News & Insights
Holiday for Stocks
The winter season so far is certainly a holiday from the jagged two steps forward one step back pattern of 2004-2005. The 14% return of the S&P 500 in 2006 was the best since 2003. As our quarterly notes reveal we remained primarily defensive on the market as a whole until last summer. In our summer note we indicated that despite slowing profits, a tightening interest rate environment and a sanguine attitude on the part of investors, we were becoming more constructive on the stock market. As support for our melting skepticism we cited the markets’ modest valuation, falling energy prices and the anticipation of easing by the Federal Reserve as reasons to go from cautious to neutral on stocks.
Before we get too carried away with our successful market call on stocks, we need to add some comment about the “quality bias” in our U.S. portfolio. We have been saying since 2004 that a rotation into high-quality growth stocks (such as those that dominate our U.S. portfolio) would provide the catalyst for index beating performance. Except for a brief moment in the fall, the lower quality stories continued to lead the quality ones, reflecting an investor “risk appetite” that was more carnivorous than we believe appropriate. The S&P was up approximately 14% in 2006, while the Russell 1000 Growth Index (dominated by large cap quality shares) was up only about 9%. Encouragingly, some quality names such as Cisco, Microsoft, Sigma-Aldrich, G.E. and Sysco all posted solid gains.
We continue to believe that high quality U.S. growth shares are among the most attractively priced asset classes and deserve an emphasis within a portfolio. Again, as in the past three years, allocations to small-cap and international shares lifted the returns of diversified portfolios.
Alternative investments in commodities, real estate and natural resources put in a mixed performance with commodities cooling off after the past four years of blistering returns and real estate doing well. Investments in these types of assets still merit consideration because of their role of insulating investors from the effects of inflation.
The environment in 2007 looks benign for stocks. Earnings underlying stocks look generous when compared to the paltry yields available in investment grade bonds. This will likely encourage the managers of pensions and foundations to consider increasing their allocations to stocks, supporting the market. Large cap shares should beat their small cap brethren (if we say it enough we will be right) and the international markets should continue to be attractive.
Bonds in general, and the lower credit tier specifically, look overvalued and so we do not advise being aggressive in fixed income.
The Altavista Investment Team - Winter 2007