Q3-09 Update

The stock market rally from the March lows continued in the third quarter with a 15% rise in the S&P 500. This pushed the index firmly into positive territory for the year to date. Stocks are up over 50% from the worst levels of the year but still have long way to go to reach the October of 2007 high.

Market leaders included companies left for dead earlier this year. Even companies with heavy debt levels and fixed costs gained as short term interest rates remain near 0% and investors moved back into riskier assets.

Corporate earnings for the first quarter were down 36% but did generally come in better than the anticipated decline of 65%. A similar feat occurred in the second quarter as profits fell by about 33% from the prior year but were generally “less bad” than expected. The bar is low again for the third quarter as companies are expected to see profits fall by 25% from the year earlier. Looking ahead to the fourth quarter, comparisons get easier. Again if companies are able to meet or even exceed expectations and pronounce confidence in their ability to grow profits, markets can move higher. If corporations can not improve on profitability, the stock market may move back down.

Final gross domestic product growth was down 0.7% in the second quarter of 2009. Economists call for the GDP to turn positive in the third quarter.

Commodities were up about 4% in the third quarter. Specific prices varied greatly. Crude oil was flat to close at $70.61 per barrel. Gold was up 9% to over $1,000 per ounce. Natural gas was down sharply as producers pumped supplies into nearly full storage facilities. Others like sugar were up sharply amid shortage concerns.

Home prices nationwide have shown a few months of stabilization. Prices from July were still about 13% lower than last year but were slightly better than June’s. Government tax credits for first time home buyers likely spurred demand.

The unemployment rate rose to 9.8%. September’s loss of 263,000 jobs was more than anticipated. That is 21 months in a row if declining employment and the highest unemployment rate in 26 years. Weak job market expectations remain even in an economic recovery.

The Federal Reserve maintained the 0.00% to 0.25% range for federal funds. The yield on 10-year Treasury Notes declined from last quarter’s already very low level to 3.31%. Low short term rates and paltry returns from money market funds have prompted investors to move to riskier debt investments too. The return on high-yield bonds was 15% in the third quarter as investors again moved to riskier assets. The spread between yields on Treasuries to speculative debt fell to 7.9% from 10.6% at the end of June. High quality corporate bonds now yield around 5% on average. Financially sound companies are able to borrow at low rates.

The Fed does not seem to be concerned about inflation at this point. There is relatively high unemployment (10%) and low capacity utilization (70%) so not much upward pressure on prices. With the core consumer price index up only 1.4% in August, inflation remains under control for now. There is very little inflation officially but continued large deficits and unconventional policies have been a factor in the decline of the value of the dollar internationally. And there is more chatter from the likes of China and Russia for an alternative reserve currency. These are potentially inflationary concerns to monitor.

Equities all over the world continued to climb in the third quarter. Excluding the U.S., stocks were up 19% in the Dow Jones Global Index. Emerging markets performed slightly better than other developed markets in general.

Please let us know if you would like additional information on any of the above.

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