Company News
BSCA Outlook August 2009
Dear Friends,
July was a tale of two halves for the domestic equity markets. The markets traded lower early in July, only to stage a strong rally into the end of the month, sending each of the three major indices to their highest levels of 2009. The rally was primarily fueled by better than expected second quarter corporate earnings, which gave investors hope that the worst is possibly behind us.
The news from the second quarter earnings season has certainly proven to be a positive step towards economic recovery. As of July 31, of U.S. companies that had reported second quarter earnings, 71% exceeded consensus analyst estimates. This is the highest rate since the third quarter of 2006, and the third highest in the last ten years. The high beat rate is a result of analysts extrapolating poor Q4 ‘08 and Q1 ‘09 results too far out into the future, and companies seeing actual increases in demand for their goods and services. Also of note was the fact that 9% of companies reporting through July 31 raised their earnings guidance for the next 12 months. This is the highest level since Q2 ‘06, but still well below levels seen earlier in the decade. Even with all of these positive results, we are still concerned about companies missing top line revenue estimates, and those making earnings estimates purely from cost-cutting measures.
Other than earnings reports, July was a relatively uneventful month. Rather than rehash a limited news month, we want to reflect on where we have been in 2009, and what we anticipate for the rest of this year and into 2010.
If you recall, in our January commentary we expected the S&P 500 to likely fluctuate between 800 and 1,000 for most of 2009, and that any movements above or below this range would be short lived. The S&P 500 did break below the 800 range on February 17 of this year, and continued lower until March 6, bottoming at 666.79. By March 24, the index had moved back above 800. Currently, we are at the top end of the range, with the S&P reaching a high of 996.68 on July 30. In February, we cautioned investors to be careful not to project the current economic weakness too far into the future, and that we expected economic data would soon improve. Economic data did in fact begin to improve in March and was the dominating story for the entire second quarter. Similarly, investors today should be careful not to project the current improvement in data inordinately far into the future. After a 50% run up in the markets, some caution is certainly warranted. Will the improvements in earnings seen in Q2 carry over for the rest of the year? Will improved earnings lead the way to stabilization in the employment markets? Will any improvement in employment help to stabilize foreclosures and mortgage delinquencies? These are the questions we will be asking in the third quarter.
During the first half of 2009, we have done well with a relatively small allocation to domestic equities. What asset classes have done well this year? Emerging markets have soared in 2009, with many performing better than even the US markets. Fixed income allocations have benefited greatly from spread narrowing. Spreads reached historically high levels in late 2008 and early 2009, especially in high yield and mortgage-backed securities. As these spreads have returned to normal levels, our fixed income managers have performed well. Finally, alternative investments have performed as expected. These assets have not rallied as much as other asset classes, but they did not fall nearly as far in early 2009. We do not employ these managers to “hit homeruns”. Their mandate is to have a low correlation to the equity markets and to mitigate risk – and that is exactly what they have done so far this year.
Going forward, we expect our asset allocation to resemble what we have done in the first half of 2009: limited exposure to domestic equities, larger allocations to managers with a global mandate, opportunistic allocation to fixed income, and a commitment to using alternative strategies in an effort to smooth overall portfolio volatility. A time will come when we once again increase our domestic equity exposure back to more traditional levels. We are not believers in the idea that the U.S. model is broken. We simply believe that there are significant headwinds to growth in the short-term and that other markets and asset classes offer better opportunities. Looking forward on the economic front, the overall picture appears to be improving. Replenishing of inventories should provide a boost to GDP in the third quarter, as should the rolling out of government stimulus programs enacted earlier in the year. Business spending could show some signs of life later in the year if companies begin to feel more confident about their prospects going forward. Nonetheless, there are still significant risks on the horizon. We cannot rule out the possibility of a “double dip” recession. Consumers continue to de-lever their balance sheets, and employment numbers remain weak. Until we see progress in these areas, we will remain hopeful in our outlook, but also sufficiently cautious.
As always, we are only a phone call away if you have any questions or concerns. We would love to hear from you! We are happy to go over your portfolio with you or answer any questions you might have about your financial plan. If you are a corporate client, we are eager to help in any way we can, from employee education to helping you meet all of your fiduciary obligations to making sure your plan provider is the most appropriate one for your situation.
Broad Street Capital Advisors, LLC