Hutchens Investment Management: “It’s the Private Sector, Mr. President.”

CONCORD, N.H. - March 11, 2013 - PRLog -- Saturday, March 9 was the four-year anniversary of the market bottom when the S&P 500 fell to 676.53, its lowest level since September 12, 1996.  On Friday, March 8, the S&P 500 closed at 1,551.18, up 129.4% from that 2009 low.  

As the market begins its fifth year of recovery, the Dow has already surpassed its pre-crisis levels and many investors remain skeptical of the bull market’s future.  We continue to climb the proverbial “wall of worry” as academics and professionals alike alert investors of impending catastrophes.  Two of the most recognizable are Marc Faber and Nouriel Roubini, with Faber at that time talking about an intensifying recession with no way out and Roubini predicting the S&P 500 would be below 500 by year-end.  To this day they remain bearish, but now are considered by many as contrary indicators, according to David Minor of Hutchens Investment Management.

Credit for the turnaround can be ascribed to a number of factors, the least of which was the Obama Administration’s American Recovery and Investment Act of 2009, i.e. stimulus, which interfered with an economic recovery.  While controversial, the Troubled Asset Relief Program (TARP) established by the US Treasury and the Fed’s Quantitative Easing were more successful with liquefying the system, but still have not produced a meaningful cyclical recovery as measured by historical standards.  The economy is plagued by high unemployment (7.7%) despite a net addition of 661,000 jobs since President Obama took office in 2009.  Structural unemployment will continue to shadow the economy and with GDP growing in the 1.5-2.5% range, full employment (5%) is in the distant future.  However, the bull market in stocks continues and the outlook for the private sector improves despite an openly hostile political environment favoring more intrusive government policies.  

We are not market timers but rather investor’s combining fundamental, economic, political, psychological, and technical analysis in an effort to develop a long-term investment strategy.  Fundamental research is employed with a “bottom-up” approach for individual stock selection.  Our research has enabled us to consistently outperform industry benchmarks.  What then does our analysis tell us to expect over the current cycle?  

A. Fed reliquification works.  There is no doubt that quantitative easing programs undertaken by the Fed, Bank of Japan and the ECB have a positive effect on equity prices.  Domestic stock prices, measured by the S&P 500 have risen significantly during each of the programs; QE1 (+42%), QE2 (+24%), Operation Twist (+20%) and QE3 (?).  Confirmation by Chairman Bernanke and Vice Chair Yellen assures a continuation of Fed reliquification into 2014.  

B. Markets are not cheap, but they are not expensive.  P/E ratios are expanding to the S&P 500 with the current trailing 12-month P/E  (15.3), up significantly from the May 2012 levels (13.5) and not far above the long-term level of 14X.  

C. Corporate earnings have continued to rise despite analyst’s downward revisions.  The most recent quarter surprised both on the bottom and top lines.  With early signs of renewed global growth and a pick-up in housing and exports we would expect earnings to strengthen as we move into the latter half of 2013.  

D. The consumer will not go away.  The slowdown in consumer spending, forecast almost universally by economists over the past two years, has yet to occur.  In fact, the recent jobs data should, if nothing else, make those already working feel more secure. Additionally, the housing recover and the appreciation of stock prices have dusted off the “wealth effect.”  According to Morgan Stanley, employment, construction spending and home values are the most significant variables in forecasting future retail sales.  Reflecting this, consumer stocks measured by the XLY, have risen 10.9% year-to-date.  But this increase in value has not gone unnoticed by short sellers, as 12 of the 20 top short positions in the Russell 2000 are consumer discretionary stocks.  

Our investment strategy is a full position in equities.  The recent run-up since the beginning of the year and a more bullish sentiment for equities opens the possibility of a short-term correction as budget negotiations approach the deadline in the latter part of March.  But in the longer term this is inconsequential as growth with a dose of inflation will be the ultimate catalyst for a sustainable bull market and deficit reduction.