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The third quarter ended with the S&P 500 index
advancing by 5.67% percent for the quarter with the Healthcare, Telecom
services, and Technology components advancing by, 9.76%, 9.63%, and 8.33%
respectively. The losing components of the index were Energy and Materials;
both down 2.14% and 1.13%. The S&P 500 index ended the quarter with a year
to date advance of 8.53%.
Looking ahead we see a continued advance in the equity
markets in the fourth quarter buoyed by a stable to moderately growing
economy. This advance, however, will be tempered by uncertainties about
inflation as well as the November election results.
Stable Economy
Second quarter GDP was revised downward to 2.6%,
showing a stable economy that has slowed down a bit from the first quarter.
While the downward revision was attributed, in part, to a slower build in
inventories and a slowdown in business spending, we expect these conditions
to slowly reverse in the third and fourth quarters and we anticipate that
the economy will continue to grow at least at a similar rate of 2.6%. If
this does indeed pan out we will have a stable moderately growing economy
that is conducive to higher stock prices in the fourth quarter of 2006.
Previous Federal Reserve interest rate hikes seem to have started taking
effect in gradually slowing down the economy. One economic indicator to be
mindful of in the fourth quarter is the unemployment and non-farm payroll
numbers. Our view is that the stock market will perform very well in the
fourth quarter so long as the economy is slowing down and there is no
significant deterioration in the job numbers.
Inflation Concerns
While inflation, as measured by the PCE, seems to be at
or above the Fed’s upper comfort zone, both the Fed and the market, to some
degree, anticipate that economic indicators in the fourth quarter will show
that lower energy prices and a slowing housing market will reign in
inflation, making an interest rate increase at the Fed’s October and
December meetings unlikely. While there is great likelihood that this will
be the case, we believe that the market will be choppy in October until
there is confirmation from the Fed to this effect in its October meeting
(October 24-25). Hence we see the October meeting as an important event that
will probably shape equity returns for the fourth quarter as a whole. Very
likely, the first three weeks of October will bring negative returns for the
S&P 500.
Given this scenario, a more defensive posture is
recommended with increased holdings in Healthcare and Staples stocks. We
continue to maintain our overweight position in Technology stocks as we
believe that the technology sector will be the biggest beneficiary of
business and consumer spending in the fourth quarter. We still maintain that
the Technology component of the S&P 500 will be one of the big winners this
year. We also continue to believe that Gold will offer valuable portfolio
insurance in the form of a good hedge against inflation and geopolitical
risks. |
