After a dismal stock market from April to September the market rallied over 10 ... The Economy is doing much better with
Market Commentary David T. Albaneze, CFA Chief Investment Strategist/CEO Carrie Beasley Jones, CFP® Wealth Manager/COO
Summary • Economy – no recession • Earnings – better than expected • Europe – still uncertain • Election – political uncertainty
November 2011
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After a dismal stock market from April to September the market rallied over 10% in October. This rally places the Dow Jones Industrial Average (DJIA) back into positive territory year to date. During the past six months, the DJIA has traded in a 2,000 point range. This unprecedented volatility is related to the tremendous uncertainty in the global economy and in the United States political scene. The main uncertainties revolve around the four Es – the Economy, Earnings, Europe, and the Election. Economy The Economy is doing much better with a confirmation that we did not enter into a double‐dip recession this past summer. Third quarter gross domestic product (GDP) came in at 2.5% annualized after growing less than 0.85% during the first half of the year. Existing home sales and prices appear to have stopped declining while new home sales rose by 5.7% in September. Monthly nondefense capital goods orders (excluding aircraft) rose by 2.4% in September, the fourth increase in five months. The Leading Economic Index rose 0.2% for the fifth month in a row. This economic data indicates we have not entered into a recession and a modest recovery remains in play.
Despite all of this positive data, the economy isn’t out of the woods yet. Housing is still trying to find a bottom and without a recovery in housing we can only expect economic growth in the 1% to 2% area, well below a healthy growth rate of 2.5% to 3.0%. Unemployment also remains stubbornly high. Mass layoffs have leveled out but job creation has remained weak. To make matters worse, an estimated two million workers on extended unemployment benefits are scheduled to stop receiving benefits by June 2012. Without an extension or serious job creation, this will weigh heavily on consumer spending. Earnings Corporate Earnings reported for the third quarter came in better than expected. Over 65% of companies reported earnings that exceeded projections. These earnings reports had a common theme: due to slow revenue growth, corporations reduced operating expenses. This enabled them to post better earnings. Companies can only cut operating expenses so much. However, 70% of the reporting companies gave guidance of future earnings that were less than analysts’ expectations. For earnings to continue to increase, revenue will have to increase moving forward. 501 Riverside Avenue, Suite 800 • Jacksonville, FL 32202 Phone: 904.396.4015 • Fax: 904.399.4012
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Europe Europe still has been unable to find an acceptable solution to its sovereign debt issue and resultant banking crisis. Their leaders keep coming up with measures that do not fully address the problem. They celebrate reaching an agreement but cannot seem to get unanimous support from all of the member nations. A major agreement was reached 10 days ago but was brought into question with the Greeks having to hold a referendum in January to approve the austerity measures required to avoid default. If there is a forced Greek default, large European banks will have to write down the value of the Greek sovereign debt they own by 60% to 80%. This will endanger their ability to operate and meet capital requirements. If the European banks are unable to honor their obligations they will have to default on financial agreements with other banks, including some based in the U.S., potentially throwing the banking system into another crisis. The Europeans can resolve this potential problem by shoring up their banks and creating an orderly Greek default. According to the European Union’s plan for recapitalizing their banks, Tier 1 capital should be at 9% rather than the current 5%. To bring them up to the 9% level will cost around 185 billion euros. They also need to take write downs (haircuts) on the value of the sovereign debt they own to the tune of 70 billion euros. To bring European bank’s coverage ratio from 40% to where U.S. banks already are (67%) would take an additional 287 billion euros. In summary, Europe needs to spend over 500 billion euros ($700 billion) to resolve this crisis. The European Financial Stability Facility (EFSF) was created last year as a special purpose vehicle, financed by euro‐zone members to combat the sovereign debt crisis in Europe and currently carries 440 billion euros. Recently, the European Council announced that member states reached an agreement to further increase the effective capacity of the EFSF to one trillion euros. The problems with implementing the EFSF stem from the fact that all 17 euro‐zone countries have a say in how to deploy aid. Germany is the largest contributor to this fund and their parliament wants a say in how the EFSF deploys these bailout funds. This has created yet another obstacle for resolving this crisis. Election Finally, we get to the U.S. Presidential Election of 2012. It is evident President Obama will be the democratic candidate. The battle for the republican nomination should continue for another 10 months. I am not very hopeful that a much needed middle‐of‐the‐road candidate will succeed. I believe we will all again be faced with a choice of two nominees, neither of whom is satisfactory to most. The gridlock in Washington and the specter of class warfare needs to end if our economy is to fully recover. In summary, there is a lot of uncertainty in the global economy. Unfortunately most of the obvious solutions are in the hands of politicians. Until these uncertainties are resolved, I expect to see continued volatility in the financial markets. The good news is market sentiment has become more positive and the trend is now positive. This bodes well for future market gains. At Thanksgiving more than ever, our thoughts turn gratefully to those who have made our progress possible. And in this spirit we say, simply but sincerely, thank you and best wishes for a Happy Thanksgiving!
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