Summary of the Quarter

After a brutal 2008 for investors, the first quarter of 2009 did not get off to a good start. The stock markets fell in early January and kept falling until March 9. At that point, the S&P 500 had dropped 25% since the New Year. However, after that relative low was reached, the stock market has rallied considerably. The S&P 500 has been in a strong upward trend and as this momentum carried into early April, the question is starting to be raised, “Is it over?...Have we seen the bottom of the markets for this cycle?” We will address that question later, but let’s first focus on a brief review of the markets for the first quarter of 2009.

For the quarter, most major stock indexes were down from 11% to 14%. Large, small and international stocks were all down. The NASDAQ composite (an index with a large percentage of technology stocks and very little financials) was the best performing stock market for the first quarter. It managed to fall only 3.1% by the end of March. As we are now into early April, we begin the most recent earnings season for stocks and that will help to determine if investor expectations (generally low) are in-line with corporate results (generally poor). If results exceed expectations, the market could continue to rally. If results are worse than expectations, the market could give back recent gains.

The credit markets finally began to operate in a more normal fashion after grinding to a halt late in 2008. This enabled the fixed income markets to behave in a less volatile manner. Fixed income is supposed to be the calmer, more stable part of an investor’s portfolio. Investors give up much of the “upside and downside” of the stock market for a modest yield and a more specific return (i.e., my principal returned to me in five years). However, since the start of the credit crisis over a year ago, bonds have been anything but stable. Last year, the bond market formed two extremes. One extreme involved very safe bonds with a government backing to which investors flocked, driving up their price and greatly reducing their yields. The other extreme was any other type of bond that did not have government backing. Investors avoided these bonds at all cost, causing these bonds to trade at historically low levels and driving spreads (the difference between a bond’s yield and Treasury yields) to historic highs.

For the quarter, Treasuries were down slightly as the flight to safety slowed and investors began to dip their toes into “riskier” bonds. Mortgage-backed bonds, municipal bonds and corporate bonds (excluding financials) were up modestly for the quarter. The best performing bond sector was the high yield (junk) bond sector, which many times trades like stocks and may have rallied in sympathy with the stock markets in late March.

Two other asset categories had pieces of data worth noting. In the money market area, yields on most money market funds are now at historic lows. Most money market funds are yielding well below one percent and some have stopped taking new deposits because they are unprofitable. The more money they take in, the more they lose; a very unusual paradox for an industry that has been based on “gathering assets.” In the commodity markets, the first quarter was a very bumpy ride. Oil started the year at about $45 a barrel, as we came off a brief December rally. By February, oil had fallen to about $35 a barrel before ultimately rising to around $49 a barrel to close the quarter. It was a very uneven path to a $4/barrel increase in oil prices. Other commodity assets (steel, copper, aluminum, lumber, etc.) continued to be weak as global demand for those commodities remained low.

Is the bear market over? We will leave the answer to that question to the market timers. However, there do appear to be signs that the economy is beginning to recover, or at least that the worst is behind us. As mentioned earlier, the credit markets are beginning to function again. This is very important since most consumers can not buy a house or car without a loan and most businesses can not build a factory without one. In the fourth quarter of 2008, it seemed as if no one could get a loan. A better functioning credit market should lead to more fluid lending, with positive repercussions for the economy as a whole. Another hopeful sign is that last week, the Labor Department reported first-time state unemployment benefits fell to their lowest level since the beginning of January. Initial claims for the week ending April 11 also fell to the lowest level since January. In addition, according to the Fed’s most recent Beige Book (a report produced twice a quarter which provides the Fed’s view of the economy), the U.S. economy did continue to weaken in March but the speed of contraction was fading amid signs the country’s recession may be nearing an end.

It is important to remember that most statistics you hear on CNBC and other news sources are backward-looking statistics. They tell a story about what happened last month or last quarter. They do not tell you about what is going to happen. Take unemployment numbers, for example. The news channels love to talk about unemployment. Every time a new unemployment number comes out, investors react. What they fail to tell you is that unemployment is a lagging indicator. Unemployment tends to peak at the end or shortly after a recession. The stock market, on the other hand, is a forward-looking mechanism, which is why the stock market tends to bottom three to six months before the end of a recession. Many experts are saying we will come out of the recession either late this year or early next year. If they are right, using the six-month rule, there is a good chance that March’s lows were actually the beginning of a new bull market.

Data sources: Bloomberg, FactSet, Ned Davis Research and The Wall Street Journal.