The Spring Swing
MAY 4, 2012
Let’s begin with a recap of the closing lines in our last blog, posted January 17:
“The first three to four months of the year will be good, potentially taking us up to the 1370 level on the S&P 500.” Check. The S&P 500 has been great over the first four months of 2012, with the index touching as high as 1422. While momentum has halted in April with choppy trading and a 0.8% loss for the month, the market has posted an impressive 11.1% year-to-date return.
“Caution will be warranted and we will continue to utilize hedging strategies and take profits over the period of May-July.” We believe that asset management is a dynamic process where the continual assessment of risk and reward is paramount to successful investing. As such, upon reaching our target levels, we decided to actively hedge accounts near the end of March. Hedging through profit-taking in stocks, writing protective call options, and increasing overall cash positions will continue to be important over the upcoming months.
Very similar to last summer, European debt and growth concerns and some softening in US economic data has led to increased volatility. Moreover, China has been experiencing a slowdown of its growth levels.
Most worrisome are the developments in Europe. At this point, the United Kingdom is officially in a double-dip recession. Additionally, France and other Eurozone nations are moving toward policies that reject austerity, increase taxes on the wealthy, invoke protectionism, and are unfriendly to businesses. Above all, Spain, one of the troubled European nations that is “too big to fail,” is experiencing a deteriorating economy, housing bubble burst, weakened banking system, and elevated government deficit. With a record high unemployment rate of 24.4% and a bad loan ratio of 7.9%, Spain recently received its second downgrade of the year from Standard and Poor’s. The nation’s credit rating currently resides at BBB+, with a negative outlook.
On the domestic front, many economists have increased their forecasts of GDP to 3%+ based on expected increases in household demand and improving trade data. The Federal Reserve even revised downward its forecast for unemployment to reach 7.8-8% instead of 8.2-8.5% previously forecasted. Consumer confidence has also improved alongside better jobs outlook and the stock market’s impressive rally since October 2011. In regards to corporate health, roughly one-third of the S&P 500 Index’s members have reported earnings and more than 82% have beaten expectations. The all-time high “beat rate” reflects that analysts lowered the bar too much for this quarter and likely next quarter as well. According to Mark Lushchini, chief investment strategist at Janney Montgomery Scott, “Any strength we’ve seen [in April] has been on the back of better-than-expected earnings results, but the sustainability of the market at this point is predicated on an accelerated pace of economic growth.”
Being wary of several potentially troublesome global economic trends, the Fed has expressed its commitment to roll out more Quantitative Easing (QE) if conditions warrant. Says Alan Abelson at Barron’s, “The stock market views any seemingly disappointing figures as increasing the odds of the Fed’s applying a fresh dose of stimulus.” With the prospect of further economic stimulus, which would likely fuel the stock market and aid the nation through any short-term soft patches, the market should remain bound in a modest range. Although, with an upcoming election and political policy uncertainty, Charles Schwab’s Senior Vice President, Liz Ann Sonders, believes that “the Fed will likely keep its ammunition at the ready due to the potential hit to the economy that is currently scheduled to come at the beginning of 2013 in the form of massive tax increases and blunt-force spending cuts.”
As we head toward the summer months, we believe the market will continue to trade in a choppy range with a slight bias to the downside, and do not anticipate any new highs prior to the fourth quarter of 2012. Therefore, we are happy to be holding more conservative positions and extra cash. These increased cash levels will be utilized through short-term trading as we embrace elevated levels of volatility over this time period. In addition, we plan to continue to invest in high-quality dividend positions and use covered calls to generate income and add protection. We will also invest in fixed-income securities to boost our monthly yield.
By continuing to use active management, we look to provide you with the best return possible, with the least amount of risk. We believe this to be a much better strategy than simply using the buy-and-hold method which has proven unprofitable during the last decade.
