INSIGHTS

On October 31, 2011

Economic Perception or Reality?

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Ever since this current equity run began about 32 months ago (3/9/09) there has been much rhetoric about what to classify it as.  Is it a new secular bull market?  Is it a cyclical bull market inside of a secular bear market?  Or is it something else all together?  We still believe it is the former – a new secular bull market; however, no matter what you call it, or what you believe was going to occur, it must sting if you missed out as the returns have been substantial.

Including the reinvestment of dividends (total return) the S&P 500 has returned 100.56% (3/9/09 – 10/28/11) and the S&P 600 (small-cap stocks) has fared even better with a return of 137.49%.  In addition, as equities have grinded higher there have been multiple obstacles that have been encountered and even more that have been predicted that have failed to materialize as prophesized and this seemed to accelerate over the last quarter.

In late July, a number of macro issues began to weigh heavily on the equity markets including debt ceiling talk in theUnited States, a possible downgrade of U.S. government obligations, concern over a default in Greece and the domino effects to the other PIIGS nations (Portugal, Italy, Ireland, Greece and Spain) and a hard landing in China.  We listened to commentator after commentator tell us this was 2008 all over again and that many economies (including the United States) were already in recession, and if not soon would be.  In a nutshell, the common perception (and projection) was we were doomed.  However, an interesting thing occurred as the quarter played out.  Consumers and corporations continued to spend and the U.S. economy posted its best GDP number in a year with a preliminary reading of 2.5% growth.  In addition, despite much pessimism corporate earnings, continued to grow and impress.

The dialogue as we entered this (or any) earnings season appears to us to follow the same repetitive script.  A news anchor will ask a commentator for their outlook on the coming earnings season and they will usually say they expect earnings to be OK as the equity analysts have lowered their expectations (once again) but they expect the actual year-over-year growth numbers to disappoint and that we have most likely seen the best of this current recovery.  At some point they could be right; however, this has not occurred yet and it should be noted if it does, it does not necessarily portend losses for the equity markets.

We are now about 60% of the way into the current earnings season and the statistics we look at – earnings surprise, earnings growth, revenue surprise and revenue growth – are coming in very strong and are on par with what we saw last quarter (which was statistically the strongest quarter of the current recovery).  In addition, year-over-year earnings and revenue growth rates continue to impress at 18.98% and 11.57% respectively compared to 16.25% and 12.01% last quarter.  Clearly this is helping drive the equity markets higher along with better than expected economic data and a belief that the PIIGS situation will be contained; however, we most likely cannot maintain the pace of gains we have seen over the last three weeks.

October is on track to post the best monthly S&P 500 gain of this current recovery, the first double-digit monthly gain since December 1991 and the best October gain since 1974.  Though we felt the equity markets were overdue for a bounce we do feel we are now ripe for a bit of consolidation before they move higher.  We think as perceptions begin to align a bit more with reality that the S&P 500 should be able to move towards the April highs of ~1363 on the S&P 500 by year end.  In order to take advantage of this, we would continue to recommend investors focus on the themes of quality dividends, quality growth and quality balance sheets that we have been highlighting for quite some time.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.