Let’s take a moment to look at the first half of 2014. Both stocks and bonds moved forward in the first half of the year. The S&P 500 gained 7.12%, and the Dow Jones Industrial Average gained 2.68%. The 10-year Treasury rate fell from 3.0% to 2.6%, resulting in a 2.1% increase in the price of this important benchmark. These results were consistent with a number of mixed signals coming from the economic recovery, which has continued to be on-again and off-again.
This in part is because the country experienced a severe winter, a bitter cold, and many weather-related economic disruptions. The result was that real gross domestic product fell 2.9% in the first quarter, considerably worse than the consensus expectations. We think first half weakness is only temporary and will result in a deferral of demand. Recent strong automobile sales coupled with improving housing demand suggest third quarter GDP could be up 3-4%. Because of the weak first half, the outlook on the balance of the year needs to be reasonably strong to reach our initial 3-4% full-year growth forecast. In order to err on the side of conservatism, our new forecast calls for growth to be in the 2-2.5% range. (more…)
The financial markets struggled in the first quarter of 2014, but despite several challenges, managed to reach new all-time highs and also experienced a period of relatively stable interest rates. The actual results were as follows:
S&P 500 +1.8%
Dow Jones -0.1%.
10-Year Treasury +3%
Russell 2000 +1.1%
These results were all the more surprising against the backdrop of adverse weather conditions in North America, continued problems with the rollout of Obamacare, and the seizure of a large part of Ukraine by a re-energized Russia lead by Vladimir Putin. Finally, there was the mysterious disappearance of Malaysian Airlines flight 370 on the morning of March 8th. In a strange way, the missing airplane brought many nations together, including China, the U.S., the U.K., Australia, and India, in a determined search for the plane. How nice to have so many world powers working towards a common objective, which if successful would represent a cooperative global achievement. (more…)
The stock market as measured by the S&P 500 recorded very powerful results in 2013, advancing 32% (total return), the best performance since 1997. Other equity indexes advanced strongly, confirming that a sustainable economic recovery has begun. The 10-Year U.S. Treasury Bond rate ended the year at 3%, up significantly from the 1.4% Iow recorded in 2012. The rise in rates suggests a strengthening in credit demands normally associated with an upturn in economic growth. None of this is very comforting to bond holders, who experienced a loss of 3.2% (according to the Bloomberg U.S. Treasury Bond Index) in U.S. Treasuries in 2013. Financial markets are a leading economic indicator and the strong equity gains of 2013 hopefully are a predictor of better economic times in years ahead. (more…)
The United States and the world suffered through a miserable quarter of political and economic disappointments. The Arab Spring turned into an Arab nightmare as Egypt’s President Morsi was ousted in a military coup, leaving the country in a state of civil unrest. Citizens of neighboring Syria, suffering through a seemingly endless civil war, were unbelievably subjected to a ruthless poison gas attack that killed fourteen hundred people, many of them children. A stunned world watched as President Obama’s threatened missile retaliation was averted at the eleventh hour by the almost fictional villain, former KGB Chief and now Russian President Vladmir Putin, who brokered a deal for peace in exchange for the destruction of Syria’s chemical weapons stockpiles. In late September, there was an Al-Qaeda-led massacre in a Kenyan shopping center. Kenya, we believed, is one of the more peaceful nations in Africa. Finally, a deranged man attacked the Naval Shipyard in Washington, resulting in twelve deaths. (more…)
The results for the second quarter were good. We estimate that the domestic economy, supported by continued gains in housing and solid automobile sales, expanded at a rate of 1.7% in Q2 2013. The current economic expansion, which began in February 2009, is now 52 months old and approaching the average 57 month expansion in the post WWII period.
