A Bright Quarter
Monday, July 26, 2010 at 8:54AM 2010 Quarter 3 Market Commentary
By Kenneth G. Bown, MBA CFP®
Investors entered the month of September fearful of past downturns, still haunted by the catastrophic decline in 2008. But yet again, the markets moved the opposite of what many were expecting, posting the highest returns for the month since 1939, and the third best single monthly return in 10 years, according to the Associated Press. The Russell 3000 rose 9.44% in September, putting it up 11.53% in the third quarter, and in positive territory — up 4.78% — for the year. The Wilshire 5000 index was up 9.43% in September, registering a third-quarter return of 11.50%, and bringing the year-to-date return up to a positive 5.57%.
The good news could be seen in all sectors of the U.S. stock market. After dipping to its yearly low on the first day of the third quarter — 1,011 — the large cap S&P 500 eventually rose 11.29% for the three months ending September 30, putting it in positive territory for the year, with a gain of 3.89%. During the month of September, the index rose 8.92% — which more than made up for the losses registered throughout the rest of the year. Similarly, the Russell 1000 large cap index rose 11.55% for the quarter, putting it up 4.41% for the first three quarters of the year.
Interestingly, for all the gloomy news about industrial unemployment in the U.S. economy, the largest yearly gainer was the Industrials sector of the S&P 500, up 11.45% for the first three quarters of the year. The worst-performing sector: energy, down 2.48% going into the last quarter.
Among the various categories of U.S. equities, mid-cap stocks have enjoyed the best returns: the Russell Midcap index was up 13.31% in the third quarter, putting it up 10.97% for the first three quarters of the year. Meanwhile, the Russell 2000 small cap index rose 11.29% in the third quarter, and was up 9.12% for the year. The Nasdaq Composite Index rose 11.30% for the quarter, putting it up 11.89% going into the last three months of trading days.
Some of the stock market gains appear to reflect good news in the economy. The Bureau of Economic Analysis reported on September 30 that it was revising its estimate of second-quarter growth in the economy: up 1.7%, after an increase of 3.7% in the first three months of the year. Corporate profits increased $47.5 billion in the second quarter after rising $148.4 billion in the first quarter.
International investors are beginning to recover some of the losses from earlier in the year. The MSCI EAFE index, which measures the composite returns of the developed nations (although it excludes Canada, for some reason) was up 15.79% for the quarter, but the index is down overall 1.25% heading into the fourth quarter. European stocks rose 18.87%, but were still down 2.98% for the year. The MSCI Far East index rose 7.05% for the quarter, up 3.10% for the year as of September 30.
Meanwhile, the emerging markets are still booming. The MSCI Emerging plus Frontier Markets index was up 21.53% for the quarter, putting it up 15.07% for the first three-quarters of the year.
Alas, our crystal ball wasn’t quite good enough to bet your entire portfolio on the Sri Lanka ASPI Index (up 50.3% for the quarter), or Peru’s Indice Selectivo Peru-15 (up 25.4%). But we were also fortunate enough not to have bet heavily on Iceland’s OMX FO Price Index (down 22.8% for the quarter), or Nepal, whose NEPSE Index fell 14.4% these last three months.
Real Estate investment trusts, portfolios of real estate property that trade on exchanges, also posted aggregate gains. The Dow Jones All Equity REIT index, which tracks 155 real estate investment trusts, was up 12.5% for the third quarter, helped by perceptions that credit may be becoming more available to commercial real estate, which depends more than most industries on credit supplies to refinance debt payments and fund new acquisitions. The NAREIT index rose 7.46% for the quarter, from 2,862.01 to 3,075.61, up from 2,711.15 at the start of the year.
Treasury Bond prices rose slightly as the yield on 10-year maturities fell from 2.95% on June 30 to 2.51% at the end of the quarter. Remarkably, the yield on 6-month Treasury notes is still hovering at 0.19%, and returns on shorter-term paper are even lower. Yield to maturity on 20-year Treasuries stand at 3.38%, and the longer 30-year maturity issues were yielding 3.69% as the quarter ended.
