Kevin Kroskey's Market Commentary

2012 Third Quarter Market Commentary

Third Quarter In Review: Climbing the Wall of Worry

It seems like every quarter we find ourselves saying the same thing: what a difference a quarter makes! In the first two months of 2012, the U.S. stock market was recording excitingly positive returns. The U.S. economy seemed to be back on track and there was talk that the Eurocrisis was finally behind us. Even the pullback in March left the markets in positive territory. Then came a difficult second quarter where the indices fell across the board, nearly wiping out the first quarter gains. Now, in the last three months, while many investors were still anxious about Europe, deficits, paralysis in Washington, elections and unemployment, the markets have delivered an unexpected gift: a steady, gradual rise in stock prices that seemed, week by week, contrary to the mood expressed in the financial press.

Here at the end of the third quarter, entering the home stretch for the year, the returns on many of the broad stock indices are, surprisingly, well into double-digit territory. Market historians will look back on the past three months as a bullish quarter, and probably conclude that investors in the first three quarters of 2012 must have been feeling ebullient bordering on giddy.

Overall, the Wilshire 5000--the broadest measure of U.S. stocks and bonds--was up 6.15% for the third quarter, and is returning a robust 15.85% so far this year. The comparable Russell 3000 index rose 6.23% during the third quarter, and is now up 16.13% for the year.

The other stock market sectors moved in a very similar pattern. Large cap stocks, represented by the Wilshire U.S. Large Cap index, were up 6.25% for the quarter, and now stand at a 15.97% overall gain so far in 2012. The Russell 1000 large-cap index gained 6.31% for the third quarter, putting it up 16.28% for the first nine months of the year. The widely-quoted S&P 500 index of large company stocks gained 5.76% in the same time period, and is up 14.56% so far this year.

The Wilshire U.S. Mid-Cap index index rose 5.59% in the three months ending September 30, up 11.86% for the year. The Russell midcap index was also up 5.59% in the recent quarter, with a 14.00% gain so far this year.

Small company stocks have posted returns nearly identical to the large multinationals. The Wilshire U.S. Small-Cap gained 5.16% in the third quarter, up 15.19% in the first nine months of 2012. The Russell 2000 small-cap index gained 5.25% in the three months ending September 30, and has returned 14.23% for the year so far. The technology-heavy Nasdaq Composite Index was up 6.17% in the third quarter, up 19.62% year to date. Twelve years after the "tech wreck" disaster in this sector, tech stocks appear to be market leaders again.

The next time you read gloomy headlines about the economy, remember that every single industry sector in the S&P 500 is posting gains so far this year, led by telecommunication stocks (up 21.04%), information technology (up 20.64%), consumer discretionary goods manufacturers (up 19.99%), and financial stocks (19.88% gains so far this year).

Global stocks have not been as robust as American shares, but they, too, are in positive territory. The broad-based EAFE index of developed economies rose 6.14% for the third quarter, and is now in firmly positive territory, with a gain of 6.95% so far this year. For the first time this year, European stocks are showing gains for their investors, in dollar terms, up 8.13% for the recent quarter, now up 8.00% for the year.

The EAFE Emerging Markets index of lesser-developed economies rose 6.97% in the third quarter, and is now up 9.41% for the year. Interestingly, the highest returns of any global index came from emerging African nations (minus Zimbabwe, which is one of the ways that EAFE calculates its indices), which are up an aggregate 34.70% so far this year. Second place goes to an index made up of the Jordanian, Egyptian and Moroccan stock markets, up 32.81% in the first three quarters of 2012.

Commodities have also moved into positive territory, with the S&P GSCI index rising 11.54% for the quarter, now up 3.47% this year. Energy and petroleum prices are up very modestly (0.55% and 0.93% on the year respectively); the biggest mover is agriculture (up 18.44% so far this year), with grain prices rising 31.05% due to the Midwestern drought.

On the bond side, those of us who could not imagine how U.S. Treasuries could possibly offer lower yields are watching it happen. The 12-month T-Bonds are now yielding just 0.15%, as investors seem to be happy to essentially lend the government money with a promise that they will get it back again 12 months later. Locking up your money for three years gets you 0.31% a year. Ten-year issues yield 1.63%, and 30-year Treasuries bring a 2.82% annual coupon yield. Muni bonds are also down from where they were last quarter, with aggregate yields of 0.203% (1-year), 0.286% (2-year), 0.624% (5-year) and 1.742% (10-year). The aggregate of all AAA corporate bonds is yielding 0.76% for bonds with a five-year maturity.

Is there an explanation for this three-month bull market during what can only be described as trying economic times? People who have long experience with the investment markets are fond of saying that rallies "climb a wall of worry;" that is, the markets go up most steadily when it requires courage to buy into them. These past three months seem to be one of the best examples of this adage that you are likely to see. Today, it requires a certain degree of courage to believe in the long-term future of the economy and the long-term return on investments, and yet the market rise is evidence that many investors are finding that courage amid the discouraging headlines.

Some economists think that the stock rally was a gift from the central banks. For months, it was rumored that the U.S. Federal Reserve Board would engineer another stimulus package, which had already been dubbed "QE3"--and indeed Fed Chairman Ben Bernanke announced that the Fed would inject $40 billion a month into the market for securitized home mortgages, adding to the money supply, possibly driving down mortgage rates and (again possibly) stimulating the housing and homebuilding sectors of the economy into hiring again.

Meanwhile, the European Central Bank has finally announced that it would do what economists were calling for three years ago: purchase Eurozone government bonds to reduce the borrowing costs of countries that are restructuring their finances--notably Spain and Italy. After two press conferences on different sides of the Atlantic, some of our worst-case economic scenarios (a 2008-like collapse of the Eurozone banking system; a U.S. recession) seem to have become less likely to occur.

