3rd Quarter Letter 2009
October 16, 2009
Greetings:
The recession and severe credit crunch that began in 2008 has ended. This
is the biggest and obviously most positive news of the third quarter of 2009. In
classic fashion, the stock market preannounced the recovery by approximately
five months, moving up sharply after an equally sharp decline to March 9 lows,
a three year low in the broad stock market averages (see attached graph). That
capitulation or sharp decline in March was largely a result of the disastrous
news out of AIG. Since that debacle and the steep discounts in stock
prices, the broad stock market has now had two consecutive quarters of positive
returns. The third quarter return for the S & P 500 Index was 15.61%.
So is this stock market rebound, a result of impending economic recovery,
sustainable? In our view, yes. Stock prices generally reflect improving
earnings trends, and this cycle will not be an exception. The consensus
projections for GDP show an approximate 2.5% rate of annualized growth for
the balance of this year and into 2010. See attached graph of the current
consensus forecast for GDP (Recovery is Sustainable).
The first part of the economic recovery will be a result of companies rebuilding
their inventories. As a result of an unprecedented credit crunch exacerbated
by the bankruptcy of Lehman Brothers and the broad banking crisis, companies
drew their inventories down to unsustainable levels. Companies are now
rebuilding inventories in order to continue business at least at low levels.
This is always the first catalyst of economic recovery. We do anticipate
unemployment levels to remain high (in the 10% area), and that the economy
will grow at a very low rate long term. We expect this recovery to be
a “V” pattern, as it typically is. The consumer, who has been trading
down, increasing their savings rates, and paring down debt, will regain confidence. A
weak dollar and infrastructure building, slow to get off the ground and provided
for by the stimulus package, will boost the industrial and exporting sectors
of the economy.
The stock market is not overvalued at these current levels, in our view. Price
to earnings multiples are always high coming out of a recession, as corporate
earnings are depressed. Earnings will increase in 2010 and 2011. After
sharply cutting costs, the rebound in earnings could be an upside surprise. Wall
Street analysts are being very cautious. We are bullish. A mountain
of cash sitting on the sidelines with nearly nonexistent short interest rates
will likely be a continuing catalyst for money going into the broad stock market. During
the third quarter we continued to add new stocks as well as average into existing
positions. You saw many purchases. While some were new positions,
most were smaller dollar amounts “averaging” into existing holdings. As
a result of this strategy, the year to date portfolio turnover on accounts
has been generally lower than in previous years, but the number of transactions
is higher.
Accounts were generally fully invested to their equity targets by the beginning
of the third quarter, after our defensive positioning during the second quarter. We
remain disciplined with our diversified strategy and focus on quality.
While our defensive positioning hurt our relative performance during the second
quarter, the performance during the third quarter was more in line with the
broad market. During the third quarter our broad diversification and
focus on quality names helped.
There has been much discussion about the shape of this recovery. Is
it a V, a W, a check mark, a square root? Historically, all recoveries
have been V’s with the exception of one when the Fed let interest rates float. This
Fed and global central bankers are committed to economic recovery and keeping
interest rates low.
From 1928 to 2009, the broad stock market as measured by the S & P 500
Index has a huge variability in annual returns (see attached graph). Positive
years greatly outnumber negative years, and the highest returns in the stock
market follow years of recovery in the economy. We feel that this cycle
will not be an exception.
We encourage you to listen to our most recent webcast that highlights our
strategy during the third quarter and current view of the market. Our
quarterly webcasts feature several members of our strong investment team including
our Director of Equity Research, Fred Labatt, Chief Economist, Jim Kee, and
Directors of Fixed Income, James Genteman and Hutch Bryan. If you did
not receive an e-mail with instructions on how to access the webcast, and you
would like to do so, please send an e-mail to stmm@stmmltd.com or contact us
at the office and we will be happy to help you.
We are tentatively planning a review of the fourth quarter with face to face
group meetings during January in addition to our regular quarterly webcast. Please
let us know if you have any questions or if there are any changes in your personal
or financial situation or investment objectives, or if you wish to impose,
add, or modify any reasonable restrictions to the management of your account. Your
Investment Advisors are available to provide you with any additional information
that you might need or want prior to year end.
This has been a very bad twelve months for the broad market and the economy. We
very much appreciate your patience and discipline, and look forward to a better
environment ahead.
Sincerely,
Jeanie Wyatt, CFA
Chief Executive Officer & Chief Investment Office
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