3rd Quarter 2010 – 2nd Quarter 2010 – 1st Quarter 2010 – 4th Quarter 2009

 

QUARTERLY INVESTMENT REVIEW
JULY 2010

July 2010

Euro-phobia, Not Euphoria

After a year of remarkable recovery from stock market lows, several market and economic events put a damper on the momentum.  While stocks continued to shine in April, fortunes reversed when Greece’s colossal debt burden and huge deficits were spotlighted.  With the fate of Spain and Portugal also in question, many wondered if the European Union would survive or if the stronger countries would simply depart the Union and preserve their sovereign wealth.  Ultimately, richer EU members agreed to lend to their poorer fellow members.

Within days of Greece’s problems hitting the headlines, the U.S. stock market suffered a mysterious and unsettling intra-day plunge of 1,000 points on the Dow Jones Industrial Average (the “Flash Crash”) only to recover two-thirds of the drop by the end of the day.  By far the greatest concern resulting from that quizzical event is that even the regulators don’t seem to be able to explain it. In other words, those in charge of maintaining an orderly market do not themselves understand it well enough to explain the chaos.

The quarter went downhill from there, accompanied by economic reports that the rate of recovery had slowed, the employment picture was stubbornly resisting improvement, and the housing market was again languishing.

Let’s take a look at the results for various indices for the quarter and how the end-of-quarter levels compare to the earlier market top in 2000.  All index values come from the Wall Street Journal.  Please note that performance of stock indices do not include dividends.

	2nd Quarter Year-To-Date	June 30 Year-to-Date	Since Market Peak (3/31/2000)
Dow Jones Industrials (the Dow)	- 10.0%	- 6.3%	- 10.5%
S&P 500 Stock Index (the S&P 500)	- 11.9%	- 7.6%	- 31.2%
NASDAQ Composite	- 12.0%	- 7.0%	- 53.9%
Russell 2000 Index (small companies)	- 10.2%	- 2.5%	+ 13.1%
Dow Jones World (non-US)	- 12.7%	- 11.5%	+ 6.6%
10-Year Treasury Bonds	+ 8.5%	+ 9.5%	n/a
Commodities: AIG Index	- 4.8%	- 9.7 %	n/a
The U.S. Dollar (JPM Index)	+ 2.4%	+ 2.4 %	n/a

As you can see, all stock indices posted significant, double-digit declines this past quarter due to the combination of fears of a global economic slowdown and profit-taking after the advances enjoyed in the previous four quarters ending 3/31 (+47% for the S&P 500) .  Capital shifted out of stocks and into the safety of bonds, cash, and gold.  Treasury bonds notched an impressive +8.5% gain for the quarter and +9.5% for the year.  With reduced expectations in economic recovery, demand for commodities eased.  As we have seen during  previous periods of concern over the stability of world financial systems, the U.S. dollar became the  go-to currency in a time of crisis, gaining +2.4% even in the face of declining domestic interest rates.

 

Where We Are Now

At the end of the quarter, stocks were in an “over-sold” condition and buyers subsequently started snapping up bargains.  While markets have gained back part of the year’s losses, averages are still in the red.  Households have been using discretionary income to pay off some of their debt.  While this helps shore up family finances—which should remain “job one,” it also restrains the type of spending that would otherwise stimulate the economy. Taken as a percentage of income, household debt is still quite high and the slow recovery in employment limits the ability of many households to pay off debt.  The Federal Reserve (Fed”) has continued to keep interest rates at historically low levels, trying to make borrowing costs as low as possible to stimulate the economy. This has helped households and--importantly--has kept the cost of financing the federal debt very low as well.  Real estate investments (”REITs) are having a better year than stocks and most are in slightly positive territory so far.  Mortgage rates are at their lowest since the 1950s.  The overall rate of default on consumer debt and mortgages has slowed but is still high in historic terms.  Some accept this as expected in the early phase of a recovery.

Looking Ahead

The Fed recently revised downward its expectation for economic growth.  A slower but positive recovery is predicted.  Economic indicators and corporate earnings reports are mixed, painting neither a clear picture of recovery nor of a double-dip recession.  While there is mild encouragement for growth, the pace of recovery should not be expected to approach the “normal” rate of recovery as measured by historical standards.    Many investors demonstrate a tendency to expect the glory days of yore rather than accepting the slow recovery that appears more probable.  We see evidence of the “pouncing bulls” in periodic 4-6% upward surges in the markets.  However, clearly there are also periods of selling, as more pessimistic (or pragmatic) investors drive stocks back down to the lower end of a trading range. 