The U.S. economy is certainly not in danger of breaking any speed records as it continues to climb out of the Great Recession; in the last week of September, the government announced that from April through June, GDP grew just 1.3%. Economists remain wary of the "fiscal cliff"--the simultaneous expiration of lower tax rates and automatic federal budget cuts--that will take place, absent Congressional intervention, at the stroke of midnight, December 31. Add in the discouraging 8.1% unemployment rate, and there is plenty of reason not to be bullish on stocks for the last three months of the year.

But of course that was also true before stocks went up the past three months. Optimists can point to 96,000 new jobs added in August, and the fact that long-term, the unemployment rate has been trending downward from around 10% at this time three years ago. A Bloomberg News survey recently forecast that the U.S. economy will grow 2.1% over the next three months, and the forecasts from the Federal Reserve Board anticipate 2.5% to 3% GDP growth in 2013. At the upper end of that estimate, we are talking about a return to economic normalcy, and a chance to chip away at the jobless rate.

Who's right? Who knows? All we know for sure is that the global economy is in a slow-growth recovery, with little indication that growth will accelerate dramatically or that the U.S. will slide back into recession. Buying stocks today is a bet that the hard work of millions of people still employed will produce positive results over the long term, which will ultimately reward the owners who hold their shares. For as long as the markets have existed, staying invested has been a good long-term strategy--and in the face of so much short-term uncertainty, this is about all we have to go on.

To Your Prosperity,

Kevin Kroskey

This article prepared in conjunction with Bob Veres.

Wilshire index data: http://www.wilshire.com/Indexes/calculator/

Russell index data: http://www.russell.com/indexes/data/daily_total_returns_us.asp

S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf--p-us-l--

Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP

International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html

Commodities index data: http://www.standardandpoors.com/indices/sp-gsci/en/us/?indexId=spgscirg--usd----sp------

Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Aggregate corporate bond rates: http://finance.yahoo.com/bonds/composite_bond_rates

Employment rate: http://www.washingtonpost.com/business/economy/us-adds-96000-jobs-in-august-unemployment-rate-drops-to-81-percent/2012/09/07/30374bfa-f8e9-11e1-8398-0327ab83ab91_story.html

Economic data: http://www.usatoday.com/story/money/markets/2012/09/28/stocks-end-third-quarter/1600451/

http://www.bloomberg.com/news/2012-09-13/fed-officials-upgrade-economic-growth-outlook-in-2013-2014.html

August Monthly Market Commentary

THE MONTH IN BRIEF
Hazards remained on the horizon last month, but that didn’t stop stocks from advancing – the S&P 500 rose 1.98% in August. Anticipation of central bank action helped, and so did more good news from the housing sector. Headlines from Europe brought anxieties, but not alarms. Gold touched a five-month high and retail gas prices flirted with the $4 mark. Stock indices around the world logged monthly gains as bullish sentiment prevailed. Quite simply, August defied expectations – ending up as a pleasant surprise for an uneasy Wall Street.^1,2

DOMESTIC ECONOMIC HEALTH
It is widely noted that consumer spending accounts for about two-thirds of GDP. So the 0.4% rise in the category for July – the biggest leap in five months – was welcome after a flat June. Personal incomes also rose 0.3% for the second consecutive month. With the economy expanding 1.7% from April-June by the government’s revised estimate, analysts hoped that the July increase signaled a pickup in growth. Another hint that it might: retail sales had soared 0.8% in July after falling 0.7% for June. They hadn’t advanced since March.^3,4

Did growth return to the manufacturing sector in August? According to the Institute for Supply Management’s manufacturing PMI, no. Last month’s PMI was 49.6, down from July’s 49.8 mark. ISM’s service sector PMI continued to stay above contraction territory, having come in at 52.6 in July after a 52.1 June reading. July’s durable goods report was only mildly positive: orders were up 4.2% in the big picture, but down 0.4% with transportation orders subtracted.^5,6,7

Consumer inflation (as measured by the Consumer Price Index) was flat in July, as it had been in June. Core CPI did rise 0.1%. Annualized inflation was running at 1.4%, the smallest yearly gain recorded since November 2010. Producer prices, however, advanced by 0.3% in July, more than in any month since February.^8,9

The jobless rate had ticked up to 8.3% in July and gas prices had taken their toll on household budgets, so consumer confidence fell – the Conference Board’s August poll showed it at the lowest level since November (60.6). Consumer sentiment (a slightly different animal) improved, however – at least according to the University of Michigan’s August survey, which hit a 3-month peak of 74.3.^3,10

Wall Street watched and waited for some sort of clue from the Federal Reserve. Could QE3 be ahead? Did the Fed think the economy would be okay without it? A strong signal flashed on August 31, when Fed Chairman Ben Bernanke noted at the central bank’s annual Wyoming symposium that the state of the economy was “far from satisfactory” and that the Fed “should not rule out” easing. That comment led some investors to believe further action was coming in fall.¹¹

GLOBAL ECONOMIC HEALTH
The good news out of Europe in August? Yields on 10-year notes from Spain and Italy respectively fell below 7% and 6%, and Spain agreed to set up a “bad bank” to clean up toxic assets as a condition of its rescue loan. The bad news? It appeared Spain might need even more than €100 billion in rescue funds from the European Union, actual bond buying by the European Central Bank appeared no better than a fall prospect, and Greece asked the EU for more time to manage its austerity cuts with France and Germany firmly against an extension. The European Financial Stability Facility (the EU’s bailout fund) would presently expand into the permanent European Stability Mechanism – provided that Germany’s high court didn’t declare the ESM illegal. Some analysts felt that the ECB would lower its benchmark interest rate 25 basis points to 0.50% in early September. Euro area statistics showed inflation at 2.6% and unemployment at 11.3% in July.^{12,13,14,15,16,17}

