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August 2009 Investment Update
Capital Advantage, Inc.
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Dear Capital Advantage Clients,
As we enter the dog days of summer, we continue to witness the decoupling of both Main Street and Wall Street. Main Street holds steady in what is now termed a ‘decession’--- the longest and deepest recession since WWII, but not quite a 1930’s type depression. Evidence indicates that the calamitous collapse of the global financial system appears to have been avoided by the unprecedented action of the Federal Reserve in concert with the World central bankers. Although economic business and financial activity remains depressed, the economic contraction of the last six months appears to be abating.
Remembering the old stock market adage “Don’t fight the Fed”, it appears that the Federal Reserve actions in ‘reflating’ the economy have been beneficial to asset prices, as markets made a strong recovery following the six weeks of a mild correction that began in June. Wall Street put back on its party hats in mid-July, sending the broad based S&P 500 up 7.4% to reach its best five months of performance since 1938---up nearly 50% from March lows. Keep in mind, however, that all of this run-up only gets us back to where we were just last September before the Lehman Brothers collapse. July also saw the DOW gain 8.6 % to register its best monthly performance in twenty years, and tech-heavy NASDAQ kept pace with a gain of 7.8% to reach its best five month stretch since March 2000. Foreign markets also surged, as the MSCI EAFE gained 9% and the MSCI EM gaining 11%.
True to historical recovery patterns, small and mid-cap funds have outperformed large-cap funds. As a group, value-oriented funds have outperformed growth-oriented funds; however, should historical patterns act as a guide, it will be growth funds that will eventually take the lead in the post-recession period. We remain unconvinced of the likely hood of a long term upward trend, and while many of our investment triggers have turned positive, we still believe that housing, corporate earnings and employment need to truly stabilize before a sustained advance can begin. Nonetheless, with an estimated $3.5 trillion residing on the sidelines (in money market funds), this dry powder is certainly available for a continued rally.
Most recently, however, stocks fell across all industries just last Friday (August 14) as investors worried that consumers' reluctance to spend will hurt corporate earnings. Many companies second-quarter results were boosted by cost-cutting, not higher sales, and the fear is that without a pickup in sales, earnings will fall. While other parts of the economy, including housing and manufacturing, are showing signs of progress, the country cannot have a strong recovery unless consumers are spending more freely. Their spending accounts for more than two-thirds of U.S. economic activity. The market's reaction to news of a reluctant consumer had many questioning whether a five-month rally was way too optimistic.
The mixed economic readings of the past several months aren't surprising. A turnaround produces mixed messages because not all parts of the economy recover at the same speed and some indicators start to show life before others. Investors who had expected the economy would rocket higher got ahead of themselves by sending stocks up so quickly, and many economists have predicted a gradual recovery in the economy, in part because unemployment rates could remain high.
While we remain cautiously optimistic in the short term, we are currently committing up to 10% more to equities, primarily to small-cap and emerging markets (depending on client objectives, of course). We continue our due diligence on investment methodologies for commodities---researching funds investing in commodity-centric countries like Australia, Canada, Brazil and Russia. Asia, India, and China appear to have turned the corner toward economic recovery, boasting strong financial profiles and growing consumer economies. While we are pleased with our current fixed income strategy, we are slightly increasing risk with a higher allocation to the Loomis Sayles Investment Grade fund, and while we have spent time researching lower grade high-yield bond funds, we have not yet allocated assets to these investment types quite yet.
As always, Capital Advantage, Inc. is here to answer your questions, address your concerns, and explain in further detail our investment strategy and current plan of action. We thank you for your continued trust and confidence.
Sincerely,
Your Capital Advantage, Inc. Team
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