Bartlett Commentaries
Market Commentary, 09 / 2006
Traditionally, the months of September and October have been viewed as the worst ones for equity investors. The five largest one-day declines have all occurred in the month of October, and the month of September has produced more overall negative returns than any other month since 1950. The experience in 2006 has been decidedly atypical.
The media widely trumpeted the fact that, in early October, the Dow Jones Industrial Average broke through the high water mark previously set during the “bubble” six years ago. And while a broader, more diversified index like the S&P 500 may still be 15% below its high from six years ago, the 2.6% return in September brought the quarter’s return to 5.7%. More recently, that positive trend has continued with October’s return equal to 3.3%, bringing the S&P 500 year-to-date returns into the double digits.
Happily, this improvement is supported by good fundamentals. Business performance has been robust by many measures – earnings and dividend growth, share repurchases, merger and acquisition activity. These trends have been building for some time in the market, but until recently have been ignored because of two macro factors: rising short-term interest rates and higher commodity prices. Recently, these two headwinds have reversed and now seem to be providing support, rather than acting as a hindrance, to the market. The Fed’s decision during September to shift monetary policy to “neutral” was a major catalyst for improved stock prices. Weakening energy and other commodity prices have also heartened investors as crude oil, copper, and gold (among other major commodities) have declined by 15-20% from springtime highs, thereby easing inflation pressures.
The best-case scenario for investors is non-inflationary economic growth as this allows for good corporate profitability and continued low interest rates. Low interest rates tend to provide support to higher stock valuations. At this juncture, the major risk is a significant slowdown in the global economy, due to the lagged impact of higher interest rates. Domestically, the US prime rate has reached 8.25%, which will restrain borrowing by consumers and small businesses. The pronounced U.S. housing market correction is a manifestation of the impact of higher rates. Foreign central banks have been tightening monetary policy around the world, but international growth prospects are still good.
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