August 2009 Recap

The S&P 500 chalked up its sixth consecutive monthly gain as stocks continue to climb a wall of worry. Domestic mid-cap stocks outperformed its large and small counterparts in August and have a sizeable lead in year-to-date performance. REITs topped all asset classes this month with a gain of more than 14%. Emerging markets and commodities were the only asset classes posting negative monthly returns.

While breadth has been very strong during the rally from March lows, it was very weak in August with only two of ten outperforming the S&P 500 as a whole. Financials drove the entire market in August with a gain of 12.99%. The Industrial sector was the only other one to outperform the S&P 500 with a gain of 4.53%.

There is still a considerable amount of skepticism about this rally and many investors are still sitting on the sidelines. As of August 31, 90% of stocks in the S&P 500 are now trading above their 200-day moving averages – a signal to some that prices have risen too far, too fast. Consumer Discretionary and Industrials have the highest percentage of stocks above their 200-day moving averages at 95%, followed closely behind Financials (94%), Technology (92%), Energy (90%), and Consumer Staples (90%). Utilities rank second to last at 83%, and Telecom is dead last at 67%.

Meanwhile, disappointing retail sales, consumer confidence, and initial unemployment claims readings show that consumers are still holding back, which could dampen the prospects of a rapid recovery. In addition, while the extremely low levels of business inventories are expected to lead to increased activity in the near future, companies may not increase spending for fear of a reversal in demand.

There is little doubt that the rebound in the Chinese market helped to fuel the U.S. market rally, but its stock market has recently declined into bear territory, which raises the concern that other markets might follow. Chinese markets have slid in response to regulators tightening lending standards and taking action reduce soak up excess liquidity.

The yield on the two-year Treasury, a rate tied closely to Fed policy, reached a high of 1.30% on August 7, but fell steadily through the month to finish at 0.96%, a sign the Fed is far from hiking its target for overnight lending. MBS spreads continue to tighten as the general rate environment remains low.