2012 Second Quarter / First Half Commentary


For those who have been watching the investment markets this year, the first half of 2012 has been a start-stop-and-start-again kind of affair. The first four months of the year saw stocks rocket upward by almost 10 percent, building on one of the best January performances in history. Then came May, with the Wilshire 5000 – the broadest index of U.S. stocks – giving back just over 6% of its value. June was a muddle – until the last day of the month, that is, when the Wilshire 5000 gained back 2.5% in a single trading day and essentially saved the quarter from being a total bust.

More representative of the globally diversified portfolios that most clients own, the Morgan Stanley Capital International (MSCI) All Country World Index is up almost 6% for the year so far, while the Barclay’s Global Aggregate Bond Index is up just shy of 3%. So, despite the tumult of the past six months, to the surprise of many, global equities – yes, even including Europe, with its essentially flat performance year-to-date – are up about twice as much as a portfolio of global government bonds. Commodities, on the other hand, are generally down for the year. The S&P Goldman Sachs Commodity index is off a little over 7% YTD, energy being the hardest hit of the commodity sectors, itself down 11% year-to-date.

The situation in Europe continues to be the mess it has been, with some signs of hope. On the last day of the quarter, markets jumped on preliminary news that a late night round of negotiations among Eurozone leaders had led to a “breakthrough” (as the news reports called it). Over the weekend following these news reports, we learned more details: the European leaders decided that instead of lending more money to the Spanish government, and possibly eroding its already shaky creditor status, they would inject bailout funds directly into Spanish banks. Additionally, the leaders agreed to use the bailout funds set aside by the European Financial Stability Facility and the European Central Bank “in a more flexible manner” in an attempt to stabilize Eurozone markets. Finally, the EZ 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 hopefully avoids a negative feedback loop whereby 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 have, so far, weakened every economy agreeing to such measures. The proposed approach seems to be a step away from austerity and instead towards a more pro-growth / pro-employment approach, which in theory may avoid the negative feedback loop of austerity causing economic hardship, leading to declines in GDP, in turn leading to lower tax revenues, and thus deeper fiscal deficits, which is, of course, what the bailouts are 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. Now one week past the last day of the quarter, some of the initial enthusiasm has evaporated, following a well-established pattern of despair followed by enthusiasm followed by yet more despair, which anyone who has remotely been 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. That said, this follows what has been a relatively predictable trend over the last several years of softening employment data in the summer months followed by a pick-up in the fall.

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, although it’s an encouraging sign none-the-less.

Is there a pattern here? Investors have been led to believe that the global situation, and U.S. economic trends, were worse than an objective view might indicate, and then, in short order, they were seeing unexpected positive news that also may have been over-hyped. The reality 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 (although much of that expectation may already be factored into European stock prices at this point, as evidenced by Europe’s essentially flat stock performance year-to-date). 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 have seen elsewhere.

The most salient thing I can say about these sharp turns in the market – the strong first four months, followed by May, and then the last day of June – is that these reversals have generally not been driven by any change in the intrinsic value of stocks, but rather by the emotional responses of skittish investors jumping into or out of the markets based on headlines that, more often than not, seem to overstate the case on both the economic upside and downside. This, of course, is not a terribly new phenomenon.

So, the bottom line is that despite tumult of this year’s economic roller coaster, the oft over-hyped headlines, and the endless cable news chatter thereabout, global equity returns have been reasonably positive for the first half of this year, despite a difficult second quarter. 2012’s second half will undoubtedly bring another set of surprises, that may hopefully remind us that we are not investing in current events, but in the far less exciting, and far more significant, growing enterprises of people and companies around the globe that we, together, own as part of our portfolios.

On a personal note, Kelly and her husband, Santiago, are proud parents of a new baby girl, Cora Isadora Valenzuela, born June 8th. Both she and the baby are doing well, and she will be out through July on maternity leave.

As always, please let me know if you have any questions, would like to schedule a time to talk, or if there is anything we can do for you.