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Market Commentary

by David C. Blough, CFA, Senior Vice President & Investment Manager  
 

“Skill and confidence are an unconquered army” - George Herbert

The month of April, 2013 witnessed solid gains and new all time highs for the Standard and Poor’s 500 Stock Index, as well as the Dow Jones Industrial Average (DJIA). The S&P 500 ended the month at 1,597 and since has easily pushed through 1,600. Likewise, the Dow Jones Industrial Average finished April at 14,840, closing above 15,000 just a few days later.

Stock market total returns (including dividends) were spectacular over the twelve months ended April 30, 2013. The S&P 500 returned 16.9%, the DJIA 15.4%, while the Standard and Poor’s  Mid-cap and Small-cap Indexes returned 18.8% and 16.6% respectively. The EAFE Index, which measures non-U.S. developed market stock returns, was up 19.4%. Only Emerging Market stock returns failed to flourish, producing a meager return of just 4.0% during the last twelve months. 

The jump in stock prices in recent months is due to many signs that the economy and corporations both here and abroad are returning to health. As the U.S. nears the four-year mark in its economic recovery, which began in July 2009, investors are focusing more on the road ahead rather than past worries. Each quarter has seen more healing in the financial sector, which brought the economy and the stock market to its knees in late 2008 and early 2009. Financial stocks have produced the best gains over the last twelve months, as loan losses return to more normal levels and bank capital levels continue to be restored. Even mortgage giants, Fannie Mae and Freddie Mac, are earning profits once again after more than four years of deep losses.

The Great Refinancing

The Federal Reserve’s extremely accommodative policy has kept interest rates at record low levels since year end 2008. The low rates have been the catalyst for the home building industry to rise from the ashes of the mortgage debacle. It has also allowed millions of homeowners with higher interest rate mortgages to refinance at much lower monthly payments, freeing up cash for other consumer purchases.

Corporations and municipalities have also benefited from the Fed’s low interest rate policy. They have been able to redeem high interest debt by issuing new low cost debt refunding securities. This has saved them large amounts of interest expense and improved profits for corporations and reduced deficits for municipal units. The net result has been a significant strengthening of consumer, municipal and corporate balance sheets.

The economy surprised on the upside in the first quarter of 2013, with real GDP advancing at a 2.5% annual rate. This occurred despite the 2% rise in social security tax withholding effective January 1, 2013. The consumer has continued to propel our economic growth, despite the federal budget sequester that acts as a temporary headwind during 2013. Consumer spending has benefited modestly due to lower gasoline prices this year and more importantly, from solid job growth since last fall. Over the last eight months, the economy has been creating about 180,000 new jobs per month on average. The income from increased employment provides U.S. consumers with rising income to spend. The rebound in housing construction from 600,000 housing units a year at the beginning of 2012 to more than one million annualized new starts in the latest month, is an important factor behind the employment rebound.

As the U.S. economy slowly weans itself from government and central bank support, we are looking forward to breaking out of the 2% annual rate of growth that we have been stuck in since 2009. Forecasts of 3% growth or better in 2014 are gaining traction.

The $1.3 trillion annual deficit of 2010 is expected to retreat to a more sustainable $500 billion - $600 billion level by this time next year. That would bring it back to about 3% of GDP, down from over 8% of GDP in calendar 2010. The improvement comes from higher taxes generated by a growing economy along with significant reductions in social spending, as unemployment falls from 10% toward 7.5%. The end of the Iraq war and the ongoing return of U.S. troops from Afghanistan are also saving the U.S. billions of dollars each month.

While all is not well in the world, we are experiencing a much improved financial situation. We continue to monitor Europe’s fiscal challenges and political hot spots around the world and will adjust our client portfolios to take advantage of future opportunities and to reduce the risk of bumps in the road as we move ahead.