If we view this recovery in terms of employment, corporate profits, and gross domestic product growth, it is clear employment is the laggard. One possible explanation could be that our economy is becoming more productive, benefitting from investments in the information revolution, which are more widespread than previously thought. This development has lowered labor needs. Another explanation could be that corporations were surprised at the suddenness and the magnitude of the fall in the economy in 2008. The recent credit crisis was fueled by the bankruptcy of Lehman Brothers, which resulted in the bankruptcies of General Motors and Chrysler. These events pushed any number of companies to the brink of insolvency. Managements, shocked by the closing of credit markets, became very reluctant to add full-time employees, contributing to the current employment woes. The third factor potentially retarding employment levels is the uncertainty surrounding the implementation of the Affordable Care Act, which impacts 18% of the US economy. Many of the details of the program are unresolved.
It’s the Economy, Stupid — Bill Clinton, 1992
It’s the Fed, Stupid — Hardesty Capital Management, 2013
The stock market performed exceptionally well in the first quarter of 2013. In fact, the Dow Jones Industrial Average broke through its 2007 high of 14,400 on March 11 and finished the quarter with a total return of 11.9%. The S&P 500 flirted with its all-time high and closed the quarter at 1,569, just above its former peak of 1,565, and had a total return of 10.6%.
Also notable was the failure of the bond market to keep pace with the stock market, confirming our long-held fears that the bond market was vulnerable to a rise in yields, which occurred in the quarter. The 10-year Treasury yield rose from an all-time low of 1.41% in July 2012 to 2.06% on March 11, only to fall back to 1.86% by March 31. With interest rates at such low levels, even small movements resulted in extraordinary price volatility, both up and down, in bonds.
Since the S&P 500’s closing low of 683 on March 6, 2009, the index has recovered 130% to 1,569. It took the S&P over 4 years to recover to its old highs. Investors have remained fearful of equities long after the 2009 lows were established. As the chart on the next page indicates, large outflows of funds from equity mutual funds continued almost monthly until early 2013. The big gains in equity prices have been accompanied by large increases in earnings. This means that the market is paying the same (or even lower!) price per dollar of earnings. As a result, valuations remain very reasonable (see chart, back page). In addition, many retail stock brokers report strong resistance on the part of small investors to increasing exposure to equities. Perverse as this may sound, the absence of the small investor provides a large reservoir of funds for future equity investment, which in turn will support or even increase equity prices down the road. (more…)
Despite an acrimonious, bordering on uncivilized, debate between the executive and legislative branches of the government, a major tax reform bill was passed and signed into law in the predawn hours of January 2nd. Regardless of when the legislation was signed, it appears our nation has avoided a journey into an economic twilight zone known as the “fiscal cliff.”
The eleventh-hour rescue appears to have temporarily avoided a crisis, but virtually no party to the legislation is satisfied with the outcome. Some would say that the can was again kicked down the road, and major issues remain. Sometime in the first quarter of 2013, perhaps as early as March 1st, additional authorizations will be necessary to increase the Federal debt limit, which created a near-crisis in August of 2011 when it was last addressed. The consequence of that crisis was the loss of the country’s AAA bond rating, and it appears this debt limit problem will be every bit as contentious as that of 18 months ago. Be assured that the hostile environment in Washington associated with economic issues will be with us for quite some time. (more…)
Economically, the doldrums settled in this summer. This is not altogether surprising considering the myriad issues confronting countries all over the world. The European financial crisis, the Fiscal Cliff, and the Presidential election are all weighing on the minds of corporate and government leaders. As we approach crunch time for these major events, rhetoric has increased and economic activity has slowed. During the quarter, U.S. economic activity stumbled along at a growth rate of less than 2%. This frustrating performance resulted in a continuation of high levels of unemployment and a significant number of workers who have ceased looking for work. This subset of discouraged workers, known as “Series U-6,” has now reached 6.6% of the workforce, and when added to the official unemployment rate of 8.1%, results in a level of 14.7%. While U-6 has improved, it is still unacceptably high.
