As Charles Dickens so eloquently stated, “It was the best of times, it was the worst of times”. He could very well have been referring to the just closed first quarter market returns. The best of times. The market had a first quarter for the record books. The Dow and S&P 500 both reached new closing all time highs. Both the Dow and S&P 500 notched better than 9% returns with broad based participation. The economy also continues flashing signs of recovery from its nearly four year slumber. The worst of times. As Britney Spears chirped, oops they did it again. Hedge funds, after turning in a dismal 4% average return for calendar 2012, continued underweight equities entering 2013. They remained convinced the market was wrong to be rallying and waited for the resumption of the secular bear market to begin taking us down anywhere from 10% to 50% depending on which Yogi or Boo-Boo you listened to. A man much wiser than myself told me something many many (is that enough many's) years ago as I was beginning my career on Wall Street that stuck with me to this day. After a fairly volatile day in the market and realizing I had positioned myself short as the market rallied fiercely, a friend came to me after the close and asked how I felt about the market. I responded I still did not like the market and rattled off a few quick strong points to support my stance. He nodded and acknowledged my incredibly insightful remarks then said, “If your opinion is wrong, lose your opinion”. His point being I could have been correct in my talking points and thought process, but the market was going against me. So, don’t be proud or stubborn and don’t fightit. Hedge Fund managers have been on a terrible run under performing the markets for a few years running and need a dose of humility. They don’t need to be rip roaring, thundering herd bulls, but they’ll need to at least get neutral to their benchmarks as investors will increasingly be taking their monies elsewhere. We can see some evidence of these managers taking on risk simply by watching intra-day trading activity. Friday was a great example of buying dips. Early Friday the market sold off sharply in the wake of some soft job figures, a bid began surfacing amid the softness. Before the day ended the market had rallied over 130 points off the lows.
Where we are: After such a near uninterrupted rally out of the gates in 2013 it would not be out of the question to see a 5%-10% correction. There remain concerns surrounding the effects of the elimination of the 2% payroll tax holiday and the so called sequestrations mandated $85 Billion in spending cuts. Also lingering out there is this little program initiated by the Federal Reserve, Quantitative Easing or QE. QE is the Feds program to purchase $85 billion in treasury and mortgage backed securities. But when it comes to where we are the devil is in the details so here we go:
Leading Economic Indicators-LEI. LEI rose .5% in February after having risen .5% in January and .4% in December. This positive three month trend suggests a continued “Goldi-locks” recovery. Not too fast to ignite a bout of hyper inflation forcing the Federal Reserve to shift policy. And not too slow to push our fearless leaders in DC to abandon austerity and embark on another round of fiscal stimulus budget busting spending.
Industrial Production-IP. IP rose .7% after being unchanged in January. There was reasonable strength across the index as Manufacturing output rose .8% and utilities output rose 1.6%. The capacity utilization remained stable and rose to 79.6% a bit below the 30 year average but the best figure since March 2008. This slack in capacity utilization should act as a buffer against any inflationary pressures arising.
Housing. Housing continues to make solid gains. We’re not yet back to the levels seen before the great recession but nor should we be. Sales of single family homes in February came in at a 411,000 annual run rate. That is below January’s 431,000 but a solid 23% gain year over year. Total existing home sales came in at 4.98 million annual run rate up from January’s 4.94 million and up 10.2% year over year. Clearly this is a positive development in housing and we should cease to see this all important sector of the economy be a drag to GDP
Employment. The cheers coming from investors after February’s non-farm payroll figure of 236,000 were hushed when March’s figures were announced this past Friday at 88,000. No way to couch this one, it stinks. We were expecting a numbers closer to 175,000-190,000 especially when we were able to look at the real time jobs figures, the weekly unemployment claims which had dropped smartly in the survey weeks. The surprise as I see it came from retail. Think restaurants, shopping malls, Macy’s, JC Penny’s etc and were responsible for a negative 24,000 jobs eliminated when we were looking for an add from the group. The Post office also contracted by 11,000 jobs due to attrition, no real firings. Taken in context with the three month average and we see the US jobs markets just about at the average for this recovery of 175,000. Still, questions now surface regarding the effects of the 2% payroll tax effects on consumers discretionary spending and the still to be felt effects of the so-called sequestration.
US Purchasing Managers Manufacturing Index-PMI. PMI for March contracted to 51.3 from February’s 54.2 and January’s 53.1. A reading above 50 still suggests a growing/expanding economy. Survey respondents paint a mixed picture. Wood products pointed to very strong demand along with automotives, furniture, food, beverage and tobacco. On the flip side there appeared to be some softness in computers and electronic along with the energy sector being in stall mode as they await any new policy and/or regulations. As we dig further, the data show some weakness in the new orders and inventory categories while we see a bounce in employment, deliveries and exports. The Non-Manufacturing or services sector PMI registered 54.4 down from February’s 56 but still in expansion mode. Again the respondents paint a mixed picture of cautious growth.
Going Forward:. The US market is surely on firmer footing than last we reached such lofty levels on the various market indices. Revenues and earnings are stronger, leverage is down, corporate balance sheets are pristine and headcounts remain lean and mean. The market multiple back then too were stretched at closer to 20 than today’s 14 ½ which is below the 15 ½ thirty year average. The domestic economy remains in Jekyll & Hyde mode. Mild mannered recovery mode by day, 88,000 jobs growth chases you down a dark deserted alley to strip you of your ill gotten profits at night. Domestically the Fed Chairman Bernanke has got our back thank goodness. Like his policies or not ( I don’t) but due to the lack of backbone, will or just a desire to keep their cushy jobs in DC the Federal Reserve is the only reason we have even a modest economic recovery. Without Chairman Bernanke perhaps perma-bear Muriel Roubini may have been proven correct in his constant calls for Dow 3,000. There remain many headwinds and potential pitfalls. The Euro-zone crisis simply will not go away. The EU has found its own Chairman Bernanke in Mario Draghi vowing to do whatever is necessary to save the EU. Chairman Draghi has been successful dousing the fears of financial contagion in Spain and Italy while helping to orchestrate the bailout of Greece and Portugal along the way and sending bond vigilantes running for cover. China and India continue to attempt to jump start their domestic economy while stoking domestic demand from their respective populace. The Bank of Japan joined the other global central bankers in the race to de-base their currencies. Chairman Shinzo Abe even one upped Chairman Bernanke vowing to do whatever’s necessary while buying treasury’s, mortgages, REIT’s and Equities in order to finally break the deflationary forces gripping the third largest economy for over twenty years. This unprecedented show of unified liquidity force should push asset prices to even loftier levels. Again, I don’t like or agree with this massive printing and debasing of currencies, but for now, I’ll be keeping my opinion at bay, as I’d rather make money than be right…..for now.
We maintain our aggressive posture to the markets with an eye towards earnings season and upcoming budget negotiations to act as the near term catalyst to drive the markets. Expectations for both have been guided down so outperformance should be simple enough. Should earnings and revenues come in on the light side or budget negotiations not get off the ground, we may move aggressively to adjust our cash positions and be in contact immediately.
I thank you again for your patience and confidence in these very challenging times.
Yours in pursuit of the KWAN.