The 1st quarter of 2012 was, by many measures, a very positive one. Economic indicators here in the US continue to improve, the Europeans seem to have finally made some progress on their debt problems and the stock market (as measured by the S&P 500) had its best 1st quarter since 1998. However, this picture is eerily similar to the 1st quarters of 2010 and 2011. In both those prior years, the US economy seemed to be improving and the equity markets had strong 1st quarter results only to peak in April and then decline precipitously (16% in 2010 and 24% in 2011) during the 2nd and 3rd quarters.
As is usually the case, the current rally in the equity market is causing investor sentiment to reach optimistic extremes. When expectations become too optimistic the markets are more vulnerable to disappointments/shocks. This is exactly what happened in 2010/2011 when events such as the Greek debt crisis, the Arab Spring, the Japan earthquake and the US deficit/debt debacle triggered the sell-offs. Some of the issues I am watching closely as potential catalysts this year are:
1. Rising gas prices and the potential for trouble in Iran.
2. Fear of a hard landing in economic activity in China.
3. Spain’s debt now becoming an issue for Europe.
4. The US “Fiscal Cliff” (so dubbed by BusinessWeek) on January 1, 2013 when Bush-era and Obama payroll tax cuts expire and deficit reduction spending cuts kick in.
While I highlight these as reasons for caution, my outlook remains positive. In the US, we continue to see improvement in the job market and in housing. Low interest rates continue to allow consumers to refinance debt such that consumer debt payments as a percentage of income have fallen to levels not seen since 1994. This translates into the slow, but relatively steady growth in consumer spending we are seeing right now (consumer spending is now well above its all-time high). Globally, most central banks (both in developed and emerging countries) are easing monetary policy to fuel growth. Finally, the first-quarter earnings season is only a couple of weeks away, and it appears analysts aren’t expecting much. Low analyst expectations set the stage for positive surprises. Evidence that low expectations for earnings are in force:
“‘While companies still seem to be trying to operate as leanly as possible, it is going to be harder for them to translate whatever cost-cutting measures are still possible into profits that can surprise analysts and beat the latter’s earnings estimates,’ Thomson Reuters says. That’s the big worry as investors turn their sights to first-quarter earnings season.” – The Wall Street Journal, March 30, 2012
“The fourth-quarter company results season was the worst since 2008 in terms of firms beating estimates. That was largely overlooked by a market in the middle of a liquidity surge, but it may come home to roost this quarter.” – Reuters, March 29, 2012
As always, I continue to focus on the current situation and the outlook, both domestically and abroad, in conjunction with your investment objectives, risk tolerance and time horizon and will let you know if we need to take any action.
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