Investors were pleased to note that first quarter economic results showed a modest expansion despite lingering weakness in the housing sector. The nation’s gross domestic product grew at an inflation-adjusted annual rate of 1.9 percent – a little better than original estimates of 1.8 percent, but a drop-off from 2010 when GDP increased 3.1 percent. It was nice to have some good news – even if gains were modest – in a month that saw a default looming in Greece and stocks decline here, in Europe, Hong Kong and Singapore.
At home, economists reported a rebound of 1.9 percent in factory goods – a good sign after April’s decline of 2.7 percent. The transportation sector was a major factor in the upswing. Automobile production continued to fall because Japanese global supply chains are still affected by the devastation from the recent tsunami. Existing home sales declined in May, as they had in April. Although month-to-month sales continue to be weak, new home sales were up 13.5 percent from May 2010. Every region except the Northeast saw new home sales increase over May of last year.
On the downside, core inflation (an inflation rate that is calculated without energy and food costs) posted its biggest increase in almost three years in May, showing a 0.3 percent gain. Consumer prices increased 0.2 percent following a 0.4 percent upswing in April. Inflation concerns continue to worry some investors.
On the heels of mixed domestic economic news, Wall Street worried that Greece’s debt problems might have caused a major ripple effect. Like it or not, when it comes to financial markets and economic news, we are one world and bad news in one locale can infect markets elsewhere. U.S. share prices dropped when the Greek crisis became public. Share prices continued to decline as protests against austerity measures in Greece turned violent, with the Dow Jones Industrial Average declining 2 percent in just one day. With eurozone authorities making little headway on possible aid to Greece and riots in the streets, investors on both sides of the Atlantic headed for the sidelines in mid-June. Not surprisingly, the Euro took a dive – bad news for U.S. exporters because a weaker Euro makes American goods comparatively more expensive.
Does this mean that U.S. investors need to overhaul their investment strategy and avoid international stocks? Knee-jerk reactions are never a good idea, but it might make sense to review the balance of various financial instruments in your portfolio with help from your investment and tax advisors. It is important to remember that although exposure in foreign markets might seem scary when a crash is under way, history shows that international diversification holds its own over the long term.
The Federal Reserve responded to the European crisis by downgrading U.S. GDP forecasts for 2011 from 3.2 percent to 2.8 percent. Separately, the Federal Open Market Committee announced that target federal fund rates will remain unchanged, but also confirmed that its second round of quantitative easing will wind down. The committee noted that the slightly slower pace of recovery was expected to be temporary, and that higher food and energy costs plus the tragic events in Japan were all contributing factors.
The above are general observations and are not intended as a substitute for advice from your professional tax and investment advisors.