Total Return Performance of Major Indexes for Periods Ending on June 30, 2011

 

The market was essentially flat during the recent quarter.  However, that result belies a lot of volatility, and forces impacting the market including the European debt crisis, the US debt problem, slowing GDP growth, and weak US job growth.  The S&P 500 reached a post-crash high on April 29, but then fell by 7.3% to its low point for the quarter on June 15.  Signs of speculation appeared in the hot IPO (initial public offering) market with LinkedIn and Pandora going public and with anticipated offerings from Facebook and Groupon.  At the other extreme, risk averse investors poured $46 billion into bond mutual funds during the quarter, despite interest rates offering historically low yields.

A more positive perspective can be seen from the S&P 500 return of 30.7% during the past year.  Even though the last year contained many negative events, (e.g. Gulf Oil Spill, the May 6 “Flash Crash”,  and the first Greek bailout)  the market continued its strong recovery.

However, there are increasing headwinds in the current economy.  The pace of the US economic recovery is slow.  In the first quarter, GDP grew at just 1.9% (compared to 9.5% for China).  Unemployment remains stubbornly high at 9.2%.  The housing market is still bouncing along the bottom.  The Federal Reserve’s second monetary stimulus program (QE2) of purchasing Treasury securities, ended in June, which raises concern that interest rates will soon rise.  Congress has not yet dealt with the federal budget deficit or the national debt ceiling.  Many state and local governments are experiencing significant financial problems.  While the Greek situation has been temporarily resolved, many worry also about Italy, Spain and Ireland. Conflicts and uprisings in Asia, the Middle East, and Africa contribute to a high level of political and economic uncertainty and volatility in the energy markets.

The pessimists argue that the recent data points to a declining economy, and a possible “double dip” recession.  However, the Federal Reserve, and many prominent economists believe the current economic slowdown is a “soft patch” or only a temporary slowdown due to a jump in oil prices, the Japanese tsunami and nuclear plant disasters, and  some bad spring weather, e.g., floods and tornadoes.  We are now  more cautious but are not in the “double dip” camp.

Despite these challenges, US companies are actually doing well in the current environment.  The combined earnings of S&P 500 companies are expected to reach record levels in 2011, increasing by approximately 15% over 2010.  Valuations for US companies appear to be reasonable, with the S&P 500 trading at 13.3 times estimated earnings.  In addition, companies have significantly improved their balance sheets and now hold record levels of cash.  These factors should result in higher dividends, share buybacks, and acquisitions of other companies – which should benefit equity investors.

However, as a result of the higher level of risk of a market downturn, we have taken some steps to reduce risk in more aggressive portfolios.   We have sold off leveraged ETFs in most portfolios, increased holdings of funds and stocks that pay a significant dividend, taken gains in company stocks in economically-sensitive areas (e.g., materials & industrials), and added some growth stocks which should do well due to innovative businesses, even in a slowing economy.

Fixed income investments outperformed stocks in the second quarter, as interest rates declined. The BarCap Aggregate Bond Index, which measures the performance of the US taxable bond market, generated 2.3% returns during the quarter.  The yield on the benchmark 10-year Treasury bond declined from 3.5% to 3.2% during the quarter.  The decline in US interest rates and strong relative performance for bonds was generally attributed to concerns over a slowing US economy and the European sovereign debt crisis.  With the likelihood that interest rates will eventually move higher as the economy improves and/or inflation increases, longer-term bonds remain somewhat risky (since bond prices decline when interest rates rise).

The news affecting the markets is an ever-changing drama that bounces to and fro between optimism, skepticism, and pessimism.  Interpreting these global signals is both art and science, but at a minimum, emphasize the importance of keen analysis.  Our frequent advice is to set the course for long-term goals, and let us worry about the daily news.  History has shown than those who do not panic when times are uncertain are more successful in the end.  Be assured that we do our best to navigate our clients’ portfolios through this sometimes turbulent environment.

Please contact us if you have any questions about the financial markets or your accounts.

 

—Tom Franks & Kirk Weiss