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Market Insight- First Quarter 2009
Global capital markets have been acutely volatile over the past three months. We believe this volatility is a result of the ongoing credit shock economies worldwide are experiencing, contrasted with expectations for improving economic conditions later in the year. The resolution of these conflicting trends should be evident later in 2009 and into 2010. While global economies are certainly in the throes of a very severe recession, we are seeing early signs of stabilization in the United States and China, two of the world’s largest economies. Further, we believe the U. S. stock market has ‘put in the low’ as technicians phrase it. While we are more optimistic on equities generally, as we write this during the third week of April, stocks have surged to over-extended levels in the short-term and we are awaiting more attractive entry points to increase holdings of stocks. We continue to counsel disciplined long-term investing accompanied by recognition that capital market volatility is here to stay. While emotions frequently dictate otherwise, investors should not react to short-term swings in the stock market. We believe that most of the current daily market swings are being caused by short-term traders. Your equity portfolio is positioned to take advantage of historic long term upward trends of stocks. The Dumont & Blake investment discipline is designed to provide respectable returns accompanied by substantially less risk and volatility than the general market. Our ultimate goal is to make sure your financial objectives are achieved.Market Commentary Equity markets took investors on a wild ride in the first quarter of 2009. While the benchmark S&P 500 index declined -11.01% on a total return basis, masked in that number were dramatic returns during two sub-periods of the quarter. Between January 1st and March 9th, equity markets tumbled globally, with the S&P 500 declining by -25% in the first nine weeks of the year. Following the release of news that the Federal Reserve and the Treasury would continue pushing an extremely accommodative monetary and fiscal policy, the markets reversed course and jumped higher. From March 9th to March 26th – a period of 13 trading days – the S&P 500 rose by more than +20% and the NASDAQ Composite by over +25%. This was the fastest and steepest upwards move in the equity markets since 1938, a fact that caused us to question the underlying reasons for the spike upwards. Dramatic moves in either direction with little change in base fundamentals causes us to be wary. This marks the second consecutive quarter in which investors experienced both a bull market and a bear market within the same quarter. Moves of 20% up and down within the same quarter have been very rare in stock market history and have clearly raised questions about the health and direction of equity markets. However, it also points out the additional challenges facing those who attempt to time the market by moving monies into and out of equities. Our Outlook The economic data released over the past few months has been weak, although there have been a few modest signs that the worst economic comparisons may have passed. It is still far too early to declare an end to the recession, although the glimmers of hope we have seen recently make us more convinced markets will be meaningfully higher 12 to 18 months hence. We find the seemingly endless waves of “stimulus” and bailouts to be quite troubling. Politicians seem to be the only people incapable of understanding that when one is significantly in debt and facing reduced incomes (revenues), the best plan is to reduce spending, not to borrow and spend even more. In the first 12 weeks of the Obama administration, nearly $2 trillion in increased spending has been proposed. The administration’s budget plan, rosy as it may be, projects annual interest payments on the national debt of almost $900 billion by 2019! The interest payments will exceed by far, the cost of any other budget department. Corporate earnings, while declining meaningfully during the past six quarters, are nowhere near as bad as the headline numbers would make you believe. For instance, AIG reported a loss of $62 billion in the fourth quarter of 2008, which essentially wiped out the total 2008 earnings of the two largest oil companies in the S&P 500. This “loss” was mostly due to non-cash charges which had no real effect on the operations of the company, other than to reduce its book value. Similar losses at many financial companies have pushed down reported earnings to levels well below where they would otherwise be. We estimate 2009 earnings per share for the S&P 500 to be over $60, when factoring out many of these non-cash charges. Thus, equities do not seem very expensive here, particularly when compared to other investment classes. The Fed’s actions to reduce mortgage rates should help revive housing sooner than would otherwise be the case. Homeowners who choose to refinance at these lower rates will see an increase in their disposable income. More importantly, the combination of the two-year decline in housing prices, along with current 50-year lows in mortgage rates, have pushed the Affordability Index (a measurement of the ratio of the median family income to the level of income needed to qualify for a mortgage on the median-priced home) to 173.5 recently, the highest level in at least 20 years. Portfolio Positioning We continued to hold above average cash positions in most client portfolios during the first quarter, but began to modestly scale back into equity positions where valuations warrant. This cash again helped lessen overall portfolio declines during the quarter. As we enter the second quarter of 2009, we continue to seek opportunities to move portions of these cash reserves back into equities over the coming months. Client equity portfolios declined less than the market when factoring in the cash holdings we previously raised. During the first quarter, we remained modestly underweight in the more cyclical areas of the market – industrials, basic materials and consumer discretionary, along with financials; while holding overweight positions in consumer staples, technology and healthcare. We expect to unwind a number of these over and underweight holdings during the next few months and move back towards our preferred sector-neutral stance. Conclusion For the past several quarters, our clients’ equity portfolios have declined less than the Standard & Poor’s 500. We continue to counsel how critical asset allocation is during times of financial turmoil. Client fixed-income portfolios outperformed their benchmarks due to our focus on safe investments in shorter-term U.S. Treasuries, Agencies and very high quality municipal bonds. Trailing returns on stocks (as measured by the S&P 500) have posted an inflation-adjusted loss of -3.15% annualized over the past ten years through December 31, 2008. This is the fourth-worst 10-year return since 1871.[1] While these returns have turned many investors away from equities, we believe that this is one of the best times to be buying equities, provided one has a long-term investment horizon. We would expect returns from equities in the next five and ten-year periods to exceed long-term average stock market returns and encourage investors to slowly and methodically increase their equity exposure using a deliberate, common sense approach.
[top] [1] Source – Jeremy Siegel, WisdomTree Investments. |
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