2011 Second Quarter Market Review Executive Summary Written by: Rick Vollaro, CPA Chief Investment Strategist Partner Carl Noble, CFA Senior Analyst July 2011 • The second quarter was a rollercoaster ride that punished some risk assets and rewarded the flight-to-quality trade despite paltry yields on Treasury securities. The quarter was largely defined by a widespread loss in economic momentum, causing investors to question whether the global economic recovery was in jeopardy. • One of the bigger risks that surfaced during the quarter was a resurgence of problems on the periphery of the Eurozone. The European debt drama refuses to go away, and towards the end of the first quarter Greece again took center stage as fears of a possible default rippled through financial markets. • Pinnacle Advisory Group managed accounts gained in the second quarter, but at a much more subdued pace as financial markets grew increasingly volatile. It was the fourth consecutive quarter of gains and returns remain very healthy on a trailing one year basis. • As the third quarter begins the U.S. business cycle seems to be at an inflection point. During the second quarter a slowdown unfolded throughout the global econ- omy. The all-important issue that market participants are currently wrestling with is whether the most recent soft patch in economic data has been driven by transitory factors, or if more permanent forces are at work. Unfortunately the evidence is still ambiguous, which lowers conviction levels and makes for a very volatile investing climate. ffffffffffffffffffffffffffffffffffffffffffffffffffffffffffffffffff • Our baseline expectation for the past few quarters has been that the cyclical bull market has the potential to carry the S&P 500 to new cyclical highs. Given the current inflection point in the cycle, there is an increasingly wide confidence interval around that forecast. We are not yet convinced that a cycle change is imminent, but risks are clearly rising. • Given the current lack of clarity regarding the investment landscape, we continue to believe that positioning close to benchmark levels of risk in client portfolios is appropriate at this time. As difficult as it may be at times, sticking with the discipline of our process should eventually lead to higher conviction levels and a more definitive stance one way or the other. In the interim we continue to focus on shoring up our defensive holdings given the present risks, and executing relative value trades as opportunities arise.
9
Embed
2011 Second Quarter Market Review - Pinnacle Advisory Group...July 2011 • The second quarter was a rollercoaster ride that punished some risk assets and ... • Pinnacle Advisory
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
2011 Second Quarter Market Review Executive Summary
Written by:
Rick Vollaro, CPAChief Investment Strategist
Partner
Carl Noble, CFASenior Analyst
July 2011
•The second quarter was a rollercoaster ride that punished some risk assets and rewarded the flight-to-quality trade despite paltry yields on Treasury securities.The quarter was largely defined by a widespread loss in economic momentum, causinginvestorstoquestionwhethertheglobaleconomicrecoverywasinjeopardy.
•One of the bigger risks that surfaced during the quarter was a resurgenceof problems on the periphery of the Eurozone. The European debt drama refuses to go away, and towards the end of the first quarter Greece again tookcenter stage as fears of a possible default rippled through financial markets.
•As the third quarter begins the U.S. business cycle seems to be at an inflectionpoint. Duringthesecondquarteraslowdownunfoldedthroughouttheglobalecon-omy.Theall-importantissuethatmarketparticipantsarecurrentlywrestlingwithiswhether themost recent soft patch in economic data has been driven by transitoryfactors,orifmorepermanentforcesareatwork.Unfortunatelytheevidenceisstill ambiguous,which lowers conviction levels andmakes for averyvolatile investing c l ima t e . f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f f
•Given the current lack of clarity regarding the investment landscape, we continueto believe that positioning close to benchmark levels of risk in client portfolios is appropriate at this time. As difficult as it may be at times, sticking with the disciplineofourprocessshouldeventuallyleadtohigherconvictionlevelsandamore definitivestanceonewayortheother.Intheinterimwecontinuetofocusonshoringupourdefensiveholdingsgiventhepresentrisks,andexecutingrelativevaluetradesasopportunitiesarise.