In spite of these pending issues, our economy continues to push ahead, albeit at a slower-than-desired rate. This, however, is much better than many other parts of the world. Cracks appeared in the great Chinese economic wall, yet Asia as a whole maintained reasonable forward momentum. The same cannot be said for Europe. Finance ministers grappled with lingering effects of excessive borrowings that violated many countries’ pledges for responsible fiscal policies that were accepted as a condition of joining the Euro. Although European economic growth proved disappointing, we sense the financial challenges did not worsen during the quarter. (more…)
The fast start the economy and markets enjoyed in the first quarter of 2012 faltered as the year progressed. Stocks fell sharply from April to May only to recover modestly in June. For the quarter the S&P 500 declined 2.75%, but for the first half of 2012, the S&P 500 advanced 9.49%. The fixed income markets continued to respond to Federal Reserve Chairman Bernanke’s stated goal of stable, low interest rates. The 10-year treasury began the quarter at 2.22% and finished the quarter at 1.67%.
Signs of a possible economic slowdown in the U.S. emerged late in the quarter as employment gains slowed sharply, retail sales ex-autos stalled, and capital spending slowed markedly. In addition, consumer confidence fell for the fourth consecutive month in June and the ISM Purchasing Managers Index fell below the critical level of 50 (see chart), which means manufacturing contracted. Put simply, the U.S. economy has been unable to establish a steady recovery pattern, and nobody seems to have a clear explanation as to why the economy cannot sustain upward momentum. (more…)
The first quarter of 2012 was a good beginning to the year. We had solid gains in the economy, which were reflected in a strong upward movement in stock prices. In part, these advances were due to good earnings growth during the Christmas season. The market was also strengthened by forecasts for continued earnings gains for the companies in the S&P 500, not only in 2012, but also for 2013. These increases in forecasts helped to paint a brighter picture for the future of our economy. Turning to the fixed income market, interest rates were steady for most of the quarter, but moved higher at the end of March, resulting in a slight negative total return in the 10-Year Treasury (see back page). Bond results were essentially flat, with the Barclay’s Government/Credit Intermediate Bond Index up .61%. Despite (indeed, perhaps because of) the flat returns in the bond market, we are still confident in equities. In this letter, I will show you why we remain optimistic for both the economy and the financial markets.
The expansion of the economy, despite being slow and uneven, has been one of the better-kept secrets in the U.S. over the last six months. This was confirmed by the recent upward revision of the Real Gross Domestic Product for the fourth quarter to an annualized rate of +3%, a level consistent with our country’s longer-term results. The skeptical stock market of last summer and fall responded to the good news, advancing 12.66% in the first quarter as measured by the S&P 500 index, the best first-quarter advance since 1998. The financial sector, one of last year’s worst-performing sectors, reversed roles and was one of the best in the first quarter of 2012. (more…)
When I was a young boy of ten or eleven, the smartest guy in my class enticed me to take a roller coaster ride with him on class day at Baltimore’s old Gwynn Oak park. Mistakenly thinking he was an experienced rider, we jumped into the last car, which my friend assured me was the safest. Only later did I realize he had never ridden a roller coaster and the last car experiences the most violent movements. We both stepped out of the car terrified by the experience. For me, it was to be my first and last ride on a roller coaster. As I look back at 2011, financially, this was much like that roller coaster ride of 50 years ago. The global financial markets rocked and swerved all over the place, only to finish near where they started. The experience was not as frightening as that real ride, but the markets in 2011 were nonetheless unpleasant.
