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