1st Quarter 2010 Client Commentary
Dear Valued
Client:
Spring is in the air! After a long cold winter in the northeast, with record snowfalls, the sun is shining, the grass is greening up and Baseball’s Opening Day is right around the corner. Spring is always an interesting time, subject to extremes where it feels like summer one week only to fall back to winter the next. The transition from winter to summer produces much atmospheric volatility. So too we are in somewhat of a springtime in the investment markets, with volatility being driven by the slow transition from crisis to more typical conditions. Where most of the volatility in Spring is caused by the clash of cold and warm air, in today’s market it is often the clash of politics and economics and those who try to use either to predict where we are and the road ahead. It seems that the weight of the majority is now on the side that we are in the beginnings of a sustained recovery. There are, of course, still some “doomsayers” out there, as there always are. Many of whom gained great credibility in the last upheaval. But just as the consummate Bulls are not correct, neither are the consummate Bears. The general concern now seems to be about the strength and length of the recovery, rather than whether or not it is actually taking place.
As always, we preach caution. Your best defense against a sudden market shock is an appropriate cash reserve, and properly structuring your investments to the time horizon of your goals. For those still saving and accumulating, the combination of rebalancing and continued investment makes every downturn a buying opportunity. For those with shorter term goals, properly indentifying them and picking investments appropriate to the time horizon will ensure that the money will be there when you need it.
If economics holds any key to understanding where we are, then it seems that we are in fact in the midst of a recovery that continues to gain steam. One easy measure to cite is the Index of Leading Economic Indicators. The Index is comprised of 10 individual components, and it is designed to show turning points in the economy before they happen. So, for instance, the Manufacturing Average Weekly Hours gives us insight into potential changes in the labor force as managers tend to adjust work schedules before laying-off or hiring additional help. The Index of Economic Indicators has been rising steadily for the last year, and now sits 9.5% higher than this time last year. Furthermore, a slight leveling occurred in March, which often signals a shift from recovery to expansion. Even more compelling, the six months that ended in February, the last date for which we have the detailed data, all 10 components advanced, showing broad based strength across the economy. Two areas that have yet to show substantial improvement, however, are also the two that are closest to home; Jobs and Housing.
The overall unemployment rate continues to remain historically high, perhaps even more than the numbers belie, given the amount of people who have exhausted benefits and are no longer being counted. Only in the last few weeks have we seen a significant downturn in the Initial Jobless Claims, signaling that layoffs may be slackening. It is difficult to see how we can consider the corner to have been turned, until we get people back to work.
Housing is an important psychological indicator for most of us since our home is typically one of our largest assets and by virtually every measure, the challenges are ongoing. Home Builders are worried about the competition posed by a flood of foreclosures on the market. New and Existing Home sales have been declining after the bump last year provided by the First-Time Homebuyers Tax Credit. Home prices nationally, as measured by the S&P/Case-Shiller Home Price Indexes, although improving in many areas, are still in negative territory year-over-year. Given the extremes to which home prices soared in the easy credit markets in the first decade of the century, the recovery here may be more prolonged than in previous cycles.
In the end, we do not believe anyone can accurately predict the path of the markets with any consistency. Economics provides tools and information to give us a sense of the current situation, but the link between investments and the economy is anything but clear. Take Real Estate for example. Commercial Real Estate is still, by far, the worst market to be in currently. Price erosion continues, and bank financing is at such a premium that many projects are in jeopardy. Counter-intuitively though, the US Real Estate Investment Trust, or REIT, market, which is also in the business of owning commercial real estate, posted a 9.8% return for the first quarter, and Globally REITs are up almost 89% in the last 12 months! There are a variety of factors that may contribute to this, not the least of which is access to the capital markets rather than trying to secure bank financing, and it speaks to the power of using a disciplined approach to investing and investing in things when it is the most difficult to do so. The Global REIT Market has declined 37% from the peak in April of 2007. Had you invested $100 at the top, it would be worth $62.63 today. At the market bottom in March of last year it was worth only $27.78. So there has been substantial recovery just leaving it alone. If, however, you followed a disciplined strategy and invested an additional $72.22 at the market bottom, to bring you total investment back up to $100, today you would have $225.42 for your $172.22 investment, a more than 30% return! We could find these examples in virtually every area where we invest, and they just continue to convince us that discipline is the safest investment strategy, and the best course is always the middle course, concentrating on the things you can control.
