Financial Market Review


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Financial Market Review

  1. 1. Financial Inside This Issue n Economic Outlook and Review Market Review n n Stock Market Review Fixed Income Market Review Second Quarter 2009 n Alternative Investments Review Economic Outlook and Review government policies have helped tremendously, overall success has been limited by reticent consumer spending. M&I Investment Management Corp. Consumer spending has been roughly flat for the Signs of Stabilization (aka Green Shoots) quarter despite government support adding to Recent economic statistics have been decidedly mixed, disposable personal income. Retail sales, less autos which should be considered a necessary precursor to and gasoline, are unimpressive at best. We would economic recovery. Although “less bad” does not yet expect that as wealth slowly rebuilds and confidence signal an upturn, it does indicate an approaching turns upward, spending growth should advance in inflection point in economic growth. Take it from Warren line with income. For now, average hourly earnings Buffet himself who commented recently that the are up a modest 2.7% from a year ago and the average “economic recovery will be a slow process.” workweek has fallen to a record low 33 hours. No The Conference Board publishes a measure known as the wonder the personal savings rate has moved from 0% Leading Economic Index TM (LEI). The LEI increased in April at year-end 2008 to near 7% today (a 15-year high). for the first time since 2008 and rose again in May. Overblown Inflation Fears Diffusion indexes such as the purchasing managers’ Over the last three months, the trade-weighted dollar has surveys appear to have turned the corner, especially the fallen 6%. The CRB® Commodity Index has advanced 30% new orders component which moved into growth over the same period. Yet, the National Federation of territory at last report. Initial unemployment claims have Independent Business surveys show very limited pricing declined to levels consistent with slowing job reductions. power. Massive excess capacity exists in many goods Temporary employment fell by just over 37,000 jobs in producing companies. Labor has no bargaining power June, the best performance of this leading indicator in with the national unemployment rate pushing closer to many months. 10% and much higher in some geographic locales. Although import prices rose 1.3% in May, they remain Although it is still likely GDP contracted in Q2 by roughly 17.6% lower than a year ago. Another sensitive barometer, 2%, more prognosticators are pointing to a modest such as the U.S. Treasury Inflation-Protected Securities rebound by the end of 2009. The near-term outlook market, shows no signs of runaway inflation over the next remains bright, but in reality a full recovery will be much 10 years. The CPI decline of 1.3% for the 12 months ended further down the road. The financial markets have in May was the largest decline since 1950. behaved well, now that the Great Depression scenario some feared has died away. There’s No Place Like Home Is the long running slump in housing almost over? Government Policies Remain Key to Recovery House prices will only hit bottom once the foreclosure Budding economic optimism is heavily dependent on the share of sales reaches a peak. Unfortunately, that may effective implementation of a myriad of government not happen soon. policies. Households are receiving a boost from reduced payroll withholding and increased Social Security checks. However, the free fall in home prices slowed in April even Infrastructure spending is set to dramatically rise. The though all 20 metropolitan areas tracked by the Case- Federal Reserve continues its effort to engineer low Shiller® Index showed declines. Foreclosure sales have mortgage rates, while the stimulus package also contains definitely helped clear inventories in the most extremely first time homebuyer incentives. Although aggressive overbuilt areas of the country, but many would-be sellers facing losses have chosen to stay put unless forced to sell.
  2. 2. Financial Market Review S e c o n d Q u a r t e r 2 0 0 9 Housing starts have leveled off nearly 20% below their Index and the Russell 2000® Index, increased 20.8% and recent peak. But, we still need to clear the overhang in 20.7%, respectively, for the quarter and 10% and 2.6% year supply of existing homes. Improvement in credit availability, to date. International stocks (MSCI EAFE Index) soared 25.4% low mortgage rates and first time tax credits should help in for the quarter and 8% year to date. this regard. Even though markets tend to discount economic news by No Help from Exports 6 to 12 months, the suddenness and strength of this rally Over the winter, world trade collapsed under the weight of was surprising. In hindsight, contrary sentiment indicators the credit crunch. Trade volumes are still 20% below the July were in place as the exhaustive selling associated with the 2008 peak. China’s economy seems healthy, but this mostly bear market reversed in mid-March. The credit markets had helps commodity exporters. Clearly, the global economy improved as evidenced by the compression of yield spreads remains debilitated. across the board, including investment grade and high yield corporate bonds. The credit market collapse led our The U.S. was the first country to firmly deal with an economic decline and a credit recovery is the first step to an imploding economy, so it makes sense to believe the rest economic and stock market recovery. The stock market of the world will lag our own recovery. followed the credit market with the lowest quality, and the Our baseline expectation is still for the domestic economy most economically cyclical, stocks showing the strongest to slowly reach positive GDP territory before year end. This returns for the quarter. International stocks followed the recovery still appears fragile, so while a darker future is less same script with the emerging markets leading the rally. likely, it is too soon to eliminate that possibility entirely. Despite this recent move, the S&P 500 is up less than 4% for the year and still stands 40% below its 2007 high. It is Stock Market Review difficult to get an accurate read on traditional stock market Equity Policy Group valuation measures such as P/E ratios and yields. Earnings M&I Investment Management Corp. collapsed and many companies have reduced or eliminated dividends. Stock valuations are still attractive in a The stock market recovery that began in March continued as normalized economic environment. Corporate earnings investors scrambled to put money back into the market. The may be at an inflection point. In the short term, stocks second quarter turned out to be a mirror image of the first reflect the rates of change in earnings; a less negative quarter; for example, financial companies, down almost 30% number can be viewed as a positive surprise attracting in the first quarter, rebounded 35% in the second quarter. buyers. Earnings comparisons against very weak second This sudden reversal surprised most investors, as the half 2008 numbers will get easier. However, can economic news was generally mixed with hints of recovery corporations, using less leverage, produce the high commonly referred to as “green shoots.” As a point of earnings they once enjoyed with robust consumer reference, this was the strongest quarterly return in over five spending and easy credit? Productivity gains through lower years. Large stocks, represented by the S&P 500® Index, costs will help, but consumer spending will remain an issue increased 15.9% for the quarter and 3.2% year to date. Small- for some time. and mid-cap stocks as represented by the Russell Mid-Cap® We enter the summer with a long list of concerns and a healthy dose of skepticism regarding the sustainability of Stock Market Returns the recovery. Recent mixed economic news has led to a pull back of commodity prices. We think the breather in the 1st Quarter 2nd Quarter stock market rally, after its sharp increase since early March, 30 25.4% is normal. Even the most optimistic scenario has to 25 incorporate stock price corrections along the way. Now is a 20.8% 20.7% 20 good time for investors to objectively assess their current 15.9% 15 asset allocation. It was difficult for any investor to calmly 10 determine their risk tolerance back at the market bottom only a few months ago. The initial bounce-back phase 5 occurred much more quickly than most imagined. Looking 0 forward, stock investors need to become more patient as -5 additional market gains will likely be sporadic as the -10 -8.9% economic recovery unfolds. -11.0% -15 -14.9% -13.9% S&P 500 Index Russell Mid-Cap Index Russell 2000 Index MSCI EAFE Index Source: Standard & Poor’s Asset Investment Management (AIM) As of 6/30/09
