INSIGHTS

On August 16, 2011

Bull Run Done?

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To put it mildly, the equity markets have been extremely weak and extremely volatile over the last three weeks. To be clear, we expected some weakness into the summer. However, the levels we have seen surprised us somewhat given – as Gene Peroni highlighted recently – the vast majority of market moving events came as no surprise and were, we believed, priced into the market. Regardless, we do believe, despite the magnitude of the market’s movements, that we are still in a bull market. That isn’t to say we go straight up from here but we do think we have put in a summer low though there is a possibility that we may go back and retest (and hopefully hold) the low 1100 range on the S&P 500.

Looking at the carnage, we see the S&P 500 lost 17.90% peak to trough (4/29/11 – 8/8/11) and 12.26% over the last three weeks (7/22/11 - 8/12/11). However, as our regular readers will recall, it is normal for there to be pullbacks inside of bull markets and some of them may even move into correction phase (greater than 10%). Just last spring and summer the S&P 500 corrected 16% and in the summer of 1998 the S&P 500 corrected over 19% as the markets dealt with fallout from the failure of the hedge fund run by Long-Term Capital Management. Both situations are similar as – like now – one of the primary headlines has to do with sovereign debt issues. Currently it is U.S. and European debt and in 1998 it was Russian debt. The good news is we don’t think the current situation is a repeat of 1998 or 2008, yet the markets seem to be pricing this in which we think should work to the benefit of long-term orientated investors.

We don’t think the U.S. economy is in great shape; however, it does still appear to be expanding at this juncture and we do believe a double dip recession is going to be avoided. No doubt if the U.S. economy entered the Olympics it would not do so as a sprinter; however, they still award medals for hurdlers and negotiating hurdles is what the U.S. economy has done over the last couple of years. Surely there will be more hurdles to come, both seen and unseen, but we do think this somewhat anemic recovery can continue with fuel provided by resilient U.S. consumers, strengthening emerging consumers and by a monetization of the strong balance sheets of U.S. corporations.

Taking a quick look at the latter, we continue to see corporations take advantage of their strong balance sheets in a number of ways including Mergers and acquisitions activity and dividend hikes. Just today we saw the announcement of two high-profile cash deals, which of course also highlights the very attractive valuations available in the equity markets. In addition, we have seen over a third of the S&P 500 companies increase their dividends year-to-date. The good news is corporate balance sheets look to strengthen even more as earnings and revenues continue to shine. We are about 87% of the way into earnings season and based on the percentages of S&P 500 companies displaying earnings and revenue growth as well as earnings and revenue above consensus, this is the best earnings season of this current recovery. This provides support for our thesis that this bull market has legs and we believe investors should continue to focus on companies with attractive dividends, solid balance sheets and the ability to grow despite below-trend growth for the U.S. economy.

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.