KanalyBlog

2008 Year-to-date Investment Performance

May 2008 Investment Performance

US equities regained some ground in May, led by a 4.6% rise in small cap stocks (Russell 2000) and a 1.8% rise in large cap stocks (Russell 1000). Energy, materials and technology stocks led performance across the capitalization spectrum. The continued commodities boom contributed to a rally of over 16% in small cap energy stocks in May. This rally, coupled with a 7% rebound in small cap tech stocks, resulted in a 5.7% rise in the small cap growth index (Russell 2000 Growth).

In May, large cap financial stocks (down 4.5%) held back the Russell 1000, while small cap financials declined less than 1%. Year to date, large cap financials have declined 11.9%, which is the primary reason that the Russell 1000 is down 3.2% while the Russell 2000 is down only 1.8%. These declines have also contributed to the continued weakness of large cap value compared to growth.

With 99% of the large cap stocks having reported first quarter results, the S&P 500 saw a 17.5% earnings decline in the first three months of 2008. This is the third consecutive decline in earnings, which has not occurred since the end of the last bear market in 2002. Financials experienced an 80% decline in earnings in the first quarter from $59.6 billion to $12.2 billion in the first quarter 2007. Ex-financials, the S&P would have had 7% earnings growth. Consumer discretionary earnings declined 23%, primarily impacted by losses in homebuilding stocks.

All eyes will soon be on second quarter earnings, which are now expected to decline by 7.3% (They were expected to drop only 2% at the beginning of April), again impacted by an expected 44% decline in financial sector earnings. In this environment, it is extremely difficult to tell whether this is going to be anywhere close to accurate. The same can be said of the expected sharp rise in second half earnings.

According to Thomson Financial, the forward P/E for the S&P 500 is 14.1x (seemingly reasonable), yet the poor track record of Wall Street analysts makes this figure of questionable use at this juncture. The more conservative trailing P/E of 17.1x may be more useful for those using this as a general gauge for market valuation. This is not exceedingly “cheap”, so the timing of earnings rebound will be the ultimate driver of market recovery.

International developed markets gained once again, despite the horrific human tolls caused by Cyclone Nargis in Myanmar and a massive earthquake in China. The MSCI EAFE index gained 1.2%, and the MSCI Emerging Markets added 1.9% in May. Small caps outperformed their larger counterparts with the S&P Citigroup EMI ex-US index rising 2.5% during the month. Within EAFE the best performing sectors were again energy and materials, which gained 5.8% and 4.5%, respectively. The financials sector lagged, losing 3.9% during May.

Kanaly Trust Investment Performance

Kanaly’s actively managed investment models posted solid performance in May and continue to significantly outperform the broader equity markets in 2008.  Holdings in energy, technology, health care and consumer staples provided the largest contribution to performance, while financial and consumer discretionary stocks detracted from returns.  The introduction of alternative investment strategies has helped to preserve capital during this time of market volatility.

While we are encouraged by the performance of global equity markets in May, investors should remain cognizant of several headwinds for global equities, including higher energy and food prices, slowing housing markets and the yet unfinished cleansing of bank and financial firms’ balance sheets. We believe that volatility and increased divergence between countries and sectors will continue.

For more information or questions, e-mail us at kanaly@kanalytrust.com. Or you can visit us at www.kanaly.com.

Disclaimer

2008 Year-to-date Investment Performance

The S&P flirted with 1,400 for the first time since early January, closing at 1,385 with its best monthly return since 2003. The drivers for this price recovery have been the slew of positive first quarter earnings from the likes of Google, Boeing and American Express. According to Bloomberg, 63% of the companies in the S&P 500 that have reported earnings so far have positively surprised. Accordingly, the Dow Jones Industrial Average rose 4.7% to close at just under 13,000, while the tech-heavy NASDAQ jumped nearly 6% to close at 2,413.

International developed markets rebounded strongly, while emerging markets soared even more, as last month’s brutal sell off appears, at least for now, to have ended. The MSCI EAFE index gained 5.6%, and the MSCI Emerging Markets added 8.1% in April. Small caps lagged their larger counterparts, as the S&P Citigroup EMI ex-US index rose 2.3% during the month. The proximate cause for the strong rally is difficult to pinpoint. Maybe there was too much pessimism on the part of media, and investors decided to put some of their cash to work? Perhaps markets breathed a sigh of relief, as another Bear Stearns situation did not turn up.

