Market Commentary: June 2008
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Capital Markets

The equity markets produced positive returns in May for the second consecutive month.  Investors were encouraged by key economic indicators that suggested the economy was still growing, albeit at a sluggish pace.  Headlines continued to focus on surging oil prices and the consequential anxiety over inflation, economic growth, and the consumer’s capacity to spend.  

Performance varied across market caps for the month.  Small and mid cap indices flourished as investors warmed up to additional portfolio risk.  The smaller cap indices provided returns over 4.5%, while large cap and international indices posted more modest gains.


Source: PMFA

Since its mid-March peak, volatility has softened considerably, also helping small/mid caps.  Our expectations, however, are for volatility to remain heightened, as investors continue to focus on slower economic and earnings growth, higher energy prices and headline inflation, and continued issues in the credit markets.

VIX  - CBOE S&P Market Volatility Index – History

Source: Yahoo Finance

May’s performance was mixed within the fixed income markets.  In general, taxable indices posted nominal losses, while municipals generated marginal gains.  Emerging market currencies, as represented by the JP Morgan ELMI+ index, continued their strong performance, returning 1.68% for the month.  Both attractive yields and strengthening local currencies have contributed to the 7.88% year-to-date return.


Source: PMFA

Performance within the alternatives space continued to show mixed results.  Commodities furthered their climb in May as oil reached a (then) all-time high of $133/barrel, before retreating under US Dollar improvement.  Precious metals rose for the month as well, while base metals lost ground.  More specifically, copper, nickel, and zinc all fell during the month, with nickel leading the downward pack with a 22% drop.  The Wilshire REIT Index fell slightly, reversing some of the prior month’s gains.


Source: PMFA

Economy

GDP

 The preliminary estimate for Q1 GDP growth came in at 0.90%, an upward revision from the advance estimate of 0.60%.  While still subject to additional revision in June, results from the last six months represent the weakest back-to-back quarterly returns in five years.  Lethargic consumer spending and persistent weakness in residential housing have been key detractors from growth.  Exports have continued to prop up otherwise anemic growth. 

Real GDP & Personal Consumption – Quarterly % Change

Source: PMFA, Bureau of Economic Analysis (BEA)

Corporate profits for all public and private companies (as measured by the Bureau of Economic Analysis) have thus far maintained a positive growth rate, as they grew 1.7% (year-over-year) in Q1.  Domestic companies continued to benefit significantly from their foreign operations, whose results were aided by the weakness in the dollar.

Corporate Profits – 12-Month % Change

Source: BEA

Inflation

Concerns over near-term inflationary pressures continue to make headlines.  There is some debate, however, about how soon these pressures will moderate.  For example, the Fed reiterated its expectations that inflation will subside by 2009-2010, but revised their inflation forecast higher for the rest of 2008.  The University of Michigan Consumer Sentiment Index echoed the U.S. central bank’s near-term forecast, as it indicated a significant increase in the one-year inflation expectations.

The Fed has expressed concern that adverse economic consequences could be ignited by further rate cuts.  Their thesis suggests that continued policy easing would further erode the value of the US Dollar, leading to even higher commodity and import prices.  In turn, these inflated prices would further reduce consumer and business spending, ultimately hampering economic growth. 


Source: PMFA, BEA, Bureau of Labor Statistics (BLS)

The trailing one-year inflation indicators have eased recently.  In April, both CPI and PCE increased just 0.1% at the core level.  This puts the 12-month Core PCE at 2.1%, just outside of the Fed’s implied comfort zone of 1.0 – 2.0%.

Inflation Indices – 12-Month % Change

Source: PMFA, BLS, BEA

Employment

May marked the fifth successive month of net job losses, with a drop of 49,000.  The year-to-date loss is now grown to an estimated 324,000.  The construction sector has now shed 475,000 jobs since its September 2006 peak.   

As of May 31, the unemployment rate rose markedly to 5.5%.  While this was an unwelcome report, this result is still less severe than what has often been the case during periods of economic weakness.  The negative environment in both the construction and financial sectors were significant contributors to the rise in unemployment.

Nonfarm Payrolls & Unemployment Rate – Monthly

Source: PMFA, BLS

Interest Rates

The FOMC did not meet formally during May; their next meeting is scheduled for June 25.  The Fed’s most recent communication follows the consensus that they may be at the end of their easing cycle.  After four reductions so far in 2008, the Fed’s target for Fed Funds stands at 2.0%.  While conditions can change rapidly, the market nearly universally expects that the Funds rate will not change in June.

Current Probabilities for 06/25/08 FOMC Meeting

Source: PMFA, Bloomberg

The yield curve continued to shift upward in May, as short-term yields advanced to a marginally greater degree than the long end of the curve.  The three-month treasury yield rose 0.46% to end the month at 1.89%.  The 10-year treasury added 0.29% to close out the month at 4.06%.

Treasury Yield Curve – History

Source: PMFA, U.S. Treasury

Vehicle Sales

Auto and truck sales represent one indicator of consumer demand and account for nearly 20% of retail sales.  While total sales have declined only marginally, higher fuel prices have resulted in material changes to consumer habits.  As a result, domestic car sales recently surpassed truck sales for the first time in over seven years. 

U.S. Light Vehicle Retail Sales (SAAR) – History

Source: BEA, Motor Intelligence

Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.

Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other source believed to be reliable. However, some or all information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis non-factual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.

Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation .