The first quarter of 2011 may have ended within a tight and sleepy trading range but for accounts fully invested at the start of the year you might have thought we were running on Red Bull. For the first quarter of 2011 fully invested Growth accounts returned an average +15.13% while Moderate Growth returned +11.9% net of all fees and expenses while the S&P 500 returned +5.9%.
Performance momentum and values peaked in mid February. Since that time accounts have been in a range of plus or minus 5% as it appears the markets are in a period of digestion after the substantial Fall- February rally. A pause such as what we’re experiencing is entirely normal.
The global bull market remains intact with the U.S. markets now being the primary leader in developed markets. Contrary to the last two years, Emerging Markets have been lagging and this lack of performance accounts for the large bias to U.S. stocks in our equity models. In January I mentioned the possibility of a market top in August based on Presidential and 10-year cycles. Anticipation of future events is always precarious and at present there is no serious fundamental data point validating an August top. If this were August rather than May, I’d have to give the markets the benefit of the doubt since earnings remain strong and interest rates have receded in line with the selloff in commodities. In addition, lending and money supply growth have accelerated which points to a healthier economy and monetary environment.
As long as earnings growth continues I believe the odds are quite high that our portfolios are merely treading sideways till the next leg up due to the increasing strength in corporate earnings growth – see chart.
Major winning holdings included (return percentages are approximations):
Travel Centers of America 147%
Town Sports International 78%
Sunrise Senior Living 74%
Material Sciences 61%
Five Star Quality Care 63%
Oscar Wilde: “Experience is the name everyone gives to their mistakes”
Multiband Corp. -35%
YRC Worldwide -23%
Bon-Ton Stores -19%
TAM S.A. -15%
Fundamentals for growth still look good: Be it Libya, the tragic tsunami and earthquake in Japan, federal debt limits or stagnant housing and employment, this isn’t the Perils of Pauline it’s the modern day world of investment management. There are always numerous intelligent reasons to build a bunker and hide out in the wilderness. Investors wonder why the U.S. markets can continue to rise but I would suggest the market is pinned to earnings growth which has been strong and continues to be so. Making money with investing is never easy, too often it seems like climbing Kilimanjaro but you have to keep your eye on what markets are responding to and realize that most market and economic talk is just blather.
Earnings growth remains strong with year to year growth approaching 18% and if you exclude Financial stocks which are dealing with their particular issues, the rate of growth is 20%, which is pretty good. In addition, the full year 2011 estimate for S&P 500 earnings is approaching $98 and if this figure is maintained or exceeded then eventually investors will have to take this into account. At present with the S&P 500 valued at 1337, it’s selling for just 13.6 times 2011 earnings of $98 below the average of 14.7 times earnings. It would appear that we could see further gains before year end and that market high of 2008 of 1400 will be breached, fulfilling what may likely be the most vicious whip-saw in our lifetime. Before I move on, it should be stated that the Russell 2000 index which is dominated by small stocks has already reached 2008 levels.
Reinforcing the view that the markets are not overstretched at this point: From Bespoke Investment Group – Of the 25 prior S&P 500 bull market rallies since 1928 our gain of just over 101% with a duration of 781 days the current rally is 11th in terms of duration and 9th in terms of return. In fact, the average return since 1928 excluding the present rally is 101.6% over 890 days, so all in all we’re very average to this point.
There are many ways to gauge investor sentiment which is valuable since major market bottoms and tops generally see investor extremes. At present the public has yet to embrace this rally despite its longevity. Mutual fund cash inflows continue to show almost a 6-1 tilt in favor of bonds over equity mutual funds. We would expect to see a radical reversal of these figures at a major top when investors would be abandoning bonds and betting the house on equities. While that may never happen during this market cycle, the potential for major cash inflows into equities from the sale of bonds and money markets (as investors realize that 3-4% yields will not achieve their retirement goals) represents a major source of buying power potential.
To sum it up: Despite the slight downward drift in equities since the February I’m not losing any sleep. Downward drifts in the midst of major bull markets are as common as overcast weather in May for Colorado. The major market direction remains higher propelled by rapid earnings growth but S&P 500 target of 1400-1425 probably has a likelier chance later this year in the 4th quarter. Markets are typically choppy in the May to October, a period full of sound and fury but little progress. Should earnings growth sustain itself into the 4th quarter, the present day period will likely be the pause that refreshes.
