The stock market slumped badly in the 2nd quarter 2010. After reaching yearly highs in April, stocks sold off in May and at the end of June. For the year the S&P 500 is down 7%.
2nd Quarter Summary
Volatility returned to the market in the second quarter sending investors fleeing from the "risk" trade and into defensive investments. The S&P 500 turned in its worst performance since the fourth quarter of 2008. The index lost 11%. We had started the quarter on a positive note as the market viewed the Greek debt crisis under control and the economic recovery continuing nicely. In fact, the market reached its highest levels since the fall of 2008 in late April.
This changed, however, as the quarter progressed. The situation in Greece deteriorated and worries that this would spread to other European countries and eventually the U.S. caused the markets to drop. In addition, there was concern that China, which was one of the leaders in global growth, would try to slow its booming economy and in turn derail the global growth machine. China has been tightening its lending and land sales to combat a perceived property bubble and broader asset-price frothiness.
With large amounts of dollars moving into bonds, the U.S. Treasury prices rose sharply driving yields on these investments down dramatically. For example, the yield on the 10-year note declined to 2.96% from 3.84% at the beginning of the quarter. Bonds, along with gold, were two of the few winners in the quarter.
Portfolio Allocation Adjustments We made in the 2nd Quarter
Because of their asset allocations, portfolios under our management have held up reasonably well. With diversification among asset classes and the bond sector, losses have been held down. Areas that have not done as well as the broader market include the energy sector and parts of the growth sector. However, we feel these areas will do well going forward, so they are included in the allocation of many of our clients’ portfolios.
There is no question that the stock market has stepped back from the strong recovery of 2009. Uncertainty is a key problem when it comes to investing. There are a lot of problems facing the economy right now. Jobless numbers have been tepid at best. Private sector jobs have gone up by less than 100,000 each of the last two months (May and June). To reduce overall unemployment to 8% from the current 9.5% requires job creation of 250,000 monthly for the next two years. A jobless recovery is something that investors do not want. Meanwhile, consumer confidence dropped dramatically in June wiping out the gains of the previous two months.
As far as resolving the European crisis, people are concerned that possible Greek default on its debt will morph into a broader problem and trip up all financial markets such as happened with
Lehman Brothers in September of 2008. Much of Europe goes on vacation for the months of July and August. Therefore, we may not have resolution until the fall comes around. However, most economists did not expect Europe to be an engine of growth in the recovery any way.
Perhaps most alarming is the concern that the economy has stalled again. Projections for the second quarter growth have been reduced from 3% to 2.5%. This is perhaps optimistic given the spending by all countries and the United States in particular. The talk of a V-shaped recovery in which the economy would rebound sharply in 2010 from the recession is pretty much off the table now.
However, there is some good news still out there. Pauses in an economic recovery are not uncommon. In late 2001 and early 2002 the economy had a 12 month stretch in which it grew and anemic 1.5%. A similar problem occurred in 1991. In both cases, however, the economy did in fact rebound nicely.
Earnings, which have taken a back seat recently to other macroeconomic concerns, will be announced over the next several weeks. Many are expecting strong results. This is a reminder that corporations have come through the crisis relatively strongly with solid balance sheets and efficient operations. Earnings are expected to grow year over year by about 27%. In addition, analysts expect the second half to grow another 15% over year earlier levels.
The S&P Index is currently trading at less than 13 times next year’s anticipated earnings. This is the lowest for the year and compares to an historical average multiple of about 18. The current multiple is the lowest since early 2009 when stocks were setting bear-market lows. This fact has made stock market enthusiasts confident that sentiment has grown too bearish and that the drops in the market are overblown. These enthusiasts feel the bottom line is that the recent economic slowdown is a natural easing in the pace of the recovery which was surging so much last year.
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