2010 Second Quarter Review

Stocks Turn Negative in Second Quarter In a volatile quarter, global stock markets took another sharp dive at the end of June. Renewed fears about a stagnating U.S. economic recovery, the continuing European debt crisis, and a decline in the Chinese growth rate all contributed to the most recent stock declines. Stock losses for the quarter were the worst since the bull market began in 2009. The S&P 500 now shows a loss of more than 7% for the year through June, and other equity indices have similar negative returns. CPIC client portfolios have held up much better during this period, since they hold a diversified mix of stocks and bonds in a wide array of sectors. This diversification decreases portfolio risk. The current economic recovery has lost some momentum in recent weeks. The slight downward revision of first quarter GDP to 2.7% from 3.0% is a reminder that this recovery is less robust than historical patterns of post-recession rebounds – frequently in the 6-7% GDP growth range.  The downward revision was due to slower consumption than previously estimated, more than offsetting faster investment growth and a positive contribution from inventories. There was also a sharp correction in housing as the homebuyer tax credit expired.  Both new and existing home sales fell in May.  Similar to earlier stimulus programs like Cash for Clunkers and Cash for Appliances, government support helped to pull demand forward, but led to sharp declines immediately following their expiration. The removal of the program comes with housing supplies high and foreclosures still elevated.  Future gains in housing will depend on a strengthening economy and improving employment and will continue to be sluggish. In contrast to the negative data, some economic indicators show improvement. While private sector employment remained weak in June, and consumer confidence has taken a turn for the worse, jobless claims have decreased in recent weeks.  The U.S. has created about 1.5 million net new private sector jobs in 2010. Another bright note is increased business capital spending, which appears to be gaining momentum and may boost industrial activity and employment.   “Double Dip” Seems Unlikely Despite the most recent stock market turmoil, a “double-dip” recession (where the economy sinks back into recession after a brief recovery period) is considered unlikely by most economists. Forecasts for GDP growth in the second quarter indicate the growth rate will likely outpace that of the first quarter. The pace may then decelerate in the second half of this year and into 2011, as the inventory recovery moderates and as fiscal spending fades. Despite any slowdown that may occur, there are only a minority of forecasts that indicate the slowdown would be so severe that the economy would actually contract and head toward another protracted recessionary period. Rates Lower for Longer The Federal Reserve Open Market Committee indicated last week that it would maintain a policy of a low federal-funds rate for an extended period. Most economists expect that period to extend at least through year-end, and many see no change in interest rates until mid-2011. These expectations for continued low interest rates have shifted dramatically from even two months ago, when forecasts called for higher rates much sooner in 2010. It appears that the Federal Reserve is acting to help spur economic growth in the immediate time frame, with less concern about later possible inflation or asset bubble ramifications. Portfolio Strategy In the short term, we expect stock markets to remain range-bound. Volatility has increased, but economic data does not point to the likelihood of a sustained decline in stock prices anytime soon. This is a very different economic climate than 2008. As the economy eventually recovers, corporate profits should continue to rise, and this should lift stock prices later in the year. In the meantime, CPIC maintains a mix of stock and bond mutual funds across many asset types in the portfolio asset allocation. We continue to monitor rapidly-moving financial markets and will use our strategy of Dynamic Asset Allocation to adjust the portfolio allocations as conditions change.