Bartlett Commentaries
Market Commentary, 07 / 2009
Market ConditionsThe end of June marked the conclusion of the first positive quarter for stocks since the third quarter of 2007, a welcome respite to a long dry spell. Corporate and municipal bonds also posted positive returns for the quarter, though Treasury bonds fared poorly, something we anticipated in our last report.
In our April letter, we noted the historical pattern of stocks rebounding before economic recovery. In previous market cycles, stock prices bottomed three to nine months before economic troughs and more than a year before peaks in unemployment. This is a timely reminder to consider, following very sobering government statistics released last week. The Labor Department reported an 18th consecutive month of job cuts, the unemployment rate reaching a 26-year high of 9.5%. The labor situation seems destined to get worse before it gets better; 10% or higher unemployment is probable before year-end. Moreover, meaningful job growth seems unlikely until later in 2010 at the earliest, because companies usually do not add workers until recovery is well underway. A silver lining to this scenario is that inflation should stay low for awhile, notwithstanding aggressive monetary easing by the Fed and European central banks. Significant slack in the labor market should limit wage increases and excess manufacturing capacity should temper price increases by most businesses.
In each of the past ten recession cycles, stocks made considerable progress in the initial three to six months following the bottom. This latest cycle is no exception. The S&P 500 is 32% above the low reached four months ago during the peak of investor pessimism in early March. This is an above-average rebound by historical standards, and suggests we should look for more modest gains for the rest of the year.
Outlook and StrategySome respected analysts have written recently about a “new normal” for the US that would feature slower long-term growth as individuals and companies reduce debt, increase savings, and adjust to more government regulation. These headwinds would be the reverse of tailwinds that buoyed economies here and abroad during the last 25 years when deregulation and tax reduction were economic policy staples and individuals augmented consumption with home equity and credit card borrowing.
The possibility of slower long-term growth suggests investors should have more moderate expectations for portfolio performance.
- With this in mind, we think a value-based approach should fare relatively well in an environment of more subdued long-term returns. Plenty of higher quality stocks are attractively valued, with moderate price/earnings multiples based on fairly conservative earnings forecasts.
- We believe investment-grade corporate and municipal bonds are attractively priced. These more conservative securities are a solid complement for stocks within balanced portfolios.
- Inflation is very low currently and likely to stay low for some time, given slack labor markets and low industrial capacity utilization. Inflation might eventually increase given the huge money creation by the Fed, which has been paralleled by European and some Asian central banks. Increasing inflation is not good for financial assets generally, but some investments will fare relatively well. Stocks of companies with growing earnings and dividends should be somewhat resilient, and companies involved in energy and related commodities should do relatively well. As for bonds, a healthy respect for inflation risk favors selections with shorter to intermediate maturities, which would hold up well if interest rates increase.
There are promising signs that the economy has bottomed, though lagging indicators such as the unemployment rate will worsen for a while. We remain mindful that improving stock prices always precede a better economy and better headlines. We will try to strike an appropriate balance by being opportunistic based on the promise of continuing market recovery while having appropriate safeguards in place in the event of renewed adversity.
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