A global manufacturing slump continued in August. China’s official PMI dropped below 50 for the first time in nine months; the nation’s Markit HSBC PMI was already under that figure. (China did not cut interest rates in August, as it had in June and July.) Taiwan’s PMI hit its lowest level since November, and South Korea’s manufacturing index was below 50 for a third straight month. On the other hand, the U.S., the EU and Great Britain saw PMIs rise – although while the Markit PMI for the eurozone rose 1.3% off a 3-year low of 44.0, it was still well into contraction territory. Manufacturing PMIs in Indonesia and India showed expansion (India’s benchmark PMI has been above 50 for more than three years).¹⁸

WORLD MARKETS
Spain’s IBEX 35 staged a 10.13% rebound in August, and the FTSE Italia All Share rose 8.03%. While the major European indices didn’t match those gains, they were also higher for the month – FTSE 100, +1.35%; CAC 40, +3.69%; DAX, +2.93%. In the Americas, Brazil’s Bovespa (+1.72%), Argentina’s MERVAL (+0.99%) and Canada’s TSX Composite (+2.44%) rallied. In the Asia Pacific region, the Hang Seng (-1.59%) and Shanghai Composite (-2.67%) were August losers, but other benchmarks were winners: Australia’s All Ordinaries (+1.16%) and Japan’s Nikkei 225 (+1.67%). While the MSCI World Index rose 2.29% in August, the MSCI Emerging Markets Index slipped 0.54%.^19,20

COMMODITIES MARKETS

Aside from two notable retreats (coffee at -5.53% and natural gas at -12.78%), most key commodities did well in August. NYMEX crude rose 9.55%, ending the month at $96.47 a barrel. RBOB gasoline climbed 7.15%. At the pump, August also brought a 9.40% jump in the price of regular unleaded ($3.83 on August 31). Heating oil rose 11.66%. Silver had a great month (+12.64%). Gold (+4.79%) and copper (+1.16%) also posted gains, gold rising to a 5-month peak on August 31 and settling at $1,687.60 an ounce. Cotton rose 8.30% while corn (+0.06%) and wheat (+0.79%) managed small advances. The U.S. Dollar Index pulled back 1.81% last month.²

REAL ESTATE
Existing home sales were up 2.3% last month, with the pace 10.4% better than a year ago; the National Association of Realtors also reported a 2.4% rise in pending home sales in August (they were 12.4% above year-ago levels). June’s S&P/Case-Shiller Home Price index showed an overall annual gain (+0.5%) for the first time in 20 months. New home sales rose 3.6% in August and were up 25.3% annually.^21,22,23

Mortgage rates finished August higher. Freddie Mac noted the following movements in interest rate averages between its July 26 and August 30 surveys: 30-year FRMs, 3.49% to 3.59%; 15-year FRMs, 2.80% to 2.86%; 5/1-year ARMs, 2.74% to 2.78%. The exception: average rates on 1-year ARMs decreased from 2.71% to 2.63%.²⁴

LOOKING BACK…LOOKING FORWARD
When was the last time that the Dow, S&P and NASDAQ all gained in August? 2009. Speaking of gains and positivity, stocks advanced for the seventh month out of the past eight.^1,2,25

As September starts, there are analysts wondering if a correction might soon occur. At any indication of possible Fed or ECB bond buying (overt or subtle), stocks have moved north. The thinking is that the market may be heading for a disappointment: if signals of decisive action from the ECB or the Fed seem to wane and Spain’s debt crisis worsens, appetite for risk might swiftly decline. Throw in any complications with Greece and another round of indicators that might further confirm economic deceleration in China (its latest set of leading indicators was its weakest in 43 months) and you could see a hasty retreat for stocks. Historically, September has been the S&P 500’s poorest month, with an average 0.65% loss for the index since 1945. An exception occurred in 2010 when Ben Bernanke used the Jackson Hole Fed symposium to talk about what would become known as QE2 – that led to the best September for stocks in the post-WWII era. September could surprise us as long as our economy continues to make progress and headlines from China and Europe don’t startle us.¹⁵

UPCOMING ECONOMIC RELEASES: Across the rest of September, here is the data stream and schedule of notable events: a critical ECB policy meeting and the ISM service sector index for August (9/6), the August employment report (9/7), a German constitutional court ruling on the legality of the European Stability Mechanism and July wholesale inventories (9/12), a Fed policy announcement and the August PPI (9/13), August retail sales figures and industrial output, July business inventories, the University of Michigan’s preliminary September consumer sentiment survey and the August CPI (9/14), September’s NAHB housing market index (9/18), August existing home sales, housing starts and building permits (9/19), the August edition of the Conference Board Leading Economic Indicators index (9/20), the Conference Board’s September reading of consumer confidence, the July Case-Shiller home price index and July’s FHFA housing price index (9/25), August new home sales (9/26), August pending home sales and durable goods orders and the government’s final estimate of Q2 GDP (9/27), and then August personal spending and the University of Michigan’s final consumer sentiment survey for the month (9/28).

MONTHLY QUOTE

“Happy people always look for opportunities where others are seeing crisis.” – Deepak Chopra

To Your Prosperity,

Kevin Kroskey

This article prepared in conjunction with Peter Montoya.

Citations.

