The economy continues to improve, if slowly. 243,000 new jobs were created last month, continuing the positive trend. Investors are showing a fairly significant increase in confidence, enough to push U.S. stocks within a couple of percent of their April 2011 recovery high. Earnings season is nearly complete, and we have seen a lower rate of upside earnings surprises than at any time in this recovery. This had created an interesting paradox where company analysts (bottom-up) are getting more conservative in their forecasts while at the same time market strategists (top-down) are raising their numbers. Two more things to note: One, consumer spending is increasing; two, the latest ECRI (Economic Cycle Research Institute) numbers continue to back away from the outright recession they have been forecasting since late last summer. We are left with two conclusions:
1) We are not on the edge of recession. Apparently, quantitative easing does something to the models that makes them less reliable. Absent a crisis triggered from outside our borders, the U.S. economy should continue to grow this year.
2) Stocks are generally overvalued. Unusually high corporate profit margins are beginning to regress to the mean. Call it the “Amazon-effect”, in which increasing price competition means more sales at less profit. Growth stocks should be better choices in this environment, because they tend to have sales and/or profit margin growth such that they can grow into their valuations.
The Big Picture
The big picture, both here and in Europe, hasn’t changed. Investors cannot lose sight of this fact. Europe and America continue to, in the words of John Mauldin, kick the (debt reduction) can down the road. We thought we had reached a point last summer where there were only two choices – a) deep budget cuts and recession, or b) a credit market strike, sharply rising interest rates, and a deep recession. Instead, world central banks figured out a way to expand their balance sheets even further without provoking a political or economic crisis. Today the mood is generally upbeat, but in no way have the real problems been addressed either there or here. We just made the eventual Day of Reckoning that much worse. There is a certain “make hay while the sun shines” attitude in the market right now.
Undervalued markets don’t necessarily go up and over-valued markets don’t necessarily go down. I wrote last month that the risk-reward trade-off was not very good. Today, with stocks up close to 7% on the year, that trade-off is awful. The upside of the S&P 500 to its post-recovery high of 1364 (4/29/11) is less than 2%. The downside to the last significant support line (1200, touched 12/19/11) is almost 11%. It is hard to sell a market where the short term technical indicators are so positive (and they are!), but in the investment world you don’t get paid for doing what is easy.
Most of the winners so far in 2012 are those funds that take on economic risk (i.e. overweight materials, industrial, and consumer discretionary stocks). One exception obviously is Fairholme, where Bruce Berkowitz is trying to bounce back from a disastrous 2011. FAIRX has over 78% of its assets in the financial services sector, and little of that is in what would be considered blue chips. I’m not tempted by the fund’s 16.9% YTD gain. I’m somewhat more intrigued by the turnaround Brett Lynn has going on at Janus Overseas (JAOSX, up 23.1%). Last year was forgettable, but the portfolio is not relying on a few names or a single sector to make its recovery. It’s the kind of concentrated fund that AGGRESSIVE long term investors might want to consider. Actually, there were a lot of growth funds that lost 10% or more in 2011. If you didn’t own AAPL (Apple, Inc.), that was surprisingly easy to do.
For those interested in more aggressive funds that out-performed both last year and in the first six weeks of 2012, consider Putnam Equity Spectrum (PYSAX), a concentrated all-cap value fund; Touchstone Select Growth (PTSGX) an earnings momentum-oriented large cap growth fund with very strong performance over the last 5 years, and Wasatch Emerging Market Small Cap (WAEMX), a very diversified fund working in an “under-fished” area of the market.
Past Performance is no assurance of future results
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