The Market is fairly valued
“…Do we have a stock market or a market of stocks?”
Now that we have some certainty about taxes, our attention can rest on the economy and its prospects. Worldwide growth is projected to be very muted in the year ahead. Economic growth in the US is believed to crawl 2% or less according to most forecasters. From this projection, it is easy to conclude that it will be difficult for most businesses to grow at all in the year ahead.
Given a challenging economy, investors need to decide how to invest to get the best returns with the most manageable risks. Stocks in the S&P 500 trade at a price/earnings multiple of 16 based on projections for this year’s earnings. This would rank as historically average. This also suggests that the market is fairly valued. Stocks are neither cheap nor expensive. Therefore, there is equilibrium in the marketplace. This means that the market should probably not rise or fall too much in the year ahead.
If the market is fairly valued due to its limited growth prospects, making a decent return will depend more on individual security selection and market timing. Since theeconomic cake can only be divided so far, investors will need to identify which companies have the best chances of increasing their share of this cake. Amidst a slow or no-growth economy, deciding which company will flourish and which will languish will be the lynchpin of growth in the near term.
The stock market has been evolving into a market of individual stocks, each with its own peculiar driving forces. Instead of a market that moves in harmony up and down like we have seen since 2009, we are more likely to see a broad mix of stocks moving in different directions. This perspective is built on the notion that for every remarkably good stock, there is likely to be a matching poor performer. This will lead to flat indices but still a fertile ecosystem to invest.
To illustrate this, Bespoke Investment Research did a study for our firm on all domestic stocks. Last year, 23% of all stocks rose by at least 50% at some point in 2012. Indeed, almost 6% of all stocks doubled at one point in the calendar year. Yet the average stock only gained 8% for the year. Surprisingly, the S&P 500 is currently about 7% below is best level first reached in 2000.
We are increasingly likely to see more big winners in the year ahead. There is a corresponding likelihood that many of these winners will flame out similar to Apple over the last year. Apple gained 75% to its peak last year before falling 25%. The theme that we are seeing is that stocks have a shelf life in which they produce nice gains. At the same time, these uptrends exhaust themselves. What was once a good investment idea is likely to become stale.
In this magnificent climate of zero interest rates, stocks are now the rented vehicle of choice for investment gains. The term rented is used because these upward moves in stocks like Apple don’t last very long. The key is to be aboard when the cycle is in our favor. Consider all of the pension funds, hedge funds, mutual funds, union trusts, and endowments all clamoring for gains in a low growth, zero interest rate economy. This creates an ecosystem for standout performers.
4th Quarter Overview
Congress passed an after-the-deadline bill that averted the Fiscal Cliff and deferred more serious reconciliation of our mounting deficit. Fortunately, the USA is in better shape than continental Europe which faces a more exacerbated condition as far as government debt. Growing concerns for the Fiscal Cliff and lingering earnings worries caused the S&P 500 Index to drop 1% in the fourth quarter of 2012. Interest rates remained low and the economy did not make measurable headway in creating new jobs. Unemployment actually ticked up to 7.8% from 7.7% at the start of the quarter.
The election initially sent the stock market down sharply through mid- December but bargain hunters used this weakness as an opportunity to buy and the market managed to recover most of the post election sell-off.
Peregrine Returns and Strategy
Our Equity and Balanced Composites finished flat in the fourth quarter and rose 10% and 7% respectively for the full year 2012. The S&P 500 fell 1% in the fourth quarter and produced a total return of 16% for 2012. We are disappointed in our results versus the S&P benchmark and expect 2013 to be better for our stock selections. This is evidenced by the strong performance of some of our recent picks as well as the consistent trading profits that our clients have captured over the past three months. Fortunately, our last year’s losses from troubled companies can be easily overcome by selecting star performers in the year ahead.
We do intend to modify our strategy in an effort to capture bigger percentage moves in the stocks that we buy for our clients. If form from last year holds true and 20% of all stocks surge 50% or more, our work should concentrate on trying to capture larger percentage gains. We will have to hold exceptional stocks longer than we did last year. It is also our intent to add to these winners over time and building positions in these companies rather than making a single investment.
Our shift of strategy hinges on the market indexes remaining in a satisfactory range. We will also proceed under the assumption that the economy and corporate earnings will continue to “muddle through” and that no big surprises are in store.
Past performance is no guarantee of future results. Investment management involves the possibility of losses. Significant general stock market moves up and down can influence the performance of client portfolios. Composite returns are based on client portfolios of over $100,000. Not all clients are included in the composites. All returns include the reinvestment of dividends. All returns are net of fees. Composite returns are derived from aggregated, time-weighted returns for clients of Peregrine Asset Advisers. Individual client returns can deviate from the composite returns. While Peregrine uses the S&P 500 as a benchmark, Peregrine does not attempt to mimic the structure of this index. Individual client portfolios vary. The number of securities held also varies per client.
Do you have questions or would you like to know more, contact Dan Botti.