From the Desk of Joe Rollins
My apologies for falling behind in keeping you updated on the current status of the financial markets – such is the course of business during tax season. First, I would like to comment on the quarter ended March 31, 2014, and then bring you up to date on the current volatility that we are seeing in the financial markets during the month of April.
For the first quarter ended March 31, 2014, the S&P 500 was up a very satisfying 1.8 %. However, the Dow Jones Industrial Average was down 0.1% and the NASDAQ Composite was up 0.8%. Interestingly, the small cap Russell 2000 stock was up 1.1% for the quarter and the Barclays Aggregate Bond Index was up equal to the S&P with a 1.8 % gain. While certainly not a sterling quarter, it was still very satisfying as some type of normal correction was expected coming off the huge gains we enjoyed in 2013.
Even with the lackluster first quarter, the major financial indexes continue to post very robust numbers. For the one year ended March 31, 2014, the S&P 500 was up 21.9%, the NASDAQ Composite 30.1%, and the Dow Jones Industrial Average 15.7%. One misconception regarding the Barclays Aggregate Bond Index, although it had a profitable first quarter in 2014 (as mentioned above), it actually had a negative return of .5% for the one year period ended March 31, 2014.
During 2013, the S&P Index was up greater than 32%, which was an outstanding year by anyone’s definition. The fact that the first quarter return was somewhat lower should be neither surprising nor unexpected. When you have a large run up in the markets, you are eventually going to get some sort of correction in order for the other financial assets to catch up. The normal rotation out of one sector into another creates quarters where some of the returns cannot really be explained.
Who would have ever guessed that the bond index would have been up in the first quarter of 2014 when virtually every economist in the world expects interest rates to go up during 2014? My suspicion really is that bonds have been a safe haven from volatility - short-term traders go into bonds as they rotate out of one sector into another.
While there is hardly any economic justification to bonds decreasing in yield during the quarter, it is exactly what they did. The 10-year treasury bonds began the year at roughly 2.9% but ended the quarter at roughly 2.7%. As you know when bond yields go down, bond values go up - so for the quarter, not only did you earn the return of the interest rate on the bond, you also got some appreciation in the underlying principal of the bond.
As we began the second quarter in April, the market was hit with a great deal of volatility. There was great outcry in the financial media that surely the next correction was underway. Hard hit particularly were small cap stocks that tend to go up the most during good times, but correspondingly go down the most during bad times. In particular, we saw a large sell-off in the NASDAQ Composite during the first several weeks of April, along with virtually any of the stocks invested in biotechnology or the science of biotechnology.
The financial gurus that forecast the market were arguing that surely the economy must be slowing and falling into another recession. However, as I write this document on April 22, 2014, the S&P Index is up 1.84% for the year and therefore is actually up from the end of March through the first three weeks of April. As I have mentioned in many previous postings, a correction of 10% in the market at any time would or could be expected. The fact that the market has corrected less than 10% certainly qualifies as a normal correction within an upward trending bull market.
I try very hard to evaluate the upward flow of information in the financial markets based upon hard statistics, not the general consensus expressed over the airways by the financial media. I actually like to look at the indexes to see if the trend is up or down, and whether any correlation can be drawn from these economic statistics and how they will affect the stock market going forward. No one can properly evaluate how the public will respond at any time, but I think a much better indicator of future market performance is whether the economic statistics support the market or whether it is a negative trend.
I have reviewed the economic statistics as of the end of March and find them almost universally higher year over year. Global manufacturing is up close to 5% and capacity utilization is approaching 79.2% with this most current reading. As many of you know, full capacity utilization is considered to be 80%, and therefore we are nearly bordering on full capacity in the manufacturing sector. Other industries that are higher year over year are manufacturing, non-durable manufacturing, personal income, personal savings, non-residential investment, and residential investment. In fact, every economic index in investment statistics reported in Barron’s for this week of March shows a positive return year over year.
Further, if you look at every important consumption indexes, you see that they are also higher. Auto sales are up, consumer spending is up, factory shipments are up, personal consumption is up, retail store sales are up, and wholesale sales likewise are up. None of the indexes that I have mentioned above show a negative year over year trend.
It is important to note that inflation continues to be very mild at a current rate of 1.5% annualized and even employment is trending up as well, although only marginally so. Construction contracts are up double digits, residential spending is up double digits, and the home price index correspondingly is also up double digits. Consumer confidence is up an impressive 33% year over year and the index of leading indicators is positive.
