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Centennial High School
Capital Markets Contest Essay
Since the low point of the “Great Recession,” the U.S. stock market has staged a dramatic
turnaround. The Dow Jones Industrial Average has increased 64.7% from March 9, 2009 to May
14, 2010, and the broader S&P 500 has improved 71.1% during the same period. More recently,
the Dow added 4.1% in the first quarter of 2010, and the S&P 500 added 4.9% to its value.
During the ten-week study period of the Capital Markets Contest between March 8 and May 14,
2010, the stock market has experienced a long period of slow, steady increase followed by a
recent period of substantial volatility. Over the ten weeks, the Dow strengthened 0.5%, and the
tech-heavy NASDAQ improved 0.6% while the S&P declined 0.3%. The consistent
improvements of the first seven weeks were a result of improving economic conditions,
demonstrated through economic indicators, and strong corporate earnings reports. Additionally,
improvements in the market were assisted to a lesser extent by the continued record-low interest
rate policy of the Federal Reserve. However, the market has exhibited increased volatility, taking
substantial drops over the final three weeks of trading due to uncertainty concerning European
economic stability.
While the releasing of indicators failed to have a substantial effect on day-to-day shifts in
the market, positive trends of indicators affirmed the strength of the recovery, resulting in steady
improvements in the market. Real GDP growth has signified an improvement in the economy.
After showing an annualized growth rate of 5.6% during the 4th quarter of last year, the fastest
growth in six years, growth slowed during the 1st quarter of 2010, but continued at a healthy
annualized rate of 3.2% according to the BEA’s advanced estimate. The first quarter’s positive
growth rate marked the third consecutive quarter of economic improvement.
The report was evidence of the sustainability of the recovery, as the majority of the
growth was fueled by improvements in consumer spending and business investment. Although
retail sales were up 0.4% in April, well below 2.1% growth in March, this improvement was
twice as much as analysts predicted. Consumer spending during the first quarter rose at an
annualized rate of 3.6%, contributing 2.6% to the GDP growth during the first quarter of 2010.
Investment has also demonstrated growth. Business spending rose 4.1% between January
and March after climbing 5.3% in the fourth quarter. The ISM Purchasing Managers’ Index
increased 0.8 points in April to 60.4 (well above the benchmark for growth of 50.0) revealing
broad growth in 17 out of 18 industries. The PMI’s sub-index for new orders rose to 65.7 points,
a 6.8% increase from the prior month, a signal that the sector's growth is not solely because of
inventory restocking after the recession. The Fed’s Index of Industrial Production has indicated
ten straight months of improvement.
Gains in the market have also been fueled by positive earnings reports. Reports
throughout April revealed a positive turnaround for most companies as 82% of S&P 500
companies had reported their earnings in April beat their Wall Street estimates. Sales numbers
are also up across the board as two-thirds of S&P 500 companies posted sales reports that
exceeded respective expectations. These reports have directly improved the value of stocks with
encouraging earnings and indirectly provided confidence to investors.
Inflation remains of minimal concern, allowing the Fed to keep interest rates low,
encouraging spending and business investment. The Fed’s preferred measure of inflation, the
Personal Consumption Expenditures Price Index, which excludes food and energy prices, rose at
an annualized rate of 0.6% in the first quarter of 2010, the slowest rise since 1959. Due to the
absence of an apparent risk of inflation, the Fed has been able to keep interest rates low,
maintaining a Federal Funds Rate of 0-0.25% since December 2008. Chairman Bernanke's
commitment to keeping interest rates low for “an extended period of time” has provided for
investor confidence which contributed to the dramatic spike in investment that has fueled a large
portion of the economic recovery.
While the economy is rebounding from the recession, improvements are still considered
below average for a recovery, largely due to uncertainty deriving from the labor market.
