Economic Review and Market Perspective |
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Economic ReviewThe U.S. economy slowed from 3.1% GDP growth in the fourth quarter 2010 to 1.9% in the first quarter 2011. The decline was attributed to contraction in government spending exceeding the ongoing expansion in household spending and business investment in equipment and software. The Federal Reserve's most recent Summary of Commentary on Current Economic Conditions ("Beige Book") reported that the pace of economic growth was slowing in four of the twelve Federal Reserve regions. Fed Chairman Ben Bernanke indicated that the overall economic recovery "appears to be continuing at a moderate pace" albeit "frustratingly slowly" for unemployed workers. Bernanke expressed ongoing concern about declining home prices, persistent high unemployment rate, and persistent weakness in the global financial system. In July, amid worries about a deadlocked debate over U.S. budget cuts and raising the debt ceiling, Bernanke warned the Senate Banking Committee that extreme cuts to government spending in the short term could derail the fragile recovery and that a U.S. debt default could wreak financial havoc. He also stated that the Fed was prepared for another round of quantitative easing (QE3) if the economy worsened but also noted rising inflation over the first half of the year. Finally, two credit rating agencies have stated that they might cut the United State's triple-A credit ratings due to concerns Congress will not raise its debt ceiling in time to avert a default on U.S. debt. Employment data for the second quarter were discouraging. The U.S. Bureau of Labor reported that 244,000, 54,000, and 18,000 non-farm payroll jobs were added in April, May, and June, respectively. The downtrend was noteworthy, and the second quarter average of net new jobs of about 100,000 per month compares with a monthly average of about 150,000 in the first quarter. Over the last twelve months, the Consumer Price Index (CPI) increased by 3.6%. However, the Core readings (ex food and energy) were substantially lower than the headline numbers and were reported at 1.6% over the last twelve months. Nonetheless, this figure has been steadily rising and most of the increase was in the last six months. Outside the U.S., headlines were dominated by the Greek debt crisis with both equity and debt markets across the globe reacting to the ongoing efforts to enable Greece to avoid defaulting on their debt. Toward the end of the quarter, a proposed austerity package briefly tempered investors' fears about the potential for global contagion. However, extreme stress remains in all of the PIIGS countries. The amazing growth story from China continued. Its economy was hardly phased by the global recession and grew 10.1% in 2010. GDP has barely slowed so far this year; according to a recent report from Beijing, it grew at a rate of 9.7% and 9.5% in the first and second quarters of 2011, respectively, compared with the year earlier level. Market PerspectiveAs indicated in the table below, since March 2000 U.S. financial markets have experienced two market tops, two bottoms, and a possible third top (namely, as of April 23, 2011).
Even though rolling 12-month returns have been impressive, longer-term results remain mixed at best. Nonetheless, they do reveal the benefit of global diversification. Updating some past information we have provided, the negative impact on asset class returns of the two deep bear markets continues to be dramatic. Annualized returns for global large company stocks were not much above breakeven over the entire 11.25-year period covered by the text table above. Small cap U.S. stocks fared considerably better, outperforming large caps consistent with the seminal Fama-French research. Over the 11.25-year period, global bonds were even a bit better; they provided annualized returns in the vicinity of 6.5% (depending on one's U.S./foreign allocation) and also were fairly consistent performers (except the second half of 2008). Further, U.S. real estate funds were extremely strong over the period, providing total returns of almost 12% annually. However, almost all of the gain occurred before the latest 5-year period; in other words, real estate funds were also hard hit by the 2007-2009 bear market. Energy funds had similar performance, with somewhat less skewing toward the earlier years. Finally, emerging market stocks, especially Latin American stocks, were also very good performers over the 11.25 years. They were especially strong in the last five years when other stocks were relatively weak. The table below shows the 11.25-year data and also one-year and five-year returns as of June 30, 2011.
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