Perception & Reality

The S&P 500 declined 9.1%  since year end and the NASDAQ declined 14.2% over the same period.  The 75% S&P 500/25% Lehman Government Bond Index lost 6.3% over the same period.  Stocks delivered the worst 4 month return since 2002.  However, volatility in the US stock market is declining, with the S&P 500 in a trading range between 1300-1400 (last 1330) and above the 52 week low of 1310 set January 22nd.

Americans are beset by deep pessimism about the state of the US economy.  Consumer sentiment plunged to a 16 year low, lower even than during the 2000-2002 bear market, which included the 9/11 terrorist attacks.  The previous low, in 1992, corresponded to the last housing slow-down in 1989-92.  The most recent report from Case-Shiller shows a decline of 8.9% in home prices in the year ending December 31st, down 10.5% from the peak of July 2006.  The peak to trough decline in 1989-1993 was 8.2%, and new highs weren't made until 1998.  Housing prices increased 127% between January 2000 and July 2006, but that's cold comfort to anyone who bought property since, or who borrowed against the equity in their home and now find themselves underwater.  Combine worries about housing with an uptick in unemployment, stagnant wage growth, high energy prices and a low rate of savings, and it's easy to see why consumers would be concerned. 

In banking, nearly $200 billion has been written down against the value of CDO (collateralized debt obligation) bonds.  In the context of a US economy growing at the rate of $14 trillion/year, with financial assets of $30 trillion, these losses are sustainable (the 9/11 attacks and Hurricane Katrina each cost $100 billion, and the economy survived those hits.)  However, it's widely perceived among consumers and businesses that the damage is severe.  People are literally talking themselves into a recession.  The reality is that US economy is experiencing a modest slow-down, and that economies outside the US continue to do well. 

As we have noted, 50% of earnings of S&P 500 companies come from non-US operations.  In the most recent reporting period (Q4 2006) earnings grew 10.5% according to Zacks.  Backing out financials, which showed a decline in earnings of 9.5% and a decline in net income of $3.3 billion versus year ago gains of $50.9 billion, and earnings grew 14.9%.  The technology sector did particularly well, with year over year gains of 28.5%, record revenues and net income at Microsoft, IBM, Intel, Cisco and Oracle.  None the less, these stocks are down 25-35% from recent peaks.

Read the entire commentary here.