Save & Invest - Second Quarter 2010
http://www.watermarkasset.com/articles/47/1/Save-amp-Invest---Second-Quarter-2010/Page1.html
By Mark Miller
Published on 07/7/2010
Apparently, it’s time to put the V
shaped phase of the recovery aside. Almost three years ago world
economies, in lock step with the Pied Piper of leveraged debt marched
off a cliff. Now, having climbed back out of the abyss, they are
struggling for traction despite government stimulus and record low
interest rates. We’re in the time of the “square root” recovery...
Apparently, it’s time to put the V shaped phase of the recovery aside. Almost three years ago world economies, in lock step with the Pied Piper of leveraged debt marched off a cliff. Now, having climbed back out of the abyss, they are struggling for traction despite government stimulus and record low interest rates. We’re in the time of the “square root” recovery.
Triggered by the flash trading incident on May 6th and then fueled by sovereign debt problems in Greece and Europe, the S&P 500 TR Index fell -11.4% in the second quarter. The 10-year Treasury bond rose while its yield plummeted to 2.95%. Year-to-date, the S&P 500 TR is now off -6.7% while foreign stocks (MSCI EAFE Index TR) are down almost -14.7%. Bonds (BarCap US Aggregate Bond Index) continue to perform well, gaining +3.5% in Q2 and +5.3% so far this year. The U.S. economy is growing, but perhaps not fast enough to break out of the current deleveraging, deflationary cycle.
While the media is having a field day talking about a “double dip” recession or a stock sell-off to rival the September 2008 period, the reality is that the Bulls and the Bears are both making compelling arguments for their points of view. Schwab’s Liz Ann Sonders outlined both cases in a June publication:
The Bull
This year is starting to look very much like 2004, the second year of recovery after the dot.com recession. That year, stocks were frustratingly flat until November and then finished the year with gains in the 9-11% range. For now, the struggle between the Bulls and Bears will continue until we have a catalyst that pushes one side ahead. We’re in the camp of continued growth, but slow growth with GDP in the 1-3% annualized range. That’s enough to keep the U.S. out of recession, but little more.
Jobs, Housing and Investor Sentiment
The stubbornly high unemployment rate, especially at this phase of economic recovery, is causing investors (and workers) concern. Initial unemployment claims have gone sideways for more than six months now. While the level of claims is consistent with
those of recessions over the past 45 years, we would expect to see more improvement by now.
Economists estimate that we need to create approximately 125,000 jobs per month to absorb new entrants into the workforce. Add another 125,000 to that and we can begin to make a dent in the millions of unemployed. Initial jobless claims are running at about 450,000 per week. Whether this is the result of too little government stimulus, too much government stimulus or simply reluctance on the part of employers to hire, the problem remains and will continue to be a drag on economic growth.
On July 1st, the National Association of Realtors announced that its seasonally adjusted index of sales agreements for previously occupied homes dropped 30% in May from April. May’s reading was the lowest dating back to 2001. The index was also down 15.9% from the same month a year earlier. New home sales for May dropped 33% to the slowest pace in the 47 years records have been kept. It was the largest monthly drop on record.
While everyone expected sales to drop off when Federal tax credits expired, such sharp declines were surprising. With interest rates at historical lows, we would expect housing sales, and prices to be much better. As anyone who has recently purchased a home or refinanced an existing mortgage knows, borrowers (and lenders) are having a challenging time navigating through the maze of new requirements resulting from the mortgage fiasco of recent years. A healthy economy is dependent on a healthy housing sector. With Fannie Mae and Freddie Mac leaking money faster than Deepwater Horizon is leaking oil, it's going to be a long time before housing improves.
Investor sentiment is often viewed as a contrarian indicator. Americans love to buy everything on sale except their stocks. The second quarter pull-back in stock prices seemingly ripped the scab off the wound of the 2008/9 meltdown. Fear and uncertainty appear to have driven stock prices back down to levels that price in a double dip recession, or worse. It is a rare time indeed when everyone calls the market correctly, and we’re doubtful this is one of them. Absent additional clarity, we look for modest US growth and a trading range for stocks.
