Commentary and Articles
4th Quarter 2009 Quarterly Synopsis
"Is recovery here to stay?"
Investors who participated in equity markets in 2009 had a substantial gain for the year, despite the dismal first quarter. Now, as optimism is improving, the question on many minds is whether the gains will continue in 2010 or will the continued lack of global economic stability create more downside pressure.
One of the key indicators of improving outlook is the continued steepening of the yield curve for bonds. In fact, the yield curve for U.S. government debt is at its steepest in history with short-term rates at extreme historical lows and long-term rates rising quickly. The yield on the 10-year U.S. Treasury Note has increased by over 40% since the beginning of 2009; a strong indication of future expectations of both recovery and inflation.
While the global economic stimulus efforts continue, with the Chinese government announcing that it will spend the entire amount of its allocated stimulus funds, the effects in the U.S. have been most pronounced. Personal spending was up by 0.5% in November, a significant rebound from the prior year. This increased spending drives the economic growth predicted by the steep yield curve as producers must begin to rectify their low inventories to keep up with growing demand. While this rebound in inventory levels has yet to produce improved employment numbers, we expect that it will.
These signs all point to an increase in short-term interest rates as the U.S. Federal Reserve begins to unwind the low rate environment in 2010. Many believe that rate increases will not occur until late 2010, but the Federal Reserve will not let inflation go too far before it must act in order to protect the strength of the dollar. Already Australia’s central bank has begun to raise rates, a sign that other developed economies are seeing indications of improvement.
Even as the “green shoots” of economic growth are present and equity markets recover, the real estate situation will continue to lessen the effects of the recovery. As we recently presented in our Chart of the Week series entitled, “The Elephant in the Room,” banks still have large levels of commercial mortgages that are increasingly delinquent. As these mortgages mature, banks will have to cope with the refinancing pressure or find other means to deal with a likely default by these borrowers. Already, this scenario is producing an environment of tight credit which is hurting smaller companies’ growth prospects as they struggle to find growth capital typically provided by banks. Large companies that have large cash balances and little debt will find many acquisition opportunities among these smaller cash-strapped companies. Also, banks are likely to relieve the commercial mortgage pressure by selling these loans to investors at a discount so that they can redeploy credit in more profitable, less risky opportunities.
There are still high levels of uninvested cash sitting idly on the sidelines. Equity markets are likely to do well in 2010 as the perception of risk diminishes and cash flows out of low yielding money-markets and short-term bonds. However, bond markets will suffer as inflation fears and expectations of rising future rates push prices downward for those investments.
International markets are garnering increased attention from many institutional investors at this point. The expectation is that the U.S. economy is less likely to be the growth story in the world over the next decade as emerging economies produce higher levels of growth. These expectations of higher growth become a self-fulfilling prophesy as capital flows into these emerging markets seeking growth opportunities. As the emerging economies attract more capital purchasing a limited pool of assets, the prices of those assets rise. As we have previously discussed, U.S. companies are already adjusting to lower expectations of U.S. growth with the average S&P 500 company having 40% of its revenue from overseas markets.
All of these factors indicate an increasing level of volatility in both equity and bond markets. A rebounding global economy, increasing interest rates, currency fluctuations, and availability of credit will provide both opportunities and risks. The challenge for investors is to avoid not just bubbles in asset prices as those prices rise, but to avoid bubbles within portfolios by remaining diversified and by frequently and systematically rebalancing among sectors.
In the 4th Quarter 2009, our portfolios benefited from broad exposure to equity markets. In particular we experienced significant gains in Business Services and Technology sectors with holdings Waste Management (WM, NYSE) and Research In Motion (RIMM, NASDAQ). Also, exposure to natural resources and currencies benefited our portfolios as those asset classes rose on expectations of inflationary pressure. We continue to maintain short durations on our fixed income holdings given the potential for increased interest rates.
WHM Capital Advisors is a financial advisory firm providing research, analysis and advice to a diversified global client base that includes institutions, corporations and high net worth individuals. Founded in 2002, the firm’s areas of expertise are in valuation consulting, succession planning, mergers and acquisitions advice and investment management. In addition, the firm has a related technology company that designs applications to analyze complex financial issues for clients.