Quarterly Market Overview
As of April 17, 2012

As the New Year came, market volatility subsided from the extreme levels of 2011. With reduced volatility came a renewed focus on the fundamental value of the equity market. As we wrote in our Market Overview for 2011, “There is nothing fundamentally wrong with the market”. There are always the emotions created by news events around the world in a constant tug of war with basic fundamentals. The fundamentals always win in the long term and thus we witnessed one of the best starts to a new trading year in history.

The S&P500 was up about 12.5% in the first quarter. Since 1950, the market has been up over 8% during the first quarter 13 times. In each of those years, with one exception, the market was up more during the remaining nine months. The only exception was 1987 when one day in October became known as Black Monday. Of course the Dow Jones crashed that day from 2246 to 1738 which is a far cry from 13000 today.

A bit of turbulence has returned as we enter April. After a triple digit move up or down proved rare for the first three months of the year, suddenly the volatility has increased of late. Some would say that increased volatility is a sign of a change in direction to come. On the other hand it may just be a typical consolidation of recent gains. We expect the latter is true and think a normal 5-10% correction would actually be healthy. If we see a pullback develop, we expect the recent trend of “buying the dips” to continue. Retail investors are still not engaged in the equity market and any weakness will create an entry point for those that missed the first quarter upswing.

We view any near term weakness as opportunity. The Price/Earnings ratio of the market also points to a continuing lack of confidence. If the Dow 30 stocks just traded at the average P/E ratio of the last two decades, it would be about 16000 right now. Once investor sentiment improves, we expect the flow of funds and increased volume to take the market to much higher levels. It is interesting to note that the last time we saw stock fund outflows for five years in a row; it corresponds to the beginning of the bull market starting in the early 1980s. In that era, investor confidence grew and the Price/Earnings ratio nearly doubled as the market rallied significantly even though corporate earnings actually slipped.

From June to January investors pulled $137 billion out of stock mutual funds. Volume on the NYSE is down about one third from three years ago. These are classical contrarian indicators. It is surprising when you consider how little CDs, money markets and U.S. Bonds pay today. We remain bullish based on fundamental valuation, earnings and the vast amount of liquidity. We have recently raised some cash in the growth portfolios partly to better preserve portfolio value but also to take advantage of any near term weakness.

Have a wonderful spring and as always, we appreciate your confidence and trust.

Royal Fund Management

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