Recovery is a Marathon not a Sprint

The most recent two months in the financial markets have been negative and erased the gains investors had accumulated through April of this year. As of the midway point in the year (6/30/10) the S&P 500 index was down -6.7%. That loss in stock value is all the more painful because as of 4/30/10 the index had been up +7.0%. In two short months our seven percent gain became a seven percent loss! This change in fortune wasn’t just a U.S. large-cap problem, most stock categories, including international and small-caps, were down at the mid-point of the year.

The good news inside this recent sell-off in stocks is that bonds did not participate this time around as they did in the 2008 sell-off. Almost all bond categories have experienced positive performance for the first half of 2010. Even US Government bond yields, which most investors thought could go no lower, have gone lower. The drop in their yield means a corresponding increase in their price as they have been one of the best performing bond groups so far in 2010.

Lately, many investors have begun to express the opinion that we are beginning a second recession. That whatever short-term rally we’ve had off the most recent lows of March 2009 were temporary and it is now time for the economy and the markets to sink back into misery. My opinion and the opinion of those whose work we value in this business is that the current pull-back is a correction inside of a long-term recovery. We don’t think that the most recent negative economic news is foreshadowing the beginning of a new downward pattern.

Let me use a non-financial analogy that occurred to me as I’ve been wrestling with the facts and the emotions of the recent market pullback. Eight years ago, during the market meltdown of 2002, I ran my first and only marathon. I trained for over six months and read several very good books about how to complete a marathon for a novice jogger. One of the key pieces of advice was to train at a pace and stick to that pace! As you get better at running longer distances and your training improves your stamina, you will be tempted to run faster, especially at the beginning of the race. However, running fast for five or six miles does not help you in a race that is 26.2 miles long. You need to run steady for the entire distance.

Despite this knowledge, I made the classic rookie mistake on my marathon day. I was caught up in the excitement of the crowd, the bands and party atmosphere and when the starter fired off that gun and thousands of us took off running, I was flying. I didn’t even feel like I was running very fast and everything felt great. When I finally did a time check at the three mile point of the race, I realized I was running way too fast and would not be able to finish the race if I tried to keep up that pace. I slowed down and found several other joggers who were running closer to the pace I should have been running and tucked in behind them. After a brief reality check, I had to force myself to slow down if I was going to be able to finish in the long-term.

That is how I feel about the current state of our economy; it is slowing down to find a sustainable pace for the long race, which should not lead to a big reversal in the equity gains we’ve made since early 2009. From 3/09/09 until 4/30/10, the S&P 500 index gained 75.4 %! The economy was bouncing off horrible lows and the markets recognized this and some confidence returned as we realized the world was not ending. Investors decided the tide had turned and it was now time to buy not to sell. However, emotional investors got caught up in the success of the recovery and may have started out, at least from a financial markets perspective, too fast. We all need to realize the economic recovery is a marathon and that we may need to slow down our gains, consolidate our investments and prepare for a slower path to recovery if we are to finish the race.

When the debt crisis of Greece became big news and the fear of sovereign debt default spread, the markets reacted to that sobering news and began to slowdown. Yet, even though we slowed down, we were still making progress in many areas. For instance, in the US, home and auto sales (two major items that people have to feel confident about to purchase) continued to improve from their lows of a year ago. We did see a slowdown in both figures from May to June as the markets consolidated, however, year-over-year sales were still up for both categories. There is a big difference between slow growth and no growth (contraction). At this point the economy is still growing slowly.

I try to rely on factual data versus anecdotal data, but over the past two months I’ve had reasons to be in Chicago, New York and Cincinnati. All those cities, along with Pittsburgh, are still very busy. Hotels are crowded, traffic is congested, restaurants are full and people are shopping. I know that the U.S. and other countries around the globe face debt issues and we have high unemployment, but most people are still working and the economy is doing its best to move forward. The path forward will not be based on politics or policies alone, but on businesses and consumers moving prudently forward with their plans. That type of positive activity should continue, unevenly, for quite a while as we continue to recover from the global collapse of 2008.

Our economy is so diverse and varied, yet still very entrepreneurial at heart, that our collective efforts cannot be stifled for significant periods of time. I think the quote that “The business of America is business” is still true. Even though our economy is facing many domestic and global headwinds, I believe the U.S. is in a classic business cycle; the recovery portion. If circumstances cause our views to change, we will update you immediately. Enjoy the rest of your summer.