Treasuries retreated 1.7% in April, the first monthly loss since June, as investors regained their appetite for riskier assets. Flows out of money market funds into high yield fixed income funds increased. Investment grade corporate credit issuance shattered previous monthly records, with more than $101 billion coming to market as many financial institutions took advantage of improved market conditions.

Performance for each of Kanaly’s equity models generally kept pace with the market in April, despite having a defensive bias. Most sectors contributed positively, led by the energy, financials, and consumer discretionary sectors. Some of our more defensive holdings in the consumer staples and health care sectors lagged the market. Year-to-date, the Core, Growth & Income, and Diversified models are significantly outperforming the S&P 500 index.

So should April’s rally in equity markets be taken as an “all is clear” sign to investors? As strategic long-term investors, we simply do not know. Certainly more write downs related to credit at large European banks and a tightening of global food situation are distinct possibilities. Either of these two situations could add to political and market discord in various regions across the world. Additionally, we still believe that volatility and dispersion of returns across countries and sectors will continue. Having been long-term students of the markets, we also realize that when investor sentiment turns too strongly in either direction, sharp and often violent market movements in the opposite direction can occur. Investors should remain well diversified and expect continued volatility.

For more information or questions, e-mail us at kanaly@kanalytrust.com. Or you can visit us at www.kanaly.com.

Disclaimer

2008 Year-to-date Investment Performance

   Our 2008 market strategy called for a difficult start to the year due to credit market troubles and fears of recession. The month of March was filled with headlines consistent with this theme: the emergency bail-out of Bear Stearns by JPMorgan and the Federal Reserve; the Fed’s opening of the discount window to non-banks; lower than expected consumer confidence data; falling housing prices and an 8% drop in auto sales from a year ago. These were just some of the enflamed topics which burned even brighter with the help of expensive oil. However, markets showed signs of attempting to find a bottom as the S&P 500, Dow Industrial Average and the NASDAQ turned in the best performance since October of last year.

   International developed markets fell slightly, while emerging markets sold off sharply, especially in Asia, during yet another volatile month. For March, the MSCI EAFE index lost 1.0%, and the MSCI Emerging Markets dropped 5.3%. Volatility continued as expected - and for good reason. What is likely the largest credit bubble in the history of the world continues to unwind, and despite the proclamations of many a pundit that the situation is “contained,” one could easily take the position that many more write-offs and credit problems are lurking in various corners of the world.

   Kanaly’s equity models have delivered strong outperformance in this difficult market environment. Our three individual stock portfolios (Core, Growth & Income, and Diversified) are outperforming the S&P 500 Index by well over 200 basis points through the end of March. As I mentioned in my last post, our relatively stronger performance is due to a more defensive position for our portfolios, along with a reduction in equity exposure.

   The Fed’s actions in the case of Bear Stearns, as well as recent successful raisings of capital by investment banks, have restored some confidence in financial markets. However, the ultimate economic impact remains uncertain as credit market conditions remain tight, unemployment is rising, and commodity prices are high. As a result, we maintain a cautious, relatively defensive approach and remain underweight in financials and consumer-related stocks.

   We expect the market to find strong support near the lows reached intraday on January 23 and March 16. In the days and weeks ahead, we will be watching for further evidence of market bottoming action. Should those signs emerge, we will turn more bullish on the market’s prospects.

Disclaimer

2008 Year-to-date Investment Performance

   Equity markets have struggled to a poor start to 2008 due to continued concerns in the credit markets and fears of a recession.  Virtually all asset classes aside from commodities and Treasury securities have posted declines this year.  However, Kanaly’s equity models have delivered strong outperformance in this difficult market environment.  Our three individual stock portfolios (Core, Growth & Income, and Diversified) are outperforming the S&P 500 Index by over 200 basis points through the end of February.  This margin has since expanded over the first two weeks of March.

   Our relatively stronger performance is due to two primary factors:

• First, beginning near the end of last year, we moved the portfolios to a more defensive position, selling more volatile and economically sensitive holdings in industries such as banking, retailing and technology.  We also eliminated our position in a China exchange-traded fund. The proceeds were invested in stocks with defensive growth characteristics in the energy, consumer staples, utilities and health care sectors. 
• Second, we reduced our equity exposure by 5% across all models in early February, a move that has cushioned the portfolios during the downturn over the last six weeks.

   We expect the market to find strong support near the lows reached intraday on January 23.  In the days and weeks ahead, we will be watching for the classic signs of market bottoming action.  Should those signs emerge, we will turn more bullish on the market’s prospects.

Disclaimer