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HERON CAPITAL
MANAGEMENT
STOCK MARKET
COMMENTARY
August 25th, 2009
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US stocks up 53% from March 9th low, still 42% below
record high
The S&P 500 gained 53.2% in the 6 months since the March 9th
bottom. Over the same time frame, the NASDAQ gained 57.1%.
These are among the sharpest gains ever recorded for either index (record
for the NASDAQ.) However, the S&P 500 still remains 34.3% below
the October 7th, 2007 record high, and the NASDAQ remains 29.02% below
the October 2007 high and 59.9% below the March 2000 record high.
YTD the S&P 500 is up 17.0%
Bottom line, both indices need to increase by 50% just to get back to the
level of October 2007. We think those levels will be achieved in
the next 3-5 years, which implies annual rates of return of
14.4-8.4%. The long term average return of stocks is 8-10%/year, so
our forecast would be straddle the long term average rates of
return. However, the average rate for return in stocks for the
current decade is negative 2.3%/year for a cumulative loss of
20.2%. There have been three other periods of negative ten year
returns in the US stocks over the last 200 years. Each of those
periods was followed by a decade of excess returns.
Yellow lights on the instrument panel
The experience of the last year made us feel like the pilot of a business
jet cruising along happily at 40,000 feet when suddenly one of the
plane's engines blows apart. In moments, every indicator on the
instrument panel turns red, the cockpit fills with smoke and the plane
plunges 30,000 feet in seconds. With the ground looming, the pilot
manages to transfer enough power to the remaining engine to stabilize
flight and regain altitude. Lights on the instrument panel turn
from red to yellow, but making the airport is not yet guaranteed.
We review several hundred economic indicators each month and read about
600 pages per week of economic forecasts, trade magazines and opinions of
other portfolio managers. From October 2008 through March 2009, all
those resources showed the equivalent of "red" across the
board. Now we're seeing a lot more "yellow." Of
note:
Housing - After falling 32.5% from the June 2006 peak, house prices
according to the Case-
Shiller indices through June 2009 have been stable to
slightly higher for four months. Case-Shiller produces their data
with about a two month lag. Concurrent analysis from Radar Logic showed
that June 2009 prices gained 3%, with gains in 23 out of 25 Metropolitan
Statistical Areas (cities.)
Existing home sales surged in July. Many of these sales were
foreclosure sales, but bottom feeders are out in force. We have no
expectation that housing prices will regain 2006 levels anytime
soon.
After the 1989 real estate market peak, prices did not
recover from a relatively mild 8.3% decline for 8 years.
Employment - the US unemployment rate more than doubled from the cyclical
low of 4.4% October 2006, reaching 9.5% in June 2009. The July
report rate showed a modest decline to 9.4%
 9.4%,
and "only" 247K jobs were lost in July, versus
741K lost in January 2009. If the current recovery 
matches the "jobless recovery" of 2003-2006,
where net jobs gained averaged $142K/month, it could be a decade before
unemployment falls below 6%.
Economic growth and prospects - US GDP lost "only" 1.0% in the
year over year period through
June 2009. The Conference Board's index of Leading
Indicators surged to the highest level since March 
2003, which marked the end of the last recession.
Commodity prices, the dollar and inflation - Commodity prices, which fell
57% in the 7 months
ending February 2009, staged a modest recovery in recent months as
demand, especially from emerging 
economies such as China, picked up. The US dollar,
the "flight to safety" currency during the crisis, sold off 
recently. We expect both to settle into a trading
range for the rest of the year, with oil trading in a range of
$65-$80/barrel. We're not worried about the dollar falling
precipitously against, for example, the Euro, because we expect the US
economy to recover faster than Eurozone economies, and interest rates to
head higher in the US before Europe.
US Consumer Price Inflation remains negative, so Federal Reserve Policy
should remain neutral for the
foreseeable future. The 10 year Treasury bond yield,
which drives both mortgage and corporate lending, is
Net: as average Americans see the value of their homes stabilize, the
security of their jobs assured and the value of their stock portfolios
gain, they'll feel more confident about purchases. Businesses,
which cut spending to the bone over the last 9 months, will respond in
kind. However, we're not going back to boom times for a
while. The loss of wealth in the financial crisis will compel the
average American to work ten years longer than planned before
retirement. Their #1 priority will be paying down debt and bulking
up savings - a long term boost but a short term drag on economic growth.
Institutional investors are also rethinking their priorities.
Pension plans and particularly US colleges and universities moved away
from traditional stocks and bonds over the last decade, and moved
aggressively into hedge funds, private equity, venture capital,
commodities, real estate and timber. When push came to shove over
the winter, the trustees discovered that when it came time to pay the dormitory
fuel bills, only US equities provided the liquidity needed. The
alternative investment managers compelled endowments to lock up funds for
extended periods of time, pay high fees, offered little transparency into
the investment process, but only provided, with some exceptions, meager
returns.
Pace of Regulatory Reform
We're encouraged by the regulatory reforms currently circulating in
Washington. After 15 years of laissez-faire capitalism, politicians
and regulators are thinking that those Franklin D. Roosevelt era
safeguards were pretty important after all. Newer investments
products such as Credit Default Swaps are moving from over-the-counter to
exchange markets. We'd be happy to see all investment firms, not
just traditional registered investment advisors such as ourselves,
regulated by the SEC (no more Bernie Madoff's!)
We'd also like certain aggressive hedge funds brought to heel. We
don't think our society can survive if a portfolio manager aggressively
shorts and buys puts on a company's stock, aggressively bids up the
credit default swaps on that company's bonds, and then puts out rumors
that the company is in trouble. Yes, the portfolio manager made
hundreds of millions of dollars but in the process destroyed billions of
dollars of other people's wealth (as former employees of Bear Stearns and
Lehman Brothers know all too well.)
The key question that must be answered in Washington is, "Do markets
exist to serve the capital needs of corporations and the savings needs of
individuals, or is it all a game for traders and speculators."
If the latter, we are all poorer.
Strategy
In March, we made the decision to take our clients fully invested.
At the time, that decision seemed insane as millions of individual and
institutional investors were liquidating their portfolios at 13 year lows
for US stocks. We were confident in our knowledge of stock market
history that, after every major sell-off of the last 100 years, stocks
always outperformed. This financial crisis, while severe, did not seem
fundamentally different from previous crises. So far our clients
have been rewarded. The easy gains have already been made, but
we're staying invested in anticipation of "normal" returns
going forward.
As always, please don't hesitate to call with questions and concerns.
Yours sincerely,
David Edwards
President
The Heron Capital Management
client letter is published immediately following month end and when
market conditions require comment. The views expressed in this letter
represent HCMI opinion and strategy as of the date published and can
change at any time upon receipt of new information. Data quoted in this
letter are from sources deemed reliable, but no guarantee of such data is
implied. |
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Heron Capital Management, Inc., is affiliated with Heron Financial
Group, LLC, an SEC registered investment
advisor providing fully managed investment and wealth management services
to individuals, families, trusts, defined benefit plans and
corporations.
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HERON CAPITAL
MANAGEMENT
www.HeronCapital.com
(800)
99-HERON
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