Second Quarter 2012 in Review
Heightened macroeconomic concerns once again took center stage and the turmoil in the Eurozone seemed to reach new levels following Greece’s failed election. Equities posted losses across the board, with the S&P 500 Index declining 2.8% for the quarter. Performance was even weaker in international markets as the MSCI World ex US Index pulled back by 7.2%. For the first half of the year, however, markets remain in solidly positive territory.
A Softening of Economic Data
On the U.S. economic front, data started to show signs of a deceleration in growth. The jobless rate remained stubbornly high at 8.2% as the last two jobs reports were disappointing. For June, the economy added a meager 80,000 jobs, while the previous month saw only 77,000 new jobs created. This is substantially lower than the monthly average of 226,000 jobs created during the first quarter. Manufacturing also slowed during the quarter, as evidenced by the ISM Manufacturing index moving into contraction territory for the first time since 2009. The latest annualized GDP data below 2% seems to confirm we remain in a “new normal” world of slow growth and high unemployment.
The housing market was one of the few bright spots during the quarter as several metropolitan areas continued to regain their footing and showed improvements from their respective troughs in housing permits and prices. The National Association of Realtors indicated existing home sales increased 10% from a year ago. Also, listed and shadow inventory has been decreasing to much more normal levels and the diminishing share of foreclosed property sales has been helping home values. These improvements in the housing sector, coupled with the recent 18% decrease in oil prices, will likely have a positive impact on consumer confidence and improved perceptions of wealth.
US Corporate Highlights
The long anticipated Facebook IPO, which grabbed the attention of many retail investors, was a flop. A last minute increase in the number of shares offered, as well as technical glitches in the first moments of trading drove the stock into a tailspin, losing almost 33% in the first few weeks of trading. This temporarily froze the IPO markets and M&A activity saw a decrease of 15% from the previous year.
Also in corporate news, JPMorgan‘s Jamie Dimon disclosed a $2 billion loss related to a hedge implemented by the “London Whale”, a trader in their U.K. office. As more details emerged about the failed hedge, it was clear that the loss would be higher than $2 billion. The actual $5.8 billion loss was disclosed July 13th when JPMorgan reported its second quarter earnings. Several high ranking executives lost their jobs as a result and one of the most respected CEOs on Wall Street saw his reputation tarnished by the event.
The Roller Coaster Ride Continues
The Eurozone sovereign debt crisis intensified after an unsuccessful Greek election on May 6th. A new election was scheduled for June 17th and the New Democracy Party– which supports enacting austerity measures and keeping Greece in the Eurozone (for the time being)—narrowly won the majority vote. This outcome came as a great relief to those who feared that an anti-austerity/anti-bailout party would come out victorious.
Spain’s and Italy’s funding costs steadily increased as their 10 year government bond yields hovered near 7%. This is seen as a critical level that is unsustainable and where other peripheral economies required bailouts. Spanish banks received a much needed $123 billion capital infusion which the markets shrugged off as concerns about the country’s debt levels took precedence.
The latest European Summit on June 28th delivered what seems to be a step in the right direction, with the announcement of the creation of a central banking supervisor and the ability of the European Stabilization Mechanism (ESM) to directly capitalize ailing banks without increasing sovereigns’ debt loads. It is still unclear how this will ultimately work, but it could be the first move towards a more fiscally integrated Europe.
Separately, there are concerns about the pace of economic expansion in China. The expected GDP growth rate of 7.3% would be the lowest since the 2008 global crisis and PMI (Purchasing Manager’s Index) is slowing but still above the key 50 level which separates expansion and contraction. In an effort to avoid a hard landing, Chinese authorities have cut the bank’s required reserve ratio three times during the first half of the year, reduced their benchmark rates and injected liquidity into the banking system.
US Political Landscape:
The Media has turned its attention on the upcoming “fiscal cliff”. This term refers to the combination of higher taxes and spending cuts that would go into effect under current policy. The Bush tax cuts are set to expire at the end of this year, as are the payroll tax holiday and the emergency unemployment benefits. In addition, the $2 trillion automatic spending cuts agreed to in last year’s debt ceiling vote are set to kick in as the Super Committee failed to achieve its objective. With the recovery still fragile, the effect of these tax increases and spending cuts could be significant and tilt the economy back into recession. According to Congressional Budget Office estimates, these tax increases and spending cuts could amount to as much as 4% of GDP. Although both political parties want to avoid the fiscal cliff, the political environment is highly charged and reaching a compromise could be difficult. The most likely result is another set of temporary fixes that would delay addressing the issue until after the election.
Health care reform will remain another heated topic of debate. The Supreme Court recently announced its decision to uphold the constitutionality of the Patient Protection and Affordable Care Act, commonly referred to as ObamaCare. While Democrats praised the decision, Republicans vowed to continue their fight to repeal it; especially Mitt Romney should he win the election.
A Look Ahead: Elevated Volatility in the Coming Months, Cheaper Stocks Prices Today
Central Banks around the world remain extremely accommodative which will continue to push investors up the risk spectrum and no major changes to this stance are expected in the upcoming quarters. The US consumer should get a much needed boost in discretionary income as the price of oil dropped significantly during the quarter and will likely remain low for the rest of the summer driving season.
As the November election looms, the political situation in the United States is highly charged and should heat up further in the coming months. We hope to hear more about job creation, health care reform and deficit reduction as these issues are the most important factors to addressing our current economic situation.
Due to European concerns, the valuations of some of certain global companies are extremely depressed while their balance sheets are very strong. This attractive stock valuation, coupled with the potential for positive upcoming catalysts are creating an increasingly interesting situation for long term investors. While we expect volatility to remain elevated due to the high degree of uncertainty related to macro events for the second half of the year, we will use these opportunities to look for quality stocks at a discounted price.
This quarterly letter was brought to you by the financial advisors at PWM Advisory Group – Private Wealth Management
Due to various factors, including changing market conditions and/or applicable laws, the presented material(s) may no longer be reflective of current opinions or positions. The thoughts and opinions expressed in the presented material(s) relate only to the author and are not necessarily reflective of PWM’s views. Moreover, you should not assume that any discussion or information contained in the presented material(s) serves as the receipt of, or as a substitute for, personalized investment advice from PWM. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Photo Credit: abmatic
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