Signs are positive for markets and economy

February 12, 2010

SCHWAB.IMG_4329-Kully Samra is UK Branch Director at Charles Schwab. The opinions expressed are his own.-

There is no doubt that since the lows in March 2009 the U.S. market has rallied massively. However, at Charles Schwab we believe that whilst economic progress will continue, we must look to the months ahead with some caution.  We remain optimistic regarding the equity markets in the longer term and the economy in the short term, but recognise that increased volatility will likely characterise 2010.

Over the last month, we’ve certainly experienced a sense of this increase in volatility in the US markets and we would stress the importance of a diversified portfolio and an appropriate asset allocation that matches one’s risk tolerance in order to combat this. Investors should also ensure that they assess and rebalance their portfolios to fit the market conditions.

Despite this, the U.S. economy is undoubtedly still continuing to improve, evident from the initial read on fourth-quarter gross domestic product (GDP) which presented a much-better-than-expected 5.7 percent. Up to this point, the recovery that we’ve witnessed since March 2009 could be described as V-shaped. However, it will become more difficult for data to continue to move in that nearly vertical pattern. This will likely result in at least some flattening in the rate of improvement in the economy at some point in 2010, possibly making the recovery square-root shaped.

One thing that we’re keeping our eye on at Schwab is the increasing debt levels in the US. In the decade to September 2009 it’s taken nearly 6 dollars of debt to create 1 dollar of economic growth. This is clearly not sustainable, and is a threat to the long-term stability of the US economy. To give this some context, in the 1950s, it took 1.36 dollars of debt to create a dollar of economic growth.

Government shake-up?

Although it may seem like an obvious point to make, it is near-impossible for investors to catch or predict every move in the equity market. The Greek banking crisis and the election upset at the Massachusetts Senate election are prime examples of this, as both events impacted short team market action in the U.S.

The outcome of the Massachusetts senate election, which gave the Republican Party a 41st seat in the Senate, has tilted the balance of power in Washington, exacerbating what was already a volatile atmosphere. It appears that some of the major proposals of the Obama administration are likely to be scaled back, which could provide some more certainty for the economy.   The proposed health care program has largely been taken off the table for now, as has major cap and trade legislation, both of which were met with some opposition by the business community.

We continue to watch the developments in Washington, and share some of the markets’ apparent concern regarding new taxes and regulations being proposed for the financial industry.  It seems that finding the appropriate balance between needed oversight and the freedom to innovate and fuel economic growth is proving difficult, and we look forward to following these developments as they unfold.

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