Quarterly Letter To Clients Part I

Image:  Napoleon’s Retreat From Moscow Adolph Northern

Today we will begin publishing our most recent investment letter to clients.  Look for the rest of it over the course of this week!

Solas!

A long Journey To Nowhere

January 27, 2012

2011, the year of the Euro’s retreat! Stocks gained nearly 8% into early May and then gave it all back through the rest of the year. Markets could never shake off the fallout from the Japanese tsunamis, worries about a slowing world economy or the acrimonious relations between the Congress and the President which led to a downgrade of US credit ratings in August. But the event that defined the last five months of 2011 and did the most damage to world markets was the continued debt related problems in Europe, the threatened loan defaults by Greece and the concerns that Greece’s problems would migrate to other countries such as Italy and Spain.

The year that never was! The S&P 500 proceeded to lose a bit over 20% over the summer before rebounding to close basically unchanged for the year. It was the highlight of 2011. The MSCI world index fell by 8.5% last year. China, Brazil & India all lost between 18% and 23%. Developed countries such as Italy {down 25%}, France and Japan {both down around 18%} and Germany {Down 15%} offered no safety. Hedge funds collectively lost 6.4%.1. Here at home, as measured in the performance of their various related ETFs, the S&P midcap index lost 3.4%, the Russell 2000 lost 5.74% and the average stock on the New York Stock Exchange lost 5.93%. Even Warren Buffett was not immune from the market’s depredations as his company, Berkshire Hathaway lost over 4%.

We started the year with a series that asked whether stocks were cheap. We thought then that S&P 500 had the potential to trade between 1,350 and 1,400 by year’s end. We lowered those projections back in early October to a range of 1250-1300 largely because we felt that the market was running out of time to reach those upper limits. At the time the S&P 500 was trading around 1100. We also noted in that same piece that we believed that stocks have the potential to trade between 1350 and 1450 by year end 2012. As we discuss in a future post, we see nothing at this juncture to cause us to rethink that assumption.

Humans divide time into periods such as years and decades. Markets are not bound by such things. They will move as is their wont in fits and starts {both good and bad}. They will meander across time periods until they get to where they need to be going and only a higher power {or randomness if you don't believe in such things} knows when that might occur or how long it will take to get there. There may have been artificial constraints such as tax selling and year end window dressing that held the market back at year’s end. Certainly there has not been enough different news that warrants why the market would have currently advanced over 4% since we've turned the pages into a new year. If 2011 had been eight trading days longer then our revised high end target of 1300 would have been realized. Ultimately things like valuation and fundamentals matter to investors. Stocks came into this year cheap, trading somewhere between 12-13 times what ought to be the final S&P 500 earnings number for 2011. They have probably now started to play catch up to where they likely should have been a few weeks or months ago.

{Tomorrow we'll begin a discussion on whether stocks are cheap}

*Long ETFs related to the S&P 500 in client and personal accounts. 

1.  Forbes Magazine, Chasing the Mirage of Hedge Fund Returns.  January 23, 2012.