In the second quarter of 2011 the markets experienced challenges from both internal as well as external forces. The high energy costs early in the quarter, stubbornly high unemployment and inadequate job creation posed substantial hurdles to the economy. In addition, the European debt issues highlighted by Greece, occupied headlines around the world for much of the second quarter and the major equity indexes made little or no headway as well. The S&P 500 advanced only .04% in the second quarter an only four days earlier on June 24th the index was down -4.3% for the quarter. The other major indexes had similar results with the Dow Jones 30 Industrials and the NASDAQ returning +.07% and -.02% respectively. Much like the S&P 500 the Dow and the NASDAQ were firmly in negative territory on June 24th, only four days prior to the quarter’s end with returns of -3.12% for the Dow and -4.6% for the NASDAQ.

Technical Market Overview

On March 31st, the S&P 500 was at 1,325.83 some 134.62 points above the 200 day moving average confirming a well-defined uptrend in the Standard & Poor’s 500. However, on June 30th the index was only 53 points above the 200 day moving average. As outlined above, the markets were significantly lower only four days earlier and on June 24th the S&P 500 was only 4.98 points above the 200 day moving average. These are indications of the markets concern regarding the continued anemic domestic growth, mounting concerns about the domestic budget deficit and the global debt issues affecting the members of the European Union. These issues have all found their way into investors psyche causing a re-evaluation of their willingness to invest in equities in the face of such uncertainty. If the S&P 500 declined sufficiently for the 200 day M.A. to have average prices less than the previous day’s average price, this would signify a trend reversal, indicating potentially lower equity prices moving forward.

Lastly, it’s important to note that as with all market observation tools there is no guarantee that the current market trend will continue.

Issues Influencing the Market

Greek Debt Crisis

Greece’s financial issues had a significantly negative effect on our markets through late June. The reality that a member of the European Union was so close to default caused great concern in markets around the world. The sheer fact that an entire country was on the brink of not being able to repay its debtors, prompted investors to drain risk from their portfolios, causing falling equity prices around the world. After much negotiation and hard work, Greece adopted an austerity plan. This attempt to reestablish some level of fiscal responsibility caused the markets to rally with a move not seen in our market in over two years. This reoccurring theme of entire countries on the brink of default is a disturbing one, although in our opinion, one that is not behind us. Only time will tell if this plan will allow Greece to get its financial house in order and the people of Greece will be able adjust to the new rules that will certainly affect their lives.

The Federal Debt Limit

Both houses of Congress as well as the President are in deep negotiation to arrive at an arrangement that will bring federal spending under control. If there is a responsible long term deal struck, we believe the markets would respond very positively. However, if ‘partisan politics as usual’ are maintained, sustainable upward movement in the markets may prove difficult at best. The elected officials that represent us must understand that the financial markets want consistency and a commonsense approach to managing the country’s financial affairs. We believe the markets are clearly signaling their concern over our enormous debt and unrelenting annual budget deficits. It seems the consistent overspending has now put our country in a position that it must resolve these irresponsible borrowing practices in an effort to avoid having the federal government’s credit rating reduced. This would have extensive consequences that may put our standard of living in jeopardy. However, by reducing spending in a substantive, consistent fashion we can again balance our books and move forward with reducing our federal debt. We believe this is the single most important issue facing our economy, our country and our very way of life.

Unrest In the Middle East

The unrest in the Middle East that so prominently occupied the headlines around the world has all but been relegated to publications specializing in Middle Eastern affairs. The unrest in Egypt, Syria and Libya hasn’t changed much from three months ago. However, they are impacting the financial markets much less than last quarter. The main reason for the lessened sensitivity toward Middle Eastern affairs is the reduced global demand for oil. The reduction in demand appears to be a result of two separate phenomena. First, the disaster in Japan created slack in the world oil markets by reducing Japanese demand for oil while it struggles to recover. As Japan rebuilds and resumes manufacturing production and rebuilding other infrastructure, their appetite for oil would be potentially at least what it was if not significantly greater. Secondly, the continued weakness in the US economy has reduced demands on the global energy markets. However, as our economy begins to accelerate and other temporary reductions in demand subside the political environment in the Middle East may again become more of interest to the markets as they analyze the possibility of a disruption in Middle Eastern oil production.

Japan

Japan is slowly resuming production in the aftermath of the tsunami and an 8.9 magnitude earthquake that caused the worst nuclear accident since Chernobyl. The economic consequences of the tragedy in Japan are still being felt by U.S. auto manufacturers. Japan’s modern industrial economy manufactures unique, high-quality products, such as pigment for automotive paints; used by virtually every automobile manufacturer around the world. With the disruption in the production of various pigments produced in Japan, several colors have been discontinued by both Ford and General Motors. Many of the world’s leading medical imaging machines such as CAT scans and Nuclear Magnetic Resonance machines are also produced in Japan, causing difficulty in the delivery of new products and the replacement parts for existing machines. It is difficult at best to calculate the economic impact on the U.S. economy from the disaster in Japan. However, by all measures it has been significant and will continue to be so until Japan is able to resume production at prior levels.

Housing

Paul Dales, the senior U.S. economist for Capital Economics released a report estimating that since the real estate collapse began from the pricing peak of 2006, housing prices have fallen 33 percent. To put that in perspective that’s more than the 31 percent dive recorded between the 1920s and 1930s. Ironically, as bad as the housing collapse was in the 1920s and 30s it affected a much smaller percentage of the population because fewer people were able to own their own home in the 1920s. The recent decline in housing prices has affected virtually everyone involved in the housing industry along with every homeowner in the country. The housing industry is responsible for about 30% of the entire US economy. Housing is perhaps the most directly affected industry by high unemployment, which remains at unacceptably high levels, further reducing the likelihood of a near-term rebound in housing prices.

