Winter Investment Letter {Part II}

Below is part II of our winter investment letter.

Now we begin 2013’s investment cycle.  Like tellers of ghost stories sitting around a campfire, many who predicted such dire consequences for last year trot out the same list of things that could go bump in the night.  Earnings will be weak in early 2013 they whisper, corporate profit margins are peaking, they warn.  The tax drag from the fiscal cliff compromise is too much for a weak economy.  We are again reminded about Europe, China and the Middle East.  So far this year they have again been wrong as stocks have gained about 5% out of the gate, their charts mirroring a similar 2012.  If markets follow last year’s pattern then stocks would gain nearly another 7% by April.  That would put the S&P 500 at 1613 under that scenario.  Guess what?  Even at 1613 on consensus 2013 estimates stocks would trade with a 15 PE and a 6.7% earnings yield.  Translation:  Stocks would not be expensive by historical valuations even at that price.

Investors should have a long-term strategy. For our clients this strategy comes from understanding their unique risk/reward criteria and then incorporating that into our investment disciplines. Our strategies are based on our playbook which is situational analysis based on historical market results. We study money flows along with the disciplines of fundamental and valuation analysis to see how markets have responded to similar historical events. It gives us different market scenarios. We use these to formulate our game plan. The game plan is a tactical and a strategic allocation of assets based on what the playbook tells us has historically occurred. It is then further refined to the specific risk/reward parameters of our clients. 

As I gaze into my crystal ball {a ball that because it looks into the future is cloudy at best} and formulate the game plan, I think two things are happening.  The first is that the world is also beginning to believe as I do that things are getting better.  For one thing there is a staggering amount of innovation that has quietly taken place these past few years.  We’ve chronicled last year how past periods of research spending-usually resulting from conflicts such as a world war or from the hostilities surrounding the Cold War-is finally entering the civilian workplace.  We’ve called this the era of miniaturization {think of the PC morphing into the Ipad}. It is having an impact on virtually every industry and business in fields as diverse as energy and computing to medicine and robotics.4.  This sort of innovation spurs productivity.  Increased productivity is ultimately good for stocks.  Secondly, investors are starting to shift money away from bonds that yield them virtually nothing back into equities.  Fixed Income’s three year performance is an annualized 4.97%, S&P 500 Total Return three year annualized performance is 15.3%.5.  I think this is the year individuals might finally take notice of that discrepancy.

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