Money Matters: A look at the second half of 2011

By Robert J. Swartout The Daily Record Newswire The first half of 2011 is done and in the books. The equity markets have performed fairly well in the first half of the year. The Dow Jones Industrial Average was up over 7 percent and the S&P 500 was up 5 percent. The Fed's very loose monetary policy has continued to pump money into our economy and has resulted in the dollar falling in relative value against most major currencies. Some commodities prices are beginning to show some signs of fatigue with their prices down year-to-date, copper (-2 percent), nickel (-5 percent) and tin (-3 percent). However, these commodities are still up dramatically on a year-over-year basis, copper 45 percent, nickel 19 percent and tin 50 percent. So, where do we go from here? From a political and historical perspective, the last two years of a presidential election cycle tend to be very good, outperforming the first two years by a 3:1 ratio. Considering the first two years of this cycle the S&P 500 was up 26.46 percent and 15.06 percent, respectively and that we are only up 5 percent at the mid-year point, the equity markets have a long way to go to catch up to their historical average. Since 1943, every pre-presidential election year has had a positive move in the DJIA and in 12 of the past 17 years in the cycle that positive move has been in double digits with an average gain of more than 16 percent. From an economic standpoint we are at an impasse until Congress and the president agree on a new federal debt ceiling. The terms of that agreement have the ability to set the country off on a new fiscal course or our elected officials may lose the nerve to affect real changes in the balance between spending and revenue. The Fed has officially completed QEII and, in theory, a very large buyer of U.S. Treasuries should no longer be in the market which should result in lower prices (higher yields) for U.S. Treasuries. Currently, the 10-year Treasury is yielding 3.16 percent which translates into a P/E of about 32 compared with the S&P 500's P/E of around 17. On a "relative P/E" basis you could easily draw the conclusion that the U.S. Treasury market is overbought relative to the U.S. Equity market. Inflation continues to be benign as the housing market remains depressed and its significant weighting in the CPI statistics continue to tell a story of no or low inflation while consumers are seeing a much different environment at the supermarket and at the gas pump. Year-over-year inflation as measured by CPI was up 3.6 percent at the June report, and core CPI, which excludes food and energy, was up only 1.5 percent. Inflation on specific commodities that many of us are very sensitive to has definitely been an issue over the past 12 months. Gasoline was up 37 percent, coffee 65 percent, corn 80 percent and wheat 22 percent, just to name a few commonly used items in our lives. Lastly, unemployment is at 9.2 percent as of the latest reading and has not responded as the Obama administration had hoped to the enormous economic stimulus packages that have been implemented over the past two years. Although there are many factors that seem to sway the American electorate, clearly a 9.2 percent unemployment rate is not where an incumbent president wants to be if he is hoping to earn a second term. Looking forward, I would expect that the near term equity market performance should continue to be positive and at some point interest rates in the U.S. are going to begin to rise which will put pressure on the U.S. fixed income market returns. As we approach this time next year, all eyes will be focused on the presidential election and we will have more data on Congress' ability to rein in spending and grow the economy at the same time. ---------- Robert J. Swartout is a vice president at Karpus Investment Management. He can be reached at (585) 586-4680. Published: Thu, Jul 21, 2011