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Market Perspective for 1/12/12

Last Friday’s unemployment report was stronger than expected.  200,000 new jobs were created last month, and the overall unemployment rate declined to 8.5%.  While that figure omits the people that have left the labor force we are clearly moving in the right direction.  The economic metrics that showed the U.S. economy slipping back into recession late last summer have either reversed or are at least not deteriorating further.  The stock market did not initially respond favorably to the stronger labor report because investors were hoping for further easing by world central bankers.  On the other hand, stocks have been helped by economic weakness.  World markets jumped 1.5% this past Tuesday after China reported weaker imports last month because people believe that this will push China to start stimulating their economy again, and we all know how much of a boost cyclical stocks got the last time (2009 and 2010). I attribute the gains in stocks over the past quarter to gloom fatigue.  Nothing that prompted the concerns last year has fundamentally changed – the sovereign debt crisis continues in Europe, with no clarification on Greece and no meaningful improvement in Portugal or Italy; China’s growth rate continues to slow and there is anecdotal evidence of further weakness in their real estate market; the political impasse in the U.S. has not been resolved and in fact it may be harder to get anything significant accomplished this year since it is an election year and each side will play to its base.  That said, all of this is already priced in.  Bulls would say that investors are under-weighted in equities because they are so focused on the risks that they are missing the opportunities.  Bears would say that a bounce was to be expected given the extreme pessimism of August-September.  Either way, stocks are near the upper end of a price channel that goes back to late 2009 (lower end SPY 1025, upper end SPY 1355).  Best case is a rally to the all-time highs near 1550 which we saw in 2000 and 2007 – a gain of about 21% from here.  Worst case is a re-test of the 2002 and 2009 lows below 800, an approximate decline of 38%.  The risk-reward trade-off from here, however you look at it, is not very good. The first eight trading days of 2012 have been characterized by a preference for cyclical (economically sensitive) stocks, higher volatility stocks, and smaller and value-oriented stocks.  Read that as a reaction to the last month of 2011, when investors were busy taking tax losses on these stocks and window dressing their portfolios with utilities and consumer staples.  January’s bounce notwithstanding, I’d still prefer dividend-paying blue chips to high growth small and mid-caps for the bulk of the year.  Consumer stocks and utilities needed to see some profit taking – there is no way a mid-single digit growing cigarette firm like Altria should have traded at 18 times earnings as it did at year end. It is fair to say that Bill Gross did not have a very good 2011.  His high-profile call to avoid Treasuries early in the year blew up in his face as Fed policy and a weak global economy pushed investors into high quality U.S. debt.  PIMCO Total Return suffered its first ever decline in assets on an annual basis.  It finished in the 86th percentile in the intermediate bond category.  But all of this is old news.  I am impressed with his ability to admit a mistake and take the necessary steps to correct it.  PIMCO Total Return finished in the 10th percentile in the 4th quarter and the 3rd percentile in December.  You will no doubt see a lot of articles in the next few weeks criticizing his 2011 performance.  The truth is, we all make mistakes.  From my standpoint, what separates good and great managers is the ability (humility) to recognize their mistakes and correct them before they do significant damage.  While PTTRX trailed the Barclays Aggregate Bond Index by 350 basis points last year, nobody’s portfolio was destroyed by only earning 4.34%.  I sold out of this fund over the summer, but I’m beginning to buy it back. I’m still underweight foreign stocks but there are two closed-end funds that intrigue me.  Aberdeen runs the Latin America Discovery Fund (LAQ) and the Indonesia Fund (IF).  Both trade at high single digit discounts to net asset value, and both focus on areas with largely favorable demographics and better than average growth prospects.

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