Don’s Outlook 10/30/09
The anticipation and release of the third quarter GDP numbers on Thursday added to heightened market volatility for the first time in weeks. First, Goldman Sachs cut their projection by 10 percent, reducing their estimate to 2.7 percent. This announcement weighed on investors until the actual report showed that GDP had risen by 3.5 percent. The stock market rallied on that news, reversing the four-day slide of the S&P 500 from October highs.
Some of the good news was tempered by the components of growth, which were heavily influenced by government spending. Based on the advanced estimates, the cash for clunkers program contributed 1.66 percent to the overall number, which was up from 0.19 percent in the previous quarter. Extracting this stimulus would bring the growth closer to two percent. Both imports and exports were higher last quarter, but imports grew faster, thereby subtracting from growth based on the government’s calculations.
Although the report has the hallmarks of government-sponsored consumption, this would not be the first time that fiscal and monetary stimuli were the underpinnings of an initial recovery. Nevertheless, with personal income falling and savings rates turning down again, we still need more to support the economy than higher federal deficits. Corporate balance sheets remain robust, so corporate spending could still provide a significant boost through hiring and capital investments.
The fixed-income market has staged a remarkable recovery in 2009, as the stress within the financial system has subsided as a result of government support and an improving appetite for risk on the part of institutional and individual investors alike. Because the decline had less to do with corporate insolvency issues than ones of liquidity, better access to credit and the resulting improvement in the aforementioned balance sheets supported the subsequent rally.
High-income funds, in particular, have recovered the losses incurred over the past year, and spreads are now in line with previous recession peaks, offering a substantial risk premium still. Valuation remains attractive despite the performance of high-yield bonds so far in 2009, and the next 12 months should bring additional appreciation as money continues to flow from low-yielding income funds to these higher-yielding securities. This will continue to support client positions, especially Federated High Income Bond (SVAAX) and Fidelity Capital and Income (FAGIX).
Risks to this outlook include rising government yields, although historically rising rates have had a more limited impact on high-yield bonds, and renewed stress in the credit markets. At this point, however, market sentiment remains positive and high-income valuation still provides a favorable opportunity to participate in additional upside.
