Wednesday, August 5, 2009

News - August 2009

The U.S. economy has posted negative growth over four consecutive quarters now, which is the first time in over 60 years that such a string has occurred. However, the second quarter 2009 GDP was only negative by 1%, beating most analysts’ expectations. And most are forecasting positive economic growth in the 3rd and 4th quarter, some even predicting rather robust growth of 3% on an annualized basis for the third quarter. Housing prices also showed some stabilization, as the index showed a slight rise in housing prices from April to May. This was the first positive monthly change for the index since the housing crisis began.

Equity markets have been the most glaring beacon, pointing to encouraging economic trends in the near future. Stocks continued their five month advance during the month of July, even in the face of some ominous news. Unemployment closes in on the 10% mark and the aforementioned persistent negative economic growth has consistently been in the headlines. Stock markets typically start to rebound long before there is any evidence of an economic turnaround. This market action sometimes puzzles analysts and investors who are focused on the current economic numbers, although the same pattern has emerged time after time. The recent market surge has added nearly 50% from the March lows. This compares favorably to the average 24% gain that has historically followed recession lows in the stock market.

The Dow Industrial Average reached the 9000 level for the first time since last October. While the recent turn in the markets feels good compared to where we were in March, we are sure that investors are well aware equity levels are still roughly one-third of the record highs of October 2007. In essence, we will need to see considerable economic progress before we get back to those lofty levels.

Almost all asset classes marked gains for the month of July except for oil and gold, which are off their highest levels of the year. But most categories of stocks, bonds and other commodities all posted varying degrees of gains for the month. The standouts for the month were developed international stocks and emerging market stocks, which gained 10%, and 11%, respectively, for the month of July. Emerging market stocks have outperformed nearly every other class, posting a gain of 44.4% for all of 2009.

China, Brazil and India have weathered the financial crisis better than some might have expected and have also benefited from rebounding commodity prices. China, for instance, is sitting on $2 trillion in reserves, with which they can use to invest and stimulate their economy. It’s nearly unimaginable for Americans to consider the envious Chinese position, holding all of those savings just as assets across the globe are on sale.

The broadest U.S. stock market index measured by the S&P 500 gained 7.6% for the month of July and is now positive by 11% for the year, through July 31st. The technology focused NASDAQ advanced 7.9% for the month and an impressive 26.2% since December 31, 2008. Technology companies’ strong balance sheets and relative earning resilience has transformed the once speculative sector into a safe haven for investors. The Dow Industrial Average managed to make it into positive territory for the year, posting gains of 8.8% for the month and 6.6% for the year.

High yielding corporate bonds as well as high grade corporate issues have also rebounded well throughout 2009. High yield bonds posted gains of 7% just during the month of July and have advanced by 18.1% for the year. Investment grade corporate bonds achieved a gain of 4.6% for the month of July and 9.3% from the start of the year. Corporate bonds of all stripes were all sold down last year as the threat of economic distress and massive defaults seemed imminent. U.S. treasury bonds, last year’s safety trade, are one of the lone losers this year. Long-term treasuries are down 19.1% for the year, medium-term treasuries have lost 5.9% for 2009, and even shorter-term government bonds have posted small losses year to date.

There is much debate about what the U.S. treasury markets price action means this year. We saw investors flood into the safest investments (U.S. treasuries) denominated in the safest currency (U.S. dollar) on earth as the financial crisis was unfolding. This was evidenced by the historic rally in treasury prices in 2008, accompanied by a surging U.S. dollar.

As the crisis abates, we are seeing those same investors move capital into riskier assets denominated in riskier currencies. These other investments are priced to offer higher potential returns than good old U.S. treasury bonds. This, in our opinion, is the most significant influence – treasury prices and the U.S. dollar. The enormous supply of new treasuries will undoubtedly send yields somewhat higher, all else equal. But we take recent market action as evidence that investors’ appetites for risk, and inflation expectations, continue to be the most significant drivers of interest rates required on U.S. government debt.

As we have said, we are encouraged by the recent rally in the stock markets. In our view, the rally since March has largely been a product of simply avoiding a Depression scenario. A Depression was never a likely outcome considering the unprecedented, while controversial, actions of the Federal Reserve and the Department of Treasury. In addition, there was constant chatter about a collapsing banking system or the only apparent alternative, a nationalized banking system.

There are consequences to these extraordinary measures and bailouts, which most likely saved the economy from even higher unemployment and even slower economic activity. There will be the endless hearings and concern over who benefited more or less in addition to some new regulations and reinstatement of some old regulations. Some additional financial institutions deserved to die, some Wall Street bankers continue to receive grotesque bonuses, and the government influence during this period can make us all uncomfortable.

This environment of bailouts and unprecedented government intervention is not the norm, however, and isn’t likely to be standard practice in the future. Capitalism will survive and thrive, just as it has post the Great Depression when new regulation and many of the government programs we take for granted were created. American style capitalism has been proven as the best economic system in the world, and is likely to remain the model of economic success in the years to come.

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