Strategy
We believe that the initial phase of the economic recovery is now behind us. That was the sharp V of the past year. Now, the economy needs to find its way through a maze of challenges, building a foundation for long-term prosperity.
Corporate America seems to be in quite good shape. The manufacturing sector continues to expand off the lows of early 2009. Technology companies are doing well. Look for companies to grow through acquisition as they use cash and shares to expand market share.
Conversely, high unemployment and a stagnant housing market will keep the lid on inflation and a strong economy for the foreseeable future. Interest rates should remain quite low and the Fed may take additional action should we enter a deflationary cycle. Right now, leveraged assets (i.e. housing, commercial real estate) are taking the biggest hit.
Foreign stocks continue to diversify portfolios. Selective growth in emerging economies should be better than in the U.S. Europe, as a whole, will experience slower growth than the U.S., but individual companies, particularly those trading with emerging economies, may outperform.
We expect bonds to provide stable income and some price appreciation. As long as interest rates remain tame, bonds will do well. If we enter a deflationary cycle, or a double-dip recession, bonds could do very well.
Our stock allocations remain near the low end of our ranges. We’ve expanded our use of structured notes as they provide stock returns with downside protection. We’ve also begun substituting our “alternative” strategy for one that includes the ability to “short” the market.
Corporate earnings announcements begin the week of July 12th. We will be watching for evidence that the recovery will hold. During times like these, we strive to aggressively manage risk while preserving capital. Uncertainty is rampant, but fear need not be.
Schwab Settlement
For years we invested in Schwab’s Yield Plus short-term bond funds. When the credit crisis froze the bond markets and prices started to decline, we quickly liquidated these positions. Unfortunately, Schwab subsequently experienced strong liquidations causing some of their investors to lose substantial sums. Schwab has agreed to make a settlement to shareholders of record, hence the reason many of our clients have received legal notification. There is no “to do” on your part. If you are eligible to receive part of the settlement, Schwab will mail you a check. If you receive a settlement check for an IRA account, it will need to be deposited back in that account.
Please be sure and give us a call with questions.
Triggered by the flash trading incident on May 6th and then fueled by sovereign debt problems in Greece and Europe, the S&P 500 TR Index fell -11.4% in the second quarter. The 10-year Treasury bond rose while its yield plummeted to 2.95%. Year-to-date, the S&P 500 TR is now off -6.7% while foreign stocks (MSCI EAFE Index TR) are down almost -14.7%. Bonds (BarCap US Aggregate Bond Index) continue to perform well, gaining +3.5% in Q2 and +5.3% so far this year. The U.S. economy is growing, but perhaps not fast enough to break out of the current deleveraging, deflationary cycle.
While the media is having a field day talking about a “double dip” recession or a stock sell-off to rival the September 2008 period, the reality is that the Bulls and the Bears are both making compelling arguments for their points of view. Schwab’s Liz Ann Sonders outlined both cases in a June publication:
The Bull
- The yield curve is screamingly positive.
- China is slowing but to a still-robust pace.
- Brazil and India are booming.
- Valuations are reasonable.
- Inflation is non-existent.
- Sentiment conditions have improved dramatically.
- Technical market support has held.
- Long-term rates are low.
- The Federal Reserve is likely to keep short-term interest rates on the floor for some time.
- China is putting the brakes on growth.
- Valuations are OK, but earnings estimates are too high.
- Deflation is a bigger threat than inflation, hence the plunge in long-term interest rates.
- Retail investors have been permanently scarred.
- Debt/deficit problems abound.
- Europe is a mess.
- The Gulf of Mexico is a mess.
- High frequency trading has ushered in a period of runaway volatility.
This year is starting to look very much like 2004, the second year of recovery after the dot.com recession. That year, stocks were frustratingly flat until November and then finished the year with gains in the 9-11% range. For now, the struggle between the Bulls and Bears will continue until we have a catalyst that pushes one side ahead. We’re in the camp of continued growth, but slow growth with GDP in the 1-3% annualized range. That’s enough to keep the U.S. out of recession, but little more.