1 - www.cnbc.com/id/48858445 [8/31/12]

2 - money.msn.com/market-news/post.aspx?post=461e046e-bbfc-4426-8cdf-e3ae3e518d70 [8/31/12]

3 - www.reuters.com/article/2012/08/30/us-economy-idUSBRE87S0ID20120830 [8/30/12]

4 - articles.marketwatch.com/2012-08-14/economy/33191357_1_sales-at-gasoline-stations-furniture-store-sales-retail-sales [8/17/12]

5 - www.ism.ws/ISMReport/MfgROB.cfm [9/4/12]

6 - www.ism.ws/ISMReport/NonMfgROB.cfm [8/3/12]

7 - www.mysanantonio.com/news/article/Drop-in-key-US-durable-goods-orders-shows-weakness-3812413.php [8/24/12]

8 - www.reuters.com/article/2012/08/15/usa-economy-idINL2E8JF2C720120815 [8/15/12]

9 - www.fxstreet.com/news/forex-news/article.aspx?storyid=0f19ea54-c96b-44db-9fa7-eebeb7368190 [8/14/12]

10 - www.marketwatch.com/story/consumer-sentiment-rises-slightly-in-august-2012-08-31 [8/31/12]

11 - www.cbsnews.com/8301-505123_162-57504249/bernanke-from-jackson-hole-no-qe3...yet/ [8/31/12]

12 - www.nytimes.com/2012/09/03/business/global/03iht-ecb03.html [9/3/12]

13 - www.cnbc.com/id/48825430 [8/29/12]

14 - www.cnbc.com/id/48882795 [9/3/12]

15 - www.cnbc.com/id/48844733 [8/31/12]

16 - epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home [9/4/12]

17 - topics.nytimes.com/top/reference/timestopics/organizations/e/european_financial_stability_facility/index.html [7/20/12]

18 - www.independent.ie/business/european/worldwide-manufacturing-businesses-contract-in-august-3217618.html [9/3/12]

19 - markets.on.nytimes.com/research/markets/worldmarkets/worldmarkets.asp [8/31/12]

20 - mscibarra.com/products/indices/international_equity_indices/gimi/stdindex/performance.html [8/31/12]

21 - www.realtor.org/news-releases/2012/08/existing-home-sales-improve-in-july-prices-continue-to-rise [8/22/12]

22 - money.cnn.com/2012/08/23/real_estate/new-home-sales/index.html/ [8/23/12]

23 - blogs.wsj.com/economics/2012/08/29/u-s-pending-home-sales-highest-since-april-2010/ [8/29/12]

24 - www.freddiemac.com/pmms/ [8/31/12]

25 - montoyaregistry.com/Financial-Market.aspx?financial-market=an-introduction-to-the-stock-market&category=29 [6/4/12]

26 - bigcharts.marketwatch.com/historical/default.asp?symb=DJIA&closeDate=8%2F31%2F11&x=0&y=0 [8/31/12]

26 - bigcharts.marketwatch.com/historical/default.asp?symb=COMP&closeDate=8%2F31%2F11&x=0&y=0 [8/31/12]

26 - bigcharts.marketwatch.com/historical/default.asp?symb=SPX&closeDate=8%2F31%2F11&x=0&y=0 [8/31/12]

26 - bigcharts.marketwatch.com/historical/default.asp?symb=DJIA&closeDate=8%2F30%2F02&x=0&y=0 [8/31/12]

26 - bigcharts.marketwatch.com/historical/default.asp?symb=COMP&closeDate=8%2F30%2F02&x=0&y=0 [8/31/12]

26 - bigcharts.marketwatch.com/historical/default.asp?symb=SPX&closeDate=8%2F30%2F02&x=0&y=0 [8/31/12]

27 - treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyield [8/31/12]

27 - treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyieldAll [8/31/12]

28 - treasurydirect.gov/instit/annceresult/press/preanre/2002/ofm71002.pdf [7/10/02]

July Monthly Market Commentary

THE MONTH IN BRIEF
July brought a new twist on an old story: headlines from Europe actually helped foster an overall stock market advance. The S&P 500 rose 1.26% on the month, and much of the gain was linked to European Central Bank President Mario Draghi’s July 26 pledge that the ECB would do “whatever it takes” to save the euro. After that statement, Wall Street seemingly forgot about the wave of poor-to-mediocre domestic indicators that had held stocks down for most of the month.^1,2

DOMESTIC ECONOMIC HEALTH
There wasn’t much to cheer about in the June employment report. Unemployment remained at 8.2%, and the economy had added only 75,000 new jobs per month in Q2 2012 compared to 226,000 a month in the previous quarter. About a third of the 80,000 jobs added in June were temporary. There was one positive note: the ranks of the long-term unemployed had thinned to 5.4 million down from 6.3 million a year ago.^3,4

Consumer spending was flat for June, even as consumer incomes rose 0.5%. (The economy had grown 1.5% in Q2 compared to 2.0% in Q1.) Consumer confidence polls diverged: the University of Michigan’s July survey hit a 2012 low of 72.3, but the Conference Board’s July survey showed 3.2% improvement to 65.9, its first gain in five months. U.S. retail sales dropped for a third straight month in June (-0.5%), a phenomenon unseen since 2008.^2,5,6,7,8

There wasn’t much movement in consumer or producer prices. The Consumer Price Index was flat in June while the Producer Price Index rose just 0.1%; annualized consumer inflation was running at 1.7% in June, the same as in May.⁹

Had growth returned to the manufacturing sector? According to the Institute for Supply Management, no. Its July manufacturing PMI came in at 49.8, after a June mark of 49.7. The service sector had fared better in June; the ISM PMI for that sector had come in at 52.1. June’s durable goods orders topped forecasts, rising an impressive 1.6%.^6,10,11

