Dear Clients and Friends,
It is difficult to believe 2010 is already 25% (and by the time you receive this probably closer to a third) behind us. It was a record setting winter here in Iowa, and fortunately the markets have thawed along with the snow! The market's low point of the recent recession was March 9, 2009. Now that a full year has passed it is useful to look at the first quarter of 2010 in light of the market's progress in the last twelve months.
For the quarter, the major indices logged solid gains, with the S&P 500 up 5.4% and the Nasdaq Composite up 5.9%. The quarter continued to add to what was already one of the strongest cyclical bull markets in history, with the S&P 500 75% higher and the Nasdaq 84% higher than their lows of a year ago. Despite this run, however, the markets remain well off their secular highs achieved in the last decade, with the Nasdaq still 54% off its 2000 high.
There are many indications that the recovery, which began in the latter part of 2009, continues. According to the Financial Times, "economists are predicting the U.S. economy will see a surge of new jobs [in March], with some 300,000 positions being created after a loss of about 8.4 million jobs during the recession." The Federal Reserve statement that business spending on equipment and software had "risen significantly" and its reiteration that interest rates would be kept low for an "extended period" were also encouraging.
But there are several economic factors that may weigh on the recovery. Even with the modest job growth predicted for March, unemployment remains very high. Household spending continues to be constrained by flat income growth and tight credit, and this will likely affect retail sales as consumers remain cautious. Meanwhile the housing market still sits at record lows. Sales of new single-family homes in the U.S. declined a seasonally adjusted 11.2% in January, which represents the lowest sales pace since these records began in 1963.
There are also two larger trends, one historical and the other demographic, that may affect market returns going forward.
Cyclical Bull Market Trends. According to Ned Davis Research, the median gain of the S&P 500 in the first year of a cyclical bull market is 29% but the second year sees only 9% growth. Small cap and lower quality stocks, which tend to lead the broader market during periods of recovery, tend to give ground as recoveries mature into their second year. With the first year of the current cyclical bull market experiencing torrid gains, which is in line with this historical trend, many analysts are expecting to see this year's returns also follow the trend and come in below last year's while still remaining positive. Ned Davis Research believes there is still a good chance the markets could experience a drawn out correction in the second and third quarter, bringing the overall gain for the two years to be more in line with historical averages.
Inflows to Bond Funds. As mentioned in The Wall Street Journal, The Investment Company Institute reported that long-term mutual funds had net inflows for 52 weeks in a row as of March 18, a shift in assets totaling some $506.6 billion. Certainly some of this inflow represents money returning to the market in the wake of recent gains. But the bulk of investment in 2009 was in bonds, which accounted for $409 billion of the net inflows.
This reveals an interesting demographic trend that may also have implications for market growth in the coming months and years. As baby-boomers enter retirement, they tend to allocate a greater share of their portfolios to fixed-income securities. As the Journal goes on to report, another factor at work in this trend, "is a dip in risk tolerance. Investors, who have seen steep losses in two bear markets, have lost some of their appetite for risky investments. Additionally, the rising use of automatic asset allocation, which moves investments toward bonds as investors age, is driving inflows to bonds."
This suggests that older investors may be less likely to invest in equities even if the broader recovery proves strong. With so much money remaining on the sidelines, the massive inflows to equities that some predict may not materialize. Lower-than-expected inflows would likely have a dampening effect on equity prices. However, the broader inflow trend is definitely positive.
Predicting which of the above factors will most influence the market is difficult. The market may present opportunities, but it also contains risk. Investors may want to proceed with caution and diligence.
There is an old saying, "Good, fast, or cheap. Pick any two". We could almost rephrase it to the world of investing with, "Safe, liquid, or the potential for high returns. Pick any two." Managing investments in this environment requires balancing multiple objectives which are often in conflict with each other. Fortunately, there are new products and tools in the marketplace which have been developed specifically to address common concerns.
The first step in the process is to identify what your goals and concerns are and I am here to help you. Please contact me anytime you want to discuss your financial plans, dreams, and concerns. We can review what you have done so far and discuss any options you might want to consider.