2
SecondQuarter2011MarketReview
www.pinnacleadvisory.com
Second Quarter ReviewThe second quarter was a rollercoaster ride that punished some risk assets and reward-ed theflight-to-quality trade despite paltryyields onTreasury securities. The quarterwas largely defined by a widespread lossineconomicmomentum,causing investorsto question whether the global economicrecoverywasinjeopardy.Corporateearn-ingscontinuedtoberesilientbuteconomicdatawidelydisappointed across theglobe.Investors were left to digest and navigateamyriadofdifferent risks to the investinglandscape. It was a particularly poor en-vironment for commodity investors whilebeingsurprisinglyprofitableforbondinves-tors. The S&P 500 Index finishedwith aminimalnetchange,buttheflatreturnwasdeceptiveasthequarterwasavolatileaffairthatcontainednumeroustwistsandturns.Bytheendofthequarter,the“wallofworry”thatthebullmarketmustclimbcontinuedtogrowduetodeceleratingeconomicdata,theendoftheFederalReserve’ssecondquantitativeeasingprogram,tighteningmonetarypolicyintheemergingworldandEurope,anduncer-taintyregardingtheoutcomeofthefastapproachingdebtceilingdeadline.
Index Second Quarter ReturnS&P500Index(w/dividends) +0.10%Russell2000Index(smallcapstocks) -1.61%MSCIEAFEIndex(internationalstocks) +1.83%DowJones/UBSCommodityIndex -6.73%BarclaysCapitalAggregateBondIndex +2.29%3-monthT-bills +0.01%
OneofthebiggerrisksthatsurfacedduringthequarterwasaresurgenceofproblemsontheperipheryoftheEurozone.TheEuropeandebtdramarefusestogoaway,andtowardstheendofthefirstquarterGreeceagaintookcenterstageasfearsofapossibledefaultrippledthroughfinancialmarkets.Onthesurface,Greeceseemsinsignificantenough,ac-countingforlessthan3%oftheEurozoneeconomy.ButasimmaterialasGreecemightseemfromaGDPperspective,investorsdread thepossibilityofanothercripplingcontagioneffect similar towhatoccurred in theU.S. in2007-08.
Top Five Performers of the Second Quarter 2011Position Weight ReturniSharesPharmaceuticalsETF 3% 10.9%UtilitiesSectorSPDR 2% 6.1%ConsumerStaplesSPDR 8% 5.2%PowersharesAerospace&DefenseETF 2% 4.6%GoldSPDR 3% 4.4%
Bottom Five Performers of the Second Quarter 2011Position Weight ReturnEnergySectorSPDR 6% -4.9%S&POil&GasExploration&ProductionETF 0% -5.5%iSharesSemiconductorETF 2% -5.9%iSharesNetworkingETF 5% -9.6%CapitalMarketsSPDR 2% -9.7%
Please note that the returns and weightings used for this illustration are based on the Dynamic Moder-ate Growth portfolio at the end of the period. The individual security returns for other strategies may vary due to trade execution or security selection differences. Securities may have been bought and sold during the quarter; therefore, client returns (which are shown here) may not reflect a security’s actual quarterly return. Holdings identified do not represent all of the securities purchased, sold, or recommended for advisory clients. Past performance does not guarantee future results.
Market Outlook AsthethirdquarterbeginstheU.S.businesscycleseemstobeataninflectionpoint.Duringthesecondquarteraslow-downunfoldedthroughouttheglobaleconomy.IntheU.S.theevidencewaswidespread,reflectedinmeasuressuchasleadingindicators,wages,housing,andjobs.AtthemomentthereisstilladeeppoolofU.S.liquidity,butmoneymul-tipliershavedecelerated,quantitativeeasinghasended,andseveralmajorinternationalcentralbanksareraisinginterestrates.Thisleavesinvestorsworryinghowtheeconomywillrespondtolessstimulusgoingforward.Theall-importantissuethatmarketparticipantsarecurrentlywrestlingwithiswhetherthemostrecentsoftpatchineconomicdatahasbeendrivenbytransitoryfactors,orifmorepermanentforcesareatwork.Unfortunatelytheevidenceisstillambiguous,whichlowersconvictionlevelsandmakesforaveryvolatileinvestingclimate.
