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Get With the Beat

Stock prices are on the move. Measured by the S&P 500 stock prices advanced 1.8% during the month of April. This lifts the index an impressive 12.7% year-to-date, and 16.9% for the trailing twelve months. Stocks have moved higher 10 of the last 12 months, or 83% of the time, while historically they’ve moved higher 66% of the time. The two down months in the last 12 were May and October 2012 when prices fell 6.3% and 2.0%, respectively, due to economic jitters.

During the prior twelve month period (4/30/11 – 4/30/12) stocks were up only 5 of 12 months, 41% of the time, and the cumulative return for that period was 4.7%. The market we are in today reflects a remarkable shift in frequency and magnitude of returns. On an absolute level, the S&P 500 and the Dow Jones Industrial Average have both broken to new all-time highs, and prices are up well over 100% from the early 2009 low. We are in a bull market for stocks.

There is some evidence the average investor’s sentiment is finally beginning to thaw, after years sitting on the sidelines. The financial crisis and recession scarred investor’s psyches. According to data generated by Credit Suisse, equity mutual funds took in net new cash for 16 consecutive weeks in 2013. Interestingly, flows into bond funds have also remained positive. This is in spite of the widely anticipated flight-from-bonds that has been forecast, as interest rates inevitably begin to rise. The source of these newly invested funds is low yielding money market funds.

At the moment, the stock market is balanced in a Goldilocks-like place. Economic data (housing and jobs) is steadily improving. This is spurring expectations. At the same time, when growth does accelerate the Federal Reserve will pull back on economic stimulus (quantitative easing). It’s not clear how long the porridge can remain “just so” before stock prices show resistance. No doubt, stalling economic growth will bring an end to the party. Conversely, things will likely become more volatile when the Federal Reserve ultimately backs-off its current monetary policy. There are of course multiple other scenarios, one or some of which will ultimately change the markets direction.

Earnings season for Q1’13 is nearly complete and the results have been fair, somewhat reflecting the Goldilocks analogy. To date, 59% of all companies reporting have beaten their earnings estimates and 52% have beaten their revenue or sales estimates. These figures are not what one might expect in light of the buoyant market. Revenue is often considered a better measure,

less susceptible to manipulation. Overall, many companies and their respective Wall Street analysts are projecting positive guidance, but often lower than had been the case. This guarded optimism, some call it sandbagging, is curious. Better to set the bar low and hurdle it cleanly. I wonder if the game will change, ironically, when corporations finally let their hair down and increase their growth forecasts.

At the present time, FactSet consensus earnings estimates for the S&P 500 are for 110.24 and 122.77 per share earnings in 2013 and 2014. With the S&P 500 in the 1,625 range stocks are selling at a 13.2x forward P/E. Generally speaking, that is not an over-priced market. Precisely how high stocks can go from here depends on many things, most of which we can monitor – jobs and housing data, consumer sentiment, the Federal Reserve, interest rates and earnings trends.

As often happens, the underlying current of the stock market has shifted, though largely unnoticed. While on the surface, the market has been heading in one direction, the stocks that are driving it have changed. For the last five months, defensive stocks (health care, consumer staples and utilities) had been the top performing sectors and the energy behind the market’s gains. Recently, technology, telecommunications, and energy stocks, the laggards year to date, have begun to break out and are now driving the bus. This is evidence that stocks more sensitive to the macro economy are emerging, and may indicate, as stock prices often do, growth data supporting the market will persist.

I suggest staying with the bull – but in accord with our targeted allocations. While we are enjoying a strong market for stocks, it is a sensible time to re-visit asset allocations and to take profits where appropriate. It is also an opportunity to re-set our weightings among the defensive stocks that have done so well, and the cyclical stocks that are now on the move. Please feel free to call if you have any questions, something has changed specific to your investment profile, or would like to review your asset allocation.

Bruce Hotaling, CFA

Managing Partner

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