Commentary for the week ending 8-27-10

The markets trended lower all week, but erased much of the losses with a pop higher Friday. At the close, the Dow lost 0.6%, the S&P 500 fell 0.7%, and the Nasdaq dropped 1.2%. Both oil and gold rose slightly higher this week.

Source: MSN Moneycentral

Poor economic reports set the tone early in the week and the markets sold off sharply, with the Dow crossing below the psychologically important 10,000 level. The most alarming report came from the housing sector, which showed a record 27% drop in existing home sales for July. We figured it would be bad, but this was much lower than expected.

The mood changed on Friday however, with the release of the revised second quarter GDP and comments from the Fed.

First, GDP was revised lower, to 1.6% from the original 2.4% number. The market was expecting a figure of 1.4%, so the 1.6% was a nice surprise. The problem is, a GDP of 1.6% is a horrible number. We feel the market is being very short-sighted here, as this was not good news. We have gone from 5% in the fourth quarter of last year, to 3.7% in the first, to now 1.6%, so the trend is definitely lower.

This report was followed by news that the Fed will be proactive in further monetary easing to help the economy recover. The markets cheered this news, as well, for it meant further stimulus. We believe the Fed will continue to purchase Treasury bonds, for this will keep interest rates low, which means borrowing costs will be low.

They are trying their hardest to get people borrowing again, so they will buy more “stuff”. The problem is, consumers are deleveraging, or paying off their debt. In fact, the savings rate has been steadily rising. That is why these low rates have not had an effect so far and we believe they will not have an effect in the future.

Until a more business friendly attitude is adopted by Washington, we believe the markets will continue to languish. Therefore, further stimulus would be futile. Even more worrisome, these policies are trading a short term gain for long term pain. Keep in mind we have spent hundreds of billions in stimulus, and have very little to show for it. All this borrowing must be paid back eventually.

Next Week

Next week will be loaded with economic reports and corporate earnings. In our view, the most important information comes on Friday with the release of August unemployment numbers. These numbers look weak, so it will be interesting to see the markets reaction.

For corporate earnings, it looks primarily like retail companies releasing their data. We will also find out how the important back-to-school season fared this year. These numbers look weak, as well.

Where are we investing now?

Even with this weak economic picture, we are modestly optimistic through the end of the year. These low interest rates and the remaining stimulus will push the markets higher. The higher interest rates down the road, 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. 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 (unfortunately this has not been the case recently).

Commodities remain a longer term favorite, as inflation will also impact prices to the upside. Government policies will weaken the dollar over time, but it is currently benefiting from a flight to safety. 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.