Weekly Commentary

Weekly Commentary

Welcome to our weekly commentary. As always, feel free to call our office with any questions or comments that you may have.

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Around the Water Cooler

Only one week left to get those closets cleaned out and bring in donations for the Haven of Lake and Sumter!  We will be accepting donations through March 26th, 2010 and appreciate anything that you can give.
 

No changes.
 

VANGUARD GROWTH ETF (VUG)

If you are looking for broader coverage of the market without the risk of a single stock, then perhaps Vanguard Growth ETF (VUG) is for you. The fund employs a passive management investment approach designed to track the performance of the MSCI US Prime Market Growth index.  VUG attempts to replicate the target index by investing all, or substantially all, assets in the stocks that make up the index, holding each stock in approximately the same proportion as its weighting in the index. VUG holds no bonds and only .5% is available for foreign investments.

What does this all mean to the average investor?  You are able to invest in the higher-growth and pricier half of the US large-cap market in a single, broadly diversified less expensive (.15%) expense ratio) ETF. Several of its top ten holdings include Microsoft, IBM, PepsiCo, WalMart and Johnson and Johnson, to name a few.  VUG provides a good diversifier for investors whose portfolios are already filled with US value stocks or managers and are looking to add some growth to their portfolio.  Along with this diversification, the volatility is within reason because of the generally high quality nature of its holdings.

It is important to note that this is not a “quick-profit” turn around investment.  Those who are seeking long term growth of capital and a long-term (5years or more) investment horizon are best suited for VUG.  Those investors unwilling to accept significant fluctuations in share price and lack of significant dividend income are best suited to look elsewhere. 

Morningstar has rated VUG 4 stars and says there are no better alternatives for diversified U.S. large-cap stocks (Morningstar, 9/22/2009); while Lipper has given VUG a 5 on the Lipper Leader index for consistent returns, preservation and expense. We, also, have been a strong believer in VUG and have been a consistent buyer in our growth portfolio since 2007.

As with many of the Vanguard ETFs, the management of VUG has been labeled passive as it tracks the performance of the MSCI US Prime Market Growth index.  Passive is a relative term to Gerard O’Reilly, the portfolio manager who has been responsible for the day-to-day management of the fund since 2004.  He has been with Vanguard since 1992, and has managed stock index funds since 1994.

The ETF industry as a whole has grown significantly since 2000.  It is important to note that not all ETFs are for all investors.   We recommend you contact your investment advisor before making any investment decisions.
 

Earnings drive stock prices, right?

It's easy to say that the stock market is nothing more than a "casino" that is driven by "speculators," but over the long term, earnings do drive stock prices. So, how do corporate earnings look these days? Actually, pretty good.

We've just wrapped up the fourth quarter 2009 earnings reporting period and 72% of the companies in the S&P 500 beat earnings estimates, according to Thomson Reuters, as reported by The Wall Street Journal. For all of 2009, S&P 500 earnings came in at about $57, up from $49.51 in 2008, but below the peak of $87.72 in 2006, according to Standard & Poor's. 

For 2010, Wall Street strategists expect S&P 500 profits of about $75, according to Barron's. With the S&P 500 closing last week at 1160, this means the index is selling at a price-to-earnings ratio (P/E) of 15.5 based on expected 2010 profits. Historically, based on the trailing 12-months earnings, the long-term average P/E ratio of the S&P 500 was 18.3, according to data from Barclays Capital, as reported by The Wall Street Journal. Therefore, if 2010 profits do arrive as projected, then the current market may be undervalued based on the historical P/E ratio.

But, here's where it gets interesting.

In 1998, S&P 500 earnings were $44.27 while the index closed that year at 1229, according to Standard and Poor's and data from Yahoo! Finance. Yet, last week, the S&P 500 closed at 1160--about 6% below the level of year-end 1998--despite the fact that S&P 500 earnings in 2009 came in at about $57--more than 28% above the level in 1998, according to Standard and Poor's. Even more remarkable, S&P earnings in 1999 were $51.68 (still below 2009's earnings) and the S&P 500 closed that year at 1469, which leaves our current market 21% below 1999 even though last year's earnings were about 10% higher than 1999's.

Are you dizzy, yet?

In short, earnings are significantly higher today than they were in 1998 and 1999, yet stock prices are still lower. This seeming paradox occurred because investors are placing a lower P/E multiple on today's earnings than they did on 1998's or 1999's earnings. That's the good news.

The bad news is an alternative measure of the P/E ratio, which uses 10-year average corporate earnings instead of just the past year, shows the S&P 500 at a P/E ratio of 20.6. Yale economist Robert J. Shiller popularized this measure and the P/E of 20.6 is currently higher than the historical average of 16 using this methodology, according to The New York Times. So, by this calculation, the current market may be overvalued.

So which is it? Whether undervalued, overvalued, or just right, you can find data to support any opinion. Nonetheless, we remain focused on helping you navigate through this uncertainty.

THE YEAR 2012 has significance for some people as a year of either cataclysmic devastation or spiritual transformation. For the people on Wall Street, it means something entirely different--big bills are coming due.

During the heady days of the pre-2008 credit crisis, private equity firms and other companies racked up more than $700 billion of risky, high-yield corporate debt to finance buyouts and other transactions. Those loans start coming due beginning in 2012 and there is some concern about the debt market's ability to absorb them, according to a New York Times article.

On top of the corporate debt, the U.S. government is projected to borrow about $2 trillion in 2012 to fund its deficit. When you combine the financing needs of the private sector with the government's needs, 2012 may turn out to be a pivotal year. If the debt markets have trouble handling all this debt, one outcome might be a rise in interest rates. If interest rates were to rise precipitously, that could hurt corporate earnings, and, ultimately, stock prices. This debt overhang will likely need to be resolved before the stock market can reach a new all-time high.
 

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.
Sources: Yahoo! Finance, Barron’s, djindexes.com, London Bullion Market Association.
Past performance is no guarantee of future results.  Indices are unmanaged and cannot be invested into directly.  N/A means not applicable or not available.

"Valuation matters. Over periods of decades, the average rarely happens; above-average returns occur when P/E ratios start low and rise; below-average returns occur when P/E ratios start high and decline."
--Ed Easterling, author of Unexpected Returns: Understanding Secular Stock Market Cycles

Best regards,

Thomas H. Ruggie, ChFC, CFP

* The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general.

* The DJ Global ex US is an unmanaged group of non-U.S. securities designed to reflect the performance of the global equity securities that have readily available prices. 

* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.

* Gold represents the London afternoon gold price fix as reported by the London Bullion Market Association.

* The DJ Commodity Index is designed to be a highly liquid and diversified benchmark for the commodity futures market. The Index is composed of futures contracts on 19 physical commodities and was launched on July 14, 1998.

* The DJ Equity All REIT TR Index measures the total return performance of the equity subcategory of the Real Estate Investment Trust (REIT) industry as calculated by Dow Jones.

* Yahoo! Finance is the source for any reference to the performance of an index between two specific periods
* Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.

* Past performance does not guarantee future results.

* You cannot invest directly in an index.

* Consult your financial professional before making any investment decision.