April 27, 2012
Key Points
- Despite an earnings season that has been much better than expected so far, investors appear to be again focusing on more macro concerns. Europe and China are dominant concerns but US growth sustainability is also being questioned. We remain optimistic on the ultimate direction of the stock market.
- The Fed meeting provided no changes but did show a slightly more hawkish tilt in their economic forecasts. Meanwhile, the US government continues to play a dangerous game of chicken as election season is already in high gear and the so-called "fiscal cliff" looms.
- Confidence is again waning regarding the ability of Europe to make the reforms needed to solve its debt crises, many of which we believe are structural in nature. But despite fears of a hard landing in China, growth continues and stocks have outperformed.
After an extended, and almost unprecedented period of relative calm, resulting in robust stock market gains from October 2011 through March 2012, we have seen some volatility return. Concerns over global growth have reemerged as Chinese economic data has disappointed, the European debt crisis again is gaining headlines as the merits of austerity are being questioned, and US economic data has been less impressive.
Volatility has picked up
Source: FactSet, Chicago Board of Trade. As of Apr. 24, 2012.
One potential benefit of this rise in consternation has been the long-awaited correction in stocks that many had been calling for. In fact, we have been comforted by numerous investor sentiment readings now showing elevated bearishness (remember that investor sentiment is a contrary indicator). The American Association of Individual Investorsâ (AAII) bull ratio recently moved decidedly below the 50% mark for the first time in 2012. The percentage of respondents saying they are bearish has moved from just under 28% to nearly 42% between April 4 and April 11; and the percentage of bulls dropped to 28% from over 38% over the same time period. We believe this change in sentiment was needed in order for the market to reestablish a sustainable uptrend going forward.
The recent mild increase in volatility again reminds us that it's important to maintain a long-term focus and to maintain a diversified portfolio. It's vital that investors review their portfolio holdings on a regular basis, while also looking at how correlations among asset classes change over time. A well-diversified portfolio in one year may not be nearly so two years later, even if the positions are roughly the sameâthe interaction between asset classes changes over time. One final note on portfolio construction: The drumbeat of bearish bond commentary has grown over the past month as yields remain near record lows. While we again remind investors that investing in bonds for speculative or capital appreciation purposes has become more risky; it is also true that for diversification, income, and capital preservation purposes, bonds will still have a valuable place in many portfolios. Again, balance is the key.
Macro concerns again trumping micro story
Investors' attention is again focused on the macro rather than the micro over the past couple of weeksâthe height of first quarter earnings season. The reporting period has been much better than expected, although admittedly from a lower barâ83% of companies have beaten expectations so far, which is an all-time record high. But market reactions to good reports have been more muted relative to the punishments doled out to those that disappointed. It appears Chinese developments, European debt and growth concerns, and some softening in US economic data has led to increased volatility.
In the United States, the economic expansion continues, but we may be in yet another soft spot. This isn't surprising given the likely pulling forward of some economic activity that was influenced by the unusually warm weather during the winter months. We believe this is a relatively modest and temporary phenomenon and that activity will again pick up in the coming months. Concern has grown that 2012 will be a repeat of the previous two years when the market declined beginning in April on softening economic data after decent starts to the year. We believe the story is different this time as jobs, lending and housing have improved and inflation has eased, allowing global central banks to keep policy loose; leading to our view that history won't repeat this year.
Recently, we've seen regional manufacturing surveys disappoint, although remaining in territory depicting growth. The Empire Manufacturing Index fell from 20.2 to 6.6 and the Philly Fed Index dropped to 8.5 from 12.5. Encouragingly, the employment expectation component of Philly Fed jumped six points to its highest level in a year, while March retail sales increased 0.8%, above estimates, indicating that the American consumer remains engaged. Commodity costs have also leveled off recently, which should help to bolster discretionary income.
Lower commodity prices should help consumers
Source: FactSet, Standard & Poor's. As of Apr. 24, 2012.
Despite this still-positive picture, recent job and housing data has weakened a touch. The March payroll report disappointed despite the unemployment rate dropping and recent initial jobless claims have crept a bit higher. We remain relatively unconcerned given that seasonal adjustments around the Easter holiday can be difficult and the level still remains well below the key 400,000 number. Jobs are a vital cog in the economy and we believe that increasing retail demand and a declining ability of companies to squeeze additional productivity out of existing workers should allow for continued improvement on the labor front.
