Fall 2009
Market Commentary
By Julie Grandstaff, Vice President, StanCorp Investment Advisers, Inc.
The third quarter brought more evidence that the economy is recovering. In fact Fed Chairman Ben Bernanke was so bold as to say in his regular testimony before Congress that the recession has likely ended.
The equity markets appear to have a similar opinion. Third-quarter gains are in line with second-quarter gains. The S&P 500 was up over 15 percent in the third quarter and over 34 percent in the last two quarters. In a sign that the market appetite for risk is returning, small, mid and international stocks did even better. The Russell Mid Cap, Russell 2000 and MSCI EAFE indices were all up more than 19 percent for the quarter. Bonds also performed well during the quarter as credit spreads relative to Treasury yields continued to compress. The Barclays Capital Aggregate Bond Index was up over 3.25 percent for the quarter.
Household net worth rose for the first time since the third quarter of 2007 during the second quarter. Equity market gains and rising home prices contributed to a $2 trillion gain for households and an increase in consumer confidence. The University of Michigan Index of Consumer Sentiment reached 70.2 in September versus 65.7 in August. This is a significant improvement from earlier in the year, but far from optimistic, which is defined as a reading above 100. Rising equity markets, consumer confidence and a pickup in homebuilding contributed to a 0.6 percent rise in the Leading Economic Indicators in August and a revision of the July numbers from +0.6 percent to +0.9 percent.
The economic stimulus packages have had an impact. The Cash for Clunkers program was a resounding success. As one congressman said, if you give people free money, they’ll use it. With over $3 billion injected into the economy to buy gas guzzlers from consumers trading for new, more fuel-efficient vehicles, it’s no wonder that retail sales were up 2.7 percent in August, the most in three years.
The strength in retail sales extended beyond the auto sector. Sales excluding autos were up 1.1 percent compared to an expected 0.4 percent. Home sales have also benefited. First-time home buyers taking advantage of the $8,000 tax credit accounted for 43 percent of home sales since the credit took effect. Prior to the activation of the tax credit, sales to new home buyers represented only 32 percent of home sales.
While the stimulus has provided tangible benefits, the question remains: What will happen when the programs end? Cash for Clunkers expired over Labor Day weekend, and the First Time Home Buyers Tax Credit expires December 1. The Federal Reserve is taking a cautious approach. They have extended the mortgage purchase program, set to expire in December, through March, and they have committed to keep interest rates low for the time being. While we’ve seen some significant improvements, we are not yet out of the woods.
The job market, while improved, remains weak. Non-farm payrolls were down by 216,000 in August, the smallest decline this year, but overall unemployment reached 9.8 percent. With 27 states reporting increases in unemployment, it is likely we will see 10 percent unemployment by year end. Surveys of employers indicate a 2 percent decline in payrolls is likely for the fourth quarter of this year.
Other signs that the economy is far from robust came with recent housing and durable goods reports. Residential home prices came in weaker than expected in July. Home prices rose 0.3 percent versus analyst expectations for a 0.5 percent gain. Home prices remain 4.2 percent lower than this time last year. Existing home sales unexpectedly declined by 2.7 percent.
Durable goods orders were also down by 0.4 percent in August, the biggest decline since January. Non-defense capital goods, an indicator of business spending, declined 0.4 percent following a 1.3 percent decline in July. Capacity utilization remains very low, which may cause business investment to remain low for some time. In addition, while household spending has stabilized, it remains constrained.
There seems little doubt that this recovery will take some time to gain its footing. While the equity market gains have been reassuring, these came off of very weak valuations. The forward-looking price/earnings ratio has improved to over 15 and the dividend yield has declined to 2.6 percent. Earnings growth expectations are limited, with economic growth expected to be slow; however, there is still room for further appreciation.
While the dividend yield has declined and the P/E ratio has increased, the earnings yield (earnings/price) remains well over 6 percent, comparing well to alternatives in the fixed-income arena. With interest rates so low, the stock market remains relatively attractive.
Given that there is still no sign of inflation, and the Treasury intends to maintain stimulus programs, such as the mortgage purchase program, we anticipate interest rates will remain low for some time. Despite recent gains and slow economic activity, there may be more room for the equity markets to appreciate.