After the very sharp stock market decline in the third quarter, the equity markets gave us a holiday present, advancing 12% in the fourth quarter, bringing the full year total return to the S&P 500 to 2%. However, 2011’s results were punctuated by over 100 trading days where the Dow Jones Industrial Average closed up or down more than 100 points and experienced 16 days where the Dow advanced or declined by over 200 points. This comes in the context of 252 trading days in a year. These levels of volatility are beat out recently only by those seen in the recession years of 2008 and 2002. (more…)
Put simply, it was a terrible summer for both the U.S. and European markets. The economic recovery that began in 2009 stalled, and the anticipated improvement in employment failed to materialize. Continued structural weakness in housing further retarded the overall recovery. Many other industries reported mixed results with one strong month followed by weakness in the next, resulting in a trendless quarter. Estimates for gross domestic product growth in the third quarter were halved from 3.6% at the start of the quarter to 1.8% at quarter-end.
In addition, a political fight over extending the debt ceiling frightened American consumers, slowing purchasing and threatening the economy with a double-dip recession. Though the debt extension was resolved at the 11th hour, it was not without cost. Standard and Poor’s, an established independent bond rating agency, downgraded the creditworthiness of the U.S. government debt from AAA to AA+. While not of major financial significance to the U.S., it was embarrassing. However, these events did have broad-based negative effects, not only on the U.S. equity markets, which declined 13.9% in the quarter, but also on foreign bonds and equities. (more…)
The economic recovery that began in Q1 2009 slowed unexpectedly in the first half of 2011. Reported growth of the GDP in Q1 2011 was only at an annualized rate of 1.9%, and a similar modest increase is anticipated for the second quarter. At the beginning of the year, a Bloomberg survey had consensus number for the quarter at 2.5%.
The shortfall caught the stock markets by surprise, and after reaching a high of 12,810 on April 29, the Dow Jones Industrial Index fell 3.1% to 12,414 to end the quarter. For the quarter, the Dow was up 1.4%, and up 8.6% for the first half. The S&P 500 was also up a hair, 0.22% for the quarter. Although there was a lot of volatility this quarter, stocks ended up where they started.
On the other hand, interest rates, sensing an economic slowdown, fell to new lows for this cycle. The 10 year U.S. Treasury note closed at a low of 2.86% on June 24th. Returns of short term Treasury notes (U.S. government securities with maturities less than a year) were even more startling. (more…)
The first quarter of 2011 was dominated by a series of events that eclipsed the financial markets as front-page news. An unexpected breakdown in the political order in North Africa spread throughout the Mideast, and several governments important to Western economic interests tottered on the brink of collapse by quarter’s end. Governments in Tunisia and Egypt fell and significant unrest spread to Bahrain, a small but important financial center responsible for the coordination of Middle Eastern oil settlements. We were surprised that by quarter’s end a Western coalition had begun offensive air operations against the repressive government of Libya and, under the supervision of NATO, the West was attempting to bring down the government of Muammar Gaddafi, the long-running leader of Libya.
The European banking system came under pressure as banks in Portugal, Greece, Italy, and Spain joined those of Iceland and Ireland in experiencing varying degrees of loss of confidence by depositors and members of the European Union. France and Germany, the wealthy nations in the E.U., although willing to aid the affected nations, offered bailout terms that were quite steep. At quarter’s end, the E.U. banking situation remained unresolved. (more…)
The economy and the financial markets performed well in the fourth quarter and for the full year 2010. The Standard and Poor’s 500 index increased 10.49% in the quarter and 14.79% for the full year, somewhat above the long-run average return for common stocks since records were established in 1926. Bonds also delivered positive returns, and the 10-year and 30-year treasuries provided returns of 7.9% and 8.7%, respectively.
But in the fourth quarter of 2010, there was a significant divergence in the performance of stocks vs. bonds. The sharp fourth-quarter advance in stocks (10.49%) was not matched by treasury returns. In the final quarter of 2010, the ten-year treasury fell 5.6% and the thirty-year treasury declined 9.8%. The bond market appears to be reacting to a sharp rise in the projected fiscal 2011 federal deficit of $1.27 trillion ($1,270 billion), up from $480 billion in fiscal 2009. Calls for spending cuts, repeal of the health care program, and a contentious debate over increasing the government debt ceiling may have temporarily spooked the bond market. (more…)