GLOBAL ECONOMIC HEALTH
A day after he assured the world that the ECB would pull out all the stops to preserve the eurozone, Bloomberg reported that Mario Draghi was meeting with the head of Germany’s central bank to arrange a round of sovereign debt purchases. Yet even as markets waited for an ECB announcement at the start of August, a Bundesbank source commented to CNBC that “monetary policy should strictly focus on its primary mandate to preserve price stability” – a comment that dampened some enthusiasm. Still, it looked like the risk of a quick “Grexit” had passed – as July ebbed into August, Greece’s government agreed to accept the austerity measures required to qualify for the next installment of its EU/IMF rescue loan.^2,12,13

Across the euro area, inflation held steady at 2.4% in June, though joblessness had ticked up to 11.2%; eurozone sovereign debt had risen to 88.2% of GDP. Assorted purchasing manufacturer indices looked weak. China’s official PMI hit an 8-month low of 50.1% in July as HSBC’s China PMI rose slightly to 49.3. Taiwan’s PMI came in under 50 in July, and manufacturing gauges in India and South Korea respectively registered their biggest monthly drops since September and December. The eurozone Markit PMI dropped to a 37-month low of 44.0 in July.^14,15

WORLD MARKETS
The “Draghi rally” certainly helped indices in Europe, though its effect was less pronounced in other regions. Data from the New York Times tells the tale for July: FTSE 100, +1.15%; DAX, +5.55%; CAC 40, +2.97%; FTSEurofirst 300, +4.11%; Hang Seng, +1.83%; TSX Composite, +0.59%; Bovespa, +3.21%; S&P/ASX All Ordinaries, +3.58%; Shanghai Composite, -5.47%; Nikkei 225, -4.48%. The MSCI World Index rose 1.20% for July, while the MSCI Emerging Markets Index advanced 1.61%.^16,17

COMMODITIES MARKETS

Wheat futures soared 17.30% in July while corn futures gained 26.86%. Energy futures also did well on the NYMEX last month: natural gas went +13.63%, RBOB gasoline +5.41%, heating oil +5.10% and crude oil +3.65. Among metals, gold gained 0.39% and silver 1.09% while copper dipped 2.26%. Cotton prices were virtually flat in July (-0.01%). The U.S. Dollar Index was up 1.17% last month. On July 31, gold settled at $1,610.50 on the COMEX, oil at $88.06 on the NYMEX; at the pump, regular unleaded was averaging precisely $3.50 a gallon.¹⁸

REAL ESTATE
Housing sector analysts had gotten used to the S&P/Case-Shiller Home Price Index bringing depressing data and gloomy analysis, so the May edition was a real surprise – prices rose in all 20 metro markets with a 2.2% composite gain. (In fact, it was the best month the index had seen in over a decade.) Existing home sales, however, slipped badly in June (-5.4%) along with new home sales (-8.4%) and pending home sales (-1.4%). Housing starts were up 6.9% in June to a three-and-a-half-year peak, with single-family starts increasing 4.7%.^19,20,21

Mortgage rates reached historical lows - again. In Freddie Mac’s, July 26 survey, the average interest rate on the 30-year FRM was 3.49% compared to 3.66% on June 29. Those eyeing refinancing watched the 15-year FRM’s average rate dip to 2.80% on July 26, down from 2.94% in the final June survey. Between June 29 and July 26, average rates for 5/1-year ARMs moved from 2.79% to 2.74% and average rates on 1-year ARMs went from 2.74% to 2.71%.²²

LOOKING BACK…LOOKING FORWARD
The Dow ended July at 13,008.68, the S&P at 1,379.33 and the NASDAQ at 2,939.52. The gain in the blue chips is relatively impressive given the fact that the Dow had many more down days than up days last month.^1,12,23

As August began, Wall Street hoped for promising announcements from the Federal Reserve and European Central Bank – two entities not known for sudden bold moves. The Fed offered carefully placed hints of possible future action in its August 1 policy statement, noting that it “will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery.” That language is just a tiny bit stronger than that seen in prior FOMC statements, and bulls are taking it as a signal that the fall may bring a new stimulus of some sort. Meanwhile, it could be that August simply continues what we have seen in June and July: stocks persistently advancing in spite of the pressures on U.S. consumer spending, global manufacturing and the European banking sector and bond market.²⁸

UPCOMING ECONOMIC RELEASES: Coming up in August, we have: the July employment report and July’s ISM service sector index (8/3), June wholesale inventories (8/9), July’s retail sales and PPI and June business inventories (8/14), July’s CPI and industrial output data and the latest NAHB housing market index (8/15), July housing starts and building permits (8/16), the initial August consumer sentiment survey from the University of Michigan plus the July edition of the Conference Board’s Leading Economic Indicators index (8/17), the release of the July 31 FOMC minutes (8/21), July existing home sales (8/22), July new home sales and June’s FHFA housing price index (8/23), July’s durable goods orders (8/24), June’s Case-Shiller home price index and the Conference Board’s August consumer confidence poll (8/28), July’s pending home sales, another estimate of Q2 GDP and a new Fed Beige Book (8/29), July consumer spending data (8/30), and a report on July factory orders along with the month’s final University of Michigan consumer sentiment survey (8/31).

MONTHLY QUOTE

“The art of teaching is the art of assisting discovery.” – Mark Van Doren

To Your Prosperity,

Kevin Kroskey

This article prepared in conjunction with Peter Montoya.

Citations.