  3. 3. Financial Market Review S e c o n d Q u a r t e r 2 0 0 9 Fixed Income Market Review Historical Treasury Yield Curve Fixed Income Policy Group 5.0% M&I Investment Management Corp. 4.0% Flight from Quality 3.0% Despite large-scale purchases by both the Federal Reserve 2.0% and foreign buyers, Treasurys ended the second quarter with 1.0% a loss of 3.0% as measured by the Barclays Treasury Index. 0% This brings the year-to-date loss from Treasurys to 4.3%, the 3 Month 6 Month 2 Year 5 Year 10 Year 30 Year worst 6-month performance in at least 30 years. Longer 3/31/09 6/30/09 maturity Treasury securities performed particularly poorly, as Source: Bloomberg indicated by a -6% return for a 10-year Treasury note during the second quarter alone. By quarter-end, a 10-year Treasury too far too fast. For example, high-yield bonds saw gains security was yielding 3.52%, substantially higher than the of 23% for the quarter, as credit spreads tightened from 2.68% witnessed at the start of the period. 17% over Treasury securities to approximately 11%. This magnitude of a move is unsustainable and caution should Mortgage rates are especially sensitive to changes in 10-year be exercised from this point, especially given that issuers Treasury yields. Consequently, 30-year mortgage rates continue to bring more supply to the high yield fluctuated from 4.85% on March 31, 2009 to a high level marketplace. Per Dealogic (a firm that tracks issuance of 5.59%, only to settle back to 5.42% at the close of the patterns), the friendly market allowed for $41 billion in quarter (per Freddie Mac statistics). Refinancing activity new issuance year to date. surged as mortgage rates touched historic lows, but fell back when rates crept higher. Investment grade (IG) corporate bond buyers enjoyed a profitable environment as well, with returns of 10.5% for the Although the Federal Reserve would like to see the level of quarter according to Barclays index numbers. IG spreads to interest rates low enough to spur a recovery in the housing Treasury securities exceeded 6% at the beginning of the market, bond buyers don’t always cooperate. So-called quarter, but have retreated to approximately 3.3% today. To bond market vigilantes demand higher rates whenever put this in perspective, IG spreads were 3.4% prior to the there is a whiff of reflation in the air. Given the huge Lehman debacle of last year. Another sign of healing in the amounts of liquidity provided by the Federal Reserve, credit markets was the ability for some large banks to issue inflation expectations have risen this year. Future inflation debt without government assistance. expectations as indicated by the 10-year Treasury Inflation- Protected Securities market (TIPs), rose from zero at year- Subtle Shift in Fed Policy end 2008 to 1.7% by the end of Q2, however, this level is still Coupled with a massive traditional monetary policy easing, muted by historical comparisons. we have seen an unprecedented number of unconventional programs put into place by the Federal Reserve, the Treasury Huge amounts of Treasury debt issuance can also be blamed and the FDIC. The true test as to the efficacy of these for higher yields. The United States is expected to issue $3.25 programs can be measured by observing credit conditions trillion of securities in 2009, nearly four times the level raised in the short-term money markets. last year. According to government statistics, approximately 51% of marketable Treasury debt is held outside the United By this measure, all these efforts are gradually working. We States. We will need this continued ownership to prevent have seen the introduction of the Term Asset-Backed interest rates from jumping a lot higher. Securities Lending Facility (TALF) unfreeze the asset-backed securities market with $43 billion of new issuance this year. Risky Business Commercial paper rates have declined to less than 0.4% Corporate bonds exhibited stellar performance for the according to S&P figures. Just this quarter, three-month quarter. Buyers piled into riskier debt, allowing many LIBOR has declined from 1.19% to 0.59%. A favorite measure different types of issuers to tap the market for cash. This all of Alan Greenspan, the LIBOR/OIS ratio has moved down to happened while Chrysler and GM were filing for bankruptcy, 0.36, with 0.25 considered to be normal. All these signs are and default rates on high yield debt rose to 8.1% in May, the encouraging. highest level since October 2002. The still-slowing economy will inevitably lead to even higher future default rates, a However, don’t miss the subtle change in Fed policy prospect ignored by yield-hungry investors. announced with limited fanfare during the last week of June. In recognition of the return to near normalcy in the markets, Meanwhile, corporate bond investors experienced gains the Fed reduced the Term Auction Facility program and across the entire quality spectrum. The riskier the better for eliminated the Term Securities Lending Facility altogether. Q2 returns, with some observers wondering if we’ve gone We believe the Fed when they tell us the Federal Funds rate