One of the three components of higher stock prices is the general overall trend in the economy. What we know from the indexes above, the economy continues to expand; while certainly lackluster, the trend is definitely up instead of down. The other two components of higher stock prices are earnings and interest rates. While I could certainly write many pages on the trend in interest rates, what we know for sure is that interest rates are low and, if anything, trending down (defying logic). As mentioned above, the 10-year treasury fell during the month which is a positive indicator for home purchases and refinances. Currently, CDs are paying practically zero and money markets are paying zero or less. If you combine the 1.5% inflation noted above with the current rate of return of money market accounts, anyone holding cash is suffering an economic loss because their investment is not keeping up with the rate of inflation.
The big unknown, of course, is corporate earnings. What we know about earnings, as of today, continues to be very positive. Earnings on the S&P 500 for the fourth quarter of 2013 were 22% higher than in 2012. Earnings are expected to grow 7.6% for the first quarter of 2014, and anticipated earnings for the remainder of the year are somewhere in the neighborhood of 12-14% growth. Even with the harsh winter the United States suffered and the drag it had on earnings, it appears that the first quarter of 2014 will set once again a record for total absolute earnings in the history of the financial markets.
The only remaining argument for lower prices would be current valuations. Currently, based on trailing earnings, the S&P 500 has a P/E Ratio of 17.45 times earnings. The estimated 2014 P/E ratio is 16, 14 for 2015, and 13 in 2016. As you can tell, earnings are expected to accelerate and bring valuations to lower levels. All of this is put into perspective when you consider that the 25 year average on the P/E ratio for the S&P 500 is 18.7 times earnings. Remember that this is an average - many times it trades much higher than that and often times much lower. By the definition of fair valuation, it appears valuation and therefore value is a long way from being extended.
I try to evaluate financial markets based upon hard economic data, not the whims of market forecasters or financial media. Based on all of the information that I have presented above, I personally see nothing that would indicate a sharp market sellout or anything that would affect the trend of positive earnings for the remainder of 2014. While I always say you can expect a market correction of 10% at most any time, there does not need to be any financial reason for that correction.
The most important considerations for stock valuation are earnings, interest rates, and current economic circumstances. At the current time, since all three are positive, I feel comfortable in forecasting that the stock market will be higher at the end of the year than it is today.
This does not mean that there will not be higher volatility and much debate regarding the proper value of stocks; however, when all three trends are positive, common sense will likely prevail and stocks will likely drift higher as the year progresses. Those of you that try to time the market, be aware that the market can correct 10% either up or down in a relatively short period of time. However, if you are not invested the possibility of you trending upward is essentially zero.
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
My apologies for falling behind in keeping you updated on the current status of the financial markets – such is the course of business during tax season. First, I would like to comment on the quarter ended March 31, 2014, and then bring you up to date on the current volatility that we are seeing in the financial markets during the month of April.
For the first quarter ended March 31, 2014, the S&P 500 was up a very satisfying 1.8 %. However, the Dow Jones Industrial Average was down 0.1% and the NASDAQ Composite was up 0.8%. Interestingly, the small cap Russell 2000 stock was up 1.1% for the quarter and the Barclays Aggregate Bond Index was up equal to the S&P with a 1.8 % gain. While certainly not a sterling quarter, it was still very satisfying as some type of normal correction was expected coming off the huge gains we enjoyed in 2013.
Even with the lackluster first quarter, the major financial indexes continue to post very robust numbers. For the one year ended March 31, 2014, the S&P 500 was up 21.9%, the NASDAQ Composite 30.1%, and the Dow Jones Industrial Average 15.7%. One misconception regarding the Barclays Aggregate Bond Index, although it had a profitable first quarter in 2014 (as mentioned above), it actually had a negative return of .5% for the one year period ended March 31, 2014.
During 2013, the S&P Index was up greater than 32%, which was an outstanding year by anyone’s definition. The fact that the first quarter return was somewhat lower should be neither surprising nor unexpected. When you have a large run up in the markets, you are eventually going to get some sort of correction in order for the other financial assets to catch up. The normal rotation out of one sector into another creates quarters where some of the returns cannot really be explained.
Who would have ever guessed that the bond index would have been up in the first quarter of 2014 when virtually every economist in the world expects interest rates to go up during 2014? My suspicion really is that bonds have been a safe haven from volatility - short-term traders go into bonds as they rotate out of one sector into another.
While there is hardly any economic justification to bonds decreasing in yield during the quarter, it is exactly what they did. The 10-year treasury bonds began the year at roughly 2.9% but ended the quarter at roughly 2.7%. As you know when bond yields go down, bond values go up - so for the quarter, not only did you earn the return of the interest rate on the bond, you also got some appreciation in the underlying principal of the bond.
As we began the second quarter in April, the market was hit with a great deal of volatility. There was great outcry in the financial media that surely the next correction was underway. Hard hit particularly were small cap stocks that tend to go up the most during good times, but correspondingly go down the most during bad times. In particular, we saw a large sell-off in the NASDAQ Composite during the first several weeks of April, along with virtually any of the stocks invested in biotechnology or the science of biotechnology.
