August 2010 – Market Commentary

Global stock markets retreated in August as evidence mounted that the economic recovery was slowing.  Numerous economic reports, lowered earnings expectations and fears of deflation all led to uncertainty about the U.S.’s ability to continue to recover from the “Great Recession.” The Commerce Dept. revised down its estimate for GDP for the 2nd quarter from the previously projected 2.4% to 1.6%, emphasizing the overall trend.  Investors’ fears of the recovery weakening led to investors bailing out of equities and moving into traditional safe haven investments over the course of the month.

Economic News
-U.S. job creation continues to be a major issue as initial jobless claims grew to 500K the week ending August 14th.  The four week moving average, used to smooth the volatility of the number, reached its highest level this year in August.  With the current unemployment rate at 9.6%, significant inroads in job creation will need to be made in order to get consumers to begin spending again.

-Despite 30 year mortgages hitting record lows of 4.49% sales of existing U.S. homes fell 27.2% in July to a level that has not been seen in over a decade.  New home sales fell 12.4% in July, the lowest since 1963.  Due to an increase in inventory, many buyers on the sidelines after the new home tax credit expired and the poor job market, home prices are likely headed for another decline.

-Factory activity grew, but at a slower pace in many major economies in July.  Non-defense capital spending dropped 8% and durable goods orders fell 3.8% in July.  Both are indicators that businesses are turning cautious about the future.

-July’s inflation numbers remained tame as the CPI rose only 0.1%, excluding volatile food and energy prices.  The low number along with the continued lack of consumer spending exacerbated fears of deflation.

-With weakening economic news being released daily, the Fed announced it would begin reinvesting proceeds of maturing mortgages into U.S. Treasury Debt.  While the move is mostly symbolic, the change from shrinking the portfolio illustrates the Fed’s concern over the recovery.  The FOMC stated that the “pace of economic recovery is likely to be more modest in the near term than had been anticipated” and they would be open to making “additional stimulus” moves.

-In Europe the picture was slightly rosier as the Euro-zone GDP rose 3.9% in 2Q aided significantly by a 9% increase in German growth.  Additionally, business purchases continued to show growth and economic sentiment improved in the Euro-zone in August, hinting that Europe might be able to withstand a slowdown in the U.S. and Japan.

-China is expected to become the world’s 2nd largest economy, passing Japan, later this year.  China’s GDP for 2Q was $1.339 trillion, or $51 billion ahead of Japan’s. This is an unprecedented position for a still developing country and is further evidence of China’s break neck expansion.

Corporate News
-Merger and acquisition news dominated the headlines over the month of August as companies, frustrated with lack of market growth, have looked to expand by taking over other firms.  The M&A activity was at its highest level since late 2009 providing some good news for the economy.  Mining goliath BHP Billiton, packaging and storage product producer Rank Group, Intel, First Niagara Financial Group, HP and Dell all were heavily involved with M&A activity over the month completing or making highly publicized attempts at acquiring other firms.

-Large tech firms Cisco and Intel both were cautious with their earnings forecast as they see weak demand eating into sales in the second half of the year.

-As investors poured into the debt markets, rates for new issues dropped precipitously.  Johnson and Johnson issued $1.1 billion of 10 and 30 year bonds at the lowest rates ever for corporate debt with those maturities and junk bond issues hit weekly highs.

Market News
-Worsening economic data weighed on stocks as the Dow lost 3.9% and S&P 500 lost 4.5% for the month of August, which has historically been a positive month for stocks.  It was the worst August for the Dow since 2001 and both indices moved back into negative territory for the year to date.  The Russell 2000, measuring small cap stocks, posted its worst August in 12 years dropping 7.4%.

-Investors’ fears of the recovery weakening led to a mass exodus from equities and a move to traditional safe haven investments.  Fixed Income indices were up across the board on the flight to quality with returns ranging from 0.1% for short term treasuries to 2.3% for 7 year Munis. Yields continued to drop as investors piled into bonds with the yield on the 10 year Treasury note falling to 2.50%, its lowest level since April 2009.

-The Yen continued to climb hitting its highest level in 8 months due to China’s rapid buying of the currency and continued weakness in the U.S.  This resulted in the Bank of Japan having an emergency meeting and agreeing to take additional steps to curb the swift ascent of its currency.

Index Performance – August
-4.51% – US Large Cap Stock (S&P 500)
-2.77% – International Stock (FTSE AW ex US)
+1.29% – US Broad Bonds (BarCap Aggregate)
+1.78% – US Government Bond (Barclay’s Govt)
+0.03% – Cash (ML 3Month T-Bill)


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