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Market Insight- Third Quarter 2009
In response to feedback we have received from many clients, we are changing our reporting to a semi-annual earth-friendly calendar: June and December. Clients have pointed out that they are getting the same information from their monthly brokerage report. Of course, if you want to continue to receive your quarterly report, please let us know and we will be happy to accommodate your request. We are glad to report that generally, clients were well positioned with their investments so that during the worst market downturn since the Great Depression their investment portfolios held up relatively well. The equity portion of portfolios have experienced returns of approximately 60% since the March 9th lows, reversing a significant portion of the declines registered in the prior 18 months. In general, client portfolios have outperformed the market over the past one, two and three year periods. Given all the events of the past two years, this could be a good time for you to review investment goals and confirm or make adjustments to portfolio allocations. It is also a good time for most clients to review their estate planning. The past two years have been challenging for both you and us. We want to thank you for having the confidence and trust in our knowledge and experience during these tough times. We are working hard to deliver the kind of advice that will preserve and grow your financial assets, and do it in a way which will not alter your lifestyle. Should you have any friends,
acquaintances, business associates or neighbors for whom the events of
the last two years have wreaked havoc on their portfolios or have
shaken their confidence in the markets, we would welcome the
opportunity to discuss their overall financial picture with them. Turning briefly to the fixed income markets, high-yield and low-rated (risky and speculative) bonds performed best during the three-month period, continuing their rebound from the fear-driven March lows. According to Bank of America-Merrill Lynch, junk bonds returned an astounding 48% during the first nine months of the year. This compares to a return for investment grade corporate bonds of 8.3%. Our Outlook It is now certain we have turned the corner on the economic downturn, although the recovery will be slow and employment will not rebound for several more months at the earliest. During the third quarter there were several unmitigated signs of slow but steady improvement after four consecutive quarters of economic contraction. The current consensus estimate of GDP growth in the third quarter is approximately 3%. While this would be a much better reading from the contraction of the past few quarters, a good portion of the gain will come from inventory rebuilding along with auto sales spurred by the “Cash for Clunkers” program. The financial system is now off life support and several of the largest financial institutions have repaid their TARP loans to the Treasury. Once again, capital markets appear to be moving close to normal – although we think there will be a “new” normal for many years as consumers, corporations, and financial institutions all continue winding down their leverage. The cleansing process on residential home loans is nearly complete, but there is a large wave of unsound commercial real estate loans that will weigh on the banking system for several more quarters. Corporate earnings continue to surprise to the upside and the second quarter releases were above expectations across most sectors. While earnings declined approximately 30% from the year ago quarter, more than 70% of companies exceeded expectations. We would caution that a good deal of this earnings “beat” was due to sharp expense reduction and layoffs. Revenue growth will be needed going forward to maintain earnings improvements. Cost cutting can only help so much before revenue gains are needed to provide the catalyst for earnings growth. As we write this in mid-October, the S&P 500 index has risen 61% since March 9th of this year – an astounding run in just seven months. In hindsight, markets were so far oversold in early March that a bounce back was warranted, but the magnitude of this surge leads many to question if we have gone too far. There have only been five other instances where the market has moved this much higher without a correction. All five occurred in either the 1930’s or in the 1970’s. While short-term market forecasting is best left to fools, we believe it is prudent to expect a modest pullback at any juncture, setting the stage for further rallies in the next few years. We are encouraged by the large amount of merger and acquisition activity seen recently. During the last five weeks of the third quarter, approximately $90 billion in transactions were announced. This shows that not only are corporate managers feeling more positive, but that financing for a portion of these deals is readily available both in stock and debt. These factors are bullish looking forward. Portfolio Positioning Cash positions were reduced further during the third quarter, as we continued moving portfolios back towards their long-term asset allocation guidelines. Since March of this year, we have been “net buyers” of equities (buying more than we sold) to reduce cash positions that we had built up over the prior 12 months. We continue to rebalance client portfolios methodically and as needed. Stocks are no longer as undervalued as they were during the spring of this year. With earnings estimates for both 2010 and 2011 creeping higher in recent weeks, the stock market appears to be pricing in a fairly normal recovery. We are somewhat concerned about the attributes of the stocks that have done the best during the past six months. For the most part, the riskier companies with weaker balance sheets and lower earnings growth forecasts have provided the greatest returns. This is not uncommon immediately following a bear market, but it does warrant some concern. During the third quarter we took gains in some holdings that had risen significantly in value and redeployed assets into areas that have lagged the broader market move, upgrading the quality of the portfolio and positioning ourselves for 2010 and beyond. We remain underweighted in the financial area, as there are still a number of challenging issues that banks must face before we would have the level of confidence needed to commit fresh capital to this sector. Conclusion The extreme market movements across all asset classes during the past 24 months serve as a reminder of the importance of asset allocation and diversification. We counsel clients about the importance of risk control across their entire portfolio. This risk control is one of the most important facets of our investment management duties. Dumont & Blake clients generally participated in the dramatic move higher since March. Equity portions of client portfolios have experienced returns of approximately 60% since the March 9th lows, reversing a significant portion of the declines registered in the prior 18 months. Client equity portfolios have generally outperformed the S&P 500 over the past one-, two- and three-year periods.
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