A Little Cold Water Thrown on the Recovery
Al Frank Asset Management
By John Buckingham
January 18, 2012
John Buckingham, Chief Investment Officer, AFAM
John Buckingham leads a team that scrutinizes more than 2500 stocks for money management clients and newsletter subscribers. He is equally resolute in his management of Al Frank’s proprietary mutual funds. John has been a part of Al Frank Asset Management since 1987 and is the company’s largest shareholder. He has served as the firm’s Director of Research since 1989 and Chief Portfolio Manager since 1990.
John graduated magna cum laude from the University of Southern California in 1987 with a B.S. degree in computer science and a minor in business administration. His opinion is widely sought: John has appeared on numerous television and radio programs, is frequently interviewed by publications and conducts workshops at investment seminars.
A Little Cold Water Thrown on the Recovery
The second week of 2012 would have to be considered an impressive one for the U.S. equity markets, given that one would have thought the news flow (weaker-than-expected economic data, disappointing earnings from financial bellwether JPMorgan Chase (JPM - $35.92) and rumors of imminent sovereign debt rating downgrades) would not engender much support. Stock prices actually managed to remain in the black over the five-day period, with the Dow Jones Industrial Average gaining 0.5%, the widely-followed S&P 500 climbing 0.9% and the broad-based Russell 3000 index advancing 1.1%.
The economic data out last week was hardly terrible, but the positive momentum seen in the past couple of months was slowed as the Commerce Department reported that higher prices for imported oil and a 7% drop in exports to Europe caused the U.S. trade deficit to expand sharply in November. Commerce also said that U.S. retail sales rose only 0.1% on a sequential basis in December with a 0.2% drop (the first since May 2010) the score if autos were excluded. Of course, overall sales did rise 6.5% when looked at on a year-over-over basis, but it appears that consumer shopped early this holiday season as the November sales totals were revised higher. The weekly jobless claims number from the Labor Department was also heading in the wrong direction, even as the 24,000 increase still left the 399,000 figure for first-time filings for unemployment benefits below the important 400,000 level.
That said, the Federal Reserve’s Beige Book summary of economic surveys out last week concluded: “Contact reports from the twelve Federal Reserve Districts suggest that national economic activity expanded at a modest to moderate pace during the reporting period of late November through the end of December. Seven Districts characterized growth as modest; of the remaining five, New York and Chicago noted a pickup in the pace of growth, Dallas and San Francisco reported moderate growth, and Richmond indicated that activity flattened or improved slightly. Compared with prior summaries, the reports on balance suggest ongoing improvement in economic conditions in recent months, with most Districts highlighting more favorable conditions than identified in reports from the late spring through early fall.”
The Fed’s view of economic activity would seem to support comments out last week from Jamie Dimon. The JPMorgan Chase CEO said, “The U.S. is in a mild recovery that is broad and strengthening.” In a CNBC television interview, he added, “When you look at all the sectors—corporate, middle market, business, consumer—for the most part they’re better than they were a year ago, and we even think housing is near the bottom if you look at rental prices, supply and demand, household formation.”
That may be true, but investors were not overly excited about JPMorgan’s fourth quarter earnings report as profits for the banking giant came in at $0.90 per share, down from $1.12 in the year-ago period, with weakness in investment banking and fixed income trading hurting the bottom line, along with an accounting charge (“DVA”) related to a tightening (a positive) of the firm’s credit spreads. Still, it was somewhat reassuring (we continue to hold tight to our JPM shares) to hear the company say: "As the economy continues to recover, we are gratified to see signs of improvement in loan demand and credit quality…Firmwide, net charge-offs were $2.9 billion in the fourth quarter, down 43% compared with the prior year, and nonperforming assets declined by 33%...We maintained our fortress balance sheet, ending the year with a strong Basel I Tier 1 Common ratio of 10.0%. Our capital position allowed us to repurchase $9 billion of common stock during 2011, including $950 million during the fourth quarter.”
Despite our long-term affection for JPM, we expect the near-term to be more volatile than usual, given the renewed drama in Europe, following the downgrade of the credit ratings for France and eight other euro-zone countries by Standard & Poor’s after the U.S. markets closed on Friday. Of course, the moves did not come as a big surprise, given that S&P had placed 15 European countries on watch for possible downgrade back in December and word of the imminent action leaked early Friday morning with U.S. equity prices quickly heading south shortly after trading opened. Interestingly, stocks managed to bounce back later in the day when investors took some comfort in the belief (subsequently confirmed) that S&P would only take France’s credit rating down by one notch to AA+ from Triple-A, rather than two notches.
Even more interesting, European equity markets actually rallied when trading resumed today, even as S&P said, “In our view, the policy initiatives that have been taken by European policy makers in recent weeks may be insufficient to fully address ongoing systemic stresses in the euro zone.” And U.S. stock futures were higher on Monday afternoon, suggesting a modestly positive opening of trading tomorrow is in the cards.
We’re still a bit concerned that investor sentiment is a little too bullish (the latest AAII numbers show that 49.1% are optimistic on the prospects for stocks over the next six months vs. only 17.2% who are pessimistic), but the index performance numbers thus far in 2012 are what we like to see. Two weeks does not a year make, but interest in equities has extended beyond the relatively safe haven of the blue-chip dominated Dow, which is up ‘only’ 1.7%. While the Dow turned in stellar relative performance in 2011, it is lagging behind the 2.5% year-to-date return of the S&P 500 and the 2.8% return of the Russell 3000.
And more importantly, Value stocks have lately been outperforming. According to data from Russell Investments, the Russell 3000 Value Index was up 1.3% last week compared to a 0.9% rise for the Russell 3000 Growth Index. Year-to-date, the numbers are 3.0% vs. 2.6% and for the last three months it’s 9.4% to 6.1% in favor of the Value component of the Russell 3000 Index. Value still lags Growth in the 1-year, 3-year and 5-year performance calculations, but for the past decade and going all the way back to 1927, stocks trading for inexpensive multiples of sales, earnings and book value have historically outperformed!
(c) Al Frank Asset Management