Q2 2011 Economic and Market Summary: July 19, 2011
Uncertainty and Volatility in Q2 – But Flat Returns in the End
The second quarter of the year is often a weak period for the financial markets as investors head into summer – hence the old adage ‘sell in May and go away’. The second quarter of 2011 followed this pattern. After a strong first quarter with the S&P 500 index up 2.85%, April started strong. Corporate earnings announcements in April reinforced investor belief that a recovery was on track. In May, however, the news flow evaporated and investors became fixated on what would happen on June 30th when the Fed stopped buying treasury bonds. Also, the European debt crisis, led by the troubles in Greece, created concern related to contagion across the region. In the U.S., investors received mixed signals on the health of our own economy as housing and unemployment continued to struggle. These concerns weighed on to May and June and the S&P lost -3.15% over this two month period. Q2 was a volatile quarter but the markets remained resilient. The broad U.S. stock market (S&P 500 index) ended the quarter up +.09% while European stocks ended up 2.44%. Bonds also fared well in the quarter as the Barclays U.S. Aggregate Bond index returned 2.29%. Despite the uncertainties, Q2 was not a bad quarter.
The Mountain of Debt Is Worrisome
Citizens and investors around the globe are living through the consequences of excess leveraging. Debt can be prudently utilized in many cases, however, when cash flow becomes constrained due to debt service costs, leverage can be devastating. Our global economy is now faced with a mountain of debt that has been accumulated over the past decade as citizens, corporations, and governments binged on borrowing and spending.
U.S. corporations were among the first to adjust their balance sheets. For the most part, they have recapitalized and now have healthy financial statements, excess free cash flow, and record levels of cash on hand. Many international corporations have done the same. Even banks are moving fairly rapidly to cut their loan losses and improve their financial health (although you wouldn’t know this based on bank stock performance). U.S. consumers are also starting to live within their means; curtailing spending, reducing debt and dare I say it… actually beginning to save. This doesn’t necessarily help the economy in the short term but will over the long run. The charts below show U.S. consumers’ savings rate and the level of household debt. We are a long way from levels reached in the 1970’s and 1980’s, but the trend is positive. Now the focus is squarely on local governments, Washington and the European Union.
The Debt Ceiling Debate
As the August 2nd deadline for resolution is fast approaching, the risk of default and lack of a serious plan are the focus of investors. We remain confident that our lawmakers in Washington will agree to raise the debt level in advance of the deadline. A default would have such far reaching ramifications that no politician would assume this risk, especially after the lessons from Lehman Brothers’ failure. The debt ceiling has been raised almost a dozen times over the last decade. We expect history to repeat itself but our larger concern is – what then?
The charts below depict the trend and level of debt the government has assumed over the past seventy years. Gross national debt is now over 90% of our Gross Domestic Product (GDP) and rising rapidly. This is simply not sustainable.
A debt level representing more than 90% of GDP and projected to go higher is a major problem that requires a clear plan from Washington. Budgets need to be balanced and this structural deficit needs to be addressed. Many analysts stress the importance of reducing the U.S. debt level back down to a more sustainable long term percentage of GDP below 60%.
Our leaders in Washington have let us down. The chart on the next page shows the rising debt level since 1981. Both parties contributed to our current situation and everyone needs to move beyond the current posturing and work together to create a balanced budget. This will take significant cuts but the cuts are long overdue. At the same time, there must be a plan to raise revenues. This debt level is so significant that budget cuts alone will not be enough to begin reducing the debt burden fast enough. Budget cuts and a plan for increased revenues are both needed if we are going to begin to climb out of the hole that we have dug ourselves.
The European Debt Crisis
The debt problems across Europe continued to spread. I can recall back in the late 1990’s when the EU was formed and the Euro was established as the currency. Our investment committee at the time discussed the validity of a combined currency and economy. We were perplexed as to how so many different governing bodies could become one unit and what would happen when a country didn’t pull its weight. Would the stronger countries revolt? Our own American government leaders can’t work together to balance a budget. How can the Euro zone consisting of 17 of the 27 member states of the EU come together and resolve significant issues? The challenges across the Euro zone are significant and the survival of the Euro as a currency is now in question.
On The Positive Side
U.S. corporations, as noted above, have largely recapitalized and their balance sheets are strong. Corporate earnings, the most important ingredient to stock price performance, continue to recover. According to analyst estimates compiled by Bloomberg, companies in the S&P 500 index are expected to increase earnings by 19% in 2011, including a 13% expected increase in Q2. Cash remains very strong, dividends are rising, share repurchases are healthy and merger and acquisition activity remains robust. Valuations, another major factor in stock price performance, remain attractive. The broad S&P 500 index trades today at 13 times projected 2011 earnings; below the longer term average of 15 times. Valuations look especially attractive in the largest or ‘Mega Cap’ corporations where valuation levels are in the 11-12 times earnings range.
Despite the positive notes above, the mountain of debt needs to be addressed before the equity markets have a chance to move meaningfully higher. The geo-political uncertainties continue to weigh on the financial markets and the markets do not like uncertainty. As these issues are addressed, investors can bring back their focus to the fundamentals of earnings and valuations. As they do, the equity markets have a good chance at continued appreciation. In the meantime, our wealth preservation programs stand ready to help mitigate risk and volatility while we patiently wait for Washington to get prudent policies in motion.
Braver Wealth Management News
Clients have asked that we share more news and information on our company in our quarterly letter. We are happy to do so.
Braver Wealth Management continues to gain recognition in the marketplace and we continue to grow our client base. We finished Q2 of 2011 with the highest assets under management in the history of the firm; we now advise on over $570 Million. I would like to thank all of you for your continued business and for your many referrals. Our client retention remains at nearly 100% and our growth continues to come primarily from client referrals to friends and family members.
Given our recent growth and our commitment to maintaining a personal relationship with each of our clients, it is likely that within the next few months we will be adding another senior level Relationship Manager. This potential addition allows us to add additional capacity ahead of demand so that we can continue to bring new ideas to our clients and maintain a proactive and highly customized level of service. Stay tuned for upcoming team news.
On the investment front, our unique ability to combine traditional investing (Asset Allocation and Dividend Income) with our wealth preservation strategies, which employ cash to preserve wealth in down markets, continues to differentiate our business in the marketplace. Our investors have the opportunity to generate competitive returns with the peace of mind provided by downside risk control. Our Wealth Preservation strategies, particularly High Yield Bond, Diversified Asset, and Tactical Allocation continue to receive industry recognition for their strong outperformance and risk control attributes. Most recently, High Yield Bond and Diversified received ‘Top Gun’ honors from leading industry consultants PSN Informa and Lipper. We are proud of these accomplishments and we remain committed to constantly improving our investment strategies and their performance. Our investment team has done a great job in maintaining investment discipline throughout these volatile markets.
If there are ways we can better assist you in reaching your financial goals, please do not hesitate to let us know. We are always looking for client feedback to guide our practice improvement.
Wishing you and your family an enjoyable summer!
Sincerely,
David J. D’Amico
President
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Published on: July 28, 2011
