THE DISLOCATION BETWEEN THE MARKETS AND ECONOMY
With the S&P 500 up 13.08% and MSCI EAFE up 8.55% year to date as of market close 8/23/12, it begs the question, have the equity markets moved too high given the current state of their economies? We have stayed committed to our equity exposure because there are reasons to be optimistic, but we have concerns about the European debt crisis and weakening US fundamentals, which is why we continue to hold hedges in our portfolios and are conservatively positioned. Highlighted below are a number of uncertainties and policy decisions to be made in the months ahead which make it very difficult to predict how the market will react in the second part of the year. Therefore, we are continuing to position our portfolios defensively and although this has resulted in missing some of the recent upside return in the market, we believe it is the prudent investment decision at this time.
Weakening US Fundamentals
- Unemployment ticked up to 8.3% in July and will continue to be a drag on GDP growth.
- Manufacturing has shown signs of weakness as of late. The ISM Manufacturing index came in at 49.8% in July (Levels higher than 50 signal expansion; levels below 50 signal contraction).
- Lackluster GDP growth; Q2 real GDP growth was a mere 1.5% (QoQ)
- Uncertainty around a possible “Fiscal Cliff.” The non-partisan Congressional Budget Office (CBO) estimates that the tax increases and spending cuts set to go into effect at the end of 2012 would cut gross domestic product (GDP) by four percent in 2013, sending the US economy into a recession.
- Increasing Consumer Debt: The issues surrounding the government’s balance sheet are well known, but, consumer debt levels are also beginning to look like a negative indicator once again. After shedding almost 7% ($180 billion) since its highest point on 6/30/08, consumer debt has risen by $146 billion, which is just 1.33% from the all-time high.
The European Debt Crisis
- Mario Draghi, the president of the European Central Bank, announced that the ECB is ready to do “whatever it takes” to preserve the European Monetary Union, but the European debt problems have not been “solved.”
- The Greek government needs billions of Euros in additional aid to avoid bankruptcy or will be forced to leave the Euro.
- The United States, with a 90% GDP correlation to European growth, will be negatively impacted by a possible deep recession in Europe.
Not Your Typical Market Rally – In Fact, Just the Opposite
- The dollar has made up ground against a basket of international developed currencies, including the Euro.
- The S&P 500 has outpaced both the MSCI EAFE Index and the MSCI EM Index
- Large Caps have outperformed Mid Caps, which have outperformed Small Caps
- Net outflows in equity funds YTD ($51,879 billion as of 7/31/2012)
Jeremy Grantham, Chief Investment Strategist of GMO summed up the market situation well in his latest quarterly letter. He wrote, “The economic environment seems to be stuck in a rather unpleasant perpetual loop. Greece is always about to default; the latest bailout is always about to save the day and yet never seems to; China is always about to collapse but instead teases us by inching down. In the U.S., the fiscal cliff looms along with debt limits and the usual election uncertainties. The dysfunctional U.S. Congress continues for the time being in its intractable ways. The stock market rises and falls and rises and falls again. It is getting difficult to find anything new to say. I, for one, wish that the world would get on with whatever is coming next.”
Although this market outlook has been prepared from public and private sources and data that LTAM believes to be reliable, LTAM makes no representation as to its accuracy or completeness. Any indices and other financial benchmarks shown are provided for illustrative purposes only, are unmanaged, reflect reinvestment of income and dividends and may not reflect the impact of fees. Investors cannot invest directly in an index and the Program’s performance may differ substantially from the performance of an index. Investors should bear in mind that past performance is no guarantee of future results and there can be no assurance that the Program will achieve comparable results. Investment products are subject to investment risk, including possible loss of the principle amount invested. The information and views expressed are given as at the date of the writing and are subject to change. This information is not to be used or considered as an offer or the solicitation of an offer to sell or buy any securities mentioned herein. Ladenburg Thalmann Asset Management Inc. is a registered investment advisor and subsidiary of Ladenburg Thalmann Financial Services Inc. which is traded on the NYSE MKT under the symbol LTS. Data comes from the following sources: Bloomberg, New York Times, GMO, Gluskin Sheff, and ING Investment Management.