Unemployment

The official unemployment rate as measured by U3 remains at 9.2% as of June 30 after having dropped to 9.1% in the month of May, while the broader U6 which includes “under-employed” remains at 16.2%. Unfortunately, the critically important unemployment rate seems to be stalled at levels not conducive to a robust economic recovery. Employers appear to remain reluctant to hire based on uncertainty over the federal deficit, federal tax policy and continually increasing regulation in almost every industry. Until the private sector is convinced that critical expenses such as healthcare, corporate taxes and ever-changing regulatory oversight have some degree of consistency or predictability, it appears as
though corporate America has decided not to expand until they have greater clarity on these important variables.

Consumer Confidence

Consumer confidence declined 3.8% from May’s 74.3 to June’s 71.5 as measured by the University of Michigan’s Consumer Sentiment Index. It looks as if falling gas prices helped stabilize the consumer’s attitude towards the current economic conditions. However, concerns about the outlook for the overall economy caused expectations to decline. The current Consumer Sentiment Index is about halfway between its January 2007 and its June 2008 trough. This insight of the consumer’s attitude towards the future doesn’t indicate optimism sufficient to support the tepid economic expansion; nor does it indicate pessimism at a level that would sabotage the current economic rate of growth.

Risk Management

Under the current economic backdrop, risk management remains a primary focus of our portfolio management, based on the macro-economic issues discussed above. Retention of capital and risk mitigation are foundational points for long-term investment success. With the risk factors outlined above, we remain convinced that managing risk is more important than trying to achieve returns that  require exposure to asset classes with greater volatility. Over exposure to these asset classes may  have a damaging effect on a portfolio to the extent that it may take several years to recover. For these reasons most, if not all, of our portfolios have increased exposure this quarter to various types of bonds, both corporate and government as well as convertibles and inflationary protected bonds. There’s no guarantee that portfolio allocations for bonds will eliminate risk, however, they spread that risk over  sectors that historically experience less volatility than equities. We continue to monitor portfolio allocations closely in an effort to identify any investments that may cause undue risk. We remain optimistic that as we enter into the 2012 political season that there may be several risk appropriate options for your portfolios.

Summary

While the recovery from the 2008 and 2009 lows seems to have stalled, so has the price appreciation of many equity investments in the 2nd quarter. However, bond investments that were a bright spot in the beginning of the 2nd quarter have begun to wane. At current, both of these investment instrument are moving sideways in a narrow trading range. The process of bonds and equities moving sideways at the same time could be interpreted as good sign that a base is forming that will provide for a stable foundation from which the next growth phase could launch. On the other hand, with the economic stimulus packages coming to an end, this sideways movement could represent an interruption in the uptrend that started March 9, 2009 or the beginning of a new protracted downtrend. It appears there are too many unknowns in the political and regulatory landscape for companies to confidently project sales growth or earnings to be able to look 3 and 5 years out into the future and begin longer term projects that would initiate the hiring needed to reduce the unemployment numbers.

The third quarter is looking like companies will continue to make profits and maintain their cash positions, which will likely underscore that a slow recovery is still underway. However, many of these profits stem from companies cutting expenses and running their businesses in a lean and low cost manner, which would still indicate that many companies have yet to move from a survival business plan to one of aggressive growth. In order for this market to provide robust investment opportunities, some company or industry is going to need to take the leadership position and provide evidence that business is back and it’s possible to grow your company’s revenue and market share in this environment.

It is always important to remember that our models are driven based on the price movement of the investment options available to that model. As the price of an investment is stimulated by purchasers who believe the security has the potential to have a higher-priced future, the models identify this positive movement in the underlying security and then rank it among the other securities available in a given model. Once an available investment choice is identified as having the strongest price action, the model will then recommend that security for investment. It will be a welcome sign to see a company or industry take the lead and have an upward trend for 2 or more quarters in a row. At current, the closest
industries look to be Health Care and Large Industrials.

Contact Us
(330) 467 -3111

vince@thewestermangroup.com

dmillet@thewestermangroup.com

Quotes
“In Washington, spending cuts are defined as less of an increase.” Vince Westerman
“We’ve been increasing our fixed income allocation since early May which has helped buffer downside risk through a choppy quarter. Conservative has performed better than higher risk so far this year.” David Millet

Disclaimer Notice

No investment strategy can guarantee profits or protection from losses as securities are subject to market volatility. The analysis, ratings and/or recommendations made by The Westerman Group, LLC/SuM-it computer models do not provide, imply or otherwise constitute a guarantee of performance.  No guarantee is offered by The Westerman Group, LLC regarding the accuracy, market predictive powers, suitability or profitability (either expressed or implied) of any information provided.   Indices are unmanaged and direct investments in them are not possible.   Actual investment performance of any trading strategy may frequently be materially different than the pursued results.

WESTERMAN GROUP, LLC is a Licensed Investment Advisor Securities offered through Silver Oak Securities, Inc., office of supervisory jurisdiction, 3339 North Highland Avenue, Jackson, TN, 38305 (800) 610-6869 Member FINRA/SIPC

Sources
· Google Finance (for price history of S&P 500 and other indexes) – finance.google.com

· http://www.cnbc.com/id/43395857/US_Housing_Crisis_Is_Now_Worse_Than_Great_Depression

· http://www.standardandpoors.com/ratings/articles/en/us/?assetID=1245311338712