The economy is showing signs of life although the recovery will be painfully slow as we try to overcome the deepest, longest recession since the Great Depression. Final estimate of 4th quarter GDP (released on March 26, 2010) was an annual rate of 5.6%, up from 2.2% in 3Q-2009. For the full year 2009, our economy contracted by 2.4%, in contrast to an increase of 0.4% in 2008. The initial 1Q-2010 estimate is a 2.5% annual gain.
Manufacturing is a bright spot for recovery and factories added workers to their payrolls. The U.S. Institute for Supply Management’s manufacturing index rose to 59.6 in March from 56.5 a month earlier. This is a survey of purchasing managers who buy goods and raw materials needed to create our products. However, output is still below pre-recession peaks in most of the world. Auto sales increased in March to 1.07 million cars and light trucks up from 875,735 in March 2009, when sales plunged and bankruptcy filings loomed for GM & Chrysler. The U.S. manufacturing index registered its best reading since 2004 with a 3.1% gain last month. Additionally, China’s manufacturing sector grew for the 13th straight month and Germany posted its best showing in a decade. The only EuroZone country to contract was Greece, which is struggling with debt concerns. The service sector is also gathering steam. The ISM index for non-manufacturing (service sector) jobs reported an increase to 55.4 up from 53 in February. Anything above 50 is considered expansionary.
Consumer spending and real-estate are drags on our economy at the present. With unemployment near 10% and the unofficial rate closer to 17%, many people have changed their spending patterns. This increases the savings rate but hurts the economy in the short-run. Construction spending fell for the 7th straight month in February to the lowest rate in over 7 years. Additionally, there is a significant over-supply of real-estate (residential and commercial). New home sales fell to the lowest number on record as bad weather, expiration of the Federal tax credit and the weak economy all contributed to a dearth of buyers. February inventories were at 9.2 months, the highest number since May, 2009.
The market’s performance was overshadowed during the quarter by the passage of the health care reform bill formally known as the Patient Protection and Affordability Act. Contrary to so much negative economic and controversial political news, the first quarter of 2010 was a great (albeit volatile) quarter for investors. The market constantly looks forward and obviously liked what it saw. Large companies as measured by the Dow Jones Industrial Average and the broader-based, S&P 500 Total Return Index gained 4.8% and 5.4% respectively during 1Q-10. The indexes still remain 25% below previous peaks reached in 2007. Smaller companies did even better as measured by the Russell 2000 index with gains of 8.9%. International stocks, as measured by the Dow Jones World Index, gained a modest 1.4%. The most notable item however was the astonishing 65% gain in stocks over the past year. Anyone who bailed out or abandoned their plans to invest missed an incredible wealth creation opportunity. Just remember, the market will typically prove the greatest number of people wrong at the most inopportune time.
The quarter’s gains did not come without a wild ride and anyone who went to the sidelines during the sell-off missed a great finale. Concerns first arose as China announced in January they were tightening their lending standards. Then Greece announced it might not be able to honor its massive debt commitments creating fears of a sovereign debt crisis within the EuroZone (mainly Greece, Spain, Ireland and Portugal). A failed Portuguese bond auction intensified fears the emerging sovereign debt issues could become a global contagion. These fears led to a weakening of the euro and a widespread selloff in stocks and commodities in February. Germany, with the largest economy in the EU, announced on March 5th that it would “stand by Greece” and the crisis significantly abated.
The bond market proved to be a source of stable, albeit modest, returns in the quarter as yields remained steady on high quality issues. The notable exception was junk bonds as spreads narrowed on lower-quality issues resulting in impressive price gains. Interest rates are still very low due to little demand for borrowing and Fed monetary policy. The yield on the 10-year U.S. Treasury stood at 3.837% at the end of the quarter almost identical to the 3.834% rate at the end of 2009. The Federal Reserve’s $1.25 trillion program to buy mortgage-backed securities designed to prop up the housing market ended on March 31. Demand for mortgage-backed debt had been frozen since the Federal takeover of Fannie Mae & Freddie Mac. Without the Fed’s support, some worry mortgage rates will climb. As of this writing that has not yet happened.
The market’s focus will now shift to the sustainability of the recovery currently underway and the potential impact of higher interest rates often associated with a recovery. The massive debts being piled up by the Federal Government and the deficits faced by state and local municipalities are true concerns. Will increased deficits result in more job losses and inflationary pressures? Will the Chinese stop buying our debt? Will we experience a double-dip recession, or will our economy hold on to these tentative gains and start the long, slow climb back to prosperity?
Experts agree it will take years to re-employ the 15 million currently unemployed Americans. A troubling statistic is the number of long-term unemployed as percentage of total unemployment. Those without a job for 27 weeks or longer hit a new record of 44.1% of the total unemployed compared to 40.9% in February and 24.6% a year ago. The longer someone remains unemployed the less likely they are to regain suitable employment and the impact can cause life-long emotional damage.
The U.S. economy is a wonderful engine of prosperity and its tendency is to expand when left to its own free-market devices. As the quarter ended, the jobs report was released showing a net gain of 162,000 new jobs in the month of March. Although some were temporary Census workers the massive layoffs from last year have surely abated. The most important thing an investor can do is to have a Written Investment Plan that incorporates a Strategic Asset Allocation policy, considers numerous variables and is measurable through time. Such a plan, properly used, should increase your probability of success and reduce the likelihood of making the Big Mistake associate with emotionally driven decisions.