Hutchens Investment Management: Where’s the Correction?

Feb. 5, 2013 - PRLog -- Naples FL – (Feb. 6, 2013) - As the stock market approaches five year highs, the outcry from both the “knowledgeable” and the “unknowledgeable” is for a correction, said David Minor of Hutchens Investment Management. William Hutchens, CFA of Hutchens Investment Management is a Naples resident.

Thus far, nothing approaching a 10% sell-off has occurred. Why then have the majority of market forecasters been wrong or at best, very early.  There were two major potential catalysts for a downturn cited in November and December 2012 -- the fiscal cliff and year-over-year negative earnings comparisons. Of course, there are also the usual culprits -- Mideast unrest, global slowdown precipitated by China and Europe, and the inability of our Congress to get anything done.  The intransigence on entitlement spending cuts by the Obama Administration has only complicated an already dysfunctional budget process.

But despite all these dark clouds, the S&P 500 rose 11.5% since mid-November 2012 until last Friday and the tech-heavy NASDAQ is up 12.1% over the same period.  What then has propelled the market to these highs? The election of the incumbent, while not viewed as favorable to private sector growth, removed an uncertainty enabling business to plan for the future.  Disruptions, such as Obamacare and new regulatory initiatives, are a given rather than an unknown.

The economy is picking up steam as private investment is increasing along with consumer confidence. Job growth, still weak, is beginning to show signs of life but not in the large secular portion of unemployment. We expect that long-term unemployment will remain high as technological advances permanently reduce unskilled and semi-skilled positions.  (A new definition of full-employment will take this secular unemployment into account.)  As we move toward more realistic growth rates, the economy will obscure this sector of the population.  Housing is an important driver of overall economic growth.  Residential sales are up, inventory is down substantially and most importantly home prices are slowly rising.  A healthy housing sector is a precondition for the Fed to exit from quantitative easing and can add 1.5% to GDP.

Quarterly corporate profits are a fundamental variable affecting stock prices most viewed as an indicator of the financial condition of U.S. business.  Over the past few months, profit expectations have come down substantially with sharp declines forecast for revenues and accompanying margin contraction.  As of this writing we are about half way through earnings season and the beat rate for EPS and revenues are 63.1% and 62.2% above consensus forecasts.  It now appears that analysts were overly pessimistic. Our propriety data show earnings coming in about 6% over 4Q2011 for companies that we follow.  As everyone knows, the stock market, a discounting mechanism for earnings, is proving again a better predictor than most analysts.

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 to a technical correction.  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.