Financial Market Commentary

Quick Review of the Quarter’s Statistics The second quarter of 2009 has finally given us some positive results to write about for the financial markets. This good news in the middle of a continuing recession is welcomed, of course. However, considering what we all have been through over the past 18 months or so, you will understand if we are hesitant to start celebrating quite yet. We will provide you with a brief update on the performance of the stock and bond markets over the past quarter, and then we will summarize what the second half of 2009 might look like for the financial markets.

Stock Returns All major stock indexes performed well for the second quarter of 2009. The S&P 500 index (large stocks) was up 15.2% for the quarter. The S&P 400 (mid-size stocks) was up 18.7% and the small stock index (Russell 2000) was up 20.2% for the period. The stock market rally was not solely a U.S. phenomenon as international stocks (as measured by the EAFE Index) were up 23.8% for the quarter. Although the stock markets’ performance was strong in the second quarter, it only managed to return most indexes to roughly even for the year. Stated another way, the performance we gained in stock investments for the second quarter just helped to recuperate the money we lost on stock investments in the first quarter!

Bond Returns Bond returns for the second quarter of 2009 were a little more varied. As fears surrounding the credit crisis began to subside and it looked as if the worst was behind us, investors grew more comfortable with taking on increased levels of risk. Bond category performance reflected this, and the riskiest fixed income category, high yield bonds, performed similar to stocks, gaining about 23.1% for the quarter. Corporate bonds of higher quality also produced positive, though smaller, returns, with longer duration bonds performing better. Short-term bonds (Barclays U.S. 1 – 5 Year Credit Index) gained 6.16%, intermediate-term bonds (Barclays U.S. 5 – 10 Year Credit Index) gained 9.44% and long-term bonds (Barclays U.S. Long-Term Credit Index) were up 10.7%. Tax-exempt municipal bonds also performed well for the quarter. The many different categories of national and PA municipals all produced positive returns over the period. The riskiest municipal bonds (high yield municipals) were the best performing category, returning a little over 8% for the quarter. The only bond category with negative returns was that of US Treasury securities. In the prior period, investors flocked to the safety of Treasuries as they have nearly zero credit risk. This drove interest rates to historically low levels. As investors’ fears subsided, interest rates increased, meaning Treasury prices fell. Most all bonds that pay interest have an inverse relationship between price and interest rates. If rates go up, prices fall; and if rates fall, prices go up. Treasury interest rates increased, their prices fell and they lost 4.66% (Barclays U.S. 5 – 10 Year Treasury Index) for the quarter.

What does the second half of 2009 look like? My desire for forecasting has diminished over the past few years as it seems the number of unknown factors has increased faster than my ability to process the data of the few known factors! I think it is actually easier to forecast the longer term (10 years and out) where in theory, we know less, than it is to forecast the next six months, where we might know a little more. Although the underlying business and political climate can change drastically over longer periods, the long-term performance of certain asset categories seems to trend toward historical ranges that are fairly constant in our ever-changing world. On the other hand, short-term market volatility can be so significant that it does not conform to any “trend.” This was what we experienced in the last six months of 2008. I think the tone for the stock market over the next few months will be largely influenced by the current earning season for stocks which starts today (July 8) and runs for the next five to six weeks. No one is expecting companies to say great things about the past 90 days, but there is an expectation (or a strong hope) that they will confirm that the worst is behind us; that they think the future is about to get better, or at least, not get any worse. If many companies announce earnings and then begin to forecast even deeper levels of doom and gloom ahead, the stock markets could start to retract some of their impressive gains from the second quarter. If the news is very negative, the flight to quality could reappear and money would flow out of stocks and credit-sensitive bonds and back into Treasuries. If the news from companies is modestly hopeful or even encouraging, then the second-half of 2009 should include more positive returns from financial markets.

My outlook for the future is starting to conform to what PIMCO (the largest bond manager in the US) is calling the “new normal” when they discuss the future. In simple terms, the economic growth of our country in the past was a little over 3% a year. That level of economic growth came from an extended period of easy money for all, easy regulations for business and lower tax rates for all. The future, for now at least, seems to hold easy money for some (if you are a bank or a car company), harder regulations for business and higher tax rates for all. The economy will still grow and businesses will still prosper, but PIMCO thinks that, in general, growth will slow to approximately 2%. That will translate into lower returns for both stock and bond investors for the foreseeable future. Things should get better over the next six months (except maybe unemployment, which will probably take at least another year to improve) but it will take some time to get back to where we were in the fall of 2007.