July, 2011
By Darren Nyce
Senior Research Analyst, Castle Investment Advisors®, LLC

My family and I celebrated Independence Day by, like many of you, watching fireworks that were launched at our local park. After the last burst of rapid fire color faded from the sky, the assembled crowd spent a few seconds of quiet uncertainty with a common murmur of “was that the grand finale?” Upon deciding that indeed it was over, the masses began packing up their blankets and folding chairs and began making the trek back to their vehicles in order to resume life as normal.

Now that the Fed has concluded its second round of Quantitative Easing (QE2) as of June 30, many market analysts are asking the same question.

This program, which involved the Federal Reserve purchasing $600 billion of U.S. Treasuries, had hoped to stimulate the economy via the impact of lower mortgage rates, increased investment, increased consumer confidence and spending, a lower dollar, and higher asset prices. The success of the program has yet to be determined and will likely be debated for some time, but the current question involves whether or not the economy is strong enough to sustain its growth without additional government stimulus for the first time in several years.

Conditions currently indicate that, while the current economy is quite wobbly, a third round of Quantitative Easing (QE3) is unlikely. But like the families at the fireworks show, many market analysts are doing a lot of looking around and wondering if it is time to resume economic life as “normal.”

Because a high level of uncertainty remains, we will continue, as we have for the past several years, to increasingly diversify portfolios, being cautious of economic weakness, but yet wanting participation in market advances. We favor floating rate bonds, dividend paying equities, and assets that have low correlation to the stock market.

Here is a recap of market performance for the second quarter of 2011:

Index Q2 2011 1 year Return 3 Year Annualized Return 5 Year Annualized Return
S&P 500 0.1% 30.7% 3.3% 2.9%
Dow Jones Industrial Average 1.4% 30.4% 6.1% 4.97%
NASDAQ -0.3% 31.5% 6.5% 5%
Russell 2000 (Smaller Companies) -1.6% 37.4% 7.8% 4.1%
Barclays US Aggregate Bond 2.3% 3.9% 6.5% 6.5%

This was the 4th consecutive quarter that the S&P 500 has shown a gain. Sector leaders were Healthcare and Utilities while Financials and Energy provided the biggest drag. Larger companies performed better than smaller during this period, reversing the trend from earlier in the year.

Some of the pieces of the economic pie that we are keeping an eye on at this time:

  • Unemployment
    • The unemployment rate is still very high, with the latest report showing 9.2%. This is an anchor that is keeping overall personal income growth very low
    • Hiring by small companies is up only 1.5% year over year.
  • Inflation
    • Higher commodity prices have caused inflation to rise, which has further limited personal spending.
  • The American Consumers
    • Will economic uncertainty motivate them to save any discretionary funds or will the outlook improve and prompt them to spend?
    • If more workers are unemployed and higher inflation is squeezing their real spending power, then it follows that consumer confidence will be lower.
  • Housing
    • Home sales remain extremely low compared with the long term averages though some of the data indicate that we may have finally reached a bottom. We expect that it will take several years for the housing market to work through its excess supply.
  • Financial Troubles in Europe
    • The European Union has taken measures to postpone a default by Greece, but indications are that at some point this is inevitable.
    • The impact of this is a big question mark, mostly because of the uncertainty of who is insuring the many credit default swaps that most of the bond holders own.
    • Even if a Greek crisis is avoided, there are several other countries in the area (Portugal, Ireland, Italy, & Spain) with situations that also could cause problems.
  • GDP Growth
    • The current growth level of 1.9% is not disastrous, but it is not robust enough to meaningfully help the employment situation, and is a significant drop from the 3.1% experienced in the 4th quarter of 2010. Normally at this stage of a recovery, we would see growth closer to 5%.
  • Manufacturing
    • It appears that supply chain interruptions caused by the Japanese disaster are ending sooner than expected and the increase in the manufacturing index has been a positive surprise.
  • US Debt Ceiling
    • This is a developing story, as Congress continues to seek a balance between spending cuts and tax increases in order to get the ballooning federal debt under control under the threat of a potential U.S. default on its debt obligations.

The combined impact of these items has lead most economists to lower their expansion projections for the rest of the year, with the majority now expecting growth of less than 3% for the year.

Many serious questions still loom out there. While we wait for answers, we continue to serve our clients diligently, keeping their best interest in mind.

On our journey through the summer of 2011, we pause to reflect on some poignant words that were written in the summer of 1776.

When in the Course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature’s God entitle them, a decent respect to the opinions of mankind requires that they should declare the causes which impel them to the separation.

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness...

But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security… And for the support of this Declaration, with a firm reliance on the protection of divine Providence, we mutually pledge to each other our Lives, our Fortunes and our sacred Honor.

If you haven’t read the Declaration of Independence in a while, it is worth a couple of minutes to do so. When I imagine the fortitude it must have taken to adopt a document that immediately put you at the top of the “Most Wanted” list in order to take a stand for freedom, it quickly brings deep feelings of appreciation: http://www.archives.gov/exhibits/charters/declaration_transcript.html

We hope that you have a terrific summer. As always feel free to give us a call.

Still proud to live in the greatest country on earth.

Sincerely,
Castle Investment Advisors®, LLC Investment Team

                    
 
Disclosures: 
Tax, legal, and estate planning advice contained in this article is general in nature. Always consult an attorney or tax professional regarding your specific legal or tax situation.
This article was prepared for informational purposes only and does not constitute an offer to buy or sell, or a solicitation of any offer to buy or sell the securities mentioned herein. Information presented does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information regarding products and services. It should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. 
Any strategy discussed herein may not be suitable for all investors. Before implementing any strategy, investors should confer with their financial advisor. No current or prospective client should assume that the future performance of any specific investment, investment strategy or product made reference to directly or indirectly, will be profitable or equal to past performance levels.