Tuesday, May 4, 2010

Weekly Market Update May 2 2010

US markets closed the week down collectively for the first time in two months despite generally good economic news.

Last week the Dow Jones Industrial Average (DJIA) gave back 152 points (-1.75%) closing at 11,008.61 and the S&P 500 lost 31 points (-2.51%). However, the month of April still managed to post a gain for both major indexes with the DJIA gaining 1.40% and the S&P 500 rising 1.48%. With one-third of the year now in the books, the DJIA is up 5.57% and the S&P 500 is up 6.42%.

International markets were mostly down for the week with the MSCI (EAFE) Index losing 1.89%. For April this index was down 2.10%, and for the year the MSCI (EAFE) is now down 1.88%.

GDP Positive for the 1st Quarter

The GDP numbers for the first three months of the year were released on Friday showing a gain of 3.2%. GDP Positive for the 1st Quarter

The GDP numbers for the first three months of the year were released on Friday showing a gain of 3.2%.

In general the report was good but the markets shrugged off this news to focus on the problems abroad. The biggest contributor to the GDP gain was consumer spending which contributed 2.6% of the overall 3.2% gain in the GDP. Growth in business inventories was also strong, but most other areas of within the economy showed little or slightly negative growth. Government spending was down 0.4% which may come as a surprise given the heavy deficit spending by the federal government; however, the category of government spending also includes state and municipal government spending. States and local governments in the aggregate are cutting spending to balance their budgets and the full impact of these efforts is just now beginning to be felt in the economy.

In other domestic news, the oil spill in the Gulf of Mexico is becoming a tragedy of historic proportions. The two companies most directly related to this terrible story are Transocean (RIG) and British Petroleum (BP). Transocean is the owner of the sunken ship/platform that was doing work for BP. For the week, Transocean fell over 19% and BP dropped nearly 13%. As a sector, the oil and gas producers were off a little more than 2% and in line with the general market pull back last week. Oil prices rose and closed above $86 per barrel. Expect this upward trend to continue as investors weigh the impact of the oil spill on future oil prices.

The oil spill temporarily knocked Goldman Sachs off the front pages, but the stock continued to drop on news that the federal government was actively considering a criminal investigation to go along with the civil review. For the week Goldman Sachs lost 7.75% including the drop of 9.4% on Friday when the markets learned of the criminal investigation. Warren Buffet defended Goldman in his remarks this weekend at the annual Berkshire Hathaway shareholder meeting in Omaha saying the trades under review were made by large, sophisticated investors who knew, or should have known, what they were buying. Buffet has had a very large position in Goldman since a purchase made during the 2008 credit crisis.

Greece Reaches Agreement with IMF and EU

Greece came to terms with the International Monetary Union (IMF) and the European Union (EU) over the weekend.

Terms of the deal were announced with the IMF and EU pledging €110 billion ($145.5 billion) over a three-year period. This number is significantly greater than the €40 billion reported last week and reflects the reality that Greece is in more trouble than originally thought. Coupled with this aid is the requirement that Greece significantly cut spending over this period. Greeks have been in the streets almost daily protesting against the announced austerity measures which will cut pensions and other government programs. While aid is likely to flow, there will continue to be significant political fallout in many of the countries within the EU. Compounding the problems in Greece were the downgrades announced by Standard & Poors (S&P). On Tuesday, S&P announced that Greece's debt was being lowered to junk status and that Portugal's sovereign debt was being lowered to A- (four levels higher than Greece). Then on Wednesday, S&P announced that it was lowering Spain's debt to AA, down one notch from AAA, with a negative outlook. Investor confidence was clearly shaken and contributed to much of the volatility and drops in US markets, as well as, international markets. While the announcement of the terms of Greece's bailout may calm markets for now, I believe that until the aforementioned European countries sharply curtail spending, this crisis will continue with negative consequences to all markets. Spain is of particular concern because it is the fourth largest EU country, and frankly, the EU does not have the resources to bailout Greece, Portugal and Spain. I also believe that this should serve as a warning to all governments (the US and UK in particular) that exploding debts will seriously harm their economies and force politically unpopular moves. Delaying action will only make matters worse.

US Treasuries and Precious Metals Gain

With the growing uncertainty in global markets last week, investors turned to US treasuries for safety.

The yield on the 10-year note fell to 3.659% down from 3.817% of the week before. Corporate bonds in general also saw small gains during the week. The June contracts for gold settled about 2% higher closing at $1180.70 per ounce. Analysts suggest that this is a similar flight to safety as seen in US treasuries stemming from concerns from the Greek debt crisis.

Looking Ahead

Volatility returned to the markets last week. During the 21 trading days in April, the DJIA had 5 days where the index closed up or down by more than 100 points. Three of those days occurred last week. This increase in volatility reflects the uncertainty in global markets and is likely to persist for the near term.

Small and mid cap stocks remain favored. Historically these stocks tend to be more volatile than the large cap stocks found in the DJIA, and last week was no different. Expect a little extra volatility in these stocks going forward for now. My favored sectors remain Real Estate, Consumer Discretionary, Information Technology, Materials and Financials. These sectors also experienced greater volatility than the DJIA and will likely continue to do so. It remains imperative to remain focused on a longer-term perspective and not overreact to short-term, daily fluctuations. If these sectors lose relative strength, they will be replaced by stronger sectors at that time.

International stocks, while still favored, must be watched very closely. I continue to favor Turkey, South Korea, Thailand, Brazil and China. I am watching Thailand closely given the current political unrest, and China because of the efforts underway by the central government to prevent that market from overheating.

I will be looking to reduce exposure to British Petroleum given BP's ongoing exposure to the Gulf spill. Gold and precious metals are showing positive momentum and will be considered for portfolios.

I still prefer US Corporate Intermediate-term Bonds and International bonds in the fixed-income area.

As always, if you have any specific questions on your portfolio or wish to talk to me, please do not hesitate to call.

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