A strong first quarter for stocks provided welcome relief from last year’s volatility and lack of forward progress. Stocks had one of the best opening quarters ever, climbing a wall of many worries, supported by improvement on the job front, overall stronger business activity, higher consumer spending and some gains in the confidence surveys.
Market volatility returned last week with the Dow Industrials declining by 100 points or more on four of the five trading sessions. This raised questions whether the market was again facing a mid-year correction. A two-week pull-back is not surprising and the S&P 500 is still up by more than 10% for the year to date.
As summer approaches, headwinds remain. The economy is showing signs of slowing, earnings estimates are being revised downward and there are concerns about the sustainability of consumer spending. Automatic tax increases and cuts in federal spending are mandated to be effective at the beginning of 2013. Along with Europe in recession, and no confidence that its debt problems have been fixed, there are signs of slower growth in emerging markets.
It’s been almost three years since the economy emerged from the recession, but expected growth in GDP for this year of around 2.5% is below prior recoveries. Chairman Bernanke says the fragile state of the economy is a cyclical problem that can be dealt with by providing the monetary stimulus needed to achieve a sustainable path for further recovery. The Fed knows that further improvement in employment will require a higher rate of business output and consumer spending so it wants to support the process by continuing to keep interest rates low.
The European Central Bank is taking a similar course to deal with its sovereign debt problems by buying some time through bond purchase programs and two LTRO (long-term refinancing operations) to bolster bank liquidity. So far however, there has been little in the way of any meaningful reform to improve the fiscal strength of these countries.
Investors understandably face some difficult choices in investing to secure acceptable returns to achieve their strategic long-term objectives when markets seem unstable. Equity market volatility is not their enemy, but their friend, giving them opportunities for attractive entry points for building their portfolio positions.
Equity Strategy – The economy and stock markets have responded positively to the Fed’s easy money policy. Our view is that recession risks outside of Europe remain relatively low, and that positive economic growth is likely to be sustained in coming quarters. Corporate profitability remains sufficiently strong to support higher stock prices and selected equities are attractively valued.
Fixed Income Strategy – Despite current low interest rates, investors who are concerned about short-term equity market volatility may include an allocation of bonds in their portfolio. In this current low interest rate environment some duration and or credit risk is necessary to achieve any return. The potential of higher inflation and rising interest rates may also eventually create significant headwinds.
Strategic View – The outlook is always uncertain, so risks must be managed to achieve the necessary margin of safety. We work with investors to make informed choices among the appropriate asset classes to build an investment portfolio designed to achieve their long term objectives. This is essential to develop a tolerance for volatility and have the patience and confidence to invest for the long term.
Note: We have gathered the information contained in this report from sources we believe reliable; however, we do not guarantee the accuracy or completeness of such information. You should not assume that any discussion or information contained in this market commentary serves as the receipt of or as a substitute for personalized investment advice from Whitnell & Co. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.