It was nice to see some positive returns for a change. The S&P 500 closed up 3.16% for the first half of the year. With increased optimism, equities have continued to move upward relative to the March 9 bottom giving us the best calendar quarter since 1998. During the last month however, the US market took a breather producing a barely negative return for June accompanied by lighter than average trading volume. On the international front, developed markets did not perform quite as well as the US Equity markets. Emerging markets however, have provided impressive results. On the fixed income side, thanks to corporate bonds, a diversified portfolio of bonds was likely to be up by a little bit, while government securities on average were down across the maturity spectrum for the year.

It is interesting to note that it wasn't long ago amidst the fear that investors had favored the safer plays, favoring stocks of companies with good balance sheets and less risky businesses. Since the market reversed course, lower quality companies have seen their stock increase far more dramatically than more financially sound and fundamentally strong companies. This is not unusual, but it is interesting in that it illustrates the disconnect that tends to occur in the short term. Long term, we know quality wins out. Our multi-disciplinary approach, which attempts to balance multiple time frames, provides the diversification that can help mitigate these issues.

On the economic front, fears of a financial system collapse and a second Great Depression have faded away. While the worst may be behind us, we will continue to face a multitude of risks. Among the biggest risks for the economy is the loss of jobs which could hold our recovery back. We have found ourselves in a recession that has been deeper and has lasted longer than any post second world war recession. As a whole, we have begun to save more and spend less, a trend that could hamper economic recovery, particularly since our economy is quite dependent on consumer spending. Consumer spending fell in April and we saw the savings rate increase to a 14-year high. There is a lot of money still on the sidelines. The massive government and central bank efforts have helped in the short term. We have seen some stabilization in housing and manufacturing, as well as a deceleration in layoffs, improving credit spreads and credit flows. Data coming in as “not as bad as expected” and/or decelerating has certainly helped sentiment.

We are left to wonder what the impact of the stimulus will be going forward as higher taxes and inflationary pressures are likely to become a concern. In the most immediate term, inflationary worries might be overdone until we start to see a decline in the unemployment rate. This is because wages are a significant portion of costs. On the other side of that equation, increases in wages result in increased disposable income which increases demand in the economy. It is therefore less likely that we will see inflation return until the employment picture improves dramatically, leading to not only cost pressures but demand pressures on goods and services. Slightly longer term, we have a big unknown and much will depend on the execution of the tightening that will have to occur once the economy is back on more steady ground. Although not an ideal situation, history reflects that inflation doesn't necessarily hurt stocks. Stocks can flourish as long as the inflation is not extreme while cash and fixed income investments typically do not do well in that environment. As investors return to more rational behaviors, the significant amount of cash on the sidelines is likely going to be looking for better opportunities and the stock market would likely be a beneficiary of that process.

Despite the fears, there are certainly positives. There has been much improvement since the dark moments of last Fall and a light has become visible at the end of the tunnel. Since falling off a cliff due to faltering demand around the globe, emerging economies have started to show signs of life. Fiscal stimulus will kick in with delayed action further enhancing our immediate outlook.

We will continue to maintain a watchful eye as things continuously evolve and change. We hope that you are having an enjoyable summer and we look forward to continued improvements in our markets and our economy. Thank you for the opportunity to be of service.