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* 60% All Country World Index/40% Barclays Aggregate
After five months of declines, the S&P 500 posted a double-digit increase in October, bringing year-to-date gains to just over one percent. Gains were broad based, as commodities, emerging markets and credit sensitive fixed income instruments also participated. To quote recent Wall Street parlance, we had a classic “risk-on” month.
So what changed? While it is difficult to pinpoint a single event that sparked investor enthusiasm for risk assets, several data points served to diffuse many of the doomsday scenarios that have haunted investors in recent months. For starters, the domestic economy continued to chug along despite ever increasing calls for a double dip recession. Recent data (retail sales, auto sales, credit card usage) suggests that the American consumer is alive and well, with expenditures actually accelerating from levels seen earlier in the year. Preliminary third quarter GDP growth was reported at a +2.5% annualized rate, up from +0.4% and +1.3% in the first half of the year, confirming the recent pickup in activity.
While the economic backdrop was supportive of a relief rally, third quarter earnings reports gave investors the comfort to go bargain shopping. With roughly 90% of the S&P 500 reporting to-date, total net income growth (year-over-year) has been much better than expected at +16.01%, well above the +11.47% in the second quarter. Top line growth thus far has been +12.43%, a slight acceleration from the second quarter. Bottom-up estimates for the S&P 500 in 2012 now stand at $106.34, placing the current market multiple at roughly 12x. From a historical perspective, one could argue that the market looks “cheap”, all else being equal. Of course, in today’s environment, this is far from the case.
Europe remains the wild card, and, unfortunately, will likely remain so for a while. Despite some incremental improvements seen throughout the month of October, the environment remains very unstable and subject to change without notice. While the ECB’s 25 basis point rate cut was a step in the right direction, it appears that Italy has successfully overtaken Greece as the prime threat to stability in the region. In addition, France continues to struggle to maintain its AAA rating, without which the euro zone might no longer be able to bail out its weakest members. And the spiral continues…
Refocusing back on the domestic front, all eyes are on the super committee tasked to reduce the fiscal deficit by $1.2 trillion over the next 10 years. With a deadline of November 23rd before automatic cuts in military and entitlement spending are enacted, one cannot help but wonder if we are in for a replay of the mid-summer fiasco that led to an S&P downgrade. We need not look but across the Atlantic to see how quickly the bond vigilantes can impart their wisdom in the form of rapidly rising interest rates. Thus far, the United States has remained out of the cross hairs. Let’s hope it stays that way.
As we look forward to the remainder of the year and into 2012, there are reasons to be both optimistic and downright bearish. On the plus side, the domestic economy appears to be accelerating despite severe headwinds both here and abroad. While unemployment remains a front and center issue, consumer spending has been a positive surprise and may continue to pick up steam as we enter the all-important holiday season. Should this trend continue, the economy could be on stronger footing than is currently the consensus. In addition, S&P 500 earnings should provide some valuation support to the markets as corporations continue to generate attractive profit growth despite economic challenges.
All is not rosy, however, especially when one evaluates the potential outcomes of the European crisis. While the situation remains fluid, it is hard to see how this all ends well. Recent progress appears to have reduced the systemic risk of a banking collapse, but the fallout seems to all but ensure a recession at a minimum and perhaps something significantly worse. And while the United States has managed to stay out of the spotlight for a while, November 23rd may bring with it our day in the sun. A trading range for equity markets appears to be the most likely scenario until many of these pressing issues come to a head, one way or another.
This communication is not an offer or solicitation with respect to the purchase or sale of any security and is for informational purposes only. Information contained herein has been derived from sources believed to be reliable, but CAPROCK makes no representations as to its accuracy or completeness. Investment in securities involves the risk of loss. Past performance is no guarantee of future returns.
