Market Resiliency

We have just lived through one of the most tumultuous quarters that I can remember and yet the markets managed to move higher.  The doomsayers are out there warning that the markets and the economy will not be able to continue to withstand these pressures and yet the economic news continues to improve.  I am not sure what the rest of the year will bring, but I certainly like the way the markets have defied those doomsayers so far this year.

Doomsayers have pointed to continuing fiscal issues in Europe.  Ireland is latest country facing serious consequences if the European Union doesn’t step in to provide some relief.  In fact, Ireland recently completed stress tests on its banking system and found that they are in serious need of bailouts to the tune of EUR24 billion which if completed would account for as much as 44% of Ireland’s annual output.  Ouch. 

Other issues bolstering the doomsayer’s case include the potential for another war in the middle-east as the U.S. and NATO seek to impose a no-fly zone over Libya.  Oil and gas prices have soared as fear spreads and global demand increases – especially in China and India.  This means higher prices at the pump with gas approaching $3.80 a gallon here in Madison.  The ongoing environmental disaster in Japan will be a mixed bag for the markets.  Clean up costs will strain Japan’s resources especially since the country already was facing a fiscal crisis and yet, there will likely be a growth boom in construction, clean-up, and other infrastructure firms as the efforts to rebuild Japan get underway.

Domestic issues continue to power doomsayers as well.  Congress is wrangling over budget issues as both sides of the aisle blame the other for not passing stop gap measures to keep the government running and hold up a new federal budget.  While some of the measures the government has taken have been designed to spur growth they also maybe the source of problems as well.  For example, the $600 billion bond buyback program that the Fed has undertaken is due to expire in June.  This will take a huge stimulus program off the books and it will mean that the private financial sector will have to become the means by which credit is created.  Should the private sector not step up to the plate, any growth in the economy for the rest of the year would be limited.

Even though the doomsayers have much to talk about, the more optimistic of us also have much to talk about and, I believe, much to look forward to.  The first quarter of 2011 ended with the market up 6.4% making it the best first quarter in percentage terms in twelve years as represented by the Dow Jones Industrial Average.  The broader markets did very well too as the S&P 500, 400, and 600 were up 5.4%, 9.0%, and 7.4% respectively.  Exports have been very strong and have been the leading element of our economy’s recovery.  Exports now stand at 12.8% of all domestic output which is the highest level since the Commerce Department began tracking the number in 1929. 

This growth has been powered both by increases in productivity and an increase in employment.  Productivity increased by 2.6% for the last quarter of 2010 and further gains are expected in 2011.  The best news on the economic front for many, however, may be the unemployment rate which has fallen to 8.8%, much lower than many of us expected and expectations are that it may fall into the lower 8% area by year’s end.  If so, that would help expand the economy as workers feel more secure and allow themselves to spend more. 

While not a consistent barometer of the economy, economic expansions last 58 months on average.  The current expansion has only passed its 21st month so potentially we have a long way to go.  One could argue that due to the depths of the last recession, this expansion will take longer just due to the fact that it has further to go to get back to previous peaks.  Profit growth will drive earnings which will drive stock prices and 2010 saw profits grow by 51%.  Expectations are that 2011 will be less robust but still strong which should continue to drive the markets higher.  Another way of looking at this is through the P/E ratio for the S&P 500.  As of December 31, 2010 that ratio stood at 15.01 which was quite a bit less than the 20 year average of 19.86.  Seems like there is still some room to grow!  Even the much (and still) maligned housing sector has seen some improvement at least locally as the supply of homes in Dane County fell by 15% over the past month.

All in all, the economy and the markets have withstood some severe shocks to the system over the past three months and still have added value.  If exports continue to remain strong, profit growth continues, and the private sector steps in to offset the Fed to some degree, there is no reason to not expect further gains this year.  There are potential headwinds to be sure, but if the economy can handle the last three months who knows what the balance of the year has in store for us!

What do you think?


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