Stock market performance was essentially flat in the second quarter with the S&P 500 moving up 0.1%.Most of our clients' portfolios actually did better than the market during this period.
2nd Quarter Analysis and Our Strategy:
Despite the net result of basically no gain for the quarter, wide divergences in investor sentiment were clearly visible.The S&P 500 reached a post-crash high on April 29th, but then fell by 7.3% to its low point on June 15th.At this point the market was barely up for the year, a big disappointment.However, the market subsequently zoomed ahead 5.6% over the final four days of the quarter so that returns are actually good for the first six months of the year.
What the late quarter move should do is remind investors that the stock market is volatile and unpredictable in the short run.Not much really changed in the final week of the quarter.The Greek parliament approved another austerity program and European banks accepted a plan to roll over Greek debt.There also was a regional manufacturing survey out of Chicago which indicated that the manufacturing sector was turning around.In addition, many speculated that large hedge funds and investors had placed short sales on many stocks leading up to the final week in June and that they were caught off guard by the rapid rise and had to buy stocks to cover their short positions.Nevertheless, the rebound was gladly accepted.
The current list of problems facing the economy is long.The pace of the U.S. economic recovery remains slow.GDP grew at only 1.9% in the first quarter.This was lower than the anticipated 2.3% forecast.Unemployment remains stubbornly high at 9.1%.The housing market continues to bounce along at the bottom.The Federal Reserve’s second program (QE2) to stimulate the economy by purchasing Treasury securities ended in June.This program has helped keep interest rates extraordinarily low and been a boost to the stock market.With its ends comes the fear that interest rates will soon rise.Congress has not yet dealt with the federal budget deficit or the national debt ceiling with an early August date set for the U.S. to exceed it debt ceiling limit.Many local and state governments are experiencing significant financial problems in meeting their own budgets.While the Greek situation has been temporarily resolved, many worry also about Portugal, Ireland, and Spain.Conflicts and uprisings in Asia, the Middle East and Africa also contribute to a high level of political and economic uncertainty and volatility in the energy markets.
What then is there to like?
Well, while it might not seem to be the best scenario for owning stocks, U.S. companies are actually thriving in this environment.The combined earnings of S&P companies are expected to reach record levels in 2011, increasing by about 15% over 2010.Valuations for U.S. companies appear to be reasonable, with the S&P 500 trading at 13.3 times estimated earnings.In addition, companies have significantly improved their balance sheets and now hold record levels of cash.These factors should result in higher dividends, share buybacks, and acquisitions of other companies, which should benefit equity investors. Fixed income investments performed strongly in the second quarter as interest rates declined.Bonds gained over 2% for the quarter, outperforming stocks on the whole.The decline in interest rates and strong relative performance for bonds was generally attributed to concerns over a slowing U.S. economy and the European sovereign debt crisis.With the likelihood that interest rates will eventually move higher as the economy improves and/or inflation increases, longer-term bonds appear to be somewhat risky as bond prices decline as interest rates rise. The results of the past quarter seem to demonstrate that the investment community has considerable skepticism about the ability of the U.S. economy to continue its recovery.Indeed, many of the current problems, such as those related to government deficits and unemployment, will likely take a long time to resolve.However, most corporations have adjusted their business models so that they are able to succeed in the current environment.In this regard, equity investments appear to be relatively attractive for investors with long-term horizons.
I mentioned last quarter that bonds would provide safety if the stock market fell.This proved to be the case as bond funds had nice gains during the quarter.They were up 2% as compared to gains of less than 1% for many equity funds.These bonds have relatively short maturities which make them less volatile and susceptible to price drops than longer maturity Treasury bonds of 10 or 30 years.This means that if interest rates rise then the bonds will hold their value better than longer maturity bonds.
Especially in this environment, I recommend reviewing portfolio allocations to provide some volitility protection. If you would like some advice in this area, please give us a call.
Bruce A. Kraig, MBA, CFP July 2011
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