Swings And Roundabouts May 2011

What a difference two days makes! Following the mid-April announcement that Standard & Poor’s had cut its long-term outlook on U.S. debt to negative, stocks declined precipitously, nearly reaching the biggest one-day loss, which was recorded on March 16 after the tsunami hit. Barely two days after the S&P announcement, the Dow Jones Industrial Average saw a major rebound, hitting its highest close since June 2008. If we needed reminding that confidence and optimism are the main factors in fueling both economic growth and stock market performance, April 2011 gave us an emphatic refresher. The ballooning deficit and concerns about the gap between the President’s solution to the problem and the GOP’s remain unresolved. What changed was the infusion of some positive news on corporate earnings and signs that the global economy continues to recover.

Here’s a quick overview of the main trends and talking points.

1. S&P kept its AAA rating on the U.S. economy, but by lowering its long-term outlook on U.S. debt to negative, it also recorded its concern about the rising deficit and the unresolved political debate over how to reduce spending. The revised rating reverberated across the board on April 18, with 97 percent of the S&P 500 losing ground, causing the index to fall 21 points (1.6 percent). The Nasdaq composite was down 50 points (1.8 percent).
2. Leaders in the technology sector, such as Apple and Intel, released earnings and financial forecast information mid-April that exceeded analysts’ expectations. Global corporations, including Citigroup and Johnson & Johnson, reported strong gains in overseas markets.
3. Some analysts see the market whipsaw as evidence that overall confidence in the global recovery is strong – despite news that made investors nervous and triggered April’s volatility.
4. Better-than-expected data on housing starts and existing home sales has helped, too. The housing sector has been a blighted part of the recovery for quite awhile, and evidence that things are improving might have provided a disproportionate boost to investor morale.
5. Commodity prices have remained relatively stable, reassuring investors concerned about profit margins, although crude oil prices continue to soar and oil producers have also seen their stock prices soar in recent weeks.

The Future and The Fed

Looking ahead to the near future, market experts are turning their attention to the Federal Reserve and its bond-buying program – dubbed quantitative easing or QE2. Specifically, some analysts are concerned about what could happen when the latest round of bond buying ends in June. The first round of the initiative, which was developed to keep bond prices up and inflation rates down, was followed by a fall in both bond and stock prices when it ended in the spring of 2010. Investors are nervous about a similar outcome this year because they predict that the Fed will not launch a third version.

On a positive note, many experts believe that stocks will be more resilient post-QE2 than they proved to be when QE1 ended, and that the Fed’s interest rate policies have made stocks a more attractive option to investors. They also suggest that if the Fed’s bond buying program ends soon, yields on U.S. bonds should increase, attracting more foreign investment to U.S. shores.

Please note that the comments above are discussion points only and are not a substitute for advice from your investment and tax professionals.

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