As always we offer you our sincerest thanks for your continued business and trust in us. We continue to strive everyday to prove your trust has been wisely placed.
Sincerely,
Thomas N. Alvaré, CPA/PFS
President
Robert M Vogel, CFP®
Chair, Investment Advisory Committee
Ryan Barrett, CFP® William T. Reynard, CFP® Robert G. Heitsenrether
Financial Advisors
1st Quarter 2010 Market Review
Equities
The US Equity Market began the year continuing the rally that dominated last year. Concerns over the true strength of the economic recovery quickly surfaced, however, causing the market to fall more than 8% from peak to trough. Concerns were quickly allayed, however, by mounting positive economic news and the market quickly recovered ending the quarter up over 5%. The gains were broad based with 7 of 10 underlying sectors in positive territory for the year. Financials, Consumer Services and Industrial stocks led the pack, all up near 10%. Technology, one of the big winners from last year, is struggling so far this year, posting a mere 1.7% return.
In the International Equity Markets, the story is less positive. Concerns over Sovereign debt, particularly in Europe, sent money running for the relative safety of the US Dollar. The resulting strengthening of the dollar eroded returns in the international markets for the US investor. The broadest measure of international equities, the MSCI All-Country World Index ex US (ACWI) posted a 2.9% return in local currencies, but just a 1% return when measured in dollars. The currency effect was particularly felt in the European Region, where the US Dollar gained more than 6.5% against the Euro. The MSCI Europe Index gained 3.0% in local currency, but lost 2.3% when converted to US Dollars. Only the MSCI Pacific Index posted returns competitive with the US Market, up 5.4%. Here currency had little impact as declines in other Pacific currency were offset by gains in the Japanese Yen.
The Emerging Markets posted positive gains in the first quarter, up just over 2%, building on the stellar gains of last year. This was in spite of lackluster performance in the BRIC countries (Brazil, Russia, India and China), which added on 0.8%.
Alternatives
The broad Commodities Market is feeling the drag of soft energy prices, by far the largest component. With the DJ-AIG Energy Sub Index down 8.3% for the quarter, the overall DJ- AIG Commodity Index is down more than 5% for the year. Concerns over the Chinese government’s actions to regulate growth earlier in the year rocked the Industrial metals market, but that has mostly subsided, with the DJ-AIG Industrial Metals Sub Index posting a 6.1% return through March 31. Maybe most surprisingly, especially given the mid-quarter flight to quality is the price of Gold, priced at the interbank rate, is mostly flat for the year. The trailing 12 month performance is now slightly behind that of the broader DJ-AIG Commodity Index.
Real Estate, which was mentioned earlier, continues to post impressive returns, especially in the US. With REITs able to achieve financing through the capital markets, using bonds or preferred stock, and the narrowing spreads on corporate debt, they are capitalizing on a significant advantage they currently have over directly held commercial real estate, which still relies on bank financing. The US REITs are far and away the better performer so far this year, posting a 9.8% return on the DJ US Select REIT Index, versus a 0.9% loss in DJ Global ex US Select REIT Index. Within the US REIT markets, Hotels continue to
lead the way, as they did last year, up more than 20% year to date. Self Storage REITs are a distant second up 10.9%. Industrial REITs were the laggard for the quarter and year, but still in positive territory with a 3.6% gain.
Fixed Income
The fixed income markets have been choppy so far this year. An early flight to quality drove down Treasury rates, only to see them pop back up again. Market concerns about short-term economics and long-term inflationary pressures created mixed results. In both long and short dated maturities , rates have risen creating price pressure since bond prices move in the opposite direction of interest rates. In the middle of the curve, 12 months to 7 years, rates have actually dropped , driving prices up.
The Corporate and High Yield segments of the fixed income market saw their yield spreads, the amount they pay over a comparable US Treasury, jump up midway through the quarter signaling investors were concerned about taking on credit risk. It did not last, however, and they both resumed their slide, and closed the quarter at or just off their 12 month low.
Overall the BarCap US Aggregate Bond Index posted a respectable 1.78% return for the quarter. US Treasuries weighed down the performance with the Barcap 20+ years Treasury and Short-Term Treasury Indexes posting 0.16% and 0.07% respectively. Corporate bonds and other credit issues were the main driver of returns with the Barcap US Credit Index posting a 2.27% return. High Yield Bonds continued to post respectable returns, up 4.8% on the Bank of America Merrill Lynch High Yield Master II Index, almost keeping up with the US Equity Market.