Europe's market underperformance early in the month, but concerns over economic troubles spread beyond Europe to global equity markets as August went on.

Here in the U.S., four catalysts led to investor worry and placed downward pressure on markets. First, the U.S. debt ceiling debate in Congress caused early market tremors. Second, although we averted default and resolved the debt ceiling, markets were jolted by Standard & Poor's downgrade of U.S. debt. Third, the unfolding eurozone debt crisis left investors concerned that bailouts would prove increasingly challenging and banks would be negatively impacted by bad sovereign debt. The fourth—and perhaps most powerful factor—was a shift in focus toward a potentially weakening global economy, particularly here in the U.S.

The Federal Reserve's impact on bond investors and gold
As equities buckled under selling pressure, Treasuries rallied on an unusual announcement by Federal Reserve (Fed) Chairman Ben Bernanke. On August 9, he declared that short-term interest rates would stay low until the middle of 2013. Traditionally, the Fed doesn't provide a definitive target date for interest rate policy, so this took some investors by surprise. Treasury yields continued to decline following the announcement, briefly trading below 2 percent on August 18. Yields ended the month at 2.22 percent, marking a huge decline from 2.8 percent at the beginning of August. The rally in Treasury prices contributed to gains of 1.46 percent over the month for the Barclays Capital Aggregate Bond Index, now up 5.88 percent year-to-date.

Meanwhile, riskier high-yield bonds lost 4.83 percent for the month, measured by the Barclays Capital U.S. Corporate High Yield Index,as concerns over the economy caused selling pressures. Issuers were forced to pull offerings, resulting in the lowest issuance level since late 2008 and putting further pressure on markets.

As troubles unfolded, investors continued to pour money into gold, driving prices sharply higher. Over the month, gold increased more than $216 per ounce, underlining investor anxiety over finding a safe haven for capital and investments. The move was the largest ever in dollar terms. In percentage terms, gold rose more than 12 percent, a magnitude not seen since it gained 17 percent in September 1999. Year-to-date, gold is up more than 29 percent (see Figure 1).

A waiting game for economic data
Still a source of frustration for market participants, economic data could not seem to come fast enough in August. This created a waiting game, in which markets moved substantially in response to each successive report. July economic data was generally positive or neutral overall, but manufacturing and consumer confidence data were less appealing in August.

On the manufacturing front, warning signs emerged when the August Philadelphia Fed Index plummeted to –30.7, its lowest reading since early 2009. Weakness from other regional manufacturing surveys followed in subsequent weeks.

Meanwhile, home prices showed signs of improving, as the Federal Housing Finance Agency House Price Index rose 0.9 percent nationwide in June, after having risen 0.4 percent in the previous month. The employment situation also demonstrated signs of stabilizing, and personal spending rose an impressive 0.8 percent in July.

There are currently two major questions at play for the economy. The first: Have concerns about the stock market caused additional economic weakness, or is it the other way around? Consumer confidence has fallen to its lowest point in more than two years as a result of the recent market correction, but lower confidence does not always result in less spending, so the jury is still out. The second question: Will the Fed begin a third round of quantitative easing? Some analysts believe the Fed could make a move at its September 20 meeting. This could boost asset prices, but it could also raise concerns about the sustainability of the Fed's balance sheet.

Investment outlook
The challenges of maintaining a comprehensive investment strategy were highlighted during August. Many investors went into the month with limited exposure to long-duration Treasuries, only to be hurt as a result. But this is the strategy we have emphasized for quite some time, as we believe that, with yields at such low levels, investors are not being compensated for risk. Arguably, staying true to a long-term strategy is even more important now, since much of the move lower in bond yields may be over.

Equity markets showed resilience at month-end, perhaps because of technical factors, expectations of a new round of Fed intervention, or increasingly attractive fundamental valuations. Trailing 12-month S&P 500 price-to-earnings (P/E) ratios are below their historical average, suggesting that equities may indeed be attractive at these levels. Historically, investors who buy assets at lower prices tend to be more successful over the long run. As a result, it is important for investors not to overreact because of short-term price fluctuations.