In the short term, the current state of the economy does not appear strong enough to support higher stock prices.   Hence, stocks will likely continue to trade in a range. We continue to see opportunity in the market when it is trading at the lower end of its recent trading range. Interest rates will remain low to help stimulate the economy. In the longer term, it seems that the economy is slowly getting its feet under it.  Traction is more unstable than we would like to see, but it seems likely that the consistency of encouraging economic reports will, at some point, enable stocks to break out from their trading range.

As always, we will continue to follow the markets closely and will take appropriate actions within client accounts to manage risk and return in accordance with each respective Investment Policy Statement.

Please feel free to call with any questions or comments.

Craig S. Limoges CFA, CFP, EA                    

George S. Middleton CFA, CPA-PFS

 

QUARTERLY INVESTMENT REVIEW
APRIL 2010

A 12-Month Space Shuttle Flight

Each space shuttle launch is well publicized and anticipated by a prolonged countdown to the defined moment when everyone holds their breath, watching in wonder as the rocket blasts upward in all its glory.  In contrast, one year ago--when this momentous recovery in stock prices began--only a small percentage of sages could have comfortably predicted the monumental voyage of the stock market in the year that followed. 

Taken as an isolated period, the recovery over the past year has been nothing short of remarkable.  However, taken as a two-year (or longer) period, it is a piece of a larger, less ebullient picture.  One must recall what conditions were like in March of 2009:  fear was rampant and the threat of a total meltdown of the financial system—both here and abroad—was a genuine concern.  People were more concerned about the limits of FDIC coverage to guarantee the safety of their resources than making money in the stock market over the following year. 

Following are the results for various indices for the quarter.  In the middle column performance figures are presented to reflect the quantum leap that stocks have made since the low which occurred one year ago.  In the far right column is a comparison to 10 years ago (the S & P 500, a broad index of U.S. stocks, is still down a full 22% since its previous high 10 years ago). 

	1st Quarter Year-To-Date	Last 12 Mo From 3/31/2009	Last 10 Yrs From 3/31/2000
Dow Jones Industrials (the Dow)	+ 4.1%	+ 42.7%	- 0.6%
S&P 500 Stock Index (the S&P 500)	+ 4.9%	+ 46.6%	- 22.0%
NASDAQ Composite	+ 5.7%	+ 56.9%	- 47.6%
Russell 2000 Index (small companies)	+ 8.5%	+ 60.5%	+ 25.9%
Dow Jones World (non-US)	+ 1.4%	+ 57.4%	+ 7.0%
10-Year Treasury Bonds	+ 1.0%	- 5.7%	n/a
Commodities: AIG Index	- 5.1%	+ 20.4%	n/a
The U.S. Dollar (JPM Index)	+ 0.0 %	- 9.2%	n/a

All index values come from the Wall Street Journal.  Stock indices do not include dividend return.

As the table indicates, all stock indices posted big gains this past quarter, with small companies setting a blistering pace.  After a long run-up, commodities experienced a significant decline—but this notably reversed upward again after the quarter’s end.  International stocks were positive but did not keep pace with U.S. stocks.  Perhaps this was due in part to the Greek debt crisis and its impact on the Euro community which is expected to divert lots of capital resources to bail out their fellow Euro member(s).  The relative weakness in the Euro currency helped the U.S. dollar hold its ground for the quarter.  Bonds notched a modest gain as investors acknowledged the slowness of the economic recovery—translated; interest rates are going to increase more slowly than previously assumed.

Where We Are Now

There are many indications that the economy continues to improve, yet job growth is slow.  Though it is common for gains in employment to lag an economic rebound, gains in hiring have been particularly slow.  It is important that real estate markets are improving in most areas of the country--especially measured in numbers of transactions rather than gains in prices--yet the steady supply of foreclosed homes coming to the market and ongoing levels of high unemployment will likely curtail housing price gains for some time.  Manufacturing and retail are both experiencing improvements as well. 

Looking Ahead

Many economists believe the economy is poised to continue to improve at a slow pace.  There is much consistency to the improved tone of recent economic reports, which bodes well for stocks.  It should be no surprise that economic reports continue to be positive since they compare current activity to a period of remarkably negative conditions.  Once one’s eyes get accustomed to darkness, even a little light seems bright!  It is likely that the stubbornly negative employment numbers will improve as employers are expected to hire employees previously laid off.

