Letter to Clients – 3rd Quarter 2009
Dear Friends and Clients:
When people who know me see me on the street, they stop and ask how I am doing. They make the assumption that given the terrible returns from the stock market and the high level of uncertainty about the economy, that I must really be professionally frustrated. The truth is actually quite the opposite. As an individual investor, I too feel the pain. But as a Certified Financial Planner TM practitioner, never have I been so excited professionally.
My mission statement begins with the phrase "to eliminate your financial stress and worry" and frankly that is exactly what most people need right now. My opportunity to serve my clients and prospective clients has never been greater. Rarely does a day pass that I do not ask myself if there is anything that I could or should be doing to better serve you. I hope that these quarterly letters are part of the value that I can bring to you. But if I ever fail to give you the support and services you desire, please let me know. It is my pleasure to work with you, and guide you through this turbulent time.
The First Quarter of 2009 ended on a note of cautious optimism, sparked by a strong March rally that lifted the S&P 500 Index to an 8.76% return for the month. That optimism seems justified as the rally pushed forward during the Second Quarter 2009, with the S&P 500 Index returning 15.9% for the period and posting a 36 % gain since establishing a twelve year low on March 9.
While those robust gains took some of the sting out of the current bear market, the S&P 500 is still well off its September 2008 pre-financial crisis levels – not to mention its October 2007 high. As the rally flattened in June 2009, new concerns were raised: Was this a bear market rally, with the slide likely to resume and deepen? Or is the economy and the markets seeing genuine signs of recovery? And if we are entering a recovery, how robust will be the market response?
Only time will tell. Nonetheless, some of the data and historical perspectives can provide a better grasp of the potential road ahead. Here are a few of the factors I am paying close attention to:
Credit
Credit is enormously important to the U.S. economy, both for business and consumer spending. The U.S. government has committed trillions of dollars to stabilizing banking and the flow of credit and, while challenges remain, liquidity does seem to be returning to the credit markets. Credit spreads have declined during the quarter, potentially signaling a greater willingness among investors to shift from the comparative safety of government instruments to corporate fixed income securities.
Banking
In May, the Federal Reserve released the results of its stress tests of 19 major banks, and announced that 10 needed to raise additional capital – which many did through the sale of non-core assets, issuing new shares, or with the help of the government. The market responded positively to these actions. Financials turned in the strongest performance of any S&P 500 sector with a 35.71 % return.
Recovery Signals
Expect to see mixed signals over the next several months as the economy moves from recession to recovery. Among the positive signs, consumer sentiment and confidence increased over the second quarter (before dipping again in June), although they remain low in historical terms. Pending home sales have also increased over the three consecutive months. Also, surveys of purchasing managers from the Institute for Supply Management, a forward-looking economic indicator, found encouraging trends, although they remain at recession levels at quarter end.
On the other hand, rising consumer confidence has not been matched by spending, at least for big ticket items. Vehicle sales, which had never dipped below the 10 million mark for any month since 1982, in each of the first five months of this year failed to reach 10 million. (June numbers are not yet available.) Unemployment also continues to rise, with higher-than-expected June figures sparking a sharp sell-off just after the quarter end. While unemployment tends to be a lagging indicator that peaks well after economic growth has been re-established, it may inhibit consumer spending, which in turn may slow recovery.
Recession Forecasts
The end of a recession, like the beginning, is only identified in retrospect. Estimates for when the current recession will end have ranged from the Fed Chairman Ben Bernanke's May 5 testimony that the recession might be ending during the Second Quarter 2009, to more cautious estimates that the recession will linger until early 2010.
One optimistic assessment comes from Ned Davis Research, Inc,., which has tracked a group of 12 indicators, including the S&P 500 Index, nonfarm payrolls, sentiment indicators, credit spreads and others, which they believe have been the most reliable at indicating the end of a recession. As of early June, they reported that all 12 indicators were signaling that the recession had finally bottomed and was moving toward expansion. It goes without saying, of course, that historical comparisons, while suggestive, are not guarantees.
Corrections and Bear Market Rallies
Perhaps the biggest debate among investment managers over the quarter has been regarding the nature of the recent rally. Is this the beginning of a new bull cycle, or is it a bear market rally with new lows to come?
Some bearish commentators look to 1930, when the market (as measured by the Dow Jones Industrial Average) recouped more than a third of the original stock market crash, only to sink drastically lower, reaching a bottom in 1932 that erased over 80% of the previous market highs.
More commentators lean towards a more positive outlook and expect that we will experience a correction before the up cycle resumes. Ned Davis Research, to name one example, conducted a historical analysis of similar bull markets and their conclusion is that today's cycle most resembles 1974 which saw a shallow 5.6% correction before the recovery resumed.
Ultimately, what will determine the direction of the market over the remainder of 2009 is the degree of concrete evidence that the economy is indeed recovering. The argument can be made that the market has priced in a third quarter recovery, as well as assumptions about the strength of the recovery. In order for current stock valuations to be sustained, let alone advance, recovery signals will have to become more pronounced. Disappointing economic news may not lead to severely declining prices, but it may leave the market stagnant for months to come.
Looking Ahead
The market rally that began in mid-March was global in scope and brought welcome relief to investors faced with the steepest bear market in decades. The coming months are critical as the market seeks to consolidate gains and the economy finds its bearings.
In any market environment, a diversity of asset classes, portfolio strategists and approaches to asset allocation can balance risks and rewards. All of which can help you potentially capture returns with reduced volatility. As always, I am here to serve you. If you would like to discuss the current markets or your portfolio, please call me at (515) 457-1222. I welcome the opportunity to spend time with you answering any questions you may have and addressing your concerns.
Sincerely,
Art Dinkin, CFP®, CLU, ChFC