Did Someone Say “Boring?” - Investment Commentary from Hutchens Investment Management

CONCORD, N.H. - Aug. 20, 2013 - PRLog -- Earnings season is completed, tapering is about to begin sometime, another Arab Spring failure with Egypt, the government is running out of money, the economy is slowing, and everyone is on vacation. No wonder the stock market is selling off. In reality, the economy is growing, earnings are better than anticipated, the government will never run out of money – they print it, and Egypt has no investment impact as long as the Suez Canal remains open, which it will. It seems what we do know is already in stock prices and what we do not know will lead to a downturn. Stocks are too high, moved too far too fast, or are ripe for a correction. Seems like a well-thought out investment strategy.

We have been writing on what we believe are the reasons for stocks to rise since the recovery in March 2009. However listening to politicians, media and economists things have barely improved. In fact, it is widely acknowledged that the Federal Reserve has propped up, through artificial means including the QE’s, asset prices at the expense of the middle class. Stocks, measured by the S&P 500, reached their previous highs on October 11, 2007 at 1,576.09. Annual earnings peaked in 2006 at $87.28 and bottomed at $60.70 in 2009. Since then, the S&P 500 has surpassed the previous highs and today is 4.7% above the 2007 levels. S&P earnings are estimated to reach $110.67 for 2013, an increase of 26.8% over the cyclical high in 2006. Looking at the economy, real GDP in 2Q2013 is 13.2% above 4Q2007 and the all- important Personal Consumption Expenditures are up 15.4% over the same period. Not great, but growing. Housing has come back strong but still well-below the 2005 peak in starts and sales and 25% below the prices of 2007.

Despite a surprising decline in August, the University of Michigan Consumer Sentiment Index reached a six year high of 85.1 in July. During the 2008-2009 recession sentiment fell to the mid- 50’s, down from the highs above 100 in the late-1990’s and in 2003. Prior to the financial crisis, the Index ranged from the mid-90’s to the low-80’s. No doubt the housing recovery and the revisiting of the wealth effect has overcome the structural employment problem. Employment is increasing monthly but well-below previous recoveries. Weekly jobless claims are foretelling a better outlook than monthly employment data.

Moving forward we expect the Fed to become less accommodative, reducing purchases below the $85 billion monthly target. As discussed in previous reports, the Fed accounts for about 1% of the monthly purchases and has less impact from QE than is generally asserted. The recent rise in interest rates, in part, is attributable to selling and/or reduced purchases on the part of foreign investors. The perception of tightening with the possibility of misjudgment by the Fed has spooked some traders. Bond sales have recently come not from mutual funds but from the more volatile ETF’s.

Not much credence has been given to an expanding economy as a reason for tapering. But this is the reasoning employed by Chairman Bernanke. Should the economy pick up steam, we would expect less accommodation by the Fed, interest rates rising to a more realistic level around 4%, and inflation to move above the current sub-2% level. The home mortgage market will be far less affected than is anticipated. In fact, a jump in housing may precede any move above the current 4.5% mortgage rate. In an environment driven by an expanding economy we anticipate rising corporate profits and increased revenues, higher multiples and lower margins. This scenario will call for equity investments concentrated in the more economic sensitive areas; Consumer Discretionary, Industrials, Financials and Technology. Just maybe, the Fed will get it right.

Our investment policy remains positive on equities. There is a possibility of a short-term correction as we approach the seasonally weak early-fall.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens