Fears that the economic recovery is faltering led to the selling of risky assets in August.  The S&P 500 lost 4.51% in the month, marking the third monthly loss in four months.   Amid stock market weakness, the yield on the 10-year note finished the month 40 basis points lower at 2.47%.

Financials, Industrials, and Technology shares were the biggest losers in August.  Economic qualms contributed to weak performance in the Financial and Industrial sectors.  Financials were also held back by uncertainties regarding the implications recent financial regulatory reform legislation.  Technology shares came under pressure as bellwethers Intel and Cisco lowered sales and profit outlooks.   Intel said consumer demand for PCs would be weaker in coming quarters and Cisco said the European economy and lack of job growth in the U.S. would affect earnings.

Telecoms and Utilities, generally considered defensive sectors, were the only sectors to post gains in August.  Investors favored these sectors for their attractive dividend yields and relatively recession-resistant revenue streams. 

Recent economic data continues to support positive growth, but at a more modest pace.  A double dip is still not the most likely scenario, but downside risks to the growth outlook have increased.  Initial jobless claims returned to the 500k mark for the first time since last November.  And even though housing data is greatly distorted by the homebuyer tax credit, the market couldn’t ignore data that showed existing home sales fell 27.2% in July and inventories jumped to 12.5 months worth of supply (more than twice the level of a healthy housing market).

The Federal Reserve’s mid-month decision to maintain their balance sheet size rather than letting it shrink by a very small amount is reflective of their view that downside risks to economic growth and inflation have increased.  Later in the month, Ben Bernanke vowed the Fed would do everything it could (which isn’t much since interest rates are already at zero) to prevent the economy from falling into recession. 

Somewhat overshadowed by Fed actions and disappointing economic data was a wave of mergers and acquisitions.  U.S. companies are carrying record cash balances, but earning next to nothing sitting idle on balance sheets.  As a result, I believe we will continue to see companies make acquisitions, buy back stock, and increase their dividend payments.   Although this is a positive development, it would be even better if businesses would use cash to invest in capital or hire new workers.  Unfortunately, this will not occur until they gain confidence in economic prospects, political policy, and tax rules.

Despite all of the various uncertainties the market will deal with over the near term, I still believe that today represents a tremendous opportunity for long-term (10-15 years) investors.  The key is to be patient and maintain a disciplined approach, because market returns are likely to remain volatile for the foreseeable future.

Related links:

 * Market Minute: Stock Performance

 * Market Minute: Long-Term Investing

Peter Lazaroff, Investment Analyst