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John Frankola has 32 years of experience in the investment and financial management fields. He is currently President and Portfolio Manager of Vista Investment Management, LLC, a registered investment adviser. Vista focuses primarily on high net worth and institutional clients, who are seeking a... More
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  • Third Quarter 2009 – Market Review

    The market’s strong rally, which began in early March, continued through this year’s third quarter.  The S&P 500 Index produced returns of 15.6% for the quarter, as more signs emerged that an economic recovery had begun.  From its low on March 9, 2009, the S&P 500 has risen 56%.  Even with this strong performance, the S&P 500 stands 7% below its year-ago level and 32% below its all-time high of October 9, 2007. 

     

    While the quarter and year-to-date numbers have been very strong, the following table illustrates that the major stock market indices continue to show 3, 5, and 10-year results that are significantly below the long-term annual average of almost 10%. 

     

    Equity Performance for Periods Ending on September 30, 2009

    Total Returns

                ___   Annualized___
      Market     Year-        
    Index Sector   Quarter to-date 1-Year 3-year 5-year 10-year
    S&P 500 Large Company 15.6% 19.3% -6.9% -5.4% 1.0% -0.2%
    Russell 2000 Small Company 19.3% 22.4% -9.6% -4.6% 2.4% 4.9%
    MSCI EAFE International 18.7% 25.5% 0.0% -6.3% 3.3% 0.3%

     

    Much has changed over the past twelve months

    Last year Congress, the Treasury Department and the Federal Reserve were working out details of a program to head off a collapse of the US financial system.  Today, almost one third of the TARP funds used to infuse capital into the banking system have been repaid.  The credit freeze that produced a virtual paralysis in commerce has largely thawed.  According to Dealogic, so far this year, corporations have issued $700 billion in new debt, an increase of more than 38% over last year.  Last year’s fourth quarter produced a precipitous drop in virtually all economic indicators.  This past September, the Conference Board reported that the Index of Leading Economic Indicators increased for the fifth consecutive month.   This streak followed 20 consecutive months of declines.

     

    The economy appears to be recovering, but there are still a number of concerns

    There are a number of other positive factors which signal that the economy will continue to strengthen.  First of all, the recession is probably over (as indicated by Fed Chairman Ben Bernanke on September 16), although an official declaration of this occurrence will not happen for some time.  As noted above, a number of leading indicators have turned positive, the housing industry has stabilized, retails sales are improving, and the manufacturing sector is strengthening.  In addition, low energy prices, low inflation, and low interest rates should continue to support a recovering economy.  Finally, forecasted growth in emerging markets like China, India, and Brazil should help to sustain a global economic recovery.

     

    Of course, all is not yet rosy.  While the economy is improving, it remains weak.  The most bothersome statistic relates to unemployment, which stands at 9.8%, the highest level in 26 years.  Unemployment is a lagging statistic – it is one of the last to show improvement, since companies will add overtime before they hire new employees.  Consumer debt remains high, which could also limit an economic expansion.  There is also uneasiness about the government’s larger role in the economy.  Stimulus spending, corporate bailouts, large ownership stakes in many U.S. corporations, proposed healthcare reform, expected tax increases, and large projected budget deficits are all significant concerns for investors.

     

    Interest rates remain low

    Interest rates declined during the quarter, which helped to generate returns of 3.8% for LB Aggregate Bond Index (bond prices rise when interest rates fall).  The yield on the benchmark 10-year Treasury note fell to 3.31% from 3.52% at the end of June.  Prices of Treasury and mortgage-backed securities were supported by purchases by the Federal Reserve, in an effort to keep interest rates low.  Corporate bond prices also increased as companies made efforts to strengthen their balance sheets and an improving economy reduced the risk of default.   With interest rates near historic low levels, long-term bonds appear to be somewhat risky, since an increase in interest rates will force bond prices lower.

     

    Looking forward

    The current consensus is that the economy will continue to improve, but that growth will be less than robust.  Some worry that the U.S. could fall back into recession once the stimulus dollars are spent.  Most expect unemployment to recover very slowly.  While this might seem like a weak backdrop for positive stock market performance, corporate earnings could recover strongly even if economic growth is lackluster.  Over the next several quarters, corporate earnings will appear to be very strong when compared to the depressed levels of the previous year.  Also, corporate cost cutting over the past year has positioned U.S. companies for strong earnings growth, with just a modest increase in revenues.  As business confidence improves and more credit is available, merger and acquisition activity is also likely to put upward pressure on stock prices.  Finally, there is a considerable amount of money on the sidelines, with money market funds currently holding $3.4 billion. As investor confidence improves, some of this money (which is earning less than 1%) could find its way into stocks.

