Conventional wisdom would suggest that the just-ended month of May could mark the end of a significant, but normal market correction. Since mid-April, markets around the world have declined by a measure exceeding 10%, which is the normal definition of a correction. And it’s not surprising – the markets were due to take a breather. Following the terrible decline which ended in March of 2009, the markets rose by almost 80% through the early part of this year. While this market recovery occurred, most investors remained shell-shocked and anxious, recalling the volatility and losses that they had so recently experienced. The recent fiscal problems in Greece, coupled with this lingering anxiety, were the catalyst which triggered the recent downturn.
We think, in this circumstance, that the conventional wisdom is correct, but we have no strong conviction that it is, nor do we suggest any portfolio changes at present. However, we thought it would be a good time to try and bring some perspective to recent trends and ongoing events.
Over the past few months our team has had the opportunity to get first hand opinions from many diverse and respected sources. We have recently attended conferences and meetings in Boston, Kansas City, Chicago, Dallas, Naples (Florida) and locally here in Houston. In the process we’ve met with and heard from top economists, portfolio managers, and analysts who have given us real-time information and opinions on the economy and capital markets around the world. The predominant theme is, almost universally, equivocal. Financial markets have had a sizable recovery, economic activity seems to be on the upswing, yet there remain significant issues, financially, politically, and economically. Several observations follow:
Greece / Europe
Probably the most troubling issue to emerge has been looming fiscal imbalances that have plagued Europe’s weakest economies, particularly Greece. Greece, like many of the smaller Eurozone economies, has, over many years, accumulated a massive amount of government debt to pay for generous entitlement programs for their citizens.
The global recession brought Greek lenders to a point where they were unwilling to lend the country any more money which sent interest rates skyrocketing. This in turn, forced the European Central Bank (ECB) and the member nations of the European Union (EU) to take action to support the Greek debt and its economy. Similar to the TARP program enacted by US regulators, the ECB has created a $1 trillion program to provide financing for countries in fiscal distress, with the requirement that countries using these emergency funds must immediately adopt policies that will get their finances in order. In Greece, these “austerity” measures were initially met with protests and riots; however, cooler heads have prevailed and the country is moving to address their budgetary excesses.
Taking a lesson from the Greek problems, other weaker members of the Eurozone, such as Spain and Portugal have begun fiscal austerity programs of their own. Ireland, in fact, began trimming their government spending some time ago and has so far avoided any sort of panic in the debt markets. The Eurozone story is still playing out, but it appears as though the backstop of the central bank should help a great deal.
There are unmistakable signs that the U.S. economy has recovered from the recent recession and has moved from a period of recovery to one of expansion. The economic signs are encouraging and the recent correction in pricing has lowered stock valuations to much more reasonable levels. Compared to the fall of ’08, things are looking much better in the U.S. Total U.S. economic output measured as Gross Domestic Product (GDP) has returned to pre-crisis levels, employment has stabilized, and corporate profits have far exceeded expectations, which are classic signs of an economic recovery.
As discussed above, there has been an almost uninterrupted rise in the market since it bottomed in March of last year. From trough-to-peak, the S&P 500 rose by 80%, with only a few mild pullbacks during an amazing 13-month stretch. This brought stock prices to a level in April that could no longer be characterized as “cheap.” The market downturn that we are experiencing has already returned valuations to a more reasonable range, offering a margin of safety against continued declines as corporate profits continue to improve.
The Bottom Line
We are left with an environment where fundamentals are headed up, and the market is heading down. We do not think that we will experience another ’08 style crash or a double dip recession. The circumstances are much different now. Today, there are signs of economic improvement all over the globe. The financial system is much stronger. Finally, real estate no longer appears to be overpriced. So, while there are significant problems left to be addressed, there are reasons for optimism that the worst is behind us.
If you would like to discuss any questions you may have or how this scenario might impact your portfolio or planning, we’d be happy to talk with you.