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Spring Fever

The bull market rumbled on in February. Measured by the S&P 500 stock prices ended the month 1.36% higher and are now up 6.6% as of February month end. Over the last twelve months, stocks have returned 13.5%, slightly higher than the long-term averages and stocks have been positive for 9 of those twelve months. From a practical point of view, the month was important in that it worked off much of what analysts refer to as “over-bought” levels, following January’s surge. Many stocks had become too expensive to buy.

Such a long stretch of positive stock returns can eventually have a constructive influence on investor market outlook and behavior. It can be stressful and unprofitable, to continually struggle with fear of an imminent meltdown. What better than to be riding a bull market and to be able to enjoy the ride? My concern is there may be a bout of spring fever working its way into Wall Street’s view of stocks.

According to Bespoke Investment Group, although the 4Q2012 earnings figures were generally above expectations, analysts have been revising their earnings expectations for 2013 downward. In my opinion, while important to monitor, this is evidence of spring fever. It’s not at all clear what it is going to take to make analysts more positive, but for now at least the market doesn’t seem to care. Maybe once analysts turn positive, it will be time to sell. (Bespoke Earnings Estimate Revisions, 3/1/13). Earnings revisions may be an accurate indicator and a sign to lower exposure to stocks. These analysts’ views may also be symptomatic, as I suspect, of spring fever, and likely to remedy itself in short order.

The economic data that Wall Street media pundits fuss over has been encouraging. The general assumption is that there is a natural positive correlation between stock prices and economic data. Assuming that is the case, we can take some comfort in recently reported auto sales, the strongest manufacturing data in 20 months, improving consumer sentiment, job growth and housing data. The sequestration is likely to have some negative impact on the economy, though no one knows precisely to what degree. The elephant still lingering in the room is the federal borrowing limit that has been pushed out until some point later in the year. Persistent economic strength will dampen the impact of the automatic spending cuts, making for a softer landing. We shall see.

If you would like some interesting free reading in support of the positive long-term market outlook, you can go to berkshirehathaway.com and read Warren Buffett’s 2012 shareholder letter. As usual he is full of practical and easy to understand advice. He did us all a favor purchasing Heinz and resetting the valuation bar on most food stocks. He also remains optimistic on rails, an area I have felt strongly about for some time. Lastly, I’m happy to review his assessment of dividends. His view is straight out of the CFA curriculum, where the favored approach is for the investor to choose to sell shares to realize a “cash” return, versus receiving a dividend.

I think dividends are important. The dividend discount model is the gold standard for stock valuation. Dividend yield is an important relative measure and income is real. This is largely different than investing for growth, over time. The appreciation potential from good investments held over extended periods of time is one of the hallmark principals of Berkshire’s market beating results over the years.

An interesting anomaly, revealed by analysis from Bespoke Investment Group, was the dramatic outperformance of “appreciation” over “income” in 2012. The S&P 500 stocks (by decile), with the highest PE ratios were up an average of 29.25%. The worst performing stocks were those with the highest dividend yields, which declined an average of 0.63%. While investors were clamoring for the safety net of dividends, as a defense against uncertainty, they were unknowingly tying one hand behind their back.

Spring fever or not (particularly among the analyst community) my sense is corporate earnings will maintain their positive slope, and PE ratios will continue to rise from their below average levels. I’m a buyer, on the dips.

Finally, we are holding several Pop-Up classes in our Wayne office, in conjunction with the Main Line School Night. Please join us for these educational opportunities and to see our new space. Call Valerie for more details and to reserve your place.

Bruce Hotaling, CFA

Managing Partner

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