October Market Commentary
Saturday, Oct 1, 2011 Global equity markets rallied sharply in the month of October as fears of an imminent global recession receded and the news flow out of Europe turned more positive. Fixed income markets were essentially flat as Treasury prices declined but corporate bonds rallied throughout the month. Market performance for the month is summarized in the following table:| Index | October | YTD | Index | October | YTD |
| S&P 500 (Total Return) | +10.93% | +1.30% | All Country World Index (Net) | +10.80% | -4.29% |
| MSCI EAFE (Net) | +9.64% | -6.78% | Barclays Aggregate | +0.11% | +6.76% |
| MSCI Emerging Markets (Net) | +13.25% | -11.53% | 60/40 Blend* | +6.52% | +0.39% |
After five months of declines, the S&P 500 posted a double-digit increase in October, bringing year-to-date gains to just over one percent. Gains were broad based, as commodities, emerging markets and credit sensitive fixed income instruments also participated. To quote recent Wall Street parlance, we had a classic “risk-on” month.
So what changed? While it is difficult to pinpoint a single event that sparked investor enthusiasm for risk assets, several data points served to diffuse many of the doomsday scenarios that have haunted investors in recent months. For starters, the domestic economy continued to chug along despite ever increasing calls for a double dip recession. Recent data (retail sales, auto sales, credit card usage) suggests that the American consumer is alive and well, with expenditures actually accelerating from levels seen earlier in the year. Preliminary third quarter GDP growth was reported at a +2.5% annualized rate, up from +0.4% and +1.3% in the first half of the year, confirming the recent pickup in activity.
While the economic backdrop was supportive of a relief rally, third quarter earnings reports gave investors the comfort to go bargain shopping. With roughly 90% of the S&P 500 reporting to-date, total net income growth (year-over-year) has been much better than expected at +16.01%, well above the +11.47% in the second quarter. Top line growth thus far has been +12.43%, a slight acceleration from the second quarter. Bottom-up estimates for the S&P 500 in 2012 now stand at $106.34, placing the current market multiple at roughly 12x. From a historical perspective, one could argue that the market looks “cheap”, all else being equal. Of course, in today’s environment, this is far from the case.
Europe remains the wild card, and, unfortunately, will likely remain so for a while. Despite some incremental improvements seen throughout the month of October, the environment remains very unstable and subject to change without notice. While the ECB’s 25 basis point rate cut was a step in the right direction, it appears that Italy has successfully overtaken Greece as the prime threat to stability in the region. In addition, France continues to struggle to maintain its AAA rating, without which the euro zone might no longer be able to bail out its weakest members. And the spiral continues…
Refocusing back on the domestic front, all eyes are on the super committee tasked to reduce the fiscal deficit by $1.2 trillion over the next 10 years. With a deadline of November 23rd before automatic cuts in military and entitlement spending are enacted, one cannot help but wonder if we are in for a replay of the mid-summer fiasco that led to an S&P downgrade. We need not look but across the Atlantic to see how quickly the bond vigilantes can impart their wisdom in the form of rapidly rising interest rates. Thus far, the United States has remained out of the cross hairs. Let’s hope it stays that way.
As we look forward to the remainder of the year and into 2012, there are reasons to be both optimistic and downright bearish. On the plus side, the domestic economy appears to be accelerating despite severe headwinds both here and abroad. While unemployment remains a front and center issue, consumer spending has been a positive surprise and may continue to pick up steam as we enter the all-important holiday season. Should this trend continue, the economy could be on stronger footing than is currently the consensus. In addition, S&P 500 earnings should provide some valuation support to the markets as corporations continue to generate attractive profit growth despite economic challenges.
All is not rosy, however, especially when one evaluates the potential outcomes of the European crisis. While the situation remains fluid, it is hard to see how this all ends well. Recent progress appears to have reduced the systemic risk of a banking collapse, but the fallout seems to all but ensure a recession at a minimum and perhaps something significantly worse. And while the United States has managed to stay out of the spotlight for a while, November 23rd may bring with it our day in the sun. A trading range for equity markets appears to be the most likely scenario until many of these pressing issues come to a head, one way or another.
This communication is not an offer or solicitation with respect to the purchase or sale of any security and is for informational purposes only. Information contained herein has been derived from sources believed to be reliable, but CAPROCK makes no representations as to its accuracy or completeness. Investment in securities involves the risk of loss. Past performance is no guarantee of future returns.
