INSIGHTS

On June 30, 2011

Second Half Equity Market Rally?

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We only have a few trading hours left in the 1^st half of 2011 and, barring any late day meltdowns, we should end up solidly in the black as the S&P 500 is currently up 5.85% (includes re-invested dividends). On an annualized basis, this equates to 12.14% which is below the 15 – 20% we predicted at the beginning of the year. However, as we have reiterated many times before, equity returns never come in uniform fashion, and we still are holding to our prediction as we expect, a better 2^nd half than 1^st half, in our opinion.

As we discussed at the end of April and reiterated at the end of May, we expected the equity markets, as measured by the S&P 500, to experience a pullback in the range of 3 – 8%. As of now, the pullback is in this range as the S&P 500 lost 7.20% from 4/29/11 – 6/15/11. There have been many reasons quoted for the pullback, including sovereign debt issues in Europe, high energy prices weighing on consumers and the global manufacturing slowdown caused by the disruption from the Japanese earthquake and tsunami. The good news is all of these seem to be improving and we believe as we move into earnings season an upward bias should return to the equity markets.

Though 2^nd quarter earnings won’t begin in earnest until mid July, we are impressed with the fact that over the last two weeks 86% (18 out of 21) of the S&P 500 1^st quarter earnings reports released have come in better than expected. We believe this will continue when the 2^nd quarter reports begin and the consensus is for S&P 500 earnings to grow close to 20% over the next year, which we think will help drive the S&P 500 higher over the next six to twelve months. In addition, we have other – somewhat overlooked – indicators reinforcing that the U.S. economy is improving. One is the fact that companies in the S&P 500 are now holding a record $1.1 trillion in cash (as of the end of the 1^st quarter), which is up 14% over year end. This cash has the potential to add a lot of momentum to the markets and economy in the form of increased dividends, share buybacks, mergers and acquisition activity and capital expenditures. Lastly, U.S. state and local tax revenue rose 4.7% in the 1^st quarter, which is the sixth straight quarter of growth and a good sign the U.S. economy is mending.

Add it all up and we think the correction was due and warranted and has now run its course. Will we experience other ones through the rest of 2011? Almost certainly we will and we will assess them as they come. However, for now we are comfortable with our thesis that we are still in a Bull Market, there is more upside to come, and we still expect the total return for the S&P 500 for 2011 to fall in the range of 15 – 20%, which means the 2^nd half should be slightly more fruitful than the 1^st.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog. For additional commentary or financial resources, please visit www.aamlive.com.