1 - www.bloomberg.com/markets/stocks/ [7/31/12]

2 - cnbc.com/id/48352210 [7/27/12]

3 - www.ncsl.org/issues-research/labor/national-employment-monthly-update.aspx [7/31/12]

4 - www.nj.com/news/index.ssf/2012/07/us_unemployment_rate_stays_at.html [7/6/12]

5 - business.time.com/2012/07/31/us-consumer-spending-flat-income-up-0-5-in-june/ [7/31/12]

6 - briefing.com/investor/calendars/economic/2012/07/23-27 [7/27/12]

7 - www.latimes.com/business/la-fi-consumer-confidence-20120801,0,543957.story [8/1/12]

8 - www.forexpros.com/news/economic-indicators/u.s.-retail-sales-drop-0.5-in-june;-core-retail-sales-fall-0.4-235976 [7/16/12]

9 - www.businessweek.com/news/2012-07-17/u-dot-s-dot-consumer-price-index-was-unchanged-in-june-core-up-0-dot-2-percent [7/17/12]

10 - www.ism.ws/ISMReport/MfgROB.cfm [8/1/12]

11 - www.ism.ws/ISMReport/NonMfgROB.cfm [7/5/12]

12 - www.cnbc.com/id/48415895 [7/31/12]

13 - www.bbc.co.uk/news/world-europe-19085236 [8/1/12]

14 - epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/ [8/1/12]

15 - in.reuters.com/article/2012/08/01/economy-global-idINL6E8J13A920120801 [8/1/12]

16 - markets.on.nytimes.com/research/markets/worldmarkets/worldmarkets.asp [7/31/12]

17 - mscibarra.com/products/indices/international_equity_indices/gimi/stdindex/performance.html [7/31/12]

18 - money.msn.com/market-news/post.aspx?post=69561ea6-6d00-4e34-8db8-b8dcd17ee72e [7/31/12]

19 - www.latimes.com/business/money/la-fi-mo-home-prices-20120731,0,1786807.story [7/31/12]

20 - www.cnbc.com/id/48335711 [7/26/12]

21 - www.usatoday.com/money/economy/housing/story/2012-07-18/housing-starts-june/56297966/1 [7/18/12]

22 - www.freddiemac.com/pmms/ [8/1/12]

23 - montoyaregistry.com/Financial-Market.aspx?financial-market=an-introduction-to-the-stock-market&category=29 [7/2/12]

24 - www.usatoday.com/money/index [7/31/12]

25 - bigcharts.marketwatch.com/historical/default.asp?symb=DJIA&closeDate=8%2F1%2F11&x=0&y=0 [7/31/12]

25 - bigcharts.marketwatch.com/historical/default.asp?symb=COMP&closeDate=8%2F1%2F11&x=0&y=0 [7/31/12]

25 - bigcharts.marketwatch.com/historical/default.asp?symb=SPX&closeDate=8%2F1%2F11&x=0&y=0 [7/31/12]

25 - bigcharts.marketwatch.com/historical/default.asp?symb=DJIA&closeDate=7%2F31%2F02&x=0&y=0 [7/31/12]

25 - bigcharts.marketwatch.com/historical/default.asp?symb=COMP&closeDate=7%2F31%2F02&x=0&y=0 [7/31/12]

25 - bigcharts.marketwatch.com/historical/default.asp?symb=SPX&closeDate=7%2F31%2F02&x=0&y=0 [7/31/12]

26 - treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyieldYear&year=2012 [7/31/12]

26 - treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=realyieldAll [7/31/12]

27 - treasurydirect.gov/instit/annceresult/press/preanre/2002/ofm71002.pdf [7/10/02]

28 - money.cnn.com/2012/08/01/news/economy/federal-reserve-stimulus/index.htm [8/1/12]

2012 First Half Market Commentary

For those who watch the investment markets, the first half of 2012 was a strange and somewhat harrowing experience. The first four months of the year saw American stocks zoom upward by almost 10 percentage points, building on one of the best January performances in history. Then came May, when the Wilshire 5000--the broadest index of U.S. stocks--gave back 6.22% of its value. June was a muddle--until the final day of the month, when The Wilshire 5000 gained back 2.53% in a single trading day and essentially saved the quarter from being considered a total disaster. On the same day, the S&P 500 gained 2.49% and the Nasdaq exchange was up 3.00%.

If there is a lesson here--and the markets are always teaching us new ones--it is that the drops, and the rises, take us by surprise, and are almost impossible to predict.

Let's take stock of the past quarter, and look at where we are after the first half of 2012. Overall, the Wilshire 5000 fell 3.13% for the second quarter, but it's still up 9.22% for the year. The comparable Russell 3000 index fell 3.15% during the second quarter, but rose 3.92% in June, and is up 9.32% for the year.

The other stock market sectors moved in a very similar pattern. Large cap stocks, represented by the Wilshire U.S. Large Cap index, fell 3.11% for the quarter, but are posting a 9.15% overall gain in the first half of 2012. The Russell 1000 large-cap index fell 3.12% for the second quarter, but is up 9.38% for the first half of the year. The widely-quoted S&P 500 lost 3.29% in the same time period, but is up 8.31% this year.

The Wilshire U.S. Mid-Cap index was the biggest quarterly loser, down 5.71% in the second three months of the year, but it, too, has posted an overall gain so far this year, at 5.93%. The Russell midcap index dropped 4.40% in the recent quarter, but is up 7.97% so far this year.

The Wilshire U.S. Small-Cap index dropped 3.33% in the three months ending June 30, but ended the first half up 9.54%. The Russell 2000 small-cap index lost 3.47% in the three months ending January 30, but is up 8.53% for the first six months of 2012. The technology-heavy Nasdaq Composite Index lost 5.06% in the second quarter, but was up 3.81% in June, and has a 12.66% gain for the year.

