Market Commentary: June 4, 2010

The stock market experienced a substantial correction today: The S&P 500 dropped 3.44%, the Nasdaq dropped by 3.64%.

Today’s declines were driven by a disappointing jobs report from the Department of Labor, which showed that there was very little non-government hiring in May.  Earlier this week, several Wall Street firms’ research departments, and the President in a press conference on Wednesday, predicted that today’s jobs numbers would show significant private sector employment growth.

The persistence of unemployment, lackluster economic growth and the European financial crisis have all played a major role in a nearly 13% decline in most stock indexes since they reached their highs in April. But most importantly, what is driving these declines are a lack in confidence in the ability of governments to manage the economy and bring the longest recession in post-War history to an end. Despite attractive valuations, a resilient consumer and impressive growth in productivity, a significant number of investors are choosing to transfer their holdings into “risk free” assets like treasury notes and money markets. We expect that they will be (eventually) disappointed. However, for aggressive, trading portfolios, we expect that there will continue to be several attractive trades that emerge, for those who seek to profit from volatility.

There are several reasons to be optimistic about US equity prices:

• Micro vs. Macro: Largely the declines in corporate earnings predicted last year have not materialized. Corporate America has been very effective at cutting costs, increasing productivity and expanding unemployment. While the macro conditions we face, particularly most governments’ budget deficits, are very concerning, we don’t anticipate that corporate tax rates will be dramatically increased or that there are many other reasons to expect a significant contraction on aggregate earnings in the coming years.
• Valuations attractive: The declines in stock prices have not been attended by compression in earnings or dividends. This means that stocks become increasingly better values with these market declines and it seems likely that investors will realize that.
• Corporate bonds rally when stock market declines: The fixed income markets for corporate bonds have held up well and corporate bonds remain very attractive investments compared to treasuries, but stocks on a dividend basis remain quite attractive to corporate bonds. The fact that investors are “flying to safety” in corporate bonds indicates that, unlike last year, the markets are operating “normally” in the sense that bonds increase in value as stocks go down. This strongly indicates that our broadly diversified asset allocation strategy will continue to be effective in managing risk.
• The US isn’t an export economy: It’s unlikely that the European financial crisis will have much impact on the long term health of the US because foreign exports represent so little of the US economy.

 Accordingly, for most clients, we’re recommending that they seek to ride out the current equity market environment, which we see as temporary.

As always, please feel free to call us any time with any questions or concerns.