While prospects for internal U.S. conditions remain on solid ground, structural issues hold us back from realizing the full potential of a recovery.  Personal debt is still high.  Investors are concerned about the ramifications of both recently-passed and pending legislation, particularly in the areas of healthcare changes and pending finance reform.  Broad measures need to be taken to shore up the regulatory oversight of the financial sector.  It has become obvious that de-regulation and myopic oversight enabled the unbridled greed of market players and this had disastrous results for our entire country.  So, yes, something must be done--change must occur.

For intelligent long-lasting change to take place, perhaps the first change that should occur is campaign finance reform.  A recent (4/21/10) Wall Street Journal article byline:  “Both Parties Have Held Dozens of Fund-Raisers on Wall Street While Fashioning New Regulations for Financial Markets” was a stomach-churner.  Removing all motivations and interests other than those of our citizens and the long-term strength of our country seems like the only viable approach to objective, effective, and meaningful change. Otherwise, special interests will determine law.

Aside from the above, the possibility of any of a number of “shock events” remains, with Iran’s nuclear aggression and a potential pre-emptive strike against their nuclear infrastructure being near the top; as well as the potential for the spread of debt crises between countries.

Stocks, the much more emotional cousin to the economy, seem tired from their long uphill journey.  They should be on solid ground for the future, but may need a rest before progressing. Once financial reform legislation passes, there may be some temporary fallout in financial-sector stocks before we regain momentum.

As always, we will continue to follow the markets closely and will take appropriate actions within client accounts to manage risk and return in accordance with each client’s respective Investment Policy Statement.

Please feel free to call with any questions or comments.

Craig S. Limoges  CFA, CFP, EA

George Middleton  CFA, CPA-PFS

 

 

QUARTERLY INVESTMENT REVIEW
JANUARY 2010

Is The Tide Really Changing?

Welcome to 2010—a new year and a whole new decade!  We at Limoges Investment Management would like to once again thank you for your business over the past year.  We look forward to another year of managing your financial resources in a responsible manner and serving your personal financial needs by offering sound advice. 

When one considers the depths of the gloom in March of this past year, the subsequent market recovery that resulted in the year’s gain of +23% for the S&P 500 is quite remarkable.  Early fears of financial chaos and a prolonged recession were transformed into hope and expectation for stability and recovery.   It is worthy to note that the good results of 2009 did not come close to making up for the losses of 2008, but we certainly welcome the advance!  Let’s take a look at the final results for 2009. 

Following are performance results for various indices for the quarter and for the year as well as how the end-of-year levels compare to an earlier market top ten years ago.  All index values come from the Wall Street Journal.  Stock index returns do not include dividends.

	For Year		Since Earlier Market Peak
	4th Qtr	2009	(3/31/2000)
Dow Jones Industrials (the Dow)	+ 7.4%	+ 18.8%	- 4.5%
S&P 500 Stock Index (the S&P 500)	+ 5.5%	+ 23.5%	- 25.6%
NASDAQ Composite	+ 6.9%	+ 43.9%	- 50.4%
Russell 2000 Index (small companies)	+ 3.5%	+ 25.2%	+ 16.0%
Dow Jones World (non-US)	+3.3%	+ 37.0%	- 5.5%
10-Year Treasury Bonds	- 3.4%	- 9.3%	n/a
Commodities: AIG Index	+ 9.0%	+ 18.7%	n/a
The U.S. Dollar (JPM Index)	+ 0.1 %	- 5.2%	n/a

All equity indices joined in the charge to positive returns, with the tech-heavy NASDAQ leading the way.  The release of pent-up demand helped produce strong results for the tech sector.  International stocks also surged as foreign economies--less encumbered by the financial chaos here in America--experienced good growth rates.  International performance was also aided by the tailwind of the declining dollar which lost another 5% over the year. Though bonds had done well in recent years as interest rates declined, anticipation of an economic recovery pushed up longer-term interest rates and sent bonds—as measured by the Ryan Labs 10-Year Treasury Index—down over 9%.  Short-term rates remain near zero, reflecting the still-weak economy and the resulting easy-money policies of the Federal Reserve.  Especially noteworthy in the above table is the rise of the commodity index by nearly 19% as increased demand for global natural resources drove up overall prices.

Where We Are Now

While most economists declare the worst to be over and the economy to be on a long uphill trudge, there is an underlying sense of uneasiness in the economy and markets.  The resurgence of the markets has neither allowed investor’s wounds to fully heal, nor their memories of recent losses to be forgotten.  Mixed early fourth-quarter earnings reports have not been helpful to those who question the firmness of the economy’s foundation.

