Nothing gives one person so much advantage over another as to remain always cool and unruffled under all circumstances.  - Thomas Jefferson 

It's hard to believe that almost a year ago we were living through a period of major market turbulence, watching the Dow Jones Industrial Average drop 777 points one day, then spring back almost 1,000 points a few weeks later only to fall again by over 700 points. 

Despite the fear and volatility that rattled many investors, signs of recovery are beginning to emerge. Last year, the U.S. government was fervently hammering out the details of a program to head off a collapse of the country's financial system. Today, almost one third of the TARP funds have been repaid. A number of leading indicators have turned positive; the housing industry has stabilized; retail sales are improving; and the manufacturing sector is strengthening. In addition, low energy prices, low inflation, and low interest rates should continue to support a recovery. 

While the economy appears to be recovering, there are still a variety of concerns. On September 16, Fed Chairman Ben Bernanke stated that the recession has likely come to an end but that the economy is still going to feel weak due to tight credit conditions and unemployment. Unemployment currently stands at 9.8%, the highest level in 26 years. However, unemployment is a lagging statistic, meaning that it is one of the last to show improvement, since companies will increase overtime for current employees before they hire new ones. 

There is also uneasiness about the government’s larger role in the economy. Stimulus spending, corporate bailouts, large ownership stakes in many U.S. corporations, proposed healthcare reform, overhaul of the financial regulatory system, expected tax increases, and large projected budget deficits are significant concerns for investors. 


The stock market continued its rally from the second quarter. The S&P 500 Index is up 19.3% year-to-date and 56% from its low on March 9th. But even with this strong performance, the S&P 500 is 7% below its year-ago level and 32% below its all-time high of October 9, 2007. 

These gains followed a brutal bear market that hit hardest those companies with shaky balance sheets, heavy debt loads and high fixed costs. As investors eased back into riskier assets in the latest quarter, many of the biggest decliners during the crisis posted the largest gains. Financial stocks were the best-performing sector in the S&P 500, gaining roughly 25%; followed by materials, up about 21%; and consumer-discretionary, which includes autos and casinos, up about 19%. 

International stocks continued to outpace the U.S. with emerging markets leading the way. The MSCI Emerging Markets Index was up 20% in the third quarter, compared to a 34% increase in the second quarter. 

Fixed Income 

The recovery in the credit markets started to take hold during the third quarter, as investors' desire to put cash to work outweighed concerns about the economy. Corporate bonds extended gains from the previous quarter, while a combination of low interest rates and strong investor demand sparked a rush by companies to raise cash by selling debt. Treasuries and short-term debt markets also benefited from improved conditions, helping to keep rates low. 

Low short-term rates and paltry returns from "safe havens" such as money-market funds have prompted investors to funnel money into higher-yielding and riskier assets. Investment-grade corporate bonds rallied in the third quarter, posting gains of 8.3%. The gap between their yields and those of Treasuries, commonly called the spread, tightened to 235 basis points from 330 bps three months earlier. High-yield corporate bonds also posted gains during the past three months, up 15% according to Merrill Lynch. Their spread narrowed to 790 basis points from 1,060 basis points at the end of June. Year to date, high-yield bonds have posted a 48% gain. 

Looking Ahead

Despite the rally for stocks and portions of the bond market, there are still large sums of capital remaining in short-term reserves like cash, bank deposits and money market funds. “Money of Zero Maturity” - an index which includes each of these forms of deposit - stands at $9.6 trillion, according to the Federal Reserve Bank of St. Louis. In contrast, the aggregate equity market capitalization of the companies in the S&P 500 index is $9.2 trillion. 

The current consensus is that the economy will continue to improve, but that growth will be slow. Some fear that the U.S. could fall back into recession once the stimulus dollars are spent. Most expect unemployment to recover slowly. Over the next several quarters, corporate earnings may appear strong when compared to the depressed levels of the previous year. Also, corporate cost cutting over the past year has positioned U.S. companies for strong earnings growth but with just a modest increase in revenues. As business confidence improves and more credit is available, merger and acquisition activity is also likely to put upward pressure on stock prices.