The financial gurus that forecast the market were arguing that surely the economy must be slowing and falling into another recession. However, as I write this document on April 22, 2014, the S&P Index is up 1.84% for the year and therefore is actually up from the end of March through the first three weeks of April. As I have mentioned in many previous postings, a correction of 10% in the market at any time would or could be expected. The fact that the market has corrected less than 10% certainly qualifies as a normal correction within an upward trending bull market.
I try very hard to evaluate the upward flow of information in the financial markets based upon hard statistics, not the general consensus expressed over the airways by the financial media. I actually like to look at the indexes to see if the trend is up or down, and whether any correlation can be drawn from these economic statistics and how they will affect the stock market going forward. No one can properly evaluate how the public will respond at any time, but I think a much better indicator of future market performance is whether the economic statistics support the market or whether it is a negative trend.
I have reviewed the economic statistics as of the end of March and find them almost universally higher year over year. Global manufacturing is up close to 5% and capacity utilization is approaching 79.2% with this most current reading. As many of you know, full capacity utilization is considered to be 80%, and therefore we are nearly bordering on full capacity in the manufacturing sector. Other industries that are higher year over year are manufacturing, non-durable manufacturing, personal income, personal savings, non-residential investment, and residential investment. In fact, every economic index in investment statistics reported in Barron’s for this week of March shows a positive return year over year.
Further, if you look at every important consumption indexes, you see that they are also higher. Auto sales are up, consumer spending is up, factory shipments are up, personal consumption is up, retail store sales are up, and wholesale sales likewise are up. None of the indexes that I have mentioned above show a negative year over year trend.
It is important to note that inflation continues to be very mild at a current rate of 1.5% annualized and even employment is trending up as well, although only marginally so. Construction contracts are up double digits, residential spending is up double digits, and the home price index correspondingly is also up double digits. Consumer confidence is up an impressive 33% year over year and the index of leading indicators is positive.
One of the three components of higher stock prices is the general overall trend in the economy. What we know from the indexes above, the economy continues to expand; while certainly lackluster, the trend is definitely up instead of down. The other two components of higher stock prices are earnings and interest rates. While I could certainly write many pages on the trend in interest rates, what we know for sure is that interest rates are low and, if anything, trending down (defying logic). As mentioned above, the 10-year treasury fell during the month which is a positive indicator for home purchases and refinances. Currently, CDs are paying practically zero and money markets are paying zero or less. If you combine the 1.5% inflation noted above with the current rate of return of money market accounts, anyone holding cash is suffering an economic loss because their investment is not keeping up with the rate of inflation.
The big unknown, of course, is corporate earnings. What we know about earnings, as of today, continues to be very positive. Earnings on the S&P 500 for the fourth quarter of 2013 were 22% higher than in 2012. Earnings are expected to grow 7.6% for the first quarter of 2014, and anticipated earnings for the remainder of the year are somewhere in the neighborhood of 12-14% growth. Even with the harsh winter the United States suffered and the drag it had on earnings, it appears that the first quarter of 2014 will set once again a record for total absolute earnings in the history of the financial markets.
The only remaining argument for lower prices would be current valuations. Currently, based on trailing earnings, the S&P 500 has a P/E Ratio of 17.45 times earnings. The estimated 2014 P/E ratio is 16, 14 for 2015, and 13 in 2016. As you can tell, earnings are expected to accelerate and bring valuations to lower levels. All of this is put into perspective when you consider that the 25 year average on the P/E ratio for the S&P 500 is 18.7 times earnings. Remember that this is an average - many times it trades much higher than that and often times much lower. By the definition of fair valuation, it appears valuation and therefore value is a long way from being extended.
I try to evaluate financial markets based upon hard economic data, not the whims of market forecasters or financial media. Based on all of the information that I have presented above, I personally see nothing that would indicate a sharp market sellout or anything that would affect the trend of positive earnings for the remainder of 2014. While I always say you can expect a market correction of 10% at most any time, there does not need to be any financial reason for that correction.
The most important considerations for stock valuation are earnings, interest rates, and current economic circumstances. At the current time, since all three are positive, I feel comfortable in forecasting that the stock market will be higher at the end of the year than it is today.
This does not mean that there will not be higher volatility and much debate regarding the proper value of stocks; however, when all three trends are positive, common sense will likely prevail and stocks will likely drift higher as the year progresses. Those of you that try to time the market, be aware that the market can correct 10% either up or down in a relatively short period of time. However, if you are not invested the possibility of you trending upward is essentially zero.
As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.
Best regards,
Joe Rollins
