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Spring 2012
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Investor's Update
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The first quarter of 2010 and 2011 produced solid returns nearing 6% for most averages.
The start of 2012 made those returns look minor with stocks far outpacing most projections
as the liquidity-induced rally entered a near euphoric phase. Risk assets outpaced
dividend paying; stable growth companies, while fixed income investors saw a reversal
of fortune. On a total return basis, the S&P 500, NASDAQ and DJIA advanced 12.6%,
19.0% and 8.8%, respectively. Nine out of ten S&P sectors advanced during the quarter,
with financial and information technology stocks leading the way with near 21% returns.
The slower growing utilities sector was the laggard. That was quite a reversal from
last year’s results. The ten-year U.S. Treasury posted a negative 2.1% return during
the quarter as the risk-on trade picked up speed.
Smaller capitalization stocks kept pace with their larger brethren as the Russell
2000 index gained 12.4% during the quarter. Japan’s Nikkei Stock Average led the
Asia-Pacific region with a 19.3% return, far outpacing the Chinese Shanghai Composite’s
advance of 2.9%. European markets also benefitted from the favorable environment
but slightly lagged the U.S as investors remained concerned over the recession level
data coming out of their constituents. Gold continued its advance, posting a 6.6%
return during the quarter. Crude oil returned 4.2%, while technological innovations
in shale fracking and major deposit discoveries caused natural gas to decline an
astonishing 28.9% in the first quarter. A coordinated, domestic natural gas policy
could be a game changer in the energy complex that has been dominated by the Middle
East for decades.
Investors finally became fed up with the paltry yields offered in the Treasury market.
This led to an across-the-board increase in rates. The current ten-year coupon jumped
18.7%, rising from 1.9% to end the quarter at 2.2%. Corporate investors fared slightly
better as the Barclays Capital Intermediate Government Credit Index returned 0.7%,
outpacing the Barclays Capital Intermediate Government Index’s negative 0.5% return.
Thirty-year mortgages may have seen a generational low as rates have now risen to
4.1%. This is not great news for the still shaky housing market.
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Economic Outlook
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The global monetary printing presses were in full gear during the first quarter,
as inflation statistics continued to drop, thus allowing central banks to focus
on promoting growth in their respective economies. Among the major players, the
Federal Reserve announced that their near-zero interest rate policy would be extended
to 2014, the European Central Bank loaned over 1 trillion Euros below market rates
to help recapitalize their banking system, Japan made money printing announcements
to weaken their currency and numerous other central banks joined the rate cutting
cycle. These initiatives helped promote stronger economic growth and finally aided
the job market in the U.S. The unemployment rate inched downward, wages rose faster
than expected and retail sales followed suit with promising results. For the most
part, these were all forecasted in previous updates. However, the resulting advance
in equity share prices at such a rampant pace was not. This leads us to believe
a lot of, if not too much of, the positive news is priced in at this point.
Our concern going forward, as it has been over the past few years, is whether or
not the economy can support itself without liquidity from the Federal Reserve and
global central banks. Remarkably, the Federal Reserve purchased 61% of the net Treasury
issuance in 2011, which has kept interest rates abnormally low and masked our Government’s
debt bubble. Many programs are ending in the summer months, again. Recent comments
lead us to believe they will not be reinstituted unless there is a significant economic
slowdown. JP Morgan estimates $500 billion in forced spending cuts to come on board
in January 2013 and another $250 billion will be lost due to Bush tax cut expirations.
This could knock off 1% of GDP, which we still expect to grow in the 2% area for
2012. Insiders have been selling into this rally, which is coming on the heels of
lighter volume and declining breadth. The wild card, outside of geopolitical events
and a deepening European recession, remains underlying global inflation. The reflationary
efforts have led to another significant increase in the price of oil. This is a
major concern as prices at the pump are reaching levels that, historically, have
led to a significant slowdown in consumer spending. Peaking corporate margins, a
slowing Chinese economy, rising rates in Spain and Portugal coupled with a fully
valued market all point to a difficult period going forward.
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Capital Market Analysis
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Even with the aforementioned concerns, we still expect the U.S. economy to continue
its growth trajectory, albeit at subdued levels. The Bernanke-led Federal Reserve
has shown every intention as to not allow deflation to set in, so any slowdown in
the economy would be met with more quantitative easing. Corporate profits are robust,
balance sheets are flush with cash and jobs are finally coming as a result of manufacturing
returning to the States. Bank lending is showing some signs of easing and the bottoming
process in the housing market is progressing. U.S. election cycles usually promote
more government spending as well. The main question remains, how much good news
is already priced in?
