Friday, September 3, 2010

Summer Doldrums and Economic Slowdown Affect August Performance

From the Desk of Joe Rollins

According to Joseph Wood Krutch, “August creates as she slumbers, replete and satisfied.” Let’s hope so, because this past August was basically a washout for the financial markets. Interestingly, the trading volume during August confirms it was one of the slowest trading months ever recorded. It seems the summer heat and gloomy economic figures got to everyone, causing a lack of interest in trading. This is unusual; September is historically the worst month for the financial markets, but perhaps we can look forward to good things happening in September since August was so awful.

For the month of August, the Dow Jones Industrial Average was down 4.1% and the S&P 500 index was down 4.5%. The more volatile Nasdaq was down 6.1% while the small-cap Russell 2000 index was down 7.3%. Indisputably, those are some terrible percentages, and in fact, it was the worst stock market performance during August since 2001. In 2001, the market was slammed due to the burst of the Internet bubble and the subsequent market sell off. Our current economic circumstance is vastly different and much better than that of August 2001, but the loss we just suffered was equally as bad.

Year-to-date, the Dow is down 2.3%, the S&P is down 4.6%, and the Nasdaq is down 6.3%. Comparatively, Rollins Financial’s entire portfolio of client accounts is slightly positive thus far for 2010. In Tuesday’s Q&A post, I indicated that we had shifted a portion of some of our clients’ portfolios into bond funds to reduce the volatility in the accounts. Since our portfolios are ahead of the S&P 500 performance by over 4.6%, it appears that this decision was a good move. A proper diversification of assets has once again proven to stabilize a portfolio in a volatile stock market environment.

As I write this post on September 1st, the stock market is performing dramatically higher for the day. Much has been said regarding the performance of the stock market and the economic situation in the U.S. today. However, there hasn’t been much news that has taken the market higher. Tuesday was the last trading day of August, and yesterday was the first trading day of September. Both days had very low trading volume. When certain investors are betting on the market to be down, they will sell the market short to control the performance in a given month. On the first trading day of the next month, they then have to cover those investments by buying them in the open market. So, even though the market was down for the month of August, it is so far up for the month of September. Frankly, however, this means absolutely nothing to us; none of us should be concerned with short-term trading patterns when we are focused on long-term investment goals.

Admittedly, I watch too many financial news programs which have probably made me almost as cynical as the analysts on those shows. Much has happened over the last 30 days, leading to a stock market sell-off, but the financial networks are seemingly convinced that the U.S. economy is at risk of entering the dreaded “double-dip” recession. I can assure you, however, that there is almost zero chance of this happening.

While it is true that Washington has not been very successful in stimulating employment, the economy has actually picked up very nicely. It hasn’t been a roaring improvement, but it is clearly positive and there is no evidence whatsoever that any economist is predicting a negative GDP growth in the upcoming quarters. In fact, since the GDP turned positive in the third quarter of 2009, it has continued improving nicely since then. It is true that the GDP was increasing rapidly through the first quarter of 2010 and has subsequently turned down (although it is still positive). However, it’s not likely that the GDP will continue to fall and will eventually slip back into negative territory. There is virtually no evidence to support that pessimistic theory.

From the economic data I have reviewed, the GDP will continue to grow at a slow pace for several years to come. The Stimulus Act may have saved jobs – who really knows? – but it is certainly not helping improve employee hiring. Truthfully, it doesn’t appear that employment will completely recover for a few more years; there is just too much risk for companies to hire new employees until they are absolutely sure the business they are doing makes it justifiable. With the new costs the government is forcing on employers, the reluctance to hire is understandable. However, it is also true that if a company’s performance justifies it, they would likely bite the bullet and add new employees to their payroll. Employers are cautious – but not stupid!

The government has now extended unemployment insurance for a staggering 99 weeks. At what point does unemployment compensation constitute a welfare program? How many people are receiving unemployment benefits that might have taken a job if they did not have the luxury of receiving government subsidies? How many people are receiving unemployment compensation that never intend on getting another job? I bet there are many. Clearly, deficit spending by the U.S. government has been ineffective in increasing employment, and therefore, it’s unlikely any new programs will come out of Washington this year.

I think that the U.S. economy will improve the old-fashioned way – with ingenuity and cost savings. Those items will increase productivity which will, in turn, increase profitability. Additional profitability will afford companies the ability to hire new employees. For all its efforts, the U.S. Congress has created $2 trillion in debt and has not improved the employment situation at all. It is now time for Congress to get out of the way of business and allow the economy to slowly but surely recover. When profitability justifies it, employment will be increased.

It may not be a good time for employment, but with the cost savings extended to corporations, it has been an excellent time for corporate profits. Corporate profits are at historic highs, and this will ultimately lead to higher stock prices. Year-to-date, we are basically at a break-even point, and therefore, substantial gains could still be made in the remaining four months of 2010. Perhaps the 2% gain we enjoyed on September 1st will be a positive omen for the remainder of the year. However, given the volatility we have suffered through over the last four months, it wouldn’t be surprising if the 2% gain were wiped out tomorrow. Again, we do not live or die by short-term trading, but a positive rally would be a welcome break to the heat of summer.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.