Tuesday, April 7, 2009

News - April 2009

Some economic and market hope was restored as the month of March drew to a close and the first quarter of 2009 mercifully ended. All hope was not lost as prognostications of “Dow 5000” relented to talk of “Dow 8000” or even “Dow 9000”. What’s 4000 market points between friends? Optimism, albeit guarded, became more fashionable towards the end of the month. The recent upturn in the market most likely signifies a stabilizing economy in the months ahead. Stock markets are a leading economic indicator; therefore a continued rally would suggest real economic growth, as opposed to stability, before the end of 2009.

Stock markets began the quarter breaking the previous November lows, racing to fresh 12 year market lows. After one of the worst investment years of all time, the continued slide after the 1st of the year was just that much more agonizing. Markets erased most of the initial 25% decline for 2009 to close the month off by a “manageable” 11% decline for the year. It’s interesting to note that each time there has been a significant 4th quarter market decline, as we saw in 2008, the market has moved to fresh lows in the following year. In addition that new low (which we may have achieved in March) has also marked the end of a bear market. While we are loath to suggest certainty in this pattern holding true this year, it does give investors some much needed solace.

As we mentioned, the S&P 500 logged a loss of 11% over the first three months of the year, while the Dow Industrial Average dropped 12.5% and the NASDAQ was relative stand out, dropping only 2.8% for the first quarter of 2009. Technology stocks did underperform the overall market in 2008, but the relatively strong balance sheets consisting of little debt, has let the once speculative sector transform into relative refuge for nervous investors.

The developed international markets continued to underperform losing 16.21%, as a resilient U.S. dollar showed continued strength. Some would have expected the U.S. dollar to be weak in the face of enormous government deficit spending. Given the lousy economic environments in the developed economies abroad, the U.S. Dollar is again showing to be a safe haven for reserves.

Emerging market stocks did better, barely posting negative returns of 0.6% during the 1st quarter of 2009. Individually, Brazil and Russia were the big winners posting positive returns of 10.4% and 8.1%, while Chinese shares were even for the 1st quarter. These markets all significantly underperformed the broad U.S. indices in 2008, so some initial outperformance early in 2009 is not surprising.

Financials and Real Estate Investment Trusts were two of the worst performing groups during the first quarter at negative 28.4% and negative 35.8% respectively. These ugly returns would have been far worse if not for a significant bounce over the past few weeks, which actually outpaced the rebound seen by the broader market. The recent market recovery coincided with positive comments from some bank executives, who claimed to have achieved modestly better results in the early part of 2009. In addition the markets were buoyed by anticipation of some relaxation in the mark-to-market accounting rules and some positive response to more details about the government plan to auction off some of the mortgage backed assets on the bank’s balance sheets.

Bonds, on average, were slight losers during the 1st quarter as the aggregate bond index fell by nearly 2%. An encouraging sign to some bond investors was the increased demand in higher yielding corporate bonds. Investors moved out of U.S. treasuries, contrasting with massive flight to safety seen last year. The 10-year treasury yield moved higher by 0.5%, leading intermediate and long term U.S. government bonds to perform poorly during the month posting negative returns of 1.43% and 10.9% respectively. Historically, treasury rates are still extremely low as investors continue to prefer the safety of U.S. backed government debt. Inflation protected bonds performed well, gaining 3.5% for the quarter as inflation expectations rose.

The government continues to dominate the market sentiment as it seems the financial epicenter has moved from Wall Street to Washington, D.C. The Congress and the president continue to steal the economic headlines as stimulus spending has been passed as well as legislation regarding banking and housing fixes are considered. Eventually, the endless debate about the virtue or folly of the proposed, and yet to be proposed, plans will end and investors will be able to make sense of where the government stands on these issues. In the mean time its causes some additional uncertainty for the financial markets.

As a result of the bailout efforts and stimulus spending, some have argued that the amount of debt the government is undertaking us going to cause a great burden in the future. While this is a valid concern, the future burden on “our kids and grandkids” as the Pols cry is not simple to analyze. We are certain that Dr. Evil (Austin Powers’ insidious rival), let alone mere mortals, would be challenged to consider such astronomical figures such as “trillions”.

As World War II came to an end, the U.S. government debt came to a staggering 125% of the GDP at that time. Strong economic growth in the post war period, which outpaced government spending increases, facilitated a reduction in the national debt burden to a more sustainable level of 40-60% of GDP in roughly 15 years. Currently, even after accounting for a massive stimulus plan, the U.S. is carrying a national debt towards the upper range of the 40-60% of GDP level.

We are not necessarily advocating the current debt level, as we would suggest a smaller debt burden to be advantageous. However, we don’t consider the current debt load as an insurmountable challenge to the country itself, as some have opined. Certainly the merits of the stimulus package and other government initiatives are more than debatable, but the amount of debt the government is undertaking should be portrayed in proper context.

Much has been made of the lousy stock market returns of the past decade. Including the recent market tumult, the S&P 500 has produced the worst 10 year track record ever, when adjusting for inflation. However, a well diversified portfolio including international stocks, bonds, real estate and commodities would have significantly enhanced returns for investors over the past 10 years. We continually advocate well diversified portfolios for investors, but given the recent returns on various asset classes we would suggest that U.S. stocks are likely to post very positive results over the next decade.

As we have noted before, stocks historically, have produced returns of 10% on an annualized basis. Should equities continue on their long term historical path, we would suggest that stocks are likely to out-perform these other asset classes over the next decade. The 1970’s, which included a decade of relatively poor stock market returns, ushered in 20 years of significant outsized returns for the S&P 500 during the 1980’s and 1990’s. While investors would rather that stocks produce more consistent results, we are optimistic that the low stock valuations seen today will lead to positive results over the next decade, as the future is not likely to not resemble the past 10 years.

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