NEWS
2011-10-11 :: 2011 Third Quarter Commentary -- 09.30.11
Looking Back
The only good thing about the 3rd quarter is that it is over. The biggest losers were Emerging Markets, International and Small Cap Stocks. Fear took over and left no stone unturned and although dividend stocks and income oriented stocks did better than the rest of the market there was no place to hide in the equity market.
Fixed income had a great quarter as fear gripped the globe and movement towards the safe haven of debt was appealing. All of that fear brought yields to all-time lows during the quarter.
Absolute return Hedge funds did not have a positive quarter, but did their job by staying ahead of the equity markets in the downturn.
Real Estate: Housing did not have any rebound during the quarter as prices moved even lower. We expected this to be long and painful, and it should remain until we have a demographic shift in our population. Mortgage rates are at historic lows, the expectation being that this would move the buy needle, but the needle did not budge. The Commercial sector is stabilizing but also saw a bit of a downturn in the quarter. The rental market is doing well, but prices have gone up dramatically, and this may be a bit problematic down the road. The retail sector was relatively stable, but demand is much slower and owners have no pricing power. The mall sector, as far as we are concerned, may be in trouble for years to come.
Commodities Gold and metals put in a decent quarter but pulled back at the end of the quarter. Almost all other commodities pulled back dramatically during the quarter as fears of economic downturns across the globe created a belief of dramatic demand destruction.
2011 YTD
Russell 1000 -9.25% Mid-cap -12.34% Russell 2000 -17.02%
Russell 1000 Value -11.24% Mid-cap Value -13.01% Russell 2000 Value -18.51%
Russell 1000 Growth -7.20% Mid-cap Growth -11.59% Russell 2000 Growth -15.57%
MSCI EAFE -17.18% MSCI Emerg Mkts -23.53% S&P 500 -8.68%
Looking Forward
Equities: We have not changed our longer term perspective (5-10yrs) of low to moderate single digit returns in the equity markets. The slow growth that we have been predicting for over a year is still present, but there are global headwinds. The market will continue to trade at a discount to historical P/E’s due to slow growth. On a positive note, valuations include consideration of a mild recession and we believe that even a little bit of good news may be an upward catalyst. Specifically, Europe could present a plan to save themselves and calm investors down enough to warrant equity investments. Additionally, earnings for this quarter can be on target or a little ahead of now discounted beliefs. The bond markets are at such low yields that the risk premium in equities has come down significantly. Our belief in large dividend growth and dividend value along with stock buybacks as a good place to be for several years has come to fruition.
Fixed income markets The 10 year treasury yield of 1.8% is indicating a recession. As of this writing most of the leading economic indicators do not support that belief. The Federal Reserve’s operation twist is a direct attempt to keep yields low to help stimulate the economy. In this kind of environment, bonds are a decent investment, as long as bond portfolios are not too far out on the duration curve. This will prevent a movement to higher yields hurting a portfolio. The municipal bond market may have a problem if the new jobs bill removes some level of tax-exempt status for those who make over $250,000, but we do not expect that to happen. High yield may not do well if issuers have a problem meeting their obligations, but this could be helped by positive trends in the economy. We continue to believe higher credit quality with shorter durations is the safest play.
Commercial & Residential Real Estate There continues to be no change to our forecast in real estate: It is simply going nowhere for years. Even with low interest rates, demand has not improved significantly. Please refer to our previous commentaries starting from Q3 2005. We think multiple unit rental properties are one of the few places to be in real estate. Residential lending has not increased by the banks. As for commercial real estate, we continue to be flat on office space and negative on the retail sector.
Absolute return hedge funds will continue to be a great place to invest if this environment continues. However, a positive catalyst that moves equities higher would likely have them underperform for the rest of this year. While they did their job in the 3rd quarter by being slightly negative as compared to the equity markets, this type of instrument is not designed to keep up with the upside of equities. Opportunities on the short side of fixed income may help them out a bit in this last quarter. However, in a slow growth economy, these types of hedge funds of funds should do well.
Commodities should start to pick up here in the 4th quarter as fear of demand destruction due to a market slowdown will probably wane. Precious metals may be relatively flat for the quarter as the fear trade may also wane.
