First Quarter, 2011 Economic and Market Commentary

The events in Libya and Japan were the major stories in the first quarter of the year. The natural disasters and resulting nuclear emergencies in Japan will clearly take a toll on Japan's already fragile economy and financial markets in the short to medium term. Longer term there is hope that the eventual re-building process will spur consumer spending, which has historically lagged other developed nations due to a higher consumer savings rate that has exasperated the deflationary cycle that Japan has been fighting for the last 20 years. We would expect that the ramifications of these traumatic events and terrible human tragedy to have a more muted effect on the U.S. and the rest of the world. There will be supply chain issues for some companies that depend on parts made in Japan, but the temporary interruption in Japanese exports will be largely filled by manufacturers in other parts of the world which have ample capacity. From an investment perspective, less than 5% of our model growth component consists of Japanese companies, so although return statistics were affected by the precipitous drop in the Japanese stock market, the overall impact was relatively muted.

The next major concern for U.S. investors appears to be the continued uprisings in North Africa and the Middle East. The political upheaval in Libya is just the latest in a string of revolutions throughout North Africa and the Middle East that has pushed oil prices significantly higher. Although U.S. consumers are no doubt feeling pinched by higher prices at the gas pump and other goods and services that are impacted by oil prices, we would not envision that oil prices at current levels of around $110/barrel would be enough to derail the continuing U.S. economic recovery. However, if the unrest in North Africa and the Middle East spreads to some of the major oil producing nations, it would not be surprising to see oil prices shoot up to the levels seen in 2008. Although this could have some negative impact on U.S. growth, we believe that such price increases should be transitory in nature. This is because we believe that new regimes throughout the Middle East will have strong incentives to maintain output for their own fiscal purposes. Thus, although real and perceived potential oil production disruptions may have a likelihood of increasing short term equity market volatility, an interruption of the current economic expansion should be more limited.

The last major concern for longer term investors would probably be the status of the federal budget. It would be impossible to guess how the myriad of issues involved in the budget process will resolved over the next several months. It would be safe to conclude that some element of tax increases and spending reductions would have to be part of the result. Although the potential impacts of the many facets of any budget resolution will likely be hugely reported and analyzed in the media, the probably impact to the economic recovery is not overwhelming. Corporate spending has been the driver to this stage of the recovery and this seems likely to continue based on very solid recent earnings. This should continue to slowly improve the employment picture hopefully to the point where consumer spending will become a more fundamental driver of the recovery. Improved growth is the easiest way out of the U.S. budget situation and that is our elected leaders preferred method over difficult political choices.

Even in light of these tumultuous global events in the Middle East and Japan, which added to equity market volatility in March, corporate profits and global equity market returns were once again resoundingly strong. This was highlighted by the Dow Jones Industrial Average's 6.4% increase, which was its best first quarter in percentage terms in 12 years. Even with a declining U.S. dollar versus most foreign currencies amplifying international returns for U.S. investors, domestic returns outpaced international returns, which is not surprising considering the aforementioned events in Libya and Japan. The same return variance held true in the REIT sector, with returns stronger in the U.S. than abroad. Small and Mid capitalization stocks provided slightly stronger returns than large cap domestic stocks. The following table illustrates the three and twelve month returns for the various index sectors that we use to gauge the relative performance of each of the managers within our model growth component.

Benchmark Sector


3 Month Return

12 Month Return

Large-capitalization Domestic

S&P 500



Mid-capitalization Domestic

S&P 400



Small-capitalization Domestic

Russell 2000



Micro-capitalization Domestic

MSC US Microcap



Developed International Markets




Emerging International Markets




Real Estate Investment Trust




Global Real Estate Investment Trust