Stocks and oil both soared in the first quarter of 2011, although for much different reasons.  Investors bid up U.S. companies’ share prices as evidence of the economic recovery continued via increased corporate earnings, employment and other signs of improved economic activity.  We are now almost two years into the recovery that began in July, 2009.  

Oil prices (and gasoline at the pump) surged on supply concerns and speculation over Middle East and North African (MENA) nations’ struggles for independence from decades of repression.  I continue to be amazed at the Internet’s influence throughout the world.  It’s only because the repressed peoples of MENA nations are able to glimpse the free worlds’ economic and cultural privileges that they are becoming less tolerant of their current conditions and of the regimes lording over them. This is the ultimate hope for China.  If the MENA political shock wasn’t enough in one quarter, on March 11 Japan suffered a massive earthquake and catastrophic tsunami resulting in the death of thousands, the meltdown of nuclear reactors, and a significant disruption of the world’s third largest economy including the manufacturing capabilities of their major automobile companies.  

In Washington our politicians continued to debate and blame each other while our fiscal situation worsens.  If only we could take the same medicine we insist EU countries like Greece and Portugal enact to get their financial houses in order.  In spite of the lack of progress on the budget front our financial markets continued to recover from the recession’s lows as evidenced by the Dow Jones Industrial Average posting its best 1st quarter gain in over 12 years, up 6.4%. 

Economic Summary 

The U.S. recovery is finally starting to transition into what many believe is sustainable job growth. March non-farm payrolls gained a net 216,000 jobs and the unemployment rate fell to 8.8% down a full percentage point since November. The drop in the unemployment rate is a combination of increased employment and a contraction in the labor pool as many people give up looking for work.  Even with recent gains, the U.S. still has 13.5 million people unemployed. The percentage of those considered long-term unemployed (out of work for at least six months) rose to 45.5% from 43.9% in February.  If monthly job growth followed last month’s trajectory, it would take eight years for the unemployment rate to return to its pre-recession level of about 5%. 

Manufacturing continues to hold its own with the March reading of the ISM Purchasing Managers’ Index at 61.2 vs. 61.4 in February.  A reading above 50 is considered expansionary. Unfortunately, recent sales and pricing data suggest no real improvement in the housing-market. This is in spite of still very affordable mortgage rates. The housing-market recession is certainly not yet over and none of the statistics are suggesting any sort of sustained recovery.  Consumer spending rose an impressive 0.7% last month. However, it drops to just 0.3% after adjusting for inflation.  The key to any sustained recovery will be the consumer. 

The third and final GDP estimate showed real gross domestic product (the output of goods and services produce by labor and property located in the U.S.) grew at an annual rate of 3.1% in the 4th quarter of 2010, up from 2.6% in 3Q-10. For the full year 2010 GDP grew at 2.9% compared to a loss of -2.6% in 2009.  Initial estimates for 1Q-2011 GDP will be released in late April. 

Market Summary 

U.S. markets had an impressive quarter with large company (S&P 500) shares gaining 5.92% for the period. Mid-cap (S&P 400) and small-cap (S&P 600) companies gained an even more impressive 9.36% and 7.71% respectively for the quarter.  Over the past twelve months these groups booked solid returns of 15.65%, 26.95% and 25.27% respectively.  Given the turmoil overseas, international stocks (as expected) did not fare quite as well. Developed markets (MSCI EAFE) gained 2.67% for the quarter and 7.47% for past 12 months.  Emerging Markets (MSCI EM) gained 1.69% and 15.89% over the past 3 and 12 months. Obviously, anyone who’s been sitting on the beach waiting for evidence it’s safe to go back in the water is probably getting a sun-burn. 

Bond investors fared less well as interest rates inched up from near record lows in response to energy and commodity price gains.  1st quarter returns ranged from slightly positive (+0.46%) for intermediate maturities (Barclays 5-10 Year Gov’t/Credit Index) to slightly negative (-0.02%) for longer bonds (Barclays 10+ Year Gov’t/Credit).   Over the past twelve months, bonds gained 3.13% (short-term) to 8.45% (long-term).  Inflation hawks betting on gold saw little gains in the 1st quarter (+2.05%). However, gold has gained an impressive 29.05% over the prior twelve months. 

What’s Next? 

The recent U.S. jobs data set the stage for a possible change in Fed policy and what many believe will be an end of its $600 billion QE2 bond buying stimulus program.  If so, this would mean a shift in its easing policy to a more neutral position.  The debate currently taking place inside the Fed is if, when and how much to raise interest rates. Many regional Fed members are calling for a swift rise in rates to ward off inflation but key Fed executives Bernanke and Dudley are cool to that idea given what they believe is a tenuous recovery.   

After last year’s tax cut deal, most economic analysts raised their forecasts for GDP and job growth in 2011. But that was before the situation in the Middle East/North Africa combined with Japan’s earthquake/tsunami/nuclear tragedy raised concerns about the global economy and by extension, the strength of the U.S. economic recovery.  Will oil at over $100/barrel become the “hidden tax” on the U.S. consumer that results in a reversal of recent hard-won economic gains?  Add to those concerns a possible government shutdown and many forecasters are now lowering their GDP growth estimates for 2011.