As always, I thank you for the continued opportunity to work together.
1 All returns sourced from Morningstar.com and Bloomberg Finance L.P.
2 "Outlook for US economy upgraded," Financial Times, March 17, 2010
3 ibid
4 ibid
5 Chart of the Day, March 9, 2010, Ned Davis Research, Inc.
6 "Fund-Inflow Streak Makes It a Full Year," The Wall Street Journal, March 18, 2010
7 ibid

Letter to Clients – 3rd Quarter 2010
Dear Clients and Friends,
First for some quick housekeeping. I am pleased to announce that I have changed my broker-dealer affiliation from Ameritas Investment Corp. of Lincoln, NE to Broker Dealer Financial Corp. (BDFS) of Johnston, Iowa. My association with Ameritas was pleasant and rewarding. My decision to make a change was based on several factors:
My move to BDFS will have no impact on your investments, or our relationships with any of the companies we are already doing business with. It is simply a change in the intermediary.
In the financial world, it has taken me nearly two weeks into this quarter to commit my opinion to writing. I feel as if I am walking a tightrope and I cannot, with certainty, predict which way to lean. There are two opposing schools of thought; some analysts see the threat of a double-dip recession and another cyclical bear market for equities, while others see the economy remaining strong and corporate earnings improving in coming months. The available data can be used to bolster both the pessimists and optimists. Before we come to any conclusions, let's examine what has happened so far this year.
At the mid-point, the broader equities markets were down for the year with the S&P 500 lower by 6.7% and the Dow lower by 6.8%. The global markets saw similar performance, with the MSCI EAFE international index returning –12.9% year to date. Despite these declines, the equity markets continued to hold general levels achieved during the sharp run-up in equity prices that followed the extreme lows of March 9, 2009. But all of this happened with increased volatility. The CBOE's Volatility Index (the VIX) reached very high levels several days during the quarter.
Markets rallied in the early weeks of April, with the S&P 500 reaching a new year-to-date high on April 23, but as concerns about the strength of the nascent global economic recovery came to the fore, equities sold off through much of May. Despite a rally in the early part of the month, in late June the S&P 500 reached a new year-to-date low. For the quarter, the S&P 500 was down 11.4%.
Regardless of outlook, the market seems focused on three main concerns: the European debt crisis, unemployment and housing.
Yet despite the discouraging news about unemployment and housing, there are many indications the economic recovery continues. Though recently revised downward, U.S. Gross Domestic Product is still expected to be 3% in 2010, with many analysts predicting more robust growth. Corporate profits have been strong, along with business productivity and exports. And the Federal Reserve continues to signal that interest rates, which are currently near record lows, will remain unchanged for an extended period.
The equities markets are always sensitive to new data regarding key sectors of the economy, and this is likely to be especially true in the coming months. Short term movements in the market are extremely irrational. We have experienced rapid drops in the markets when good news is announced, if the good news did not quite reach the consensus expectations. We have also seen the opposite occur.
Given the push and pull between the bad news about housing and unemployment and the generally good news about economic growth, I am cautiously optimistic. I believe we will see growth for the remaining months of 2010 but it will neither be rapid nor smooth. Instead of looking at the day to day (and, as the May 6th "flash crash" taught us, sometimes minute to minute) investors need to focus more on the horizon and ignore the gyrations along the way.
Even though I am optimistic, there are many defensive techniques we can employ to offset the volatility we expect in the months and years to come.
The change from Ameritas to BDFS does require that we transfer each account one by one. We can usually complete the paperwork through email, fax, or US mail but I am also available should you want meet personally. We are in the process of reaching out to every client, but if you would like to transfer your accounts sooner, please get in touch with me or my assistant, MacKenzie, so we can accomplish the transfer in the method most convenient to you.
Be sure to let me know if you have any questions or concerns about the transfer or your financial well being in general. Thank you for the opportunity to continue serving your needs as well as your continued trust. I remain confident in my ability to serve you well in the future.
Posted by Art Dinkin on August 11, 2010 in Commentary, Communications | Permalink | Comments (0) | TrackBack (0)