Wednesday, April 7, 2010

News - April 2010

The stock rally over the last 12 months has continued in earnest through March of 2010. Stocks are roughly 75% higher than they were at their nadir in early March of 2009. The early part of the rally indicated the first signs of economic stabilization, and now economic indications like retail sales and employment are showing actual improvement. The improving economic landscape has sustained the push higher for stocks in early 2010. The recovery in asset prices has been nothing short of amazing until you put the rally in a longer term context.

The S&P 500 spent most of the month of October 2007 nearly 30% above the current valuation. The 1,500 level achieved in 2007 was first eclipsed in March of 2000. The S&P 500 ended this past March 31st just below 1,170, where it spent much of late 1998. Therefore, some observers could say that not much has happened in the past 11½ years. Hence, there has been a lot of talk about the “Lost Decade” that investors have endured.

It’s true that the S&P 500 did not offer any returns for investors from January 2000 through December 2009. In fact, the return offered over that period was slightly negative. That said, a diversified portfolio of international stocks, bonds, real estate, and commodities did fare considerably better.

Emerging market stocks and REITs both gained over 10% per year for the “Lost Decade”. Commodities returned over 7% annualized and the most widely followed diversified bond index gained 6.3% annually from 2000 through 2009. Of course, many investment portfolios had a significant weighting to large cap U.S. stocks that are represented in the S&P 500, but even a small weight to these other assets classes would have had a tremendously positive impact on returns.

The S&P 500 has gained 5.4% through the first quarter of 2010. While many still argue that the market has gotten ahead of itself, we would also like to point out that the S&P 500 index first reached the 1,175 level in 1998 and also has only regained about 50% of the loss from the 2007 highs. The DOW and the NASDAQ posted similar gains at 4.8% and 5.9% for the quarter, respectively. Small cap stocks were the notable outperformer of the widely followed indexes, gaining 8.7% from December 31, 2009 through March 31, 2010. The U.S. dollar climbed a modest 3.1% during the quarter, but has surged 7.8% over the past five months. This may explain some of the outperformance in U.S. small cap stocks as they don’t have as much international business, which can be aided by a weaker U.S. dollar.

Likewise, international investments generally trailed the U.S. markets as evidenced by the 0.9% positive return for the developed market index; the emerging market index gained 2.8% for the quarter. Gold rose 1.5% for the quarter, while the price of oil increased by 4.6% through March 31, 2009. The widely followed commodities somewhat bucked the trend of trading inversely to the U.S. dollar. Strong oil prices may indicate more confidence in a recovering worldwide economy, as stronger gold prices may reflect a continued surge in investor appetite for diversifying investments and hedging against future inflation.

The employment report for March showed the unemployment rate remaining at 9.7%, but finally, a significant 162,000 jobs were created during the month. The government data suggests hiring across most industries as many companies are at last showing enough confidence to hire at least some new employees. The number of new jobs created in March pales in comparison to the 8 million jobs which were lost during the recession, but it’s hopefully the start of a new longer term trend.

The question going forward is how the economy and markets will react when much of the government stimulus is removed. Short term interest rates will eventually need to go higher and the Fed has already said it will put an end to its program of buying mortgages. The Federal government cannot afford many more, if any, spending initiatives. Tax cuts are almost certainly off the board for some time. The low interest rates, government spending, and various bailouts, for better or worse, were intended to temporarily patch up the ailing economy. Now that the economy has improved, it may well be time to pull back on government spending, let interest rates inch up, and allow the economy to try and sustain its own improvement.

Some would certainly make an argument that the aforementioned programs will actually deter economic progress and growth going forward. That may be true due to the higher taxes and debt burden on those taxpayers. But without at least some of those programs, the economic trough might have been deeper and even more people would have been unemployed.

We don’t have much doubt that the economy can overcome the challenges. If there is an unemployment reduction of 1% per year, which will should be accompanied by higher economic growth than many are predicting, say 3.5%-4% annually. Big “if’s,” but that might be the best case scenario; it’s also the likeliest given the U.S. economic history. Despite the relative strength of the emerging nations, the United States still offers the most compensation and best market of consumers for the innovators and entrepreneurs.

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