Commonwealth Financial Network

Quarterly Market Commentary – Q210

Volatility returns to markets

The second quarter brought renewed volatility, as markets continued to trade on fears of a global slowdown and worries over the worsening European debt situation. Markets ended the quarter to the downside, with major U.S. indices trading sharply lower on the last two days of the quarter. European markets were hardest hit, and there were ripple effects across global markets.

·         The MSCI EAFE lost 13.97 percent for the quarter, and it has lost 13.23 percent for the year.

·         The broad U.S. market, as measured by the S&P 500 Index, lost 11.43 percent for the quarter and is now down 6.65 percent year-to-date.

·         The Dow Jones Industrial Average lost 9.36 percent for the quarter and is off 5 percent for the year.

Bonds are a bright spot . . . again

Bonds made strong gains during the quarter, helped in large part by a significant reduction in interest rates.

·         The yield on the 10-year bond moved from 3.83 percent at the beginning of the quarter to 2.95 percent at the end of the quarter.

·         The Barclays Capital Aggregate Bond Index gained 3.49 percent for the quarter and is higher by 5.33 percent for the year.

·         As opposed to the beginning of the year, when credit-sensitive corporate and high-yield bonds saw strong gains, interest rate-sensitive U.S. Treasuries helped push the index higher last quarter.

Greece and the other “PIIGS”

Greece took center stage on the global news front as the severity of its debt crisis came to light.

·         The nation had reached the end of its borrowing capabilities and was threatening to default on its outstanding debt.

·         While Greece took most of the heat, other “PIIGS” nations—namely, Portugal, Italy, Ireland, and Spain—also began to raise the alert over difficulties in refinancing their own debt.

·         The European Union provided a comprehensive aid package of roughly $1 trillion to avoid widespread default.

There could be a larger crisis looming, however.

·         Roughly $3 trillion of debt is held by European banks, and ongoing concerns over this huge liability have helped pushed many of these bank stocks sharply lower.

·         Global markets have continued to be cautious over the potential for further fallout from the debt crisis, which could add to volatility in the coming months.

The recovery continues, but how strong will it be?

Signs that the economy is continuing to move forward can be seen in the manufacturing sector.

·         Companies have been rebuilding inventory and factory reorders have been strong.  

·         Industrial production ticked up 1.20 percent in May, after a 0.70-percent increase in April.

Yet this recovery is showing signs that it is not as strong as past recoveries.

·         The Federal Reserve has continued to cite high unemployment, modest income growth, and tight credit as a caution to growth prospects, saying, “Financial conditions have become less supportive of economic growth on balance.”

·         We believe this continues to support the argument that interest rates will remain low; we may even see short-term rates at or near zero percent through 2011.

There are also signs that the housing market is turning down again, following the expiration of the $8,000 tax credit.

·         Only 300,000 new homes were sold in May—the lowest level since the Census Bureau began recordkeeping in 1963.

·         Existing home sales also fell to 5.66 million units in May, from 5.79 million units in April.

Many economists also point to a less followed metric from the Economic Cycle Research Institute for some insight into the future health and direction of the economy.

·         The readings for the Weekly Leading Index were down 6.90 percent for the week ending June 18, following a 5.80-percent decline the week before.

·         In addition, first-quarter GDP estimates were lowered to a 2.70-percent annualized growth rate, from the initial reported estimate of 3 percent.

Investing in this “new normal”

Equity markets have definitely become more volatile recently, and investors need to be vigilant about risk, positioning portfolios to take advantage of the potential for a slower growth environment.

·         Investors may want to seek market returns as well as income to help cushion some of the volatility and preserve capital.

·         Income-producing stocks with strong fundamentals may make sense for investors, as could diversification within fixed income to help provide an ongoing income stream.

·         Also, with the current turmoil in Europe, a focus on domestic holdings could prove to be more beneficial in the near term.

Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. All indices are unmanaged and investors cannot invest directly into an index. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a nondiversified portfolio. Diversification does not ensure against market risk.

Authored by Simon Heslop, CFA^®, director of asset management, at Commonwealth Financial Network.

© 2010 Commonwealth Financial Network^®