All the best,
Brad Pappas
At the time of this article RMHI was long the following securities: CLUB, SRZ and FVE.
Past performance is no guarantee of future results. Investing in sectors may involve a greater degree of risk than investments with broader diversification. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks. The information contained herein is obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not a solicitation or a recommendation that any particular investor should purchase or sell any particular security. Rocky Mountain Humane Investing, Corp. does not assess the suitability or the potential value of any particular investment. All expressions of opinions are subject to change without notice
Recently I watched an ad for a mutual fund on television that scoffed at the notions of investing for a retirement lifestyle that was popular a decade ago. Investors used to be teased with the notion of investing with the goal of “buying a vineyard” but now its a matter of “get real” as if the vineyard could never happen. While I’m not saying the vineyard is realistic, can we settle for enough discretionary income to buy the vintage of your choice, as often as you choose?
Call me stubborn or merely persistent as hell. Your dreams shouldn’t die easily, persistence is critically important. But, you may have the sense that there are so few options available that could bring new life to those dreams. If you walk into your local bank or stock broker you’ll be fed the standard line to expect 6% to 8% along with a shrug of the shoulders. Seriously, why bother with the aggravation of investing when you could just settle for the 3-4% being offered by annuities, is it really worth the headache? If you’re going to take the risk of equities it better be damned worth it, yes?
Personally speaking, I’ve never met an individual who’s significant wealth can be attributed to the ownership of mutual funds whereas I know of many who’s wealth can be attributed to ownership of individual equities.
For example, the Dalbar study measure the results of individual investor performance versus the market indices. While the S&P 500 grew at an 8.2% rate from 1990 to 2009 individual investors only made 2.3% on average.
The chart below highlights the Dalbar study with a hypothetical $100,000 investment:
Quantitative Analysis of Investor Behavior
Why such a large discrepancy between potential investment returns and reality? The truth be told for Socially Responsible Investors and the public at large is primarily due to emotionally based decision making aka “Buy High / Sell Low”, buying when confidence is high and selling when confidence is low.
Investors must keep in mind that mutual funds are first and foremost a business designed to run profitably, well…. so are we for that matter. But the difference is they are subject to group behavior and primarily will only invest in popular growth stocks with very large size like Apple, Exxon, Pfizer, which allows the fund to grow almost indefinitely in size. I’m always amazed at how few Small Cap Value Funds exist. In addition, if you look at portfolio composition you’ll frequently see many of the same holdings, in my opinion this is primarily due to more of a fear of failure than desire to excel.
But is there really a sensible solution that bridges the gap between the mundane and conflicted mutual fund industry and your dreams of a worry free retirement?
Yes there is. What surprised me the most over the last three years of research and development into Quantitative Investing is that there was actually no great revelations in terms of investment technique and philosophy. The correlations between academic research of individual stock performance holds up quite well under scrutiny. Value Investing paired with Small Cap investing remains the titan of performance that it has been for decades.
Based on my three years immersed in financial geekdom is that the method in which stock data is processed and utilized into real time actionable decisions had to change. In addition, it was shocking to see how poorly the mutual fund industry was with these discoveries. Quant theory and development had been the primary space for the Hedge Fund industry, with good reason as the data forthcoming will show. But nary was there any alignment with SRI, Socially Responsible Investing or the Green Investing universe.
The solutions will likely have to come from smaller entrepreneurial investment firms without entrenched management that insists on existing methods or subjective decision making.
While its impossible to predict exactly how the Quantitative strategies will be reviewed 10 years from now, we do know that a repeat of the last decade is simply unacceptable.
More to come.
Be careful out there,
Brad Pappas
Ok I must confess I don’t have a tie in for “Derek” other than being a great fan of Eric Clapton, so I’m thinking of Dominoes today with the effect of GDP to Corporate Earnings to Stock Valuations. So much for the Gloom and Deflation from this past Summer.
