2010 has witnessed increased market volatility and mounting uncertainty as bulls and bears have waged a tug of war regarding the future prospects of corporate earnings and economic growth. Stock markets started the year strongly on expectations of continued robust growth. In April, a number of economic indicators began to flat-line or weaken and fears over Greece’s mounting debt quickly spiraled into a broader concern about sovereign debt in Europe and the sustainability of the European Union as a whole.
After an initially slow response, the EU made a $1 trillion commitment to support troubled member nations and the Euro crisis appeared to stabilize. As July began, markets turned their attention to corporate earnings results and, more importantly, company guidance towards future business conditions and expectations. Results have been better than expected and while there are valid arguments why a “double-dip” recession may occur, there are also reasons why it may not, including low interest rates, low inflation, record corporate earnings and cash flows, and continued growth in the economy albeit at a slower pace.
The economic uncertainty witnessed this year has impacted the equity market. the stock market rally which began in March 2009 has stalled and a more range bound, choppy trading environment has enveloped the equity markets. Historically, stock market performance tends to diminish in the second year of a bull market and in the second year of an economic expansion, both of which we are now in.
While market behavior does not always repeat, it often rhymes. After a period of a strongly trending environment, as we have recently been in, the market often goes through a period of rest and profit-taking. After a period of consolidation, markets more often than not resume the previous trend. Interestingly, the current 2009-2010 market cycle closely mirrors that of 2003-2004. If 2010 continues to mirror the market action of 2004, we may be in a choppy, high volatility environment for a few more months before the potential for a market recovery near the end of the year.
Our portfolios are currently bullishly positioned but we have also made defensive moves at times and are watching several key indicators which may cause further defensive adjustments to future portfolio allocations. Many key technical indicators have turned mixed with the recent market volatility but are still mostly bullish (institutional fund flows, moving averages, market breadth and volume). We continue to monitor these indicators closely and may make tactical adjustments as necessary.
