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Market Insight - July 2012

The second quarter, and the first half of 2012, ended on a much better note than anyone expected.  By early June the major averages were flirting with correction levels, as the Euro-crisis, for the third summer in a row, smothered the markets.  The worst case scenario, a currency collapse and transatlantic contagion, gained plausibility through endless repetition.  Investors’ sentiment fell to its lowest level in 20 months as funds continued to be withdrawn from the stock market. A scant 69,000 reported jobs were added in May and the jobless rate ticked up. The looming “fiscal cliff” of tax increases and budget cuts lengthened the rope of worry, and stoked fear that markets would twist and turn in the slipstream of partisan gridlock. 

Abruptly, things changed.  In the final days of June, European finance ministers reached an agreement that markets responded to, which would allow the European Stability Mechanism to lend directly to banks, and the European Central Bank to buy Euro zone bonds.  The spotlight of worry has now moved on, to weaker numbers on US manufacturing output, slowdowns in China and India, and the inevitable effects of European problems on US corporate earnings.

The Numbers

Still, U.S. markets posted strong gains through 6/30/2012. The S&P 500 added 8.5 percent; the Dow, 5.4 percent. Global investments were mixed; the MSCI EAFE (EFA) index of developed markets eked out less than a 1 percent gain, while emerging markets rose 3.1 percent. Gold (GLD) gained 2.1 percent. Other asset classes delivered acceptable returns as well; investment real estate, measured by the Cohen & Steers Realty majors index (ICF) added 12 percent, while the S&P Small Cap 600 rose 7.3 percent.

Outlook

Short term concerns persist over slowing factory output and earnings growth.  Although estimates for the 2nd quarter have already been revised downward, early numbers suggest that the markets will have to overcome some disappointment over earnings announcements.  Lower oil prices, though, will help; reduced energy costs add to growth, ease inflation concerns, and allow the central banks more room for action.  We believe that housing and employment will set the tone for the second half of 2012 and beyond; as usual, we can count on at least one step back for every few steps forward.

Both new and existing home sales are showing month to month gains, gains that have momentum and look sustainable for the first time.  Median prices of existing home sales are up 10.1% year over year.  Leading economic indicators increased 0.3% in May (after declining 0.1% in April) and valuations of US stocks remain attractive; approximately 12 times forward earnings vs. a long term average of 16 times earnings.  Election season should have a minimal effect on the markets in the second half, but be prepared for the endless droning of political pundits on the markets and market pundits on politics.

Our expectations for client returns have become much more positive

Our outlook for portfolio returns over the next 2-3 years has continued to evolve and our expectations have grown more positive.  We of course remain aware of and responsive to risks and uncertainty, both actual and potential. However, objective realities, in our view, no longer support muted expectation for returns over the long term, much less the current level of pessimism. We know that many thoughtful people see the future as grim and current reality in apocalyptic terms. We all have been marked by the effects of the global financial crisis in 2008. Now, though, the weight of the evidence going forward must push aside emotional baggage, at least for investors who intend to participate in the future.

We are experiencing a profound economic, demographic and cultural shift, both globally and here in the US.  This change seems particularly painful and unsettling; still, we have been through equally uncertain periods in the past; recessions, fear of war and nuclear disaster, regional instability, etc. Investors felt every bit as fearful and despondent then, as many do now.  Yet, here we are.

The Engines of Growth

We expect both employment and residential real estate values will begin to see accelerating and sustainable gains. The deep pessimism of investors today is a powerful contrarian indicator of a shift in sentiment that will buoy financial markets going forward.  Markets have moved decisively from the financial crisis of 2008. Investors’ psychology and confidence will follow, and strengthen the foundation for real growth.

 

Steven Weber
Registered Investment Advisor
The Bedminster Group

 

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