Thursday, July 2, 2009

2nd Quarter Financial Review

From the Desk of Joe Rollins

The month of June came to a close on Tuesday, although it was only marginally positive, it was the fourth straight month that the major financial markets had positive returns (as measured by the S&P 500). I am following-up on my May 30th post (Light at the End of the Tunnel – And It’s Not a Train) to show how much the markets have moved in a positive fashion since early spring. Year-to-date results are as follows:

The markets are truly starting to heal. The reason the markets are better today than they were during spring is because the economy is noticeably better. While it’s true that most economists are forecasting a negative GDP growth in the 2nd quarter of 2009, it’s only a relatively minor amount, estimated at 1.3%. In fact, virtually all economists are forecasting that the 3rd quarter of 2009 will be breakeven from a GDP standpoint, and the 4th quarter of 2009 will be solidly positive. I understand that these numbers are not sterling, but the fact that we came from virtually the edge of the abyss in the 4th quarter of 2008 to positive GDP less than a year later in 2009, should be very encouraging to everyone. The stock markets are reflecting that positive trend.

I’d be willing to bet that you haven’t heard that the 2nd quarter of 2009 was one of the best for positive financial results in the history of investing. For the 2nd quarter of 2009, the Standard & Poor’s Index of 500 Stocks was up 15.9%. The Dow Industrial Average was up 11.9% and the NASDAQ Composite was up a whopping 20.3%. In fact, the S&P 500 has not had such an excellent quarter since 1998. Given how bad the markets were from September, 2008 through February, 2009, to see these types of positive returns in the 2nd quarter of 2009 was very heartwarming.

Most of my clients completely ignored my recommendations to invest their IRA’s during February and March of this year. I understand that the markets were terrible at that time, and it takes a lot of nerve to invest when the markets are bad. However, as the 2nd quarter of 2009 has illustrated, the best time to make money in the financial markets is when no one else wants to invest. If you wait until the markets have already turned themselves around and have headed towards a positive trend, you are often too late. We’ve had a great 90 days, but I don’t believe that the upward trend is now over.

Historically, the financial markets suffer from the summer doldrums in July, August and September. In fact, many traders take off the entire months of July and August and only return to work full-time after Labor Day. For that reason, it would not surprise me to see the markets trend sidewise during the next few months.

There is a great deal of encouraging news, but one of the most encouraging signs is that as a general rule, fund managers are way underinvested. For example, I continue to read that there are literally trillions of dollars of uninvested cash in money market accounts paying practically nothing. It’s only a matter of time before this money migrates away from the low yielding money market accounts and is either invested in stocks or high-yielding bonds. No respectable fund manager would dare risk losing a client invested in cash when relatively conservative alternative investments yield many times cash’s low annual rate of return.

As pointed out in many of my prior posts, virtually none of the stimulus bill money has been spent to this point. There’s no question that money will begin to flow from the bureaucracy of the Federal government to projects in the 3rd quarter of 2009. In fact, I read that almost $100 billion in new construction around the U.S. will be funded with your tax dollars in the 3rd quarter. Notwithstanding the questionable nature of these expenditures, they will unquestionably create employment, which was the goal. We should never lose sight of the fact that many of the problems in the economy were created by the fact that not enough Americans were working. If these stimulus dollars create employment, then the plan will have been positive for us all.

Yes, it’s true that I worry that spending stimulus dollars into 2010 might overheat the economy and create inflation somewhere down the line in 2011 and 2012. However, any form of inflation today would be a positive, not a negative. It is truly hard for the average person to see how much the economy has improved given the information we receive from the nightly news. However, an economy that goes from a deficit greater than 6% in the 4th quarter of 2008 to a positive GDP one year later in 2009 cannot be underestimated. The United States will be the first of the developed countries to recover from the recession, and the others will soon follow.

Asia is already reporting better numbers and the growth of consumer spending in China, India and the developing countries will dramatically increase GDP and wealth around the world. The economy is improving and stock prices will soon reflect that improvement.