Long-termtechnicalconditionsremainconstructiveasthebulltrendfromthe2009lowremainsintact,thenumberofadvancing stocks continues tooutpacedeclining stocks, andmajor indexes are tradingnear their recent cyclehighs.However,someintermediatetechnicalconcernsarestartingtoappear,suchasdivergentmomentumindicatorsandun-derperformancebythefinancialsector.Additionally,ameasureofimpliedmarketvolatilityhadrecentlyfallentolevelsindicatingthatinvestorshadbecomecomplacentagain,whichcouldbeapotentialcatalystforfurtherdownsidevolatilityifitreverses.Lookingpastnormalconsolidationphasesthatareahealthypartofbullmarkets,webelievethecyclicaltechnicalconditionscontinuetobesupportiveforfinancialmarkets,butarestartingtoshowsomecracks.Iftheinterme-diate-termpicturedeterioratesfurthertherecouldbepotentialforlonger-termconditionstofollowsuit. Earningscontinuetobestrongandselectmarketvaluationmetricscaneasilycreatetheimpressionofanextremelycheaporexpensivemarket,dependingonwhichmeasureofearningsoneprefers.Fromourperspective,marketvaluationre-mainssomewhereclosetofairvaluewhenapplyingaweightoftheevidenceapproachandthusdoesnothaveamajorinfluenceoncurrentportfolioconstruction.OurbaselineexpectationforthepastfewquartershasbeenthatthecyclicalbullmarkethasthepotentialtocarrytheS&P500tonewcyclicalhighs,withaloosetargetrangeofsomewherebetween1400toashighasthepreviouspeaksinthemid-1500s.Giventhecurrentinflectionpointinthecycle,thereisanincreas-inglywideconfidenceintervalaroundthatforecast.Wearenotyetconvincedthatacyclechangeisimminent,butrisksareclearlyrising.
Soft Patch or Something More?Duringthequartertherewasanotabledownshiftinavarietyofeconomicdata.Leadingindicators,liketheEconomicCycleResearchInstitute’sWeeklyLeadingIndex,aswellasmarketbasedindicatorslikecopper,bothyieldedthesamemessageofslowinggrowth.Themajorityofregionalmanufacturingsurveyshavealsobeenindicatingsteadyerosioningrowthoverthelastfewmonths,andafewhaverecentlyregisteredreadingsconsistentwithcontraction.Atthesametimehousinghascontinuedtosink,realwagesarefallingfast,andstagnantmoneymultiplierscontinuetosignalthatlendingvolumesarenotexpandingastheynormallyshouldbeatthispointinthecycle.
Meanwhile,hereintheU.S.,investorshavebeenbracingfortheendoftheFed’sQE2bondbuyingprogram,whichendedonJune30th,duetotheuncertaintyofhowmarketswillreacttolessstimulusmovingthroughthesystem.Thebullsbe-lievethatthereisstillplentyofpolicyaccommodationthroughzeropercentinterestratesandtheFed’sdecisiontomain-tainitsbalancesheetatitscurrentsize.Butinvestorscan’tbecertainexactlyhowthemarketwillreacttothesechangesinthefinancialsystemgiventheunprecedentednatureoftheprogram.ThebearshavepointedoutthatthelastfewtimestheFedstoppedbuyingbonds,markets struggled. Noone can rule out additional quantitative easing mea-sures ifmarketssag in theabsenceoffreshbondbuy-ing. However, given thatthe latest quantitative eas-ing program is now beingblamed for higher inputcosts,andthatthereappearsto be a growing austeritymovementgoingonwithinpolitical circles, it wouldlikely take a sustained downturn in the economy andmarketstogettheFedtoridetotherescueagain.Lastly,thedeadlinetoraisetheU.S.debtceilinglooms,andthoughmarketsareratherwellbehavedatthemomentdespitedirepredictionsofanotherfinancialcalamityifanagreementisn’treached,itcreatesthepotentialforfurthervolatilityifapolicymistakeismadeandtheU.S.goesintoatechnicaldefault.