     

    John Frankola, CFA, CPA

     


    Oct 09 03:09 pm | Link | Comment!
  • Second Quarter 2009 – Market Review

     

    Stock markets produced positive gains in the second quarter of 2009. The S&P 500 Index generated returns of 15.9% for the quarter as investors’ confidence improved with signs that the economy may be turning around. While most economic data continued to show significant weakness, the rate of economic contraction has slowed, and some indicators have begun to turn positive. In particular, the Index of Leading Economic Indicators, which weighs ten forward-looking statistics, increased sharply in April and May. There are even signs that the housing market may be improving, with the Pending Home Sales Index rising for four consecutive months. Credit markets are functioning almost normally again as creditworthy companies are now able to borrow at reasonable rates.   In addition, the banking sector, while not fully recovered, has improved significantly. In March, some worried that the entire banking sector was insolvent and facing nationalization; by June, many banks were repaying their TARP loans, once again on firm financial footing.
     
    During the second quarter interest rates on Treasury securities rose, partially due to the significant issuance of new debt by the federal government, but also because other investments became relatively more attractive as investors become more risk tolerant. The yield on the 10-year Treasury bond rose from 2.60% to 3.52% during the quarter. The LB Aggregate Bond Index – a broad measure of the entire bond market - produced total returns of 1.78% for the second quarter.
     
    While it is possible to cite many individual signs of improvement, perhaps the most important factor contributing to the strong stock market performance in the second quarter was the general improvement in consumer and investor psychology. For much of the previous six months, fears of another great depression weighed on the collective public consciousness. Although the current recession will be remembered for its length and severity, the possibility of another great depression seems to have faded.   The University of Michigan Consumer Sentiment Index has shown three consecutive months of improvement, reflecting this positive change in attitude.
     
    With the depression scenario fading away, one of the most significant trends of the second quarter was the shift of funds from lower-risk assets to higher-risk assets.   Small companies outperformed large companies; emerging markets dramatically outpaced developed markets; and junk bonds recovered in price while longer-term Treasury securities produced losses. If the economy continues to recover, this trend is likely to continue for some time.
     
    At the end of the quarter, the S&P Index stood at 919, which was 35.9% above its bottom of 677   (March 9, 2009), but still 41.3% below the all-time high of 1565 (October 9, 2007). 
     
    The market’s 35.9% gain from the bottom reflects the improving fundamentals discussed above. But trading at a level 41.3% below its peak seems to indicate that investors still have significant concerns that a recovery will materialize. Unemployment continues to rise, businesses struggle with losses and solvency (GM and Chrysler both entered bankruptcy), banks expect more bad debt problems related to commercial real estate and credit cards, states and municipalities are running out of money, and the federal government is generating a massive budget deficit and is issuing debt at an alarming rate.
     
    So while it looks like the worse case – a depression – is no longer a major worry, the stock market will need to see further improvement in economic conditions and corporate earnings for it to move higher.   In all likelihood, there will be a number of mixed signals, which will produce market volatility in the short term. However, with credit markets now functioning in a more normal manner, emerging markets (China in particular) starting to rebound, stimulus spending kicking in and consumer confidence strengthening, the U.S. economy should show more signs of improvement in the second half of the year. 
     
    Looking beyond the near-term uncertainty, stocks appear to have very good return potential for long-term investors. First, lower stock prices have made stocks cheap based on traditional measures of value. As an example, S&P Equity research notes that the S&P 500 currently has an average price-to-book value ratio of 1.3. Its average over the past 22 years has been 2.2. This ratio has not been this low since the bear market of 1990, which preceded a nine-year bull market. 
     
    Although the recession and stock market correction have been very painful for most Americans, the lessons learned from the current situation should result in better future behavior by businesses and consumers. Banks will be more careful when lending money and making investments. Consumers are likely to be more prudent in their spending. Already a significant change in consumer behavior is evident. The U.S. saving rate was close to zero in the first quarter of 2008 - it is now at 6.9%. While this has temporarily hurt economic growth, the long-term benefits will be a stronger consumer and a more stable economy.  In all likelihood, a sustained economic expansion should lead to an eventual recovery in asset values.
     
     
    Jul 07 12:54 am | Link | 1 Comment
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