Investment returns were solidly negative in the second quarter. The European debt crisis and uncertainties about the pace of economic recovery were the main catalysts for the drop in valuation.
The returns in the fixed-income sector mirrored investors’ risk appetites. Treasuries enjoyed significant appreciation, as illustrated by the second quarter return of nearly 15% in the iShares Barclays 20+ year Treasury ETF (TLT). Meanwhile, most global and corporate bond positions underperformed the Barclays Aggregate Bond Index.
Last quarter’s pullback in stock prices puts the major indices down in the high single-digits for 2010. Industry pundits differ as to whether this retreat is a buying opportunity or the first sign of a market top. There are several reasons why we think the former is a more likely scenario.
First, corporate earnings continue to sparkle. Profit margins of the S&P 500 companies were 36% in the second quarter–the highest in recent memory, and even greater than the 30% margins posted during the Reagan era. It seems obvious to us that large companies are well managed, well capitalized, and should deliver impressive after-inflation returns in the next market cycle.
Second, there is now little doubt that the low interest-rate environment we are in will continue in the foreseeable future. The renewed commitment by central banks to maintain policy accommodation through 2011, combined with the positive cyclical momentum makes a double-dip recession a highly unlikely event, in our view. We see the encouraging announcement from China that they would let their currency steadily appreciate as a meaningful sign that their economy is strong enough to handle a slight tightening and that its growth can be shared with the rest of the world. It is also worth noting that recent European data, the weakest link of the global economy, have mostly surprised on the upside.