Although energy stocks are down 3.37% for the year, as a result of falling oil prices, other sectors are posting significant gains. Telecommunication services stocks are up 13.34% for the year, while information technology stocks have posted a 12.71% gain, even though they fell 6.96% during the second quarter. Financial stocks are up 12.63% and Consumer Discretionary stocks have gained 12.06%.

Internationally, the broad-based EAFE index of developed economies fell 8.37% for the quarter despite a 6.79% gain in the past month. For the year, the index is up a scant 0.77%. Not surprisingly, the weakest component is EAFE's Europe index, down 9.11% for the second quarter, down 0.12% so far this year.

The EAFE Emerging Markets index of lesser-developed economies fell 10.00% in the second quarter, but is up 2.29% for the year. The bloodiest quarter was experienced by the Eastern European EM countries, down 15.03% in the three months ending June 30, but still up 0.38% for the year.

Commodities are generally down for the year, with the S&P GSCI index falling 12.38% in the second quarter, down 7.23% so far this year. The hardest-hit: energy (mostly oil) down 17.05% for the quarter, down 10.98% so far in 2012.

On the bond side, U.S. Treasuries remained at rock-bottom yields. The 12-month T-Bond yields just 0.20%. Locking up your money for three years gets you 0.39% a year. Ten-year issues yield 1.64%, and 30-year Treasuries bring a 2.75% annual coupon yield. Muni bonds are even lower, with yields of 0.211% (1-year), 0.343% (2-year), 0.808% (5-year) and 1.922% (10-year), while the aggregate of all AAA corporate bonds is yielding 1.14% for bonds with a five-year maturity.

It is worth looking at what led to the sudden jump in investor enthusiasm for stocks on the very last day of the quarter, and see whether we should be feeling the same exuberance as the general public. The market jumped on preliminary news that a late night round of negotiations among the Eurozone leaders had led to a "breakthrough" (as the news reports called it). Over the weekend following these news reports, we have learned more details: the European leaders have decided that instead of lending more money to the Spanish government, and possibly eroding its already shaky creditor status, they will inject bailout funds directly into Spanish banks. In addition, the leaders agreed to use the bailout funds set aside in the European Financial Stability Facility and the European Central Bank "in a more flexible manner" in order to stabilize the Eurozone markets. Finally, the leaders announced plans to create a 120 billion euro fund to stimulate growth across Europe and create jobs.

All of these moves represent at least a quarter-degree turn from previous policies. Giving money directly to the Spanish banking system avoids a negative feedback loop where lending to the government simply burdens it with more debt and causes investors to demand cripplingly high interest rates on Spanish government bonds. Making the bailout funds more flexible seems to be a concession by German government leaders, who wanted any bailouts to be accompanied by austerity measures in the receiving country, which has, so far, weakened every economy that agreed to it. The growth funds seem to be a step in the same direction, away from austerity toward promoting growth and employment--which avoids the negative feedback loop of austerity causing economic hardship, leading to declines in GDP, leading to lower tax revenues, leading to deeper fiscal deficits, which is what the bailouts were intended to alleviate.

However, as investors read the fine print, they will notice that the newly-flexible bailout funds amount to about 500 billion euros, compared with roughly $2 trillion in potentially distressed government debt. It is possible that some of the enthusiasm generated on the last day of the first quarter will have evaporated within the week, following a well-worn path of enthusiasm followed by panic that investors who are paying attention will have already grown tired of.

Meanwhile, there is some cause for concern in the U.S. economy, which has recently seen the kind of good news that should be put into better perspective. The number of Americans filing for first-time unemployment benefits fell to 386,000 for the week ending June 23, down from 392,000 the previous week. But the four-week average fell by just 750, meaning that if you look past the headlines, an economist would have trouble discerning a trend in the data. Similarly, home prices in the 20 largest U.S. cities rose 1.3% in value in April, based on the S&P/Case-Shiller Home Price indices. But this, too, calls for some perspective: the rise only brings home prices to levels seen in early 2003.

Is there a pattern here? Investors have been led to believe that the global situation, and the U.S. economic trends, were worse than an objective view might indicate, and then, in one day, they were suddenly seeing unexpected positive news that may have been overhyped. The truth is that Europe is still working its way out of a crisis, and many analysts are still predicting a recession in the Eurozone this year. The U.S. has been on a slow recovery path, and it is not easy to predict its progress beyond feeling grateful that the situation is not as dire as we see in Greece, or as unsettling as what we're seeing in Spain.

The most truthful thing one can say is that these sharp turns in the market--in May, on the last day of June--are not driven by any change in the intrinsic value of stocks, or any interruption in the actions of millions of workers who are daily building stronger, more profitable franchises throughout the global economy. The lurches of the roller coaster represent emotional responses by skittish investors who want to jump into or out of the markets based on headlines that usually seem to overstate the case on the upside and the downside.

So far, 2012 has been a very bumpy ride, and has certainly been scary at times. But from a real investor's point of view, behind all the sturm and drang, the first half of the year has seen unusually positive growth in the markets. We cannot predict what the second half will bring, any more than we can predict what the weather will be at a certain date in October or December. Remaining steadily invested and paying as little attention as possible to the shrill voices of our increasingly frantic news outlets has been a solid strategy so far this year, and has generally worked out well for investors over time.

2012's second half will undoubtedly bring us more surprises. It will force us to remember that we are not investing in current events, but in the far more boring, far more significant daily work and effort of the people who get up each morning and contribute to the growth of our global economy and the growth of the businesses they work for--the companies that we, together, are invested in.