The U.S. economy is clearly accelerating regardless of the weakness in Europe so the recent rise in equity prices is justified IMO. In fact, I do believe that 1200 on the SPX will be surpassed and will become the next support level by this December. While I’m gratified for having nailed the recent market stop with our sales in ETF’s, that top may prove to be a momentary top along the road higher.
RMHI model portfolios have actually exceeded the peak from a month ago and are on their way to an above average year. Since the model is about being “above average” I’m not surprised just gratified. Taking a look at the fund performance list on www.socialfunds.com the top of the heap appears to be the Calvert Capital Accumulation fund which was up approximately 15% at the end of October. Our portfolios have moved almost in sync for the past 3 months and I hope this will rank RMHI as close to the top of the heap as 2007.
Otherwise:
This morning Goldman Sachs raised estimates for real U.S. GDP:
2011 GDP goes from 2.0% to 2.7% and 2012 goes to an estimate of 3.6%.
With that kind of growth, where’s the love for bonds now? If investors want to recoup losses from past years they must adjust for the resurgence of growth in the U.S. and dispense with the “fear trade” of bonds over equities. Bond investors, especially those owning Treasuries will find that there is a very high price for the concept of “safety” and that the perception of safety is a myth to begin with when you find that your pursuit is enjoined with the masses. Safety can most often be found with high investor negativity when the urge to sell is at its peak, no when its the overwhelming trend.
On the Green Investment / Socially Responsible Investment ledger our models are identifying a class of equities that appear to have our favored combination of Value plus Momentum: In particular are Battery Manufacturers and China based waste to energy plays.
Be careful out there
Brad
No Positions
For the first time in many months we’re doing some serious selling. Learning when to do some selling is essential for any socially responsible investor as many of our holdings have run quite far.
We’ve sold off all leveraged ETF holdings which were purchased this summer during the midst of the deflation debate.
We have also sold our shares of Dorman Products as the rise has become parabolic. Yesterdays decline was a tip that the momentum crowd has taken hold of the stock, so today’s sharp rebound in shares seems opportunistic.
Investor sentiment has simply gotten too extreme and I believe the upside is limited until we increase investor negativity. Earnings growth remains positive so this is not a call for a bear market or anything severe, its just a matter of investors getting too aggressive betting on the upside.
Brad
No positions
Overnight Chevron has made a bid for Atlas Energy which to my way of thinking confirms that natural gas has real potential to be a bridge fuel, a transition away from gasoline for the nations trucks and autos. While it has been believed by many that our President was loathe to get behind natural gas and is a supporter of the fuel of Dickens, coal. This purchase of Atlas may indicate that natural gas and not coal could come to the forefront if the US intends to wean itself off gasoline.
Green Investors should understand that the weaning process away from petro based gasoline fuels will be a piecemeal process, sometimes moving glacially slow and very dependent upon political support. The purchase of Atlas by Chevron marks the second major purchase in recent years followed by Exxon’s purchase of XTO Energy. Do we see a trend emerging?
RMHI has had a substantial position in Atlas subsidiary Atlas Pipeline Holdings for several months. While the search for more glamorous alternative energy investments can be enticing for green investors, we’ve preferred a more conservative position with investing the eventual transition from gasoline fuels to natural gas to ??.
Long AHD
Brad
Future earnings growth for the S&P 500 has resumed once again after the flat patch this summer. With the new surge in earnings growth fair value for the S&P 500 has grown as well with our calculation being 1150 on the S&P 500. In reality the recent market surge is discounting the current growth and into 2011 where its likely to accelerate. While Socially Responsible equity investors should be winners at this point and in the intermediate term I’d caution against exuberance.
Investor Sentiment is approaching frothy levels (not quite there yet) caution is advised: Data from AAII shows individual investors, especially those of a speculative bent are very bullish. The Barron’s Big Money Poll shows that institutional managers are extremely bullish as well.
On the positive side of the blotter: Earnings growth is accelerating once again after the soft patch this Summer, so much for the Deflationists. And, who wants to fight the Federal Reserve at this stage with QEII, a losing battle every time.
The bottom line is the recent performance is warranted but don’t get carried away.
Be careful out there
Brad
No positions
