In the October 2012 Quarterly Market Overview we wrote the following: “So where do we go from here? We have witnessed a degree of confidence return to the market. The “risk on” trade has returned as money is again flowing to the growth sectors. The housing sector may be in recovery mode. Consumer confidence is improving. The economy is growing and not contracting. As we’ve mentioned, the amount of liquidity is amazing with over $2.5 trillion in money markets and corporate cash at historical levels. Imagine what may happen when all this cash is unleashed on our economy. We are optimistic about the prospects for the market. The only ingredient missing is confidence. We believe we will look back on and see the opportunity that the current environment presented.”
Year to date the S&P500 has amassed a 10.60% gain. The DJIA is up about 11% which is the best 1st quarter since 1998. When the DJIA is up at least 8% in the first quarter it has never ended the year negative. The economy itself continues to expand at a sluggish pace; however, we still see opportunity going forward. Equity valuations are still reasonable based on earnings, interest rates remain historically low and there is still a massive amount of sideline cash. It is also interesting to note that just as we might refinance a mortgage, companies have been able to recapitalize (refinance) their balance sheets which improves net earnings.
Home prices continue to recover rising 8.1% in January from a year ago. The Case-Shiller index tracks prices across the 20 largest markets around the country. We are seeing tighter existing home inventories, a drop in foreclosures and mortgage rates are still near record lows. Both existing home sales and new home construction represent a huge driver for the economy over time. The improvement in the housing market will also help improve consumer confidence. The consumer is said to be about 70% of economic growth. February US Retail Sales were up 1.1%, the biggest gain in five months and this was despite the 2% increase in Social Security withholdings from consumer pay checks.
Obviously, we expect to see a pause develop soon. The market does not go straight and a normal consolidation of 4-7% is probable. As a “big picture” money manager, we would see this as opportunity rather than a reason for concern. There is still a lot of liquidity that has missed the market rise of late and we think any weakness will be shallow as new money decides to participate. The index may be at all time highs but, the valuation of the index components is more important. Based on earnings, the 30 DJIA stocks are far less expensive than they were the last time we were at these levels in the years 2000 and 2007. We are far from the valuations that made famous the words of Alan Greenspan in 1996, “irrational exuberance”. Also, it is interesting that the market continued up for four more years after that legendary speech.
The last thirteen years may just have been a long term consolidation of the prolific bull market of the 80’s and 90’s. Maybe we have just recovered from the emotional markets of five years ago and are just now starting a new bull market?
As always, we thank you for your confidence and trust….
Royal Fund Management