Commentary for the week ending 6-25-10

Please note: Due to the 4^th of July holiday next week, there will be no market commentary. Have a safe and happy holiday.

Another round of bad news sent the markets lower this week. At the Friday close, the Dow lost 2.9%, the S&P fell 3.6%, and the Nasdaq was off 3.7%. Gold hovered around its record highs, while oil popped higher on fears of a hurricane in the Gulf of Mexico.

Source: MSN Moneycentral

The week started out strong with news that China will allow its currency to appreciate. Markets shot higher, but the excitement quickly faded and the market began its trend lower. Newly released economic reports contributed to the downtrend. Both new and existing home sales came in significantly weaker than expected. For some reason, analysts were expecting a rise in home sales. It was clear to us that with the expiration of the homebuyer tax credit, home sales would fall - which they did. We see this trend continuing for a considerable period and would avoid housing-related stocks, as well as banking stocks due to the significant amount of foreclosures on (or will eventually be on) their books.

The biggest story of the week came on Friday with the announcement of a completed financial regulation bill. The bill is heralded as the most sweeping legislation of the banking industry since the Great Depression. In our opinion, this bill does very little, which was supported by the rise in banking stocks after the announcement. This bill does increase government control of banks and substantially increase costs, though. These costs will not be paid by the bank, however, but by the bank customers (just like corporations don’t pay taxes - the customer pays the tax in the form of higher costs). We anticipate more fees and higher costs for services, as well as a reduction in the amount credit available for lending. In the long run, we see this as harmful to bank stocks and another reason to avoid this sector.

We were disappointed by the lack of attention paid to Fannie Mae and Freddie Mac, who require substantial changes. If this bill was implemented before the financial crisis, it would not have prevented it, nor do we do not see it accomplishing anything in the future.

Unfortunately this bill was rushed through a marathon all-nighter session in order to have something to discuss at the G-20 summit. It appears to be over 2000 pages long, and no one is sure exactly what is in it. Similar to the healthcare bill, we worry what has yet to be discovered and the unintended consequences it will cause. At any rate, the bill is likely to be passed in a close vote next week.

It wasn’t all bad news last week. Both consumer sentiment and current economic conditions climbed to the highest level in over two years. Additionally, a report on corporate profits showed a significant gain. Frankly, businesses appear to be performing relatively well. The crisis has forced companies to become leaner and meaner, and we think they are better prepared for a potentially rocky future. The greatest risks and worries we see are politically related, as policy mistakes, both here and abroad, have been the driving factor of the markets recently.

Next Week

Next week looks to be a busy one. As the week progresses, we will receive personal income and spending reports, consumer confidence, Case-Schiller home price index, manufacturing, and most importantly on Friday, the June unemployment rate. Any surprises with these will certainly impact the market.

The G-20 summit kicks into full gear next week, as well. The message from the U.S. is to continue deficit spending in order to further stimulate global economies. The message from the European countries looks to be just the opposite, as they have taken substantial austerity measures in response to their recent crisis. Oddly enough, these messages are typically reversed. It is troublesome that European countries would lecture us on financial responsibility. However, we agree with them and would love to see fiscal discipline return to the U.S.

Where are we investing now?

With the volatility of the last couple weeks and months, we still believe a simple ladder of corporate bonds and bond funds looks like the least-scary investment. For a long term horizon, some values in stocks can be found, although we remain cautious. Our big-picture outlook still remains the same, as we are optimistic through the end of the year with the low interest rates and stimulus funds pushing the markets higher. The higher interest rates, higher taxes, increasing government involvement in the private sector, and a still-high unemployment rate have us worried for the longer term.

In equities, we are focused on higher-quality and multi-national stocks, but some smaller stocks look promising, as well. We continue to avoid banking and insurance sector stocks, and new government regulations have us staying out of oil companies. TIPs are important as we expect inflation to increase in the future, while U.S. treasuries are a sector we are very bearish (pessimistic) on as yields will increase over time. Commodities remain a longer term favorite, as inflation will also impact prices to the upside. Government policies will weaken the dollar over time, although we have been getting hurt on this trade recently since the drop in the Euro has strengthened the dollar. Municipal bonds will play a more important role in our portfolios over the coming months and years as higher tax rates take effect. Finally, we are optimistic about international stocks, as emerging markets (excluding China) are areas we favor.