Growth estimates for the leading economies of the past decade, namely China, continue
their downward trend. The slowdown is likely to continue, causing demand for industrial
products and commodities to decline for the foreseeable future. It seems the emerging
markets can no longer support the global economies by themselves and we look for
support in the developed markets. European governments are in austerity mode and
an extended recession seems probable. Japan has been in a multi-decade bear market
with declining demographic trends. This leaves much of the responsibility to the
U.S., which has relied upon government stimulus to achieve minimal growth over the
past four years. Recent comments by the Federal Reserve indicate that the punch
bowl could be pulled back again, similar to the end of QE1 and QE2. These were not
good times to be aggressive in the equity markets. Fixed income investors are likely
to see negative returns in the first quarter for the first time since 2010. We continue
to believe the suppression imposed by the Operation Twist will ultimately prove
unsuccessful and rates will return to their normal, potentially much higher levels
over the coming years. A long-term trend change from bull to bear in the fixed income
arena seems likely.
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Summary
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Our focus continues to be preservation of capital first and the long-term growth
of assets second. We do not believe in mimicking an arbitrary index that remains
fully invested at all times as that brings unnecessary volatility, as we all saw
in 2008. Capital preservation is at the forefront of our minds now. There has been
too much monetary intervention, too much free money, too many influences holding
interest rates down. This has a negative effect on savers and creates a misallocation
of capital towards higher risk assets. Healthy markets do not need this type of
intrusion by governments. Even with this approach, we have not returned to the long-term
growth rate the U.S is accustomed to, let alone made up for the recession. Investors
should be rewarded by focusing on dividends, globally diversified franchises, high
quality balance sheet companies and reducing risk as the market advances. Increasing
credit quality while emphasizing shorter maturities in the corporate bond market
will remain our strategy for fixed income investors. Protecting principal in the
short-term, while identifying positive, long-term stories over the coming months,
should yield positive results.
We appreciate your confidence and business. Please do not hesitate to call if you
have any questions or if we can be of assistance.
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Barclays Capital Intermediate Aggregate Index: An unmanaged index
that consists of 1-10 year Governments, 1-10 year Corporates, all Mortgages, and
all Asset-Backed securities within the Aggregate Index (i.e. the Aggregate Index
less the Long Government/Corporate Index).
Barclays Capital Intermediate Government/Credit Index: An unmanaged
index based on all publicly issued intermediate government and corporate debt securities
with maturities of 1-10 years. This index represents asset types which are subject
to risk, including loss of principal.
Standard and Poor’s 500 index: is a capitalization-weighted index
of 500 stocks, including the reinvestment of dividends and other distributions,
designed to measure performance of the broad domestic economy through changes in
the aggregate market value of 500 stocks representing all major industries.
The Dow Jones Industrial Average: is the most widely used indicator
of the overall condition of the stock market, a price-weighted average of 30 actively
traded blue chip stocks, primarily industrials.
The NASDAQ Composite Index: measures all NASDAQ domestic and international
based common type stocks listed on The Nasdaq Stock Market. The NASDAQ Composite
is calculated under a market capitalization weighted methodology index.
Barclays Capital Municipal Bond Index: A broad-based, total return
index. The index is comprised of 8,000 actual bonds. The bonds are all investment-grade,
fixed-rate, long-term maturities (greater than two years) and are selected from
issues larger than $50 million dated since January 1984. Bonds are added to the
Index and weighted and updated monthly, with one-month lag.
MSCI EAFE: The MSCI EAFE Index is a capitalization weighted index
that monitors the performance of stocks from Europe, Australiasia, and the Far East.
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Your financial needs are our highest priority. To meet with a Wealth Management
Advisor, call or visit any of our
Regional Offices.
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- Securities, insurance products, and investment advisory services are offered through Valley Forge Asset Managment Corp. (VFAM) and is a SEC registered investment advisor, a registered broker-dealer (Member FINRA & SIPC), and a licensed insurance agency. VFAM is a wholly owned subsidiary & non-bank affiliate of Susquehanna Bancshares, Inc. (SBI).
- Susquehanna Wealth Management® is a registered service mark of Susquehanna Bancshares, Inc.
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Securities and Insurance Products Are:
• Not FDIC Insured • May Lose Value • Not Bank
Guaranteed
• Not a Deposit • Not Insured by any Federal Government Entity |
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