Blog

March 31, 2010 Market Commentary

Posted by: STEVE ARNETT

Posted on: April 8, 2010

by Steve Arnett

Sharon Miller Pryse, President & CEO of The Trust Company recently returned from China where she participated in a business leaders program, The Society of International Business Fellows. We thought her comments and observations would be of interest:

Her first comments about her trip were remarks about China’s tremendous population. We all know that Shanghai (20 million), Hong Kong (7 million) and Beijing (13 million) are huge cities, but there are other more rural cites with populations over 10 million. There is a huge migrant population which is estimated to be 300 million or even greater. Each household is required to be registered in their home community, and that registration entitles them to basic services such as education and healthcare. If someone can’t find a job in their home town, they become the migrant worker who goes to the city to get work. These migrant workers are also known as the floating population.

The One Child policy that was established in the 1970’s to control the population growth has resulted in “Little Emperors” who have been doted on by their parents and grandparents. As they enter the workforce, they expect to be the promoted very quickly. Since this generation of Chinese has competed very hard through school, developing collaborative teams in the business environment has proved challenging for companies, both domestic and foreign.

Although China is a Communist state, the country has certainly adopted capitalist ways. They are great negotiators who find ways to get the prices down - and not just by cutting corners. The Chinese perspective is to always find a way to make it a better deal. Their old saying, “The Mountains are high and the Emperor is far away,” leaves room for much negotiation at the local level. Even so, in China the relationship comes first and the deal second. Until a personal relationship is built you can’t even begin to talk about a business transaction.

Sharon’s group was interested to learn that outsiders’ success in China arises from working within their system, doing things in their ways, and above all, building relationships first. The Chinese do not believe that they need anything from the outside world, be it Google or comments about the valuation of their currency, the Renminbi (RMB). China believes that the U.S. ruined Japan’s economy, and they are determined not to allow it to happen to them.

In summary, even though the Chinese savings rate is very high and their business and economic philosophies can tend towards insular, the mass population of China has a huge potential to impact the global economy.

Other Economic Highlights

We recently passed the one-year anniversary of the market bottom of March 9, 2009. Since the market low the S&P 500 is up 68.29%, yet we are still 27.26% below the October 9, 2007 bull market high.  However, among the countries that comprise the G7, the United States is only second behind Italy.  Among the “BRIC” countries, Russia, India, Brazil and China were up 161.66%, 109.58%, 86.64%, and 44.11%, respectively.

The global stock market capitalization at the bull market peak was $61.3 trillion, which subsequently fell to $25.6 trillion at the market bottom but has rallied back to $46.8 trillion or 82.90%. During this time period the U.S. has represented 30%-31% of the world’s market capitalization. Currently, the U.S. has an equity market capitalization of $14.24 trillion. 

A year ago banks were on the brink of collapse. At the market low, Citicorp’s market capitalization sank to $5.75 billion. Citicorp’s market capitalization is now $118.52 billion. Currently the largest bank based on capitalization, Bank of America carries a market value of $181.18 billion - up from $24 billion at its low.

Stock funds’ impressive returns over the last year might suggest that money had been pouring into them and thus driving prices up. In fact, the opposite is the case.  While more than $377 billion flowed into various asset classes of mutual funds in 2009, but there was actually a $25.75 billion outflow from U. S. stocks. This was almost offset by $25.53 billion of additions to international stocks, resulting in a net zero flow into and out of stocks.  But the big story here is that over $356 billion flowed into taxable and municipal bond funds, representing a net flow of over 96% of all monies. Clearly, a tremendous amount of money is still on the sidelines as investors remain fearful of another decline in stocks. Not only is there cash in mutual funds, but there is almost $1 trillion in cash and cash equivalents on the books of U.S. corporations, all waiting for signs that the economic outlook is better.

In our meetings with clients, one of the most frequent questions we hear is, “Where should I be investing my money in light of Washington’s current spending policies and the potential for our budget deficit to increase?” Our outstanding unfunded Medicare and Social Security liabilities are a concern for many bond investors, and as a consequence, they are limiting their exposure to very short-term fixed-income instruments. Likewise, our fixed-income portfolio manager PIMCO is keeping the maturities in their bond funds very short. The 30-year Treasury is currently yielding 4.6% versus the two year, which is less than 1%; there is risk in the long-term. PIMCO’s Chief Investment Officer Bill Gross predicts that the recent passage of the healthcare reform will add to rather than subtract from our future deficits and unfunded liabilities. As a result, PIMCO’s approach is to take on less risk through shorter maturities rather than risk the specter of inflation, which could hit the prices of long-term bonds very hard. 

For the quarter ending March 31, 2010, returns for the S&P 500, NASDAQ, Russell 2000, MCSI EAFE, and Barclays U.S. Aggregate Bond indexes were 5.38%, 5.90%, 8.85%, 0.85%, and 1.80%, respectively.  For the same period, our Stock, Aggressive Stock, Balanced and Fixed portfolio returns were 4.40 %, 4.88%, 3.30% and 2.20%, respectively.