July 7th, 2010
The Standard & Poor's 500 Index declined by 6.7% and the NASDAQ Index by 6.6% on a year-to-date basis through June 30, 2010, which includes declines of 12.8% and 14.1% for the Standard & Poor's 500 and NASDAQ, respectively, in May and June. Through the first half of 2010, all ten investment sectors provided negative performance to the Standard & Poor's 500 Index. Although negative, Consumer Discretionary, Industrials and Financials provided the best relative performance thus far in 2010 declining by 1.1%, 1.4% and 3.1%, respectively. The stock market exhibited exceptional volatility in May and June in response to investors' growing concerns regarding the oil spill in the Gulf of Mexico, the debt crisis in Greece, Portugal and Spain and its potential implications to the Euro-zone Financial Institutions and the potential for slower global economic growth in the second half of 2010 than anticipated. The Standard & Poor's 500 and NASDAQ remain 34.1% and 26.3%, respectively, below their peaks of October 2007.
First quarter 2010 real GDP advanced by a moderate 2.7%. Output in the first quarter increased by 4.0% and positive growth was reflected in contributions from personal consumption expenditures, private inventory investment, exports and nonresidential fixed investment. These positives were partly offset by spending decreases by state and local governments and for residential fixed investment. Inventory investment added 1.6 percentage points to first quarter GDP, which decelerated slightly from an extraordinary strong pace in the fourth quarter of 2009. Durable goods and domestic private investments were also strong in the quarter as automobile sales were robust and business spending on equipment and software increased significantly. Productivity was revised lower to 2.8% in the first quarter, down from the 3.6% originally reported as employees worked more hours than initially reported.
First quarter corporate profit growth for the Standard & Poor's 500 companies was impressive, advancing by 91% compared to unusually depressed first quarter earnings one year ago, and was led by extremely robust recoveries in Consumer Discretionary, Energy and Financial Services sectors. Strong corporate cost controls, together with a rebound in consumer spending and inventory restocking provided for exceptional profit growth in the quarter. For the second half of 2010, corporate profits are projected to grow at a more moderate mid-teen rate as the year over year comparisons will become increasingly more difficult. Earnings reports may be better than many anticipate as corporations are not expanding employees yet sales continue to increase. For 2010, Standard & Poor's 500 profit growth could exceed 40%, which would equate to earnings of $81 per share and 2011 corporate profits could approach $95 per share, or 17% above 2010 levels.
Economic activity in 2010 continued to expand in June, although at a slower rate than formerly projected and unemployment, although high, appears to be stabilizing. Household spending is expanding at a moderate pace, but remains constrained by modest income growth, lower housing wealth and tight credit. Manufacturing continued to expand at a modest rate in June with strength in new orders. The New Orders Index has averaged 61.3 percent for the past eleven months and this growth is captured in the ISM manufacturing survey which recorded its eleventh consecutive monthly expansion in June. Although manufacturing growth slowed somewhat in June when compared to growth in March, April and May, it continues to expand and will be an important factor for economic growth in the second half of 2010. Global manufacturing growth slowed in June, although it remains at remarkably high levels, as the Euro-zone debt crisis and China's attempt to slow economic growth subdued demand. U.S. Leading Economic Indicators (LEI) advanced by 0.4% in May and April's small decline was revised to no change. The LEI has been positive for the past twelve months, although the growth rate has moderated recently indicating a lower level of economic activity during the second half of 2010. While risks involving Europe appear to have moderated, the foregoing factors indicate that 2010 real GDP could advance by a moderate 2.5%, which would include the benefit of a lower rate of savings rate of 3.4% down from a prior 4.6%, continued improvements in consumer spending and business investment which will be slightly offset by slower housing growth due to the cessation of the housing tax credit.
Non-farm payrolls declined by 125,000 jobs in June and included the loss of 225,000 temporary workers from the Census Bureau. Excluding the Census workers, private payrolls advanced by 83,000 jobs in June which represents the fifth consecutive month of expansion. The unemployment rate declined very slightly to 9.5%, only because many individuals dropped out of the jobs market in the month. In addition, the long-term unemployment rolls, which represents job seekers who have been unemployed for over 27 weeks remained unchanged in June and represents a record 6.8 million of the total 15.0 million unemployed. Since the inception of the recession in December 2007, private payrolls have declined by 7.5 million jobs which includes 170,000 jobs in the past twelve months. It is our judgment that the unemployment rate will remain stubborn as the natural growth of the nation's work force requires 120,000 to 140,000 new jobs per month for an annual rate of 1.44 million. Accordingly, the economy must generate this number of new jobs just to maintain the present unemployment rate.
Global stock markets experienced exceptional volatility in May and June notwithstanding the European Central Bank's (ECB) increased 2010 economic growth forecast and steadfast policy commitment to maintain very low interest rates. Investor's appear to be more concerned with Greece's debt crisis, its potential to spread to other European nations and implications for a European economic recovery and trade with the United States. Critical to Greece's recovery, and other European countries, is the ability to meaningfully reduce its significant budget deficit and institute unpopular structural reforms set in place by the European Union and International Monetary Fund. While these reforms are expected to be implemented immediately and will retard Greece's 2010 and 2011 economic growth, the global implications should be limited and unlikely to cause another worldwide recession as Greece's 2009 GDP of $334 billion represents 2.2% of the twenty-seven country European Union total 2009 GDP of $14.8 trillion and just 0.46% of global 2009 GDP of $70.2 trillion.
Common stock valuations appear attractive, in our judgment, based on projected 2010 operating earnings growth for the Standard & Poor's 500 that could exceed 40%. In addition, the Federal Funds Rate should remain at historically low levels as the economy continues to recover. Corporations have substantial cash to unleash for acquisitions, share repurchases, dividend increases and capital investment. Lastly, inflation pressures do not prevail in the current environment, especially in consideration of the existing output gap and lack of wage pressures. It remains our judgment that common stocks will provide patient long-term investors with attractive investment returns.
