July was a sharply bullish for both equities and bonds. Stocks rallied in the face of generally sluggish economic data and as we write this newsletter are positive for the year. The last couple of months have been up and down for U.S. stocks as indicated by the chart below (which you can click on for greater detail).
S&P 500 from 5/19 to 7/30
During this period the volatility of the market was 40% higher than it had been from for the first 1/3rd of the year. Greater volatility tends to be associated with poor market performance and tests the intestinal fortitude of investors. The rally in the last month has been fueled by generally positive
earnings for publicly traded companies. Economic data for the overall economy has lagged- particularly for industries closer to the consumer such as housing
and retail sales
. The continued efforts of the overindebted U.S. consumer to pay down debt as well as a tepid recovery plagued by high unemployment has resulted in historically low growth in the discretionary income that drives consumer spending.
Year over year change in Per Capita Disposable Income
High profit margins, a result of cost cutting by companies over the last 18 months and complete lack of wage pressure in this high unemployment environment, has been one driver of increased corporate profits. Another is record demand from developing markets that has led to impressive earnings reports from companies with international operations such as Intel
. Continued strength from these emerging markets will be the most important factor in maintaining a global recovery as they are in position to generate the demand for external goods necessary for the developed nations to cure their own financial messes. After selling off sharply in April and May amid the global equity slide and a sharply rising dollar, emerging market funds have recovered and are now slightly outperforming U.S. equities for the year despite overall dollar strength over that period.
S&P 500 vs Emerging Markets
Interest rates remain near historical lows. While the flight to the security of government securities abated in light of the rally in stocks, yields on those bonds did not rise over the month. At the same time yields on low rated "junk" bonds have declined significantly after spiking in early June. This indicates to us that the bond market continues to expect low inflationary pressure but has discounted the likelihood of a steep drop in economic activity.
We continue to believe that the U.S. will avoid a dip into recession in the second half of 2010. We think the likely scenario is a weak but modestly growing economy with little inflation. The most obvious risks to this scenario would be a reignition of the sovereign debt crisis in Europe, a significant slowdown in emerging markets particularly in Asia or severe fiscal tightening in the U.S. caused by federal and/or state debt loads.
As always we welcome your comments and feedback.