In the second quarter of 2011, the stock market, as represented by the Standard & Poor’s 500 stock index, declined 0.4%% to close at 1321 on June 30, from 1326 at the end of the first quarter. The benchmark ten-year US Treasury note saw its yield decrease 29 basis points, or hundredths of a percentage point, to 3.16%, from 3.45% on March 31, while the price of Gold increased 4.3% to $1500 per ounce from $1438. Crude oil decreased 11.2% to $95 per barrel from $107.

The stock market came under pressure, and Treasuries rallied in the second quarter for three principal reasons. First, and most significantly, both the global and domestic economies appeared to have slowed in the first six months of the year relative to the pace of the fourth quarter of 2010. While economic data had previously surpassed Wall Street’s expectations on a regular basis, in the second quarter this pattern reversed itself. The data consistently came in below forecasts, particularly on employment. As it is said that the market is a game of expectations, this reversal in trend removed support for equities and put a bid into bonds. The economic weakness was attributed primarily to the disruption in global manufacturing caused by the Japanese earthquake and tsunami disasters in March and a sharp increase in the price of oil to $114 per barrel, which has since pulled back to $95. As Japanese production is gearing back up, and oil prices are in retreat, at least for now, many economists predict that growth will reaccelerate in the second half of the year. The trend in the economic data has indeed begun to moderate, and share prices ended the quarter on a firmer note while Treasuries weakened.

Working against this will be a backdrop of tightening fiscal and monetary policy in America and around the globe. In the US, while the 2009 enacted stimulus tapers off, additional stimulus spending is not on the table, with Democrats and Republicans focused on how to cut spending further. The Federal Reserve, meanwhile, has ended its bond purchasing program known as QE2 with no indication that it has any appetite for further action at this time. Taken together, along with the weight of high unemployment, a housing market that continues to struggle, and fiscally retrenching state and local governments, we are not as sanguine that the economy will substantially reaccelerate in the second half of the year. We are by no means calling for another recession, but would not be surprised by subdued real (inflation adjusted) growth in the 2-3% range, either.

A further weight on the stock market, and a support to Treasuries, was the reemergence of the Greek debt crisis. Simply put, Greece has more debt than it could ever hope to repay without some form of relief. The challenge for European governments is to reduce this debt in such a fashion that does not result in a continent wide financial crisis. If serious doubts about the ability or willingness to repay debt spread to Portugal, Ireland, and, most ominously, Spain, events could spiral out of control, leading to a Lehman Brothers-style banking panic in Europe that could bleed into American markets as well. Greece in and of itself is not a large economy, and the European authorities do have the financial wherewithal to resolve this particular crisis. The threat of a larger contagion, however, is very real. As of this writing, a short-term fix seems to be in the works. The real worry is whether or not the Europeans have the political will to coherently develop long-term policy. This remains to be seen.

Lastly, the uncertainty surrounding the US debt ceiling increase is souring market sentiment. Apart from potentially disastrous consequences if America were to voluntarily default on its debt, the whole exercise in partisan posturing and brinksmanship on such a serious matter undermines the market’s confidence in the ability of the United States government to function in a rational and responsible way. We fully expect this issue to be taken at least to the August 2d deadline the Treasury department has identified for a default, if not beyond. There is some dispute as to whether or not this is a hard deadline. The closer the deadline looms, however, the larger the issue this will be for the market. Ultimately, we see a ceiling increase being authorized, but not before the drama is taken up a few notches first.

Over the longer-term, we see an economy and stock market that will expand at a modest pace below what was considered “normal” prior to the 2007 to 2009 financial crisis. The deleveraging of the American consumer and the related weakness in housing will not be unwound quickly. As the consumer is the main driver of economic activity in America, it is difficult for us to envision more aggressive long-term growth than the aforementioned 2-3%. Such a growth rate could produce real (adjusted for inflation) annualized average stock returns in the 3-5% range over the next decade. While far superior to what is currently offered in the bond market, we believe our quality/value oriented approach will return a premium over the generally more expensive and speculatively oriented broad market averages, such as the Dow Jones Industrials, the S&P 500, and the NASDAQ Composite. Our experience through the financial crisis demonstrates that our four pillars of quality, value, diversification, and patience can deliver positive long-term results in even the most treacherous investment environments. In this sense, we remain positive on the potential returns of your portfolio regardless of the many challenges and potholes that line the road ahead. For the remainder of the year, we see the S&P 500 trading in a range from 1225 to 1425. It currently stands at 1321.