Recovery Is Two and One Half Years Old
The latest report for Gross Domestic Product showed a 3.0% annual rate for the last three months of 2011. For two and a half years now, economic growth has come in positive (albeit at a subdued pace). The labor market is finally showing signs of health. The average number of Americans filing new claims for unemployment benefits fell below a 400,000 reading, which suggests layoffs are easing and hiring may be picking up. The March 2012 unemployment rate was reported at 8.3%. Consumer confidence readings are about 70—nowhere near the low of 25.3 reached in February 2009. However, it’s also not close enough to a level of 90, which signals a healthy economy. The U.S. housing market, a notable soft spot in the nation’s economy, is also showing signs of life. Home sales and new construction are finally becoming less of a drag on the recovery and look likely to actually start contributing to the nation’s recovery. In general, Americans remain upbeat about the state of the economy but are becoming a bit worried about the next six months given rising gasoline prices. One other notable cloud on the horizon is the risk that the debt problems in Europe will throw the global economy off course.
The Stock Market
2012 Starts With a Surge in Stock Prices
After surviving the roller coaster ride of 2011, stock investors were amply rewarded in the first quarter of 2012. The S&P 500 was up 12.6% for the first three months of this year. Small- to mid-sized companies enjoyed a similar rally with gains slightly over 12%. The index for international stocks (MSCI Europe, Australia, Far East) was up 10% for the quarter. U.S. corporations came through as a bright spot for the U.S. economy with record earnings achieved in 2011. At year end, equity investors appeared to take note of the high earnings and the reasonable valuations that stocks offered. Also, there was a sense of relief about Europe upon receiving news that the European Central Bank had grasped the severity of debt issues with Greece and nearby countries and had developed a plan of action. While the earnings growth rate of corporate America is likely to decelerate from substantial double-digit gains, expectations are for earnings gains to persist. Meanwhile, corporations are sitting on large amounts of cash that are likely to be used for dividends and stock buybacks.
The Bond Market
Rates Tick Up a Notch
For the past several years, the Federal Reserve has had an extremely easy monetary policy. They have kept short term rates near zero since December 2008 in an effort to allow the economy to expand and sustain its recovery. In addition to that policy, the Federal Reserve embarked on a bond buying strategy designed to lower long term rates and encourage business activity. Recent statements by the Fed reiterated their intentions to keep the short term rates near zero through the end of 2013. However, a statement was made after a recent policy meeting that the Fed does not expect to initiate a new round of bond buying anytime soon. These comments appeared to cause a sell-off in the bond market (prices go down when yields go up). Some economists see this as the beginning to the end of the great bull market in bonds that began in the early 1980s. The yield on a 2-year Treasury note has risen to .32% from .24% at year-end 2011. The 10-year Treasury note had a yield of 2.2% on March 31, 2012 versus a 1.9% yield at year end. Given the inverse relationship between bond prices and yields, the result was a negative 2.27% return for the 10-year Treasury note. The 30-year Treasury note, likewise, saw its yield rise to 3.3% on March 31, 2012, up from 2.9% at year end.
In this volatile interest rate environment, a prudent strategy for investors is to focus on short term, high quality bonds or fixed rate certificates of deposit that can provide safety and stability as part of a diversified portfolio.