Market Comments for 12/20/2010

As far as the stock market is concerned, Christmas has come early as Santa Claus has been delivering gifts for investors all month-long. Stocks are on an impressive year-end run fueled by improving economic data, solid corporate profits, accommodative Fed policy and a more business-friendly tone from Washington . It's hard to tell when all this good cheer will end but for now Wall Street is in no mood to turn down that last slice of Grandma's fruitcake or last glass of egg nog.

Last Week 

The current December theme of bonds selling off and stocks rising persisted yet again as the major indexes posted more gains last week. Specifically, the Dow rallied 0.72%, finishing at 11,492. The S&P 500 rose 0.28% to close at 1,244. The Nasdaq advanced 0.21%, pushing the index to 2,643.

While stocks have been surging, bonds have been going in the opposite direction. The 10-year treasury yield, in the 2.4% range back in October, briefly touched 3.5% before rallying to 3.3% on Friday. It seems that a combination of a recovering economy and a lack of interest in government debt has caused bonds to drop in value (forcing yields to rise).

Not even disappointing earnings from both Best Buy and FedEx were enough to derail stocks. Instead, the market focused on reports from tech companies Accenture and Oracle that were better-than-expected. Those stocks, in addition to FedEx, did, however, issue rosier forecasts looking out to next year.

Lastly of note, Congress did approve the extension of the tax cuts. Key points for investors are that capital gains and dividends will remain at the 15% tax rate, employees will pay lower payroll taxes and unemployment benefits will be extended an additional 13 months. This should be very positive for stocks as it lifts the cloud of uncertainty and lays out a framework which is more tax-friendly for both investors and businesses. Whether it will lead to more hiring is still too early to tell but it is a step in the right direction.

This Week

Markets will be closed Friday, Dec. 24, for Christmas. Still, there is a pretty good mix of news that could move the market in this shortened week. Nike, Adobe Systems, Walgreens and Bed, Bath and Beyond all report their latest results. In terms of economic releases, revised GDP, existing home sales and personal income data are all on the calendar.

Portfolio Impact  

Many clients are accustomed to stocks dropping in value but when bonds drop in value that can be another story. And over the past few weeks, bond yields have risen sharply causing bond values to decline. Keep in mind, bond yields and prices have an inverse relationship. (Think of it this way: You have a bond yielding 2%. Now current yields are 3%. This implies that the increased demand for the 3% bond makes your 2% bond less valuable in the marketplace).

In our portfolios, we buy high-quality bonds with the purpose of holding them until maturity. That means that unless there is a credit issue (default), clients will receive their principal value back at maturity. So really nothing has changed, despite the fact that bonds are fluctuating daily according to the current level of interest rates. In addition, we are buying bonds more in the short-to-intermediate part of the yield curve as that limits sensitivity to rising rates and also allows us to reinvest at higher rates upon maturity.

We do think it is possible that rates could move higher. This is a reflection of an improving economy and possible inflation. With bonds regularly maturing, this will allow us to increase portfolio income in bond portfolios. So while it is discouraging to see current bond values decline, our portfolios are less affected by rising rates and ultimately will benefit by reinvestment in bonds with higher yields.