There seems to be a lack of conviction in the direction of the economy, as well as in Washington’s ability to do anything truly helpful, and in the Fed’s ability to manage the money supply back to a normal condition without triggering either inflation or stagnation.  While economic activity has improved, unemployment remains very high and may be under-reported, as many have simply given up trying to find work.  The housing sector has been beset by conflicting reports:  while the number of existing homes sold increased for the first time in four years, the average sales price declined during the year by the greatest percentage since the great depression.  Anna Piretti, senior economist at BNP Paribas, has stated “the numbers clearly indicate that the rebound in housing demand observed so far has been largely supported by government programs”, while many observers explain this as a consequence of the selling of foreclosed properties.

Looking Ahead

There are signs of life coming from the economy--the patient does have a pulse. Unfortunately, this is not a normal business cycle and the rate of growth of any recovery will likely be slower than many anticipate.  The need for consumers to pay down debt will likely curb the rate of spending and thereby the rate of recovery.  Goldman Sachs projects a positive growth rate in the economy of a little less than three percent for both of the next two years—relatively slow but a nice change from the negative rate of nearly 3% for 2009. 

There are a number of potential developments that could impact our growth rate:  (1) increased regulation of banks and their unwillingness to lend, (2) possible interest rate increases, and (3) the wind-down of federal spending programs.  Regarding bank regulation; to the average citizen, many banks have gone overboard taking advantage of the previous deregulation of their industry. With the potential for government reinstituting restrictions that would curtail the breadth of the services and products that banks offer, there would be an uncomfortable adjustment period when some would see the “sky is falling” while other financial intermediaries would assume those lines of business. The effect would be to make the largest U.S. banks less competitive internationally and less profitable and the values of bank stocks would decline.  On the other hand, it could stabilize these large banks.  Banks are reportedly unwilling or unable to lend to any but the strongest of borrowers.  This trend, if continued, will not help the recovery.  Secondly, if the economy does pick up steam the Federal Reserve will begin to increase short-term rates (they can’t get any lower!). If interest rates increases are “too much too soon” it could put a damper on a fragile recovery, making this a difficult course for the Fed to navigate.  Lastly, as the economy begins to recover, the historic flood of government spending will need to be reversed, with the cessation of stimulus spending and the repayment of emergency loans.  When the home buyers’ credits expire, the billions of dollars of federal funds used for infrastructure spending run out, job training programs are withdrawn, and so many other special spending programs are terminated, it is unknown whether the economy will stand on its own merits or teeter.

While the recovery in the American economy is expected to be restrained in terms of its pace, the international community of economies--especially those of emerging countries--may hold better prospects, as they did this past year.  These countries are experiencing industrialization and infrastructure build-out similar to that which we experienced over 100 years ago.  We feel that investment in these markets presents better risk-adjusted return prospects than they have in years.  Along the same vein (no pun intended) this surge in development is placing more international demand on natural resources.  This increased demand for what many would describe as limited resources will likely result in increased prices for natural resources. 

While slow economic growth will likely find traction here in the U.S and thereby merit ongoing investment of an appropriate portion of your account, the opportunities in foreign markets have increased.  This will have a direct bearing in the management of client accounts—warranting a somewhat increased allocation to international equities.  While we remain open to opportunity, we will continue to exercise prudence with client assets.

As always, please feel free to call with any questions or comments.

Craig S. Limoges CFA, CFP, EA

George S. Middleton CFA, CPA-PFS

 

 

QUARTERLY INVESTMENT REVIEW
OCTOBER 2009

Up Where The Air Is Thin But Not Clear

Fall may be falling but the stock market has been busy springing!  The Dow Jones Industrial Average (the Dow) had its largest quarterly percentage advance since 1998, with a huge gain of +15.0%--a gain matched evenly by the S&P 500 Stock Index.  Another way of looking at the impressive run we have had:  the Dow’s advance recorded over the past six-month period (+28.0% over the second and third quarters) is the biggest six-month advance since the two-quarter period ending March 31, 1987.  To those of us who are still shaking our heads, wondering whether this binge is warranted, we think in terms of associating 1987 with the stock market “mini-crash” that occurred in October of that year.  

Before going into more detail about whether there is adequate economic support for this remarkable recovery, let’s take a look at the results for various indices for the quarter and how the end-of-quarter levels compare to an earlier market top in 2000.  All index values come from the Wall Street Journal.  Please note that performance of stock indices do not include dividends.

