Halvorson Research Associates LLC - Market Commentary 8/31/12 Hoping for a change? The market took on a more positive outlook, after Fed chief Bernanke made his comments about extending the time frame for Federal Reserve interest in boosting the economy into 2014. It looks like some form of quantitative easing (QE3) is already being baked into the stock market numbers, and we saw a nice pop in Friday’s stock market indices. Another major worry of the stock market has been the European debt crisis, and we’re seeing more positive belief that the ECB will be able to step up and take care of the mess, with a much smaller impact on the U.S economy. At least, that’s the news of the week, and sentiment is what drives the market these days. Now that we are taking our Labor Day break, and the summer is almost gone, it is time to look through to the end of the year and beyond the November elections. Risk and reward: how much risk is the average investor willing to put up with to reap the rewards of either capital appreciation or income? Let’s take a look at where the major market benchmarks stood as of 6/30/12: 1-year 3-year 5-year 10-year S&P; 500 Index (Large Cap U.S. Equity) 5.45% 16.40% 0.22% 5.33% MCSI EAFE (net MA) (International Equity) -13.70% 6.10% -5.95% 5.32% BC U.S. AGGREGATE BOND INDEX 7.47% 6.93% 6.79% 5.63% (Fixed Income) BC U.S. 3-MO TREASURY 0.07% 0.14% 1.05% 1.90% (Cash/short-term) Other alternative investments, such as real estate and hedge funds, have mixed returns over these periods, but we’ll stick to the basic asset allocation benchmarks for this illustration. Looking at these returns, one would think that Fixed Income investing is the safest allocation with the highest return. However, with interest rates as low as they currently are, with an average AAA Bond rate of 3.6% according to Value Line as of 6/30/12, the risk of replacing older investments that carry a higher interest rate with the newer, lower-yielding rates, will most likely pull this asset class’s return back more towards the norm of 5.6% over 10 years. International stocks bear the brunt of dealing with the European debt crisis, the falling GDP in China, as well as some good regional yields, yet the volatility of this asset class and its correlation to the U.S. stock market make it an asset class to be included in an investor’s portfolio, but in a smaller proportion, as its short-term outlook appears less appetizing than the U.S. stock market. What about U.S. Stocks? We can see the high volatility of average returns even over this 10-year period, with the 3-year average of 16.4% much higher than the recent 1-year return of 5.45%. With the 5-year average including the 2008 stock market drop, will this asset class ever be safe enough to invest in over the long term? In our last commentary (8/15/12), we went through an analysis of earnings growth, which is the primary producer of economic and market price growth. Looking at the most recent YTD S&P 500 return, through 8/31/12, we can see that the Index has returned 11.85% YTD, and 15.4% for one year. The last three months have brought the S&P 500 Index a return of 7.35%, boosting returns investors are seeing in these stocks. So why is so much of investor money still on the sidelines? Why aren’t managers and investors willing to jump into the U.S. stock market for these more exceptional returns? Our HRA OU-P Factor, which measures the level of market sentiment, is showing that the U.S. stock market is underpriced by a factor of over 31% (see graph), now that we’re using projections into 2013 that show a much more positive outlook for individual companies. Our theoretical investment percentage for Equity portfolios has gone back up to 100% based on this under-pricing, which suggests that investors who can find good growth stocks and invest in them now, when the market is still so under-priced, may be in for good long-term returns. However, as everyone knows, historical returns are not indicative of future returns. Here we get into the question of whether or not good stock selection can produce better returns than investing in a passive index such as the S&P 500. Our HRA Portfolios of 30 stocks and 6 stocks, both theoretical in nature, are meant to show how picking good growth stocks may increase an investor’s return above that of the index. (See our Theoretical Portfolio returns table at www.hrastockpicks.com). By selecting good growth stocks, using fundamental and quantitative methods, our HRA theoretical portfolios have shown the following: HRA Favorite 30 HRA Tiny 6 S&P 500 Index 1-month 6.02% 4.27% 1.98% 3-months 11.59% 5.91% 7.35% YTD 8/31/12 13.68% 7.84% 11.35% Annualized rate Since 1/1/2003 8.58% 9.63% 4.97% Stock selection, including sector investing, has buoyed the Favorite 30 theoretical portfolio to outpace that of the S&P 500 Index through this year, as well as over an 11 year period (we chose the end of 2002 as the beginning of the most recent bull market). See our stock performance table for more periods and disclaimers showing that several assumptions are made, and that no trading costs are involved in these theoretical portfolios, much like the S&P 500 Index. WHAT DOES THIS MEAN FOR HRA? Our fundamental approach to picking good growth stocks shows great potential for the near-term as well as the future in the U.S. stock market, as we take advantage of sector rotation, meaning picking more stocks in good sectors and avoiding others over the short-term. Our analysis of continued earnings growth (see Market Commentary, 8/15/12 AT WWW.HRASTOCKPICKS.COM) is the basis for our measurement of over- or under-pricing in the market, as well as for each stock. The power of using a proven model for predicting theoretical future stock prices to show which stocks are currently under-priced makes a huge difference in stock selection – we are not always right, as we don’t believe that we can time the market, but our fundamental approach has been working well for long-term investors. Our Favorite 30 is available at an additional subscription cost, as well as our Tiny 6 portfolio. WE at HRA, as observers over the last 25 years, are convinced that stock investments and corporate earnings are very much cyclical in nature, and we’ve come to a point where the U.S. economic engine is poised for a substantial recovery. On the more personal side, all investments should be based on the individual investor’s risk tolerance – if you want to be aggressive, and can live with volatility over the short-term, then investing in stocks over the long-term may provide increased returns along with that higher level of risk. Remember, not all investments are suitable for all investors – check with a financial advisor if you plan to make major changes in your portfolio. Also, remember that historical returns are not predictors of future returns, and HRA does not believe that you can time the market. With those qualifiers, we at HRA wish you luck in your investing, and are here to answer your questions! Halvorson Research Associates, LLC. Phone: 239-330-7142 e-mail: JCR@HRAstockpicks.com Bill Halvorson, FSA,MAAA, MBA Janet Raphael, CFA Erik Hughes ...read more
By Halvorson Research Associates LLC September 07, 2012
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