This so-called world recession that we have suffered through has been unusual in many respects. It seems like the U.S. was the first to feel the full impact of the downturn, but the rest of the world quickly caught on. Never in the history of modern finance have we seen such a coordinated effort on the parts of all major governments to stimulate their own economies. Clearly, China led the way, but other countries quickly followed. Even the stately and slow-moving Socialists in Europe eventually got on the bandwagon and funded stimulus plans in their countries. As hard as it is to believe, the Shanghai market was up a stunning 63% so far in 2009. I guess we all have to admit that’s a good rate of return for a country in a supposedly slow economy.

Virtually all the major banks have now repaid their TARP money and fortunately for them, and for you, Barney Frank now has no say-so in how their banks are run. There’s still a lot of work to be done in the banking industry, but we certainly don’t need to worry about financial viability. The major banks are adequately funded and will report “blow-away” profits in the quarter just ended. As I’ve mentioned on numerous occasions, when the government loans money to banks at practically nothing, it doesn’t require the banks do much to make big profits when they’re charging their customers interest. Many of the banks will report close to unbelievable profits in the 2nd quarter of 2009.
It was also quite an extraordinary quarter for some of the emerging markets and some of the economies of the developing countries. For example, India’s market is up 50% year-to-date. Argentina is up 47%, and of all places, Turkey is up 38%. Mexico continues to rally and is up 34% for the quarter, but Treasury bonds have lost 4.21% for the year. It’s clear that during the quarter, investors embraced the growing economies and traded away from the safety of Treasury bonds.

Almost every day, I hear one fund manager after another promoting the safety of Treasury bonds. It’s hard to envision that fund managers would be willing to accept the low rate of return on Treasury bonds in the face of increasing inflation, which we all know is coming. This quarter, the financial markets turned from a major loss in January and February to a marginal profit in the second quarter, making up all the major losses from the first quarter. In many respects, it is a very satisfying quarter.

I do not believe anyone is operating under any illusions that we can have positive results in the 3rd and 4th quarters like we did during the 2nd without increasing profits. I continue to hear a cascade of negative comments regarding upcoming profits. I suppose I am just not in the negative camp. I know for a fact that the banks will record extraordinary profits during the 2nd quarter of 2009. I think that should be very encouraged. Even the maligned car manufacturers will have better performance in the second half of 2009. The evidence is out there for anyone to read.

The U.S. car market is now on course to sell about 9 million cars in 2009 (17 million in 2007). During the 2nd quarter of 2009, the manufacturing rate for the automobile industry in this country was only 4 million units. Therefore, the production to meet the demand must increase by 100%. There’s no question that the automobiles will not have robust profits, but there losses will be significantly less for the remainder of 2009. That increase in profitability will bring stock valuations back into normal ranges.

I’ve read so much about how the recession will affect travel and hospitality. Did you know that the hotel stocks as a sector were up 73.8% in the 2nd quarter? Even the downtrodden retail sector stocks outperformed, returning 43.2% for the 2nd quarter. There are extraordinary opportunities available in stocks at the current time. However, the vast majority of investors continue to ignore the potential gains.

I feel comfortable saying that 2009 will show positive returns. I attribute that to the lack of competition that cash and CD’s have compared to stocks. If money markets and CD rates ever become competitive again, I would not have the same confidence level in stocks.

There was an article in Wednesday’s edition of The Wall Street Journal that was very interesting. It was referring to jumbo CD’s, which usually means CD’s of at least $100,000 or more. It was amazing to see how poor the rates are on these exclusive jumbo CD’s. The six-month rate was at 0.9% annualized. The two-year CD yield was 1.52% and the five-year jumbo rate was 2.31%. It’s perfectly possible that during the five-year term of that CD, inflation in the United States will reach 4%. Any investor willing to take the risk of inflation will have a significant reduction in purchasing power at the end of that five-year CD term than they did at the beginning. For that reason alone, much of this rollover CD money will eventually find its way back into the equity and stock markets.

If you haven’t been investing for fear of a new major market downturn, you should review the information contained in this posting to evaluate whether your money market account offers you the same potential for gains that the equity markets provide. I expect the years ahead to be excellent for the financial markets. I urge you to participate.

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