A Steady Climb?
Keeping perspective about where we have been is important when managing investment portfolios with the goal of “Making Assets Thrive”. As of this week, the Dow Jones average is up nearly 70% from its low last March. Since that time, stocks have advanced for four quarters in a row and 11 of the past 13 months. The market has made a remarkable rebound since those dark days of March 2009. Just this month, the market has finally recovered to the September 2008 level when the Lehman Brothers failure was announced.
Previous “Market Overviews” stated that the financial crisis caused stocks to overshoot their fair value on the downside. During the decline, stock prices fell too far even given the fallout from the Great Recession. Now stocks have to revert and will most likely overshoot on the upside at some point.
The one year old recovery in the stock market has taken two phases. The first was a 58% recovery sprint from last year’s oversold March low. This sharp bounce ended last fall. From that point the advance slowed and became more pedestrian. This second stage began in October. The S&P 500 gained 5.4% by the end of the first quarter of 2010. In the previous quarter the index gained 5.8%.
This trajectory over the past six months appears to be carefully crafted. It has been a steady climb. Perhaps it is being guided by all of the Wall Street firms that lost so much money during the financial crisis. No doubt this trend is being supported intentionally by various government agencies. Government stimulus programs and rescue packages help build business confidence. This market rally feels uneasily like it is nursed and controlled. Large investment institutions and hedge funds are dominating trading and driving prices higher.
Short Lived Corrections
We’ve had steady gains over the past two quarters but we have also had corrections. Both of the past two quarters saw 8% corrections in the S&P 500. Yet in both periods, the markets managed to recover and post gains by quarter end. Market volatility has dropped to two year lows as measured by the VIX, which is a rudimentary measure of general index volatility. Stocks have been trading in tighter ranges. This declining volatility has been welcomed by investors who don’t want to see scary plunges. Investor sentiment has also been supported by steadily increasing prices. Anecdotally, people feel constructive when their investments improve.
Stocks take their cue from the general economy. Gains have been slow and steady in the areas of job creation, gross domestic product output, durable goods orders, industry supply managers’ gauges, rising home price trends, and declining foreclosure rates. These gains are not robust but steady, nevertheless. The only disputable aspect of the current economic recovery is that it might not be happening fast enough for all of our wishes.
A recent concern is that interest rates have been pushing to their upper range from last summer and fall. If rates on such items such as home mortgages should raise much beyond 5%, this might sufficiently dampen the economic recovery enough to interrupt the smooth, steady ascent of the stock market.
More on the “New Normal”
Bill Gross, of the famed Pimco Mutual Fund Group, and his fellow TV personalities have popularly coined the term “New Normal” to describe the economy as well as the investment landscape facing investors. “New Normal” describes an inherently fragile economy that relies on government support for growth. “New Normal” also implies that this condition will remain with us for a very long time. Many excesses fueled by the real estate bubble still need to unwind and this should keep a lid on growth. This view also holds that the recovery will continue to be very slow. Furthermore, when the government and the Federal Reserve reign in the lifeline as they suggest, the unassisted economy will struggle.
Steve Leuthold argues differently as quoted in the 4-10-10 issue of Barrons.
“We are in an expansion, and it’s better than expected,” says Steve Leuthold, investment strategist and founder of the Minneapolis-based Leuthold Group, a provider of market research and money-management services. “It’s different because it’s led by an improvement in manufacturing and not by the consumer.” And he argues that this isn’t a “new normal” — in which U.S. economic growth slows permanently — as many contend, but a good old-fashioned “old normal” expansion. He points to the surprisingly high 5.9% fourth-quarter rise in gross domestic product as proof.
The conflicting views of Messrs. Gross and Leuthold serve a vigorous debate in the investment business. Will a weak, government supported economy remain with us for some time as Mr. Gross suggests or is the economy ramping up to an expansion mode as Mr. Leuthold suggests?
Peregrine Returns and Strategy
The temporary setbacks that clipped the market over the past two quarters serve as a warning for the current quarter. Despite the threat of a correction like we saw in the past two quarters, it is reasonable to assume that the setback would be temporary and that a high probability exists for further stock market gains in the second quarter and even for the remainder of 2010. It might even be safe to project a gain for this upcoming period in the neighborhood of 5%, consistent with the past two quarters.
This sanguine view of stocks for the short term is moderated by the inevitable corrections that can occur as part of a profit taking process followed by investors. We will still take profits from trading just in case we get a moderate correction. It is also our aim that our client portfolios will come through the next correction better than the setbacks in January and last October.
A new year resets the benchmarks and the challenge of being “ahead of the curve”. Our clients hold vastly more stocks today than they did during the financial crisis. This increased weighting will mean our client portfolios will be more sensitive to the stock market.
Our Composites lagged the S&P 500 for the first quarter. During this period, our firm’s largest investment in Google was the biggest reason for the drag in our client portfolios.Our Equity Composite climbed 2.14% and our Balanced Composite gained 1.82%.
Client portfolios in the Balanced Composite were also negatively impacted by a gradual rise in long term interest rates. This trend causes bond values to decline. Interest rates on short term securities pay virtually zero. We believe that clients should own bonds with guaranteed maturity values in order to capture the difference between long and short term rates.
Past performance is no guarantee of future results. Investment management involves the possibility of losses. Significant general stock market moves up and down can influence the performance of client portfolios. Composite returns are based on client portfolios of over $100,000. Not all clients are included in the composites. All returns include the reinvestment of dividends. All returns are net of fees. Composite returns are derived from aggregated, time-weighted returns for clients of Peregrine Asset Advisers. Individual client returns can deviate from the composite returns. While Peregrine uses the S&P 500 as a benchmark, Peregrine does not attempt to mimic the structure of this index. Individual client portfolios vary. The number of securities held also varies per client.
Do you have questions or would you like to know more, contact Dan Botti.