Investing: Sizing Up the Second Half
The first quarter of 2010 gave investors hope that the bull run that sprang from the March 2009 stock market lows would continue. The second quarter dashed those hopes in decisive fashion. What can we expect for the remainder of the year?
The Standard & Poor's 500-stock index fell 1 percent on June 30 to finish the second quarter with a 12 percent loss (following a 4.9 percent gain in the first quarter, it was down 7.6 percent for the first half). The S&P 500 broke a four-quarter winning streak that drove the large-cap index up 47 percent. Late in the June 30 trading session, the S&P 500 hit a low at 1,028.33, the lowest price since Oct. 2, according to data compiled by Bloomberg. The market's decline in the past two weeks was prompted by the index's failure to stay above its average price in the past 200 days, which chart analysts see as a key bullish level. The broad market has lost 15.3 percent of its value since this year's high on Apr. 23.
Earnings for the S&P 500 are expected to rise 34.3 percent in the second quarter from a year earlier, with sales projected to be up 9.4 percent, according to a Bloomberg analyst survey. That would be substantially weaker than the 54 percent spike in profits and the 12 percent jump in sales in the first quarter of this year.
Weak Economic Data
Recent data don't signal that the U.S. economy will continue growing at the healthy pace many people had come to expect after initially seeing gross domestic product growth of 3.2 percent for the first three months of 2010. Those hopes would appear to be slipping given successive downward revisions of the first-quarter growth rate to 3.0 percent and most recently 2.7 percent.
U.S. new home sales plunged 32.7 percent in May to a 300,000 annual pace after a downwardly revised 446,000 pace in April, while the average price fell 4.1 percent from a year earlier. The March new home sales were also revised lower. The record low rate in May was much worse than expected and more than reversed the downwardly adjusted gains in March and April that were attributed to the tax credit deadline.
The May unemployment rate of 9.7 percent was slightly above January and February's 9.69 percent level, with only 41,000 private-sector jobs created in May.
State and local governments are raising taxes and cutting spending to address near-term deficits and the federal government seems ready to allow prior tax cuts to expire at the end of 2011. That, plus a regulatory environment that's urging the financial sector to increase capital levels and reduce credit availability, while discouraging private-sector employment by not adequately addressing rising health-care costs, adds up to an overall incentive for the private sector to reduce risk, says Chris Wallis, co-manager of the Natixis Vaughan Nelson Small-Cap Value Fund (NEFJX). (The fund placed 13th in a June 2010 ranking of the top 20 U.S. diversified equity funds by Bloomberg Rankings. View the top 20 funds.)
Private vs. Public Sectors
"As a society, we're in the process of renegotiating the roles and responsibilities of the private vs. public sectors," Wallis said in an e-mail message. "That translates into lower multiples for asset prices, further reductions in leverage, and increases in savings rates."
Since it takes years to work through these issues, that will only add to the volatility and uncertainty in the capital markets, he adds. He thinks investors need to take a longer-term view and look for individual company situations where there's a specific catalyst for underlying earnings growth that can overwhelm those pressures and drive returns.
Adam Peck, co-manager of the Heartland Value Plus Fund (HRVIX) (10th in the June 2010 Bloomberg rankings), is optimistic about the U.S.
economy and doesn't believe it will dip back into recession. Unlike the runup to previous recessions as far back as 1957, the yield curve, or the spread between long- and short-term interest rates, has neither flattened out nor inverted recently, he says. In the last three downturns, the inversion started well in advance of the economy slipping into recession, he adds. The flattening of bond yields typically warns investors to turn defensive and "we're not seeing that today," he says.
Peck says he still sees a lot of attractive opportunities in equities. The S&P 500 index normally trades at 15 to 16 times aggregate earnings, but currently it's priced at just 12.8 times the consensus estimate of $84 per share for 2010. And many of the companies in the index have cash levels and free cash-flow yields close to 30-year highs, he says.
Surveys show nearly half of individual investors are bearish, having experienced one of the worst 10-year returns in the last 100 years, but Peck believes returns over the next 10 years will be better.
Blows to Confidence
Mario Gabelli, founder and chief executive officer of Gabelli Asset Management Company Investors, says "80 percent of U.S. consumers were starting to get over the shell shock" they experienced with the housing market collapse and the financial system's crash and were starting to spend again, and American companies had built up substantial cash reserves. (Gabelli's GAMCO Westwood Mighty Mites Fund (WMMAX) was eighth in the June 2010 Bloomberg rankings.) But between the BP disaster in the Gulf of Mexico, the Greek debt crisis, and the federal government's increased oversight of the financial industry, "we've created a short-term air pocket in confidence and we've got to work our way through that," he says. "The stock market has anticipated softness [in the economy] in the first half of 2011 because of the [expected] lack of incremental stimulus from governments."
Gabelli says he's confident the stock market will be slightly higher at the end of this year than at the beginning, but he expects a lot more volatility between now and then. He sees a need for financial markets to restore confidence, which requires them getting a handle on non-exchange trading platforms and high-frequency trading, as people wait for a return of stability to the investment process.