Roosevelt Investments Market Commentary August 2011 There has been an explosion in market volatility over the past few weeks fueled by the debt ceiling debacle, the subsequent rating downgrade of U.S. Treasuries, weak macroeconomic data and a continuing sovereign debt crisis in Europe. The Federal Reserve has responded with a first step in what could ultimately be some heavyweight infusions of liquidity, and as a result the market is attempting to stabilize. Because the situation is fluid and fraught with risk, we have continued our recent strategy of seeking to reduce the cyclicality of the All Cap Core portfolio and increasing the deployment of risk tools. Buying opportunities are also presented during such volatile times, and we are therefore evaluating potential new holdings and adding to some existing positions.
The U.S. economy appears to have downshifted into a slower speed, and based upon recent revisions to GDP it is hard to argue that the economy is growing at anything but a snail’s pace. We are probably now in what is referred to as a “growth recession”, where the growth rate of the economy is so slow that it does nothing to bring down unemployment. With the economy in what may be referred to as “stall speed”, a negative external surprise or shock could throw the economy back into negative growth, or a recession.
There has been continued deterioration in July’s macroeconomic data, with generally weaker consumer confidence, flattish consumer spending, disappointing durable goods orders, marked declines in the ISM services and manufacturing indexes, and slightly lower auto sales relative to expectations. Starting off the third quarter in this fashion makes it unlikely that consensus GDP growth rates for the remainder of the year can be achieved, and we have noted that some economists have lowered their forecasts.
In contrast, the results of second quarter corporate earnings season through August 10th have been quite positive. With 85% of the S&P 500 index members having reported, 72% came in ahead of sales expectations, growing on average by 13%, while 76% came in ahead on earnings per share that grew by nearly 18%. There is clearly a disconnect between the macroeconomic data and what the corporate earnings are indicating. Given the heightened uncertainty in the market relating to the persistent European sovereign debt problem (among other headlines), the stock market is leaning in favor of the macroeconomic data.
Michael Cembalest, Eye on the Market, August 2, 2001
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Roosevelt Investments Market Commentary, Cont’d. “Buying opportunities are also presented during such volatile times, and we are therefore evaluating potential new holdings and adding to some exisiting positions.”
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A recent JP Morgan note makes the point that GDP is impacted more by items relating to household consumption and is hurt by a weak dollar, while the S&P 500 index constituents relate more closely to manufacturing/exports, resources, and capital expenditures and benefits from a weak dollar. With the recent downdraft in the stock market, investors appear to be making the further assumption that the probability of a recession has increased dramatically, and that significant downward revisions are likely for many companies. A number of pundits have also begun handicapping the odds of our economy slipping back into a recession (the “double dip”), although so far we haven’t seen any that rate the odds higher than a coin toss. The most likely future path for our economy is very difficult to predict at this point. There are many reasons to believe the economy will continue along its path of slow recovery. While macroeconomic indicators have deteriorated, collectively they still point to an economy that is in expansion. Crude oil has fallen dramatically from its recent $100-plus level, and gasoline prices at the pump seem likely to move lower as well. If these levels persist, they should help to reduce inflationary pressures throughout the economy and provide a potential boost to consumer spending, which has been anemic of late. Capital spending by businesses continues to be very strong, corporate profitability remains near historic highs, and balance sheets are strong. Unemployment claims have declined in recent weeks to a four-month low, and job openings have increased for two months in a row. Interest rates are likely to remain exceedingly low in most developed markets. Lastly, despite a strong rally in treasuries (ironic after the downgrade from AAA), the treasury yield curve is still very positively sloped, while recessions are typically preceded by flat or inverted yield curves.
Roosevelt Investments Market Commentary, Cont’d. “Roosevelt’s AllCap Core portfolio outperformed the Russell 3000 in July, and the majority of economic sectors were additive to performance. During...August, the portfolio gained additional ground on the market, aided by
Possible developments that could point to a recessionary path for the economy include a Eurozone sovereign debt crisis that deepens and results in the failure of one or more large financial institutions in Europe, creating a financial crisis overseas. In addition, the very recent, highly politicized debt ceiling resolution, subsequent S&P downgrade of US debt, and recent stock market plunge could damage consumer and corporate confidence to the point that both groups pull back on spending. Macroeconomic data can be a lagging indicator and it could be the case that data has deteriorated further but that it has not yet shown up in the official figures. While a handful of anecdotes does not make for solid evidence, we have had a number of discussions with company management teams in the last few days, and most see little evidence of changes in the tone of their business, order cancellations, or any other marginal negatives that might imply the economy is about to head south. We will continue to actively search for evidence of weakness. The most plausible negative development is probably loss of confidence leading to a spending pullback. Roosevelt’s All-Cap Core portfolio outperformed the Russell 3000 in July, and the majority of economic sectors were additive to performance. During the market’s downdraft in the first ten days of August, the portfolio gained additional ground on the market, aided by the risk tools and reallocations in the portfolio away from the more cyclically-oriented companies. Roosevelt Investments Please visit our website at www.rooseveltinvestments.com
the risk tools...” INVESTMENT PRODUCTS: NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Our current disclosure statement is set forth on our Form ADV Part 2, available for your review upon request, and on our website, www.rooseveltinvestments.com. Past performance is not a guarantee of future results. Indices are unmanaged and cannot accomodate direct investment.
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