July 2009 Recap

The S&P 500 pushed its winning streak to five months on better-than-anticipated earnings reports and the expectation that the U.S. economy will expand in the current quarter for the first time in a year.

Historically defensive sectors like utilities, healthcare, and telecom were laggards during the month. Offensive groups like technology, industrials, materials, and consumer discretionary, continued to shine in July. These offensive groups have led all other sectors since March 9, excluding financials. The year-to-date performance for financials disguises the sector’s enormous volatility – declining roughly 50 percent from January 1 to March 9 and recovering 100 percent since then.

As of July 31, three out of four companies in the S&P 500 have reported earnings results that exceeded analysts’ estimates. They’ve beaten forecasts by an average of 9 percent, even as earnings tumbled 32 percent and sales slid nearly 17 percent. Cost cutting, rather than revenue growth, has been boosting companies’ bottom lines. However, easier comparisons in the second half of 2009 and extremely low inventory levels should help bolster revenue growth in the near term.

Highly accommodative monetary policy is helping buoy markets in developed international countries. Meanwhile, emerging markets economies are healing – especially China which has resumed strong growth – thanks to massive global stimulus.

In the fixed income markets, corporate bonds have seen huge gains and spreads on investment-grade debt have narrowed to levels prior to the Lehman Brothers bankruptcy. The Treasury market has occasionally shown that investors are concerned with the increasing level of government borrowing and spending. If that concern persists, then interest rates could move substantially higher and stymie the recovery.

The S&P 500 may not be as cheap as it was several months ago, but at 13 times 2010 earnings, the index is reasonably valued by historical standards, especially considering the low yields on longer-term Treasuries and near-zero yields on money-market funds. The biggest risks we see going forward include a possible economic “double-dip,” the threat of higher taxes, and higher inflation.
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Peter J. Lazaroff, Investment Analyst