	September 30		Since Market Peak
	3rd Qtr	Yr-to-date	(3/31/2000)
Dow Jones Industrials (the Dow)	+ 15.0%	+ 10.7%	- 11.1%
S&P 500 Stock Index (the S&P 500)	+ 15.0%	+ 17.0%	- 29.5%
NASDAQ Composite	+ 15.7%	+ 34.6%	- 53.6%
Russell 2000 Index (small companies)	+ 18.9%	+ 21.0%	+ 12.1%
Dow Jones World (non-US)	+19.2%	+ 32.7%	+ 2.2%
10-Year Treasury Bonds	+ 2.7%	- 6.2%	n/a
Commodities: AIG Index	+ 4.2%	+ 8.9%	n/a
The U.S. Dollar (JPM Index)	- 4.0 %	- 5.3%	n/a

As you can see, all stock indices posted extraordinary advances this past quarter.  Year-to-date results are well in the plus column for all stock indices, with the technology-dominated NASDAQ composite the clear “winner” for the year.  Coming in a close second for the year is international stocks which notched this quarter’s greatest percentage gains.  The ongoing decline of the U.S. dollar continues to provide a tail wind for international performance, as international results are “brought back” to valuation in the dollar.  Bonds had a good quarter, somewhat reducing the year-to-date decline for this category.  Commodities, represented by the AIG Commodity Index, vaulted another 4.2%, bring the year-to-date increase in the index of overall natural resources and other physical goods to almost 9%.  Part of the reason that the commodity index is advancing so steadily has to do with the declining dollar.  Both oil and gold--components of the commodity index--are valued around the world in terms of the U.S. dollar.  When the dollar declines by a given %, even without any supply & demand issues considered, the price of oil and gold will go up accordingly (it takes more, less-valuable dollars to buy the same barrel/ounce).

Where We Are Now

A balanced perspective is hard to achieve.  It is difficult to make sense as to why stocks have advanced so mightily in the absence of clear economic justification for it.  On the other hand, whereas the Dow is up a monumental 48% from March lows, it is still 31% below its all-time highs reached in October 2007.  Is the glass half empty (inadequate support for this advance) or half full (the large financial institutions have been saved and it is only a matter of time before the entire economy is back on its feet)?  If you think it’s half empty, you are holding your breath in anticipation of a healthy correction.  If you see it as half full, you are anticipating the Dow going over 10,000 on a day in the near future.

Market valuation in terms of comparing stock prices to per-share earnings (P/E ratio) has risen from a very undervalued level to something near the historic average of 15.  A worthy question is: should the markets be valued near its historic average at this time?

Indications are that the balance sheets of the formerly shaky large financial institutions seem to be shored up, thanks to the flood of myriad capital and intercessions from the Federal Reserve.  While the manufacturing sector is showing tentative signs of strength after a horrible year, increasing unemployment will be a ball-and-chain to economic recovery.  With so many out of work and an uncertain near-term future, consumers have contained their spending and instead paid down some of their debt.  Unfortunately household debt is still 125% of after-tax income--barely below the peak and well above the 80% levels of the mid-1990s.  As a whole, we still owe a boatload of money and don’t have as much set aside in savings as we should!  It is doubtful consumer spending will be “unleashed” in the near term.

 

Looking Ahead

The recovery in stocks appears to have outpaced the recovery in the economy.  With the earnings season again upon us, earnings will likely be improved compared to a year ago (a low bar for comparison).  However, if higher profits are reported without increases in sales (ie, if profits result mostly from more cost-cutting) there will be disappointment.  To support the run-up of stocks, results will have to be pretty spectacular to avoid a negative reaction.

It is hard to have confidence in the market’s recent advance.  With “Cash For Clunkers” and the $8,000 home-buyer’s credit programs now expired, we have to wonder what other stimulus the government has left in their toolbox. With a current year’s budget deficit projected to reach $1.8 trillion, an expensive Health Care Plan wending its way around the hallowed halls of DC, and Medicare and Social Security coming closer to their own bankrupt state, it is easy to envision both increased income taxes AND a monstrous federal debt for generations to come. These issues aren’t going to just go away.

As always, we will continue to follow the markets closely and will take appropriate actions within client accounts to manage risk and return in accordance with each respective Investment Policy Statement.

Please feel free to call with any questions or comments.

Craig S. Limoges CFA, CFP, EA                    

George S. Middleton CFA, CPA-PFS