Q2 2010 Economic and Market Review

At the mid-point of 2010, the broader equities markets were down for the year, with the S&P 500 lower by 6.7% and the Dow lower by 6.8%.  The global markets saw similar performance, with the MSCI EAFE international index returning –12.9% year to date¹.   Despite these declines, the equity markets continued to hold general levels achieved during the sharp run-up in equity prices that followed the extreme lows of March 9, 2009. The second quarter of 2010 saw increased volatility, with the CBOE's Volatility Index (the VIX) ² reaching very high levels several days during the period.  Markets rallied in the early weeks of April, with the S&P 500 reaching a new year-to-date high on April 23, but as concerns about the strength of the nascent global economic recovery came to the fore, equities sold off through much of May.   Despite a rally in the early part of the month, in late June the S&P 500 reached a new year-to-date low.  For the quarter, the S&P 500 was down 11.4%.

In the wake of such volatility, some analysts see the threat of a double-dip recession and another cyclical bear market for equities, while others see the economy remaining strong and corporate earnings improving in coming months.  The available data can be used to bolster both pessimists and optimists.  Regardless of outlook, the market seems focused on three main concerns: the European debt crisis, unemployment and housing.

European debt crisis:  The European debt crisis was clearly the big financial story of the quarter, as investors weighed the threat of default in countries such as Greece, Spain, Italy and Ireland against the overall strength of the European economy and the ability of European nations to tighten government spending.  In May, the European Union, along with individual European nations and the International Monetary Fund, created a loan package of over a trillion dollars in an effort to forestall the crisis.

While the loan package was generally welcomed by investors, individual countries in Europe may still face major difficulties in working through their debt issues.  Greece, in particular, has the least competitive economy in the
EU and appears to have more deeply rooted financial difficulties than most European nations.

Unemployment:  Though many sectors of the economy have shown signs of growth, unemployment remains stubbornly high.  Recent months have seen modest jobs growth, however the number of jobs added has had only minimal impact on the larger employment outlook.  Ned Davis Research believes the job market will likely remain difficult: ''We worry that the pace of job creation may not be rapid enough to quickly bring down the unemployment rate.  We believe it could take several years for the labor market to get back to full employment.''⁴
Supporting their view, Ned Davis cites concerns among employers about the long-term strength of the economy, limited job creation among small and new business owners, and the fact that employers now have more alternatives to hiring permanent employees, among other factors.

Housing:  For those cheering on the economic recovery, the housing market has been both friend and foe.  Earlier this year, prices seemed to have found a bottom and some regional markets actually showed signs of improvement. ⁵  But more recent news has not been as good.  Though a pullback in the number of new single-family home sales was expected following the rush to sign contracts before the April 30th tax credit deadline, the housing numbers for May were worse than many expected, down 32.7% to the lowest annualized rate ever. ⁶  Sales in the West were even worse, down 53.2%. ⁷  Meanwhile, according to the Case-Schiller home-price index, home prices have fallen for six straight months. ⁸  Going forward, it appears the housing market will be highly dependent upon the jobs market, which in turn is likely to be most dependent on the strength and pace of the economic recovery.

Economic Recovery:  Despite the discouraging news about unemployment and housing, there are many indications the economic recovery continues.  Though recently revised downward, U.S. Gross Domestic Product is still expected to be 3% in 2010, with many analysts predicting more robust growth. ⁹  Corporate profits have been strong, along with business productivity and exports.  And the Federal Reserve continues to signal that interest rates, which are currently near record lows, will remain unchanged for an extended period.

Conclusion:  The equities markets are always sensitive to new data regarding key sectors of the economy, and this is likely to be especially true in the coming months.  There is considerable uncertainty about the impact of all of the new legislation being passed which could stall business spending and hiring. Given the push and pull between the bad news about housing and unemployment and the generally good news about economic growth, portfolios utilizing a diversified approach to asset allocation and multiple portfolio strategists may help balance risk and reward while reducing volatility.

These are challenging times that require focus. The trend I've noticed has been more people taking pro-active steps to put their financial houses in order. This is a good thing. I welcome the opportunity to visit and discuss your specific situation and hope you will set up time to address your concerns. As always, I want to thank you for your business and continued trust as we navigate these uncertain economic currents together.