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Gains in First Quarter
Stocks and bonds moved upward in the first three months of 2010, continuing the rally that began last year. Despite considerable month-to-month volatility, stock indices managed to gain a few percent for the quarter. Reversing last year’s international trends, U.S stock markets performed much better overall than those in Europe and many emerging countries. As the world emerges from global recession, U.S. economic growth currently is outpacing growth in Europe. Stock markets seem to reflect this difference. CPIC client portfolios have solid gains year-to-date in 2010, but with much less risk than stock market indices.
Bonds also continued to deliver positive returns, despite fears of rising interest rates. Although yields on longer-term bonds rose during March, the increase was seemed not enough to cause much immediate investor concern. The possibility for interest rates to rise significantly this year might be one of the largest worries of bond investors, since rising rates hurt the value of corporate and other fixed income securities.
Defying most analyst expectations, the U.S. dollar rose in value against the euro and many other currencies. Worries about the debt crisis in Greece were a major drag on the euro. Negative euro sentiment was also fueled by concerns over heavily indebted Portugal and Spain. As of the end of March, the euro has lost about 11% against the dollar since its peak last November.
U.S Economic Growth At or Above Trend
Despite a recent pick-up in economic activity, investors continue to worry. Fears of a “double-dip recession” persist, as recent economic data indicate weak housing sales, restrained construction spending, continued weak labor markets, and subdued consumer sentiment. A recent survey by Blue Chip Economic Indicators, polling 50 economic forecasters, contradicts the “double-dip recession” fears, however. In this survey, not a single professional forecaster expects another significant economic decline in 2010 or 2011. The consensus prediction for economic growth was 3% or better through 2011. The economy grew nearly 4% in the second half of 2009 and appears to be growing at roughly that pace in the first half of 2010 – so forecasters appear to be on target for now. Below are updates to key economic indicators:
Growth As described above, U.S. economic growth appears to be at the secular 3% trend rate or better. Although this is below the 6% post-recession historical figure, it is still a rate indicating reasonable growth.
Employment Economists forecast the unemployment rate to gradually fall from current levels of about 10% to below 8% by the end of 2011.
Profits The most recent corporate earnings have been robust, with double-digit gains compared to last year. More than half of S&P companies beat expectations in the last reporting period.
Inflation With the much excess capacity and the high unemployment rate, inflation pressures remain absent for now. Despite rising energy prices over the course of 2009, measures of core inflation remain subdued.
Interest Rates The most recent statements from the Federal Reserve indicate that the current policy is to remain “on hold” with very low interest rates (Fed Funds target of 0.25%). It appears economic recovery is a higher priority than worries about inflation risk.
Portfolio Strategy
After last year’s rally in stocks and bonds, and with many current economic headwinds, stock price movement may be choppy for an extended period. In the short term, we expect a range-bound stock market, before a more sustainable upward trend later in the year. For this financial environment, CPIC has positioned portfolios to optimize the risk/return tradeoff. Portfolios are likely to benefit from current stock and bond mutual funds that both pay current dividends as well as hold potential for capital appreciation. Both international and U.S. funds are in the mix. As we monitor financial markets that change to reflect the economic recovery, we expect to adjust asset allocation as conditions indicate.
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