September Musings

"Blue Moon in August"

September 3, 2013

The SPX - S&P 500 lost 3.1% in August as Treasuries fell for the fourth straight month. The index has gained 14.5% year to date with 67% of that gain taking place in the first quarter. Corporate earnings growth was 5% in the first half while revenue growth was below 2%. 

Investors are suffering from negative bond market returns in 2013. We note that Jeff Gundlach's DBLTX - Doubleline Total Return fund is down 0.88% year to date having averaged 7% gains the past three years. This year he has outperformed 86 percent of his peers. The well known PTTRX - Pimco Total Return Fund managed by Bill Gross is down 3.6% for the year. U.S. government securities lost 0.7% in August declining 3.5% in the prior 3 months. 

Municipal bonds a $3.7 trillion dollar market segment have lost more than 6% year to date, measured by iShares National Muni ETF - MUB which closed the month at 101.91 down 11% from it's all time peak last November. Fears of rising rates and looming defaults abound in spite of municipal bonds excellent credit history. 

While the US dollar was flat in August gold and oil rallied. Emerging markets and EM currencies dropped once again. 

Syrian concerns surfaced late in the month as President Obama announced a retaliatory attack for the use of chemical weapons by the Assad regime. Over the Labor Day weekend Mr. Obama hesitated and decided to seek Congressional approval for a military strike. This uncertainty will hang over the markets until a conclusion is reached. 

Many of the world's stock markets are down year to date, with Brazil and India losing about 25%, Western European markets have recently turned positive as the Eurozone emerged from its long recession. 

US GDP was revised to +2.5% for the second quarter. The Federal Reserve looks for +3% growth in the second half of this year but some remain skeptical. 

Global markets are facing the following uncertainties going into the balance of the year: 
1- An imminent attack on Syria. 
2- The reduction and eventual withdrawal QE stimulus by the FED. 
3- The appointment of a new Fed Chairman. 
4- The effect of higher rates on consumer spending. 
5- The outcome of the September 22 national elections in Germany. 
6- The outcome of debt ceiling and budget negotiations in October. 

Ten year governments have climbed from 1.40% last summer to 2.90% without a negative impact on US or Euro stock markets. Past experience shows that if rates climb due to a strong economy, equity markets move higher. 

There is currently no sign of wage inflation with workers having scant bargaining power. Since 2009 non-government hourly pay is down from $8.85 to $8.77. 

On the positive side of the ledger we have diminishing unemployment, lower budget deficits, a stronger dollar and improving current account deficits. We are moving towards energy independence. We are the largest world economy and the US dollar is the reserve currency. 

While we are stuck in a 2% growth economy and for now headwinds must diminish to achieve 3% growth. Europe and Asia improvement will help.

The SPX closed August at 1633 up 4.3% from the 2007 peak of 1565. With the 2013 consensus SPX estimate of $107.85, earnings are up 23% from the 2006 peak. This implies downside cushion for stock prices. 

Selling at 15 times consensus numbers, equities are not unreasonably priced. Further gains should come if we have improving GDP and better earnings. It is unlikely we benefit from additional multiple expansion which has floated the market higher thus far. 

Money has continued to flow out of bond funds into money market funds. If confidence rises, stock allocations will likely increase. 

In the coming months we shall see how events unfold. Fed moves remain "data dependent". 

Our goal to guide your funds with diligence, preserve your capital, and achieve acceptable returns over the long run. 

Doug Coppola

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