It should be noted that the U.S. markets are close to finally climbing out of the deep holes they fell into in 2008 and early 2009. The 3-year performance of various indices, for the period ending September 30, is within striking distance of positive territory. The Russell 3000 broad market index is still down 6.59% from the end of September 2007, and the large cap Russell 1000 is down 6.79% over the same three years. Over the same three-year time period, the Russell Midcap index is down 4.16%, and the Russell 2000 smallcap index is down 4.29%. If the markets offer gains in the last quarter similar to what we experienced in the third, investors who managed to stay in the market through the turmoil might be able to celebrate a full recovery of their portfolio value.
Meanwhile, it’s helpful to remember that at the start of the quarter, people were questioning the viability of U.S. and global markets after the near-meltdown of Greece, Portugal, Spain and other Southern European economies. Each quarter, each year, seems to bring a new thing to worry about. But looking longer term, the U.S. equities markets have managed to post long-term gains despite some fairly serious disruptions, including World War II, the Cold War, the conflict in Vietnam, stagflation and the oil shocks of the 1970s, the market crash of 1987, the bursting of the tech stock bubble, and the subprime mortgage meltdown and collapse of Bear Stearns, Lehman Brothers and AIG in 2008.
Indeed, if you look at the long-term movements in the stock market since the Great Depression, all of those events, which seemed pretty dire at the time, look like blips on the screen, small dips in the long-term growth of value in American and global publicly-traded enterprises.
There is no doubt that there will be other events in the future which will seem to endanger — or at least derail — the long-term growth of capitalism. But based on the history of the past two centuries, one might feel confident that whatever challenges await us, people in all sectors of the U.S. economy will find ways to build additional value.
The final three months of the year may bring the market indices back up to pre-meltdown levels, or they may disappoint. We simply cannot predict the short-term movements in stock prices. Despite all of our attention on protecting client portfolios, and the complex work of identifying risks and opportunities, the primary focus is still on a long-term bet that risk assets will be up more often than they are down, regardless of what dire thing you will read in the paper between now and the end of the year.
Disclosures
Past performance is not a guarantee of future results. As with any investment strategy, there is potential for profit as well as the possibility of loss. LJCooper does not guarantee any minimum level of investment performance or the success of any investment strategy. All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. This is not a solicitation or an offer to sell securities or investment advisory services except where applicable, in states where LJCooper is registered, or where an exemption for such registration exists. Returns data are sourced from DFA Returns Program, are net of DFA’s management fees, and assume monthly rebalancing. LJCooper’s management fees vary by client and are not reflected in returns shown. Custodial transaction fees are not reflected in returns shown. Performance information presented in the charts or tables in this brochure represents back tested performance for the asset class funds indicated and not the experience of any one individual client. Actual performance of client accounts may differ from the asset class portfolios. Direct investment cannot be made into an index.
1DFA Equity Portfolio is comprised of 15% DFA US Large Company Portfolio, 15% DFA US Large Cap Value Portfolio, 10% DFA US Micro Cap Portfolio, 10% DFA US Small Cap Value Portfolio, 10% DFA Real Estate Securities Portfolio, 14% DFA International Value Portfolio, 8% DFA International Small Company Portfolio, 8% DFA International Small Cap Value Portfolio, 4% DFA Emerging Markets Small Cap Portfolio, 3% DFA Emerging Markets Portfolio, 3% DFA Emerging Markets Value Portfolio. Diversified Equity Index is comprised of 15% S&P 500 Index, 15% Russell 1000 Value Index, 10% Russell 2000 Index, 10% Russell 2000 Value Index, 10% Dow Jones US Select REIT Index, 30% MSCI EAFE Index, 10% MSCI Emerging Markets Index.
2DFA 60/40 Portfolio is comprised of 60% equity funds in the same proportions as the DFA Equity Portfolio plus 40% DFA Five-Year Global Fixed Income Portfolio. Diversified 60/40 Index is comprised of 60% equity indexes in the same proportions as the Diversified Equity Index plus 40% Merrill Lynch US Corporate and Govt. 1-3 Years Index.