Unemployment has remained at 9.7% since January 2010 until rising in April to 9.9%. The
United States lost over 8 million jobs during the recession and 15.3 million Americans remained
jobless and seeking work in April. These grim statistics have created reservations in the market,
as investors have feared the effects a “jobless recovery” could have on consumer spending,
which accounts for 70% of the economy. Nevertheless, the labor market has seen improvements
recently. Change in nonfarm payroll has indicated a net-gain of 452,000 jobs between March and
April, a dramatic improvement over last year when the economy experienced a net loss of
1,281,000 between March and April 2009. Nonfarm productivity rose at an annualized rate of
3.6% during the first quarter, bringing the 12-month increase to 6.3%. This indicates future
hiring, because companies are nearing the limits of the productivity of their existing workforce.
New hiring will inevitably be needed to supplement greater output. Despite the positive trends in
the labor market witnessed recently, improvements have been inadequate to indicate a full
rebound on pace with prior recoveries which have generally seen substantially faster returns of
jobs. While news of improvement is welcomed, fear still exists, preventing greater amplification
in the market indices.
Between March 8 and April 25, the market saw a general upward trend without any days
of substantial volatility. At its peak, on April 26, the DJIA stood at 11,205, a 6.2% increase from
the beginning of trading on March 8. However, stability came to a sudden halt during the final
three weeks.
The period of volatility began on April 27 after Standard & Poor’s lowered their
sovereign-issuer credit rating, which assesses the risk level for investments in a particular
country, for both Greece and Portugal. In response to the announcement, the DJIA dropped 212
points. The market rebounded amid strong earnings reports in the following days and positive
signs that Germany was moving closer to approval of a bailout plan, previously valued at $8.4
billion, to resolve Greece’s debt problems. This momentary rebound gave way to another large
slide on April 30 as word came that Goldman Sachs would be the focus of a criminal
investigation, leading to sell offs in the financial sector. The DJIA closed down 0.9% pulled
down by 3.0% declines in both J.P Morgan Chase and Bank of America. The month of May
began with good news as estimates of the S&P 500’s first quarter profit growth rose and helped
to drive the Dow up 143 points. This was completely erased the following day when worries
about Europe’s ability to contain Greece’s growing financial crisis emerged on the same day as
a Wall Street Journal article, speculating on the possibility of a Justice Department investigation
into Apple, which contributed to a broad slide in the tech sector, helping to drive the Dow down
2.2%. May 4 was the fifth day of triple-digit swings for the DJIA in the last six sessions.
Throughout the first week of May, stocks continued to fall across all of the major indices
as growing concerns about the debt crisis overshadowed evidence of a sustained U.S. recovery,
none of which compared to the swings in the market on Thursday, May 6. The Dow dropped
nearly 1000 points in less than an hour, the largest intraday drop on record, before recovering
most of the losses by the close of trading, ending at -3.2%. The plunge is believed to have been
catalyzed by electronic trading algorithms and the breakdown of fail-safes, which should have
prevented massive electronic trading from spiraling out of control. By the beginning of trading
on May 10 however, the Dow had jumped nearly 500 points from the Friday closing of 10,380,
an increase of 2.3%, due to the almost $1 trillion bailout supported by the eurozone and the
International Monetary Fund. This brief rally proved to be unsustainable as both the Dow and
S&P continued to see minor decreases at the close of trading Tuesday, amid fears that the
European bailout failed to address systemic problems and may, in fact, only further aggravate the
investment in the future by drawing on increased debt in order to raise the funds. On the bright
side, the bailout will halt the immediate panic and limit the risk of financial contagion.
Continued austerity cuts in Portugal and Spain dropped the Dow 162 points by the end of trading
on Friday, May 14.
The ten weeks were dominated by a sustained rally for the first seven weeks followed by
a three-week period of volatility that essentially left the market back where it began on March 8.
Growth in the domestic economy remains strong despite concerns surrounding the European
financial crisis. The resolution of these uncertainties should return the stock market to a bulltrend.