To Your Prosperity,

Kevin Kroskey

This article prepared in conjunction with Bob Veres.

Wilshire index data: http://www.wilshire.com/Indexes/calculator/
Russell index data: http://www.russell.com/indexes/data/daily_total_returns_us.asp
S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf--p-us-l--
Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP
International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html
Commodities index data: http://www.standardandpoors.com/indices/sp-gsci/en/us/?indexId=spgscirg--usd----sp------
Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
Aggregate corporate bond rates: http://finance.yahoo.com/bonds/composite_bond_rates
Euro pact analysis: http://money.cnn.com/2012/06/29/investing/european-union-summit/index.htm

May Monthly Market Commentary

By just about any measure, May was an awful month for investment performance, which is another way of saying that the past 31 days have made stock indices 5% to 10% more affordable than they were in April. However, after the dramatic (and largely unexpected) runup through the first five months of the year, most of the major indices were still in positive territory after the decline. The Wilshire 5000 index, which is the broadest measure of all categories of U.S. stocks, lost 6.22% last month, but remains up 5.08% with 30 days to go before 2012's halfway mark. The comparable Russell 3000 index fell 6.18% in May, but is still in positive territory so far this year, up 5.20%.

The stock market is fundamentally a gauge of optimism or pessimism for investors. If we think the future is bright, as most shareholders apparently believed until the end of April, there is more demand for more shares and prices go up. So we have to ask: why did sentiment turn around so dramatically, and does the herd of investors know something important about the future?

The headlines have suggested two reasons for gloom. The first is jobs. The latest employment report from the Labor Department shows the first increase in U.S. unemployment in 11 months, as the jobless rate ticked up from 8.1% to 8.2%. In the simplest possible terms, these numbers are interpreted as meaning that companies aren't hiring new workers as quickly as new workers are coming on the market. However, buried in the Labor Department report is a statistic on "labor force participation" that shows that more than 600,000 people got off their couches rejoined the work force in May. Somebody, somewhere, is feeling more optimistic about the jobs picture.

The report also said that the overall economy had added just 69,000 new jobs. However, a survey from the payrolls processing company Automatic Data Processing (ADP) showed that the American private sector added 133,000 new jobs in May, meaning that much of the job loss was in government and public sector payrolls.

Is this true? If you look at the chart below, the trend is very different from what you are likely hearing in the news reports. The red line, which is trending depressingly downward after a brief stimulus-related spike in 2010, is federal government employment, which corresponds with the numbers on the right-hand side. As you can see, Washington's payroll is declining dramatically, as the country works to restore its fiscal balance. Since the beginning of 2009, over half a million government jobs have been slashed or eliminated altogether.

The blue line looks a bit more hopeful. That represents the total number of private sector jobs in the U.S., corresponding with the numbers on the right-hand side. The Great Recession caused a dramatic freefall in total private employment that bottomed out around January of 2010. Since then, you can see a steady (and largely unreported) improvement in the jobs picture exactly where we would want it: in the private sector, in the for-profit companies that most of us invest in.

The other reason why investors have become allergic to stocks, according to the press, is the continuing fiscal problems in Europe. Overall Eurozone unemployment has reached 11%, and economists believe that a recession has either begun or is imminent. There are worries that Spain and Ireland could fall into the same economic precipice as Greece. Spain's 10-year bonds are now trading at a 6.7% yield, their highest level since November.

You can see, in the map below, a kind of "cheat-sheet" on where the sovereign debt problems are most acute. Purple countries are not in danger, the orange countries are facing worrisome conditions, and the bonds issued by countries painted in red are basically downgraded to junk bond status.

The recent selloff suggests that many investors are expecting widespread defaults in Europe that will spread (the word "contagion is often used) to the U.S. banking system, and from there into the U.S. economy, not unlike the way the collapse of U.S. investment banks caused the Great Recession.

However, if you read the news reports closely, you see that the European governments have a solution at hand, which some are reluctant to put into place. The new French government has proposed that the European Central Bank be authorized to issue its own bonds. This would make Europe function more like the U.S. fiscal system, where the states (comparable to the individual European countries) issue bonds, and our government (comparable to the ECB) also has borrowing power to sell Treasuries. The money raised by those Eurobonds would be used to contain the crisis, and the interest rate to Eurobond investors would be dramatically lower than what the countries in orange and red are currently paying in the open markets.

Presto! The ECB would step in as their surrogate borrower, swap their high rates for its lower rates, and eliminate the threat of contagion. Of course, this would also expose the purple countries to the credit risks of the orange and red ones (this is why Germany is dragging its feet on the idea), but presumably any deal would come with guarantees about future fiscal discipline, and would remove the crushing borrowing costs from countries as they dig out of their debt. That, in turn, would allow these countries to begin re-growing their economies, which might reduce the size and extent of the expected Eurozone recession.

Armed with this information, pessimistic stock investors might want to take another look at their European fears, and ask themselves: will European leaders eventually accept this way out of the crisis? Or will they allow the economic crisis to spiral out of control?

Meanwhile, it might be helpful to ask: where, in all the world, do investors feel the safest? Recently, German government 2-year bonds were issued at auction, where investors were willing to accept a negative yield for the first time in the country's history. That means that investors, today, are willing to pay the German government for the privilege of lending to it. This follows a record-setting Treasury Inflation Protected Securities (TIPS) auction issued by the U.S. government, which was also priced at a negative yield. These are unprecedented events, and suggest that you and I are fortunate to be living in a nation whose debt is regarded by investors as one of the safest havens in the history of finance.