The financial markets have proven to investors that the “all-clear bell” has been sounded
prematurely. The European situation is
downright awful, and is spilling over into the global economy. Can the United States and its fragile
economy continue recovering with the massive headwinds coming from
overseas?
Economic Situation
The bright spot of the US economy at the beginning of 2012
was the increase in new jobs, an apparent rebound in the housing sector, and a
reasonable increase in overall economic activity. Unfortunately, job creation has since
stalled, surprising to the downside with only 69,000 new jobs being created in
the month of May, with expectations of 164,000. To make matters worse, the government
revised the previous two months (March and April) down significantly. Mortgage applications fell 1.3% in May, pending
home sales dropped 5.5%, and each of the previous months’ respective indicators
have been revised downward. Moreover, 1st quarter GDP was
revised from an initial reading of 2.2% down to 1.7%. Since the beginning of the month, economists
have drastically reduced their 2nd quarter estimates from a mean of
2.5% to less than 1.9%. Needless to say,
the financial markets have reacted adversely, and expectations for a strong
2012 have been dampened.
The most significant underpinning affecting the equity
markets going forward is Spain’s ability to access the debt markets,
and the continued appreciation of the US dollar. Two
weeks ago, Spain made it public that they need $125 billion in aid to recapitalize
their banks. With a 25% unemployment
rate, and a 50% jobless rate among workers under the age of 30, Spain’s economy
is contracting at nearly a 2.0% annual rate.
The European Union has agreed to loan funds to shore up the current
deficiency with in the country’s financial system. As a result of non-performing bank loans
caused by a massive housing bubble, Spain’s borrowing costs have increased to
over 6.5%. This is threatening the
country’s ability to finance its ongoing spending needs at the central government
level. Spain’s economic woes are threatening
an already fragile global recovery, which could ultimately be the spark that
causes a global recession towards the end of the year.
Investment Strategy
After having an excellent start to the year among all of our
managed portfolios, significantly outpacing all major benchmarks, our bullish
investment thesis has been upended by negative economic surprises and an
eroding geopolitical situation in Europe over the last two weeks. The US equity market has now given back most
of its gains for the year. Even though
the market had its best weekly gain last week, we remain very cautious going
into the second half of the year. We are
anticipating more geopolitical turbulence out of Europe, regardless of positive
news out of Greece and Spain. Moreover, China
has lowered interest rates for the first time since 2008, after a much worse
than expected change in economic growth for the first half of the year, and the
rapid appreciation of the US dollar among currency pairs will cause US exports
to be more expensive and ultimately slow growth prospects.
At this time we are lowering our prospects for any
significant moves to the upside within the equity markets, based on the headwinds
briefly discussed above. We are
reallocating the managed portfolios to favor a more conservative allocation in
anticipation of a global economic slowdown.
If we see our data points continue to worsen we will become more
aggressive in our defensive stance.
Unless Europe can repair the major damage that has already been created
in the short term, the prospects for new market highs are highly unlikely
through summer.
