September 3rd, 2010
The Standard & Poor's 500 Index declined by 4.6% and the NASDAQ Index by 6.3% on a year-to-date basis through August 31, 2010, which includes declines of 3.2% and 6.1% for the Standard & Poor's 500 and NASDAQ, respectively, in the May through August period. Thus far in 2010, just two of ten investment sectors have provided positive performance to the Standard & Poor's 500 Index. These sectors include Industrial and Consumer Discretionary, which have advanced by 0.53% and 0.89%, respectively. Conversely, Technology, Energy and Health Care have performed the least favorably in 2010, declining by 10.9%, 10.5% and 9.9%, respectively.
Second quarter 2010 real GDP advanced by a modest 1.6%. This growth, which was below first quarter real GDP growth of 3.7% and fourth quarter 2009 GDP growth of 5.0%, reflected positive contributions from nonresidential fixed investments, personal consumption expenditures, exports, government spending and to a lesser extent, private inventory investment. These positives were offset by the largest increase in imports since the first quarter of 1984. The sharp increase in imports is considered to be temporary due to special factors and unlikely to recur in the coming quarters. During the quarter, consumer spending, which is the largest component of GDP, provided a positive contribution of 1.4 percentage points, government spending, the second largest component, added 0.9 percentage points, Business Investment 1.5, Exports 1.1 and Housing and Inventories each added 0.6 percentage points, while imports reduced second quarter GDP by 4.5 percentage points. Second quarter growth marked the first time since the first quarter of 2005 that every component of domestic demand, which includes consumers, business, exports and government, expanded in the quarter. The below graph illustrates the foregoing contributions to GDP growth in the second quarter.
Second quarter profit growth of 50% for the Standard & Poor's 500 companies was impressive, albeit less impressive than the 92% annual growth experienced during the first quarter. The growth was led by extremely robust recoveries in the Consumer Discretionary, Energy, Financial Services, Technology and Materials sectors. For the second half of 2010, corporate profits are projected to grow more modestly as the year over year comparisons will become increasingly difficult. Earnings reports may be better than many anticipate as corporations are not expanding employees, yet revenues continue to increase as evidenced by a solid 10.9% increase, excluding Financials, in the second quarter. Higher revenues, together with strong cost controls, continue to provide the basis for improving operating margins and profits. For 2010, Standard & Poor's 500 profit growth could exceed 40%, which would equate to earnings of $83 per share and 2011 corporate profits could approach $94 per share, or 13% above 2010 levels.
Economic activity continued to expand in August, although at a slower rate than the past several months. Manufacturing, as measured by the Purchasing Managers Index (PMI), expanded for the thirteenth consecutive month and continues to benefit from solid export growth, with eleven of eighteen industries reporting increases. Seven of the eleven components of manufacturing expanded in August compared to July including production, employment, PMI and inventories which reduced the negative impact of slower order backlogs and supplier deliveries. Global manufacturing growth also expanded in August, but continues to decelerate from elevated levels. U.S. Leading Economic Indicators (LEI) advanced by 0.1% in July after declining by 0.3% in June, which confirms very modest economic growth during the summer and a moderating economic environment with the potential to produce very modest, but positive, economic activity during the third quarter. The components of LEI further suggest that inventory building has slowed while no other growth factors has yet to emerge to accelerate GDP growth. Accordingly, the foregoing factors indicate that 2010 real GDP could advance by 2.0%. This includes continued improvements in consumer spending and business investment, two important components for a sustained economic expansion, which will be slightly offset by slower housing growth due to the cessation of the housing tax credit.
Strong second quarter corporate earnings helped to produce favorable stock market performance in July, which was not sustained in August. Investors' growing concerns with the policies of the Obama Administration and their potential negative implications to economic growth provided for a majority of the stock market's weakness in August. The exceptional volatility of the stock market in July and August is similar to that which occurred in May and June when the stock market declined in response to investors' concerns regarding the Gulf oil spill, the debt crisis in Greece, Portugal and Spain and the potential for slower global economic growth in the second half of 2010 than had been anticipated.
Notwithstanding the potential for modest economic growth for the remainder of 2010 and 2011, common stock valuations continue to appear attractive in our judgment based on projected 2010 and 2011 operating earnings growth for the Standard & Poor's 500 that could exceed 40% and 13%, respectively. In addition, monetary policy remains very accommodative which should allow the Federal Funds Rate to remain at historically low levels as the economy continues to recover. Corporations have an estimated $1.8 trillion of 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.
