Aspiriant | Insight July 2010 | Volume XVII No. 2 | Correction!


Second quarter 2010 results were significantly negative in all equity asset classes. After a solid performance early in the quarter through late April, domestic and overseas markets suffered losses in May and June, accumulating to, in some cases, well over 10% for the quarter.

Source: Zephyr StyleAdvisor; Bloomberg

Source: Bloomberg

We’re experiencing what is often defined as a “correction,” a decline of at least 10% from a recent high value. These occurrences, through unsettling, are actually quite common (the S&P 500 has experienced 23 “corrections” since World War II) and more often than not do not continue to decline to result in a loss greater than 20% (there have only be 10 “bear markets” in that post-war time frame). We’ve gone through a very deep one of those all too recently, thank you very much. We don’t believe we’re headed for a repeat.

No Double Dip

Many investors fear that the world’s economy is headed for another recession while barely emerging from the one we’ve just endured. Job growth is painfully slow and the ranks of the very long-term unemployed and discouraged is growing. This is in part due to a permanent restructuring of the labor market; many of these unemployed will not find new work without significant retraining in new job skills. Moreover, sovereign and private debt in several European countries and Japan, as well as in the US, has reached worrying levels, threatening, as some see it, a renewed global banking crisis. In the US at least, some of this concern may be being fed by partisan rhetoric on both sides: Democrats looking for justification for more stimulus, Republicans hoping for electoral advantage this November as voters lay blame for a weak economy on the party in power.

As our Chief Investment Officer, Jason Thomas, comments in the article to follow, a further area of potential major risk is the new global theme of government austerity (increased taxes and/or reduced spending). As almost everyone agrees, deficit spending is necessary short-term medicine; but it should not...and a steady diet. Even in the US, there is a growing acknowledgement of the need for greater fiscal discipline and an eventual achievement of more balanced budgets and reduction of accumulated debt; the debate is now only about the pace of implementation. Many fear that it will be too much and too soon, withdrawing government support for a fragile economy before private investment has the opportunity to fully revive.

We are mindful of these risks and suspect that markets will not be able to avoid continuation of sharp, day to day (or even hour to hour) volatility for some time to come. Still, we remain optimistic that the world’s economy will continue to grow and we’ve helped clients position their portfolios to benefit from that future growth.

We wouldn’t be surprised to see the market’s current gloomy sentiment change course, rapidly, and with considerable force. Current market volumes are historically light; quite a bit of capital (some estimate several $ trillions) is "sitting on the sidelines", waiting for a clearer signal to resume riskier commitments. All that liquidity is earning virtually nothing as interest rates remain extremely low. Meanwhile, valuations hover at the lower reaches of historical ranges (the S&P 500 is now trading at a multiple under 12, where 15+ is average, and this is with a discount rate near zero!) The catalyst for a change of heart will likely be better news on the housing front and a sizeable pick-up in job creation. Both of those could still be some time off. In the very near term, however, there is likely to be quite good news in the growth in corporate earnings, both in the top and the bottom lines; better than 25% year over year improvements in earnings are broadly expected for this second quarter.

Still, the general tone of uncertainty regarding tax treatments and rates, implementation of the new healthcare regime and of other regulatory policies, and the disgust and sense of helplessness associated with the Gulf oil spill combine to nearly paralyze many market participants. Meanwhile, wars in Iraq and Afghanistan continue to take their psychic and financial tolls, terrorism remains a significant threat, and the re-rationalization of the highly leveraged model for business and government is still incomplete. We are not expecting a comfortably smooth ride. However, we are thoroughly convinced that people and businesses will continue to figure out ways to create value. Our clients’ portfolios are designed, with broad exposures at every stage of the value chain, and throughout the world, to take advantage of that value creation over the long-term. And along the way, we continue to look for effective and low cost ways to facilitate those exposures and to mitigate their risks as much as possible.

Beyond these generalities, please let us know how we can address your specific concerns, as we meet or talk in the coming weeks. We are always eager to discuss these important issues with you.

Tim Kochis

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