Bartlett Commentaries
Market Commentary, 04 / 2010
Economic and Market ConditionsEquity markets made continued progress in the first quarter, with 4 - 5% gains for the Dow Jones and S&P 500 benchmarks. Stocks were buoyed by a combination of positive factors including economic recovery, solid corporate profit reports, and relatively low interest rates. Additional encouragement came from improved business confidence, evidenced by more dividend increases and stock repurchases. Meanwhile, corporate and municipal bonds delivered positive returns, outpacing U.S. Treasury securities. Job losses have stopped with unemployment recently down to 9.7% from the peak of 10.1% last October.
While ultimately rewarding, the latest quarter included a swift but noticeable correction during January and February. Domestic stocks fell 7 - 8% and foreign markets declined by 11 - 12% during a three-week tailspin, amid financial emergency in the Euro-Zone economy. The crisis is still developing as of this writing, and is a useful reminder of ongoing fragilities in world financial systems caused by falling real estate prices and high debt levels in the aftermath of global recession. Policymakers will remain focused on these problems for some time to come.
Outlook and StrategyWe are encouraged by economic recovery and heartened by the resilience of well-managed companies, yet remain mindful of significant long-term headwinds for the world economy. Household debt is still too high relative to income; the recent increase in household savings will be a continuing necessity. Government deficits and debt levels are at unsustainable levels, and must eventually be rationalized. Deleveraging by households and governments, coupled with related secular trends toward higher taxes and greater regulation, augur slower long-term economic growth for the U.S. and most Western countries. Emerging economies, though in better shape, may be negatively affected by a slowdown in export activity from these developed countries as they continue their transition to economic growth from domestic consumption, away from exports.
Long-term economic challenges do not necessarily predestine poor investment performance. The key question at all times: what is reflected in current stock and bond valuations? It is when equity valuations are too extended – when optimism prevails and expectations are high – that risk is elevated and prospective returns are low. By contrast, if investor sentiment is more neutral and valuations already reflect a subdued economic outlook, then risk/reward is more promising. This seems to be the case currently. The equities of well-run domestic and foreign companies carry reasonable price/earnings multiples of 10 - 15 with sustainable and growing dividend yields of 2 - 4%, which makes them attractive relative to most bond and cash investments.
As for bonds, we think corporate, municipal, and selected non-U.S. government issues are still relatively appealing for balanced and conservative accounts, notwithstanding considerable recovery from 2008 - 2009 when yields were unusually high relative to Treasury securities. We are very careful in our bond selections, because lower absolute yields provide little margin of safety. Furthermore, large federal deficits and state budget pressures could ultimately lead to higher long-term interest rates and heightened default risk.
Concluding CommentsMore subdued performance is a near certainty going forward, following the remarkable rebound over the last twelve months. We think the Federal Reserve will begin tightening monetary policy later this year, gradually unwinding the extraordinarily accommodative measures implemented in response to the global financial crisis. However, this reversal is likely to be very gradual, with money market yields remaining below 1% for the balance of the year.
Be assured we are aiming for an appropriate balance between return and risk, grounding our investment assessments in realism rather than optimism or pessimism. Asset allocation, diversification, and value remain our guiding principles. We think this approach should provide good risk-adjusted performance over the long term.
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