Whistling Past the Graveyard
2Q 2011
Like many that have come before it, the second quarter of 2011 offered a full palette of potentially grave scenarios. Media headlines and expert commentators alike focused our attention on the “soft patch” being felt throughout the global economy (growth rates below 2% in most developed countries), the fact that domestic unemployment remains challenging (1-in-6 Americans lack the work they desire), inflation that’s now seriously taking hold (trending above the 40-year historical average of 3.4%), and then there’s Greece to serve as the poster-child for the Eurozone’s ongoing debt concerns. Add to this a political environment where bi-partisan wrangling has resulted in nothing that resembles a forward looking solution, and you could understandably allow the last bit of optimism to evaporate under the hot summer sun.
While these troubling realities certainly did not go unnoticed in the markets or by those of us here at BAMG, we are thankful for the battle-tested mechanism of price discovery. Markets and democracies work not because investors or voters are perfect, but rather because they are self-correcting. After reaching calendar year highs in late April, global equity markets declined for six consecutive weeks to effectively give back any previously registered gains. With the apparent identification of oversold conditions in mid June, with S&P 500 companies trading barely above 12x projected earnings, the downtrend suddenly began to reverse course in a meaningful way. In reviewing the statements that follow, you’ll likely observe modest quarterly gains in most of the instruments used to construct your diversified portfolio.
Specific detail for the varied asset categories are below:
- Domestic equities returned between -2.6% (Small Cap Value) and +1.6% (Mid Cap Growth). Having reached all-time highs earlier this year, smaller company stocks traded with a lot of volatility during the quarter. The S&P 500, commonly considered “the market” for domestic stocks, returned +0.1%.
- Ongoing weakness in the U.S. dollar versus a trade-weighted basket of currencies aided returns for the international stock categories. That said, the advances in foreign markets were relatively contained at the index level, ranging from -1.1% (Emerging Markets) to +1.8% (Large Cap Developed) given the global scope of sovereign debt and policy concerns.
- Within the alternatives space, global commercial real estate continued to appreciate modestly (+2.5%), while our managed futures benchmark (the S&P DTI) surrendered much of the gain it had accumulated earlier in the year (-2.8%).
- Despite the expiration of the Federal Reserve’s quantitative easing program (a.k.a. deficit funding), interest rates on U.S. Treasury obligations actually fell during the quarter. In such an environment, the Barclay’s Aggregate Bond Index recorded gains of +2.3. Tax-exempt municipal bonds (+3.9), TIPS (+3.7%), and emerging markets debt (+3.4) all provided incremental value relative to the more traditional bond index.
As the post World War II baby-boom generation ages into retirement (1946 + 65 = 2011), it’s believed that the overall appetite for risk among market participants will decline. When combined with the previously mentioned economic and fiscal concerns, the concept of a “perfect storm” with systematically lower return profiles seems almost feasible. In our opinion, however, companies operating within a capitalist system will always be willing to take a measured amount of risk to obtain higher returns. It then follows that investors will be afforded the opportunity to participate in this upside via their investment choices. Changing humanity to eliminate this relationship between risk and return would be akin to the death of capitalism. While never turning a blind eye to the events of the day, we feel most comfortable whistling past that graveyard.