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Market Commentary — 3rd Quarter 2011
When we last wrote in early July, the equity markets were celebrating with a quarter-end rally as Greece finally agreed to austerity measures in exchange for a European bailout. While we never believed this to be a final solution to the sovereign debt risk in Europe, we were at least hopeful that it would temporarily remove the headline risk associated with European debt concerns. As you may have surmised by the tone of this letter, our outlook is increasingly cautious. We expect the economy to grow but at a slow pace. As such, earnings estimates are likely to be ratcheted down in the coming months, and we are keeping a close eye on events taking place in Europe and other international markets. Despite our caution, we continue to believe that an allocation to equities is prudent as news or even rumors of effective policy solutions has the potential to send equity markets markedly higher. In addition, corporate balance sheets generally remain strong, and merger and acquisition activity has been relatively robust. We continue to focus on high-quality companies trading at attractive valuations that offer sustainable dividend income. Until we see stabilization both here and in Europe, earnings growth is likely to be subdued, and as a result, we prefer to invest in companies that generate income for shareholders as we await the eventual recovery.
Equity markets around the world responded to the lack of any closure in Europe by going into free-fall in late July and early August. In fact, from July 25 through August 8, the S&P declined by almost 17%. The second half of the quarter was marked by almost unprecedented volatility as uncertainty surrounding a European solution intensified and flashbacks of the 2008 financial crisis danced in investors’ heads. Despite the extreme volatility, equity markets did not meaningfully move up or down during the remainder of the third quarter, and the S&P 500 ended the September quarter down 13.8%. The Dow Jones declined by 11.5%, while the small-cap Russell 2000 index shed 21.8%. For the first nine months of 2011, the S&P 500 and the Dow Jones were down by 6.5% and 3.7%, respectively, while the Russell 2000 declined by a much worse 14%. Equity and commodity markets also suffered from news that China’s economic growth was possibly slowing significantly more than expected. In response to fears of a housing bubble bursting in China, government authorities have steadily been implementing policies such as higher minimum down payment requirements and tighter monetary controls in an effort to reduce speculation in the housing market. The negative effect of these actions has been an apparent slowdown in economic growth, and reports coming out of China late in the quarter indicated that manufacturing activity actually contracted in July and August. As the world’s largest importer of raw materials, the news sent commodities such as oil and copper into a tailspin. As we have stated in the past, projections for continued worldwide GDP growth are largely dependent on robust growth in China. While we believe that growth in China will slow in percentage terms, it is likely to continue to post annual GDP in the mid to high single digit range, but there is unquantifiable “tail” risk due to the lack of transparency and rumors of significant leverage. In addition to the international headwinds, domestic issues that we have been commenting on over the past several quarters continue to act as a drag on growth. These include a perpetually weak housing market, a near double-digit unemployment rate, and ballooning government deficits at the federal, state and local government level. While many of these symptoms are not getting worse, we do not expect much improvement in the foreseeable future, and as such, we see little hope for robust economic growth going forward. Many of the pundits that were earlier forecasting a return to 3% growth in the second half of 2011 are now arguing that we are on the verge of a “double-dip” recession.
Market Commentary 3rd Quarter 2011Market Commentary 2nd Quarter 2011Market Commentary 1st Quarter 2011Market Commentary 4th Quarter 2010 |
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