  4. 4. Financial Market Review S e c o n d Q u a r t e r 2 0 0 9 will stay at “exceptionally low levels” for an “extended period,” The second quarter was a period of manager recalibration. but don’t miss the start of the gradual withdrawal of The deleveraging that has become so central to all economic unconventional monetary policies. activity has created a chasm between what buyers and sellers perceive as true fundamental value, whether the Alternative Investments Review asset class is private equity, hedge funds, commodities or Alternative Investments Group real estate. Bid and ask prices for some assets have become so wide that trading activity has been relatively quiet, and M&I Investment Management Corp. the willingness to commit to new positions, and to take on Though aggregate performance of alternative investments new risks has been diminished. has held up very well, managers carry the weight of heavy Managers are more preoccupied with liquidity, volatility baggage from 2008, as sentiment remains subdued. Abrupt and price transparency than they are with the market’s trend reversals have corrected oversold conditions in several short-term direction. Will a deal be funded? Can a bond or asset classes, though some of the turnarounds were not easy mortgage be refinanced? Can an asset be sold at fair value to navigate nor supported by fundamentals. to raise cash? What’s our exit strategy? We can cite three examples of dramatic, yet counterintuitive In a positive vein, managers and their investors have been trend changes. In spite of collapsing demand, oil has surged buying time, and extending the game clock in hopes that to $70 a barrel from the mid-$40s. REITs, facing the a real recovery takes foot. Improvements in equity market overhang of heavy debt refinance, were the second and credit market valuations during Q2 have meant that quarter’s star performers — gaining 29%, although legacy positions that stayed on the books of many funds remaining 15% lower year to date. Finally, last year’s worst have recovered amidst little trading volume. The U.S. hedge fund strategy, convertible arbitrage, has been this Treasury’s TALF program has revived demand for asset- year’s best — up 21%, despite an increased supply of $30 backed securities and attracted a following of managers billion new convertible issuance. wanting to take advantage of Federal Reserve Bank financing and the leverage it provides. A new normal is on the horizon — less dependent on leverage, more focused Selected Alternative Indexes vs. S&P 500 Index on price transparency, and perhaps willing to reinvest those 1st Quarter 2nd Quarter profits that were generated by opportunistic buyers of 29.77% oversold assets. 30 20 15.93% 12.39% 10 4.85% 0.68% 0 Contributors -10 -6.31% -11.01% Tommy O. Huie, CFA, Chief Investment Officer -20 John D. Boritzke, CFA, Senior Vice President, Director of Fixed Income -30 William A. Frazier, CFA, Senior Vice President, Portfolio Management -40 -35.24% Daniel V. O’Connell, Vice President, Alternative Investments REITs S&P 500 Index Hedge Funds Commodities Source: REIT returns represented by the Dow Jones Wilshire REIT Index, Hedge Funds represented by the HFRX Global Hedge Fund Index and Commodities represented by the Dow Jones AIG Commodity Index. As of 6/30/09 29.77% 30 This is not intended to serve as a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment as of date of publication and are subject15.39% 20 to change. Information has been obtained from sources we consider to be reliable, but we cannot guarantee 12.39% the accuracy. This publication is prepared for general information only. This material does not constitute investment advice and is not intended as an endorsement 10 of any specific investment. It does not have regard to specific investment objectives, financial situations nor the particular needs of any specific person who 4.85% 0.68% may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or 0 recommended in this report and should understand that statements regarding future prospects may not be realized. Investment involves risk, and investing in foreign-10 markets involves currency and political risks. Investors should note that income from such securities, if any, may fluctuate and that each security’s price or -6.31% -11.01% value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance. -20 M&I Wealth Management offers products and services through various affiliates of Marshall & Ilsley Corporation, including Marshall & Ilsley Trust Company N.A., M&I Investment Management Corp., M&I Financial Advisors, Inc. (member FINRA/SIPC, maintaining its principal offices at 111 E. Kilbourn Ave., Milwaukee, WI -30 53202), North Star Trust Company, North Star Deferred Exchange and Taplin, Canida & Habacht, LLC. Insurance coverage is underwritten by a number of insurers. -40 -35.24% Insurance products are the obligation of the insurance company. ©2009 Marshall & Ilsley Corporation Investment products are: Not FDIC Insured No Bank Guarantee May Lose Value Banking products and services are provided by M&I Marshall & Ilsley Bank or M&I Bank FSB, Members FDIC 09-326-053