Winter 2010
Market Commentary
By Julie Grandstaff, vice president and managing director, StanCorp Investment Advisers, Inc.
We’ve said goodbye to 2009, and it was a year to remember (or wish we could forget). The year had a rough start. The financial sector was still in turmoil following a near meltdown in the fourth quarter of 2008. Despite significant efforts, government attempts to calm the markets and stabilize the financial sector only added to anxiety, and the market reached its low point for the downturn in March. In the second quarter, we began to see the light at the end of the tunnel. Equity markets rallied substantially from their lows, consumer confidence improved and job losses slowed. While home values continued to decline, low prices started bringing buyers to the market, and there was an uptick in home sales. The third quarter brought further recovery and a declaration by Fed Chairman Ben Bernanke that the recession was likely over. Another rally of the same magnitude as the second-quarter rally didn’t hurt either.
The fourth quarter brought additional good news, but also highlighted how difficult it will be to fully return to capacity growth rates. Third-quarter GDP rose at a 2.2 percent annual pace. Leading economic indicators continued to rise, indicating growth will be sustained into the first half of 2010. Analysts speculate that inventory restocking could add to industrial production for the next several months. Existing home sales are on the rise, capacity utilization is up and retail sales have improved.
However, the economy continues to lose jobs. After a modest gain in payrolls in November, the economy lost 85,000 jobs in December. That brings the total for the recession to 7.2 million jobs lost. With moderate growth, it could take 5 years to replace the lost jobs. The weak job market is leading to increased foreclosures of prime mortgages. To date, most foreclosures have been in the sub-prime market, but emerging data suggests prime mortgage (mortgages to individuals with good credit) foreclosures will continue to increase into 2010, keeping home values from gaining ground. In addition, commercial property vacancies will create further weakness in the commercial mortgage market. Ongoing weakness in residential and commercial loan portfolios may keep banks on the sidelines for the near term, keeping credit tight.
The equity markets increased during the fourth quarter, but at a slower pace than in the previous two quarters. The S&P 500 was up 6.04 percent for the quarter. Small-cap stocks (Russell 2000) gained 3.81 percent and international stocks (MSCI EAFE) gained 2.18 percent. Fixed-income markets were nearly flat with treasury yields rising during the quarter. The BarCap Aggregate Bond Index was up 0.20 percent for the quarter. For the year, the S&P was up 26.46 percent, the Russell 2000 was up 27.17 percent and the MSCI EAFE index was up 31.78 percent.
For the quarter and year, growth outpaced value. The best performing category for the quarter was large-cap growth (Russell 1000 Growth), up 7.94 percent. The best performing category for the year was mid-cap growth (Russell Mid Cap Growth), up 46.29 percent for the year.
Market valuations have increased significantly. Based on forward earnings estimates, the price/earnings ratio of the S&P 500 is over 20, up from a low in March of just over 13. The long-run average P/E ratio is around 16. Based on this information alone, the market would appear to be overvalued; however, there are mitigating factors. Primarily, interest rates remain low. The yield on the three-month Treasury bill remains near zero and the yield on the 10-year Treasury bond ended the year at only 3.8 percent. Flipping the P/E ratio upside down provides the earnings yield for the S&P 500. At over 5 percent, equities remain a good value relative to bonds and money market securities. In fact, the P/E ratio of the S&P 500 is typically in the mid 20s in low interest rate environments.
Looking ahead, the economy faces considerable headwinds. Economic growth appears to be running at around a 4 percent annual growth rate currently, but it is not unusual to see a bounce in economic activity after such a deep plunge. Economists are concerned that job creation will stay low as companies remain concerned about the sustainability of the recovery. Credit will remain tight until bank balance sheets have recovered further. With delinquencies continuing to grow in both residential and commercial mortgages, it will take time for those balance sheets to recover. With tight credit, one of the usual fuels for economic growth is running very low. We’ve come out of the recession, and we are likely on a sustainable growth trend. However, it is likely to be slow going to recover to our pre-recession growth path.