Jobs, Housing and Investor Sentiment
The stubbornly high unemployment rate, especially at this phase of economic recovery, is causing investors (and workers) concern. Initial unemployment claims have gone sideways for more than six months now. While the level of claims is consistent with
those of recessions over the past 45 years, we would expect to see more improvement by now.
Economists estimate that we need to create approximately 125,000 jobs per month to absorb new entrants into the workforce. Add another 125,000 to that and we can begin to make a dent in the millions of unemployed. Initial jobless claims are running at about 450,000 per week. Whether this is the result of too little government stimulus, too much government stimulus or simply reluctance on the part of employers to hire, the problem remains and will continue to be a drag on economic growth.On July 1st, the National Association of Realtors announced that its seasonally adjusted index of sales agreements for previously occupied homes dropped 30% in May from April. May’s reading was the lowest dating back to 2001. The index was also down 15.9% from the same month a year earlier. New home sales for May dropped 33% to the slowest pace in the 47 years records have been kept. It was the largest monthly drop on record.
While everyone expected sales to drop off when Federal tax credits expired, such sharp declines were surprising. With interest rates at historical lows, we would expect housing sales, and prices to be much better. As anyone who has recently purchased a home or refinanced an existing mortgage knows, borrowers (and lenders) are having a challenging time navigating through the maze of new requirements resulting from the mortgage fiasco of recent years. A healthy economy is dependent on a healthy housing sector. With Fannie Mae and Freddie Mac leaking money faster than Deepwater Horizon is leaking oil, it's going to be a long time before housing improves.
Investor sentiment is often viewed as a contrarian indicator. Americans love to buy everything on sale except their stocks. The second quarter pull-back in stock prices seemingly ripped the scab off the wound of the 2008/9 meltdown. Fear and uncertainty appear to have driven stock prices back down to levels that price in a double dip recession, or worse. It is a rare time indeed when everyone calls the market correctly, and we’re doubtful this is one of them. Absent additional clarity, we look for modest US growth and a trading range for stocks.
Strategy
We believe that the initial phase of the economic recovery is now behind us. That was the sharp V of the past year. Now, the economy needs to find its way through a maze of challenges, building a foundation for long-term prosperity.
Corporate America seems to be in quite good shape. The manufacturing sector continues to expand off the lows of early 2009. Technology companies are doing well. Look for companies to grow through acquisition as they use cash and shares to expand market share.
Conversely, high unemployment and a stagnant housing market will keep the lid on inflation and a strong economy for the foreseeable future. Interest rates should remain quite low and the Fed may take additional action should we enter a deflationary cycle. Right now, leveraged assets (i.e. housing, commercial real estate) are taking the biggest hit.
Foreign stocks continue to diversify portfolios. Selective growth in emerging economies should be better than in the U.S. Europe, as a whole, will experience slower growth than the U.S., but individual companies, particularly those trading with emerging economies, may outperform.
We expect bonds to provide stable income and some price appreciation. As long as interest rates remain tame, bonds will do well. If we enter a deflationary cycle, or a double-dip recession, bonds could do very well.
Our stock allocations remain near the low end of our ranges. We’ve expanded our use of structured notes as they provide stock returns with downside protection. We’ve also begun substituting our “alternative” strategy for one that includes the ability to “short” the market.
Corporate earnings announcements begin the week of July 12th. We will be watching for evidence that the recovery will hold. During times like these, we strive to aggressively manage risk while preserving capital. Uncertainty is rampant, but fear need not be.
Schwab Settlement
For years we invested in Schwab’s Yield Plus short-term bond funds. When the credit crisis froze the bond markets and prices started to decline, we quickly liquidated these positions. Unfortunately, Schwab subsequently experienced strong liquidations causing some of their investors to lose substantial sums. Schwab has agreed to make a settlement to shareholders of record, hence the reason many of our clients have received legal notification. There is no “to do” on your part. If you are eligible to receive part of the settlement, Schwab will mail you a check. If you receive a settlement check for an IRA account, it will need to be deposited back in that account.
Please be sure and give us a call with questions.