Granite Group Advisors -


2010-06-30 :: 2010 2nd Quarter Commentary - 6/30/2010

Looking Back
The 2nd quarter of 2010, as we had predicted in our 1st qtr commentary, was a tough quarter as the markets were fully valued entering May. Many strategists who were predicting a V shaped recovery were quickly proven wrong. The continuing European debt crisis started a fear cycle that continued throughout the rest of the quarter. Economic indicators demonstrated that the economy was not as good as hoped, which impacted the equity market valuations. Investors realized that we are in for very moderate growth. As we mentioned in past issues, value and dividend stocks continued to outperform on a year to date basis, however the small cap sector saw growth out-perform value in the quarter. The U.S. dollar strengthened during the quarter, specifically against the Euro due to the problems with Greece, Spain and other members of the Eurozone. However, this peaked in the first few weeks in June. Outside of the U.S., emerging markets performed better than their developed constituents; however, both developed Europe and emerging Europe did very poorly and this affected their indexes negatively.

Fixed income has proven to be the best asset class this year as fear has helped prices to continue to move up. This occurred in almost every sector of the fixed income markets. As long as fear dominates the landscape bonds will continue to do well.

Absolute Hedge funds performed better than equities during the quarter but were slightly negative. As we had stated earlier these funds continue to be a great way to hedge out volatility from equities.

Real Estate: while the housing sector continued to stabilize and prices even showed a bit of an increase, housing starts and new home building started slowing to levels not seen since the 1970’s (Please see previous quarter commentary as we had suggested this was coming). The problems in the commercial real estate market are still there and the many buildings under water will have a tough time refinancing as banks do not want to help restructure.

Commodities continued to trade in ranges. Gold and other metals, due to fear of inflation and economic woes that affect currency, pushed even higher.

2010 YTD

Russell 1000 -6.40% Mid-cap -2.06% Russell 2000 -1.95%
Russell 1000 Value -5.12% Mid-cap Value -0.88% Russell 2000 Value -1.64%
Russell 1000 Growth -7.65% Mid-cap Growth -3.31% Russell 2000 Growth -2.31%
MSCI EAFE -14.72% MSCI Emerge Mkts -7.22% S&P 500 -6.65%

Looking Forward

We expect volatility to continue in the Equity markets in the upcoming quarter. Equity valuations are undervalued by historical standards, but the presiding fear will keep them from trading at peak valuations. However, with depressed valuations, we could still see a 10-15% upside from here. Businesses are hoarding an enormous amount of cash as companies are preparing for a slow growing economy, but have never been in better financial shape. We are still holding fast that in this type of environment, value oriented and dividend oriented stocks will do better than the overall market. There will be some opportunities in the M&A markets. Many companies will continue to hold cash until they feel safer with policy and the future. The US debt situation is a big problem and we see that contributing to slowing growth in the future.

Fixed income markets are in a tough spot for the short term. The fear trade is creating artificially lower rates but just like our Federal deficit, the longer term structural problem will probably not show up until later next year. We still see the shorter durations (roughly 3-5 years) as being the best value in the market, coupled with certain fixed income asset classes a proper place for the future rise in interest rates. Investment Grade Corporate bonds are still relatively safe as most major corporations are cash rich and continue to make money albeit at a slower rate. Non-essential municipal bonds could be entering a rough patch as most municipalities are not in great shape. Essential service municipal bonds and taxable municipal bonds should be the most durable, but again durations in the shorter range will be a better place to position portfolios. Treasury yields (sub 3% as of this writing) have come down as investors are fleeing for safety, however the fear trade will pass and rates should climb in 2011.

Commercial & Residential Real Estate will continue to be a problem. On the housing front we are starting to enter another difficult period. The Federal tax credit has gone away and we are getting to the end of the major buying season. Mortgage rates are at 50-year lows and that could help, but not enough to make a major dent in inventory. On the Commercial front, many problems will show themselves in the next few years as loans need to be refinanced or extended. With slower growth, the demand to buy properties will not be as robust. Funds are opening to buy distressed properties but we believe that asset class will not be in favor for quite some time.

Absolute return hedge funds will continue to be a good place to hedge out equity volatility in portfolios as we see slower growth and lower equity returns for a time.

The commodity markets are dealing with slower demand and are priced to a point where they will trade in a range. Metals should do well as fear and currency issues make them more attractive. The environment and the economy continue to be difficult and volatility will be here for the foreseeable future.

Have an enjoyable Summer!

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