The second quarter certainly provided a response to the question everyone was asking after reaching recent market highs in the first quarter. Where does the market go from here? Many familiar factors contributed to the downturn during the second quarter. Concerns about the European financial crisis re-emerged, reported GDP growth in the United States and China continue to reflect ongoing weakness and earnings estimates continue to be adjusted downward due to the same concerns about global economic growth.
We remain comfortable with a balanced approach in the allocation of our portfolios due to existing uncertainties with a focus on dividend yielding stocks and fixed-income investments. As we follow the universe of dividend yielding stocks we see a pattern where many of these companies are priced at a premium relative to fundamentals. Prices are being driven up by an overall demand for such securities despite the lack of appreciation potential for these companies. Many of them are in sectors such as the pharmaceutical industry and utilities where projected earnings growth is unremarkable. This must be monitored closely in anticipation of a turnaround in the global economy where a possible selloff may occur as investment professionals/investors transition to companies with stronger appreciation potential tied to economic growth.
Our approach to fixed-income investments continues to be defensive with regards to the possibility of a rising interest rate environment even though we feel that such a scenario will not occur in the near future. Sluggish economic growth and the lack of inflationary pressures are factors that drive our current outlook for interest rates.
Should a recovery occur at a pace sufficient enough to drive up commodity prices resulting in a possible rise in interest rates, we expect the fixed income component in our portfolios to hold up well. In addition, the higher commodity prices will certainly benefit the commodity related companies that we are currently holding despite their continued selloff. Our expectations for these out-of- favor sectors to outperform the overall market have not changed and we have informed many of our clients that we will be revisiting the possibility of acquiring additional shares at lower prices. The question is when?
This question is also a major factor in our observance as to how stock prices and earnings will converge in the future. At this point we do see a discount in current prices relative to fundamental valuation. But, should the economy turn around much later, we see a scenario where earnings estimates continue to be adjusted downward to meet current prices or drive down prices. Our hope is that the turnaround occurs sooner so that current earnings estimates hold their ground or increase, allowing share prices to appreciate, meeting fundamental valuation. Again, the question is when?
We do see positive signs moving forward regarding decisions that are being made globally. China has become more aggressive in making sure their economy will grow at a quicker pace. Decisions being made in Europe regarding their financial crisis have been positive even though, in reality, they are just short-term fixes. We are also waiting for any indication of a possible stimulus package in the U.S.? Like everyone else, we shall wait and see.