Summer 2009
Second Quarter Market Commentary
By Julie Grandstaff, Vice President, StanCorp Investment Advisers, Inc.
The equity markets continued to rebound in April and May. Through the end of May, the S&P 500 was up 15.70 percent, while the Russell 2000 was up nearly 19 percent. International markets were even stronger, with the MSCI EAFE index gaining over 26 percent. Since the end of May, markets have struggled to make additional progress. The strength of the markets can be linked to better economic news and reduced anxiety in the financial markets.
The economy appears to be bottoming out, relatively on schedule. The pace of the contraction is slowing with home sales picking up, improving consumer confidence and slowing job losses. In addition, the financial markets appear to be healing. However, consumers are more focused on “deleveraging” (paying off debt rather than spending), which means consumption and industrial production are both down. As a result, a rapid expansion is not in the cards, though we expect to see continued improvement.
With home prices continuing to decline, more buyers are being drawn into the market. Whereas existing home sales have improved, new home sales continue to be weak; inventories in both markets are down from their highest points. The existing home inventory is down to 9.5 months, while the new home inventory is down to just over 10 months. The housing affordability index remains high, though not quite as high as in January. While home prices continue to decline, mortgage rates are up, offsetting the lower prices. Mortgage rates have climbed despite the Fed’s efforts to keep rates low. The 10-year Treasury bond yield, which is the basis for most mortgage rates, is 1.27 percent higher than it was at the end of 2008.
Consumer confidence has rebounded. The Conference Board's Consumer Confidence Index rose to nearly 60 in June while the University of Michigan’s Consumer Sentiment Index rose to over 69, its highest level in nine months. Improvement in both measures reflects stabilization in both housing and manufacturing sectors, and fewer job losses. These levels do not indicate a positive outlook; an index reading of more than 100 is required for that.
Financial markets have shown improvement as well. The interest rate spread on corporate borrowers over Treasury bonds has narrowed dramatically. Year to date, corporate issuers have been able to issue an average of more than $29 billion per week in new debt. Compare that figure to the $15 billion for the entire fourth quarter.
In addition, the Treasury department’s review of the largest banks’ balance sheets helped restore confidence in these institutions. Their new capital requirements were found to be manageable, and most have already been able to raise the capital in the private markets. The SEC’s guidance on fair-value accounting rules has relaxed valuation requirements for assets without an active market, and that has reduced ongoing pressure on bank balance sheets. Several institutions are already repaying their TARP money. Loan portfolios remain stressed, however, with high and rising delinquency rates that will continue to keep credit tight for consumers as banks try to improve the quality of their loan portfolios.
Personal consumption has improved significantly. Real personal consumption was up 1.5 percent in the first quarter. While we do not expect further contractions of the magnitude of the last half of last year, we are unlikely to see a significant rebound in spending. The recent crisis has elicited a new attitude of frugality. The savings rate has risen dramatically to nearly 7 percent as the consumer continues to deleverage; many analysts are expecting it to rise to over 10 percent. Combined with historically low capacity utilization rates, this is expected to lead to a long and slow recovery.
The significant market rebound has increased valuations. The price-to-earnings
ratio on the S&P 500 based on forward earnings estimates is
now over 14. The dividend yield remains close to the yield on 10-year
Treasuries, indicating the relative value to Treasuries is still
attractive. In the current economy, we are unlikely to see significant
earnings expansion — growth expectations are too uncertain.
As a result, the market may be approaching fair valuation. Continued
good news on the economy as well as improvements in company earnings
in the second quarter will be important to keep the market going.
