New Market Commentary

August 3, 2009

Market Update

Given the gyrations of the U.S. stock market this year, we believe some perspective on the market’s movements is appropriate before discussing the outlook for stocks. In July, the S&P 500 rose over 7% and has gained 11% year to date. From the March 6 market low, the S&P 500 has risen 48% but is still down 35% from its October 2007 high. Moreover, Barron’s recently reported that in July 1997, the S&P 500 was at 954 compared to 987 currently, a 3% increase subsequent to a 12 year roller coaster. Over this time frame most portfolios on an inflation adjusted basis are down and adjusted for the price of gold are down even more.

With that cheery preface, we agree with the consensus view that the U.S. economy is bottoming and should produce modest growth in the second half of 2009. The bulk of the massive liquidation of inventories is past and production should show improvement in the months ahead. Net exports should also be a plus while U.S. government stimulus may be less than that evident in the second quarter. With improving cash flow, thanks to aggressive expense management, business spending may perk up by year-end. Nonetheless, the key driver of an economic recovery, consumption, remains a question mark given the likelihood of further deleveraging, and ongoing effects from negative employment trends. Spending has fallen more than incomes, but optimistically that trend is unlikely to persist for a lengthy period. Moreover housing starts are below normal trend and pricing is beginning to firm.

We believe stocks continue to be in a cyclical bull market. Our expected range has been 750-1100. We now project 850-1200 with the market reaching new highs relative to current prices by year-end. As stated in the past, the major risk in the market is on the upside.

At the outset of July, we proved to be too cautious about stocks. The earnings surprises produced by better management of costs had been recognized by us in previous months. Because it had already been recognized in earlier months, we did not believe that earnings surprises would be that plentiful nor would have the impact that they did. In any event, the classic summer rally was produced.

Beginning in August and continuing through October, the stock market can be more volatile, especially in September and October. While believing the market will be higher by year-end, we would be cautious about putting new money in the market at this time. Better buying opportunities may appear in coming months.

Positive factors for the market continue to include favorable monetary pressure, still high cash reserve positions, more upside than downside earnings surprises, very positive market breadth leading the market averages, and profits well below their long term trend.

On the negative side, the economy and profits recover slowly and stocks may outpace the recovery in their fundamentals. Corporate insiders are currently more aggressive sellers of stocks than they have been in recent years. It is unclear why they are selling other than taking advantage of higher stock prices. If they are selling because of concerns about the economy, then their selling actions may portend additional concern about future economic trends. In any event, substantial corporate insider selling is viewed as a negative. The price of gold tends to rise from August into the fall. Reinforcing this possibility in 2009 may be increased likelihood of higher taxes subsequent to the August Congressional recess; increased concern about protectionism; further financial fallout from CIT, municipalities, and commercial real estate; a rising number of bankruptcies and a continuing high level of unemployment.

In terms of strategy, growth is outperforming value. Given the likelihood of a slow economic recovery, growth types of equities should outperform value until the pace of economic growth speeds up. Large capitalization stocks in the U.S. and outside the U.S. offer a favorable valuation – growth ratio. Small capitalization and emerging markets stocks appear to be running ahead of their fundamentals. They appear more attractive longer term than over the short term. Commodities, especially gold and energy, are expected to continue to rise as the world economy recovers. There is an increasing probability that gold will be the next market bubble if the dollar depreciates further. Meanwhile, alternative investments in distressed debt still look good and merger arbitrage is more attractive than it has been for some time.

A. Marshall Acuff, Jr., CFA
Managing Director
Chair, Cary Street Partners Investment Committee
Cary Street Partners Investment Advisory, LLC