News & Insights
Lurching Toward Prosperity
The equity markets crossed into the new year under quite a head of steam. Since July 2nd, the S&P 500 has advanced over 20%. Small cap shares, commodities, and other risk assets have advanced even further. The first trading session of the year sent the indices to two year highs. Investor sentiment, both institutional and individual, is just off 2 year highs. The economy, while still sending mixed signals, is generally seen as lurching unevenly forward, with even the labor market showing tentative signs of strength in the year's first week. The risks seem to be shifting away from the feared deflationary spiral and a sluggish economy toward inflation and quickening growth.
We think much of the current enthusiasm is well justified. Profits, the mother's milk of stock prices, have been better than expected and analysts have been increasing their estimates for 2011. We remain constructive on stocks, but believe our focus on the highest quality companies with stable and predictable earnings is even more important to maintain in the new year. According to Ned Davis Research, from 1980 to 2009, high quality S&P 500 stocks have outperformed lower quality stocks by 2 to 1 during periods when inflation exceeded 3.5%. So if inflation is a concern, quality is your friend.
We are likely in the phase of a stock market recovery that favors quality shares. From the bottom of the bear markets in 1982, 1987 and 2002, lower quality shares led high quality shares by an average of over 25% in the first 12 months of recovery. During the next 12 months higher quality shares and lower quality shares were just about even. During the following three years the returns of higher quality shares were far superior to their lower quality brethren. Over the 30 years ending in 12/31/2009 the returns of stocks that grew their dividends (a good proxy for high quality) returned 10.9% annually while stocks that paid no dividend (a good proxy for low quality) returned only 2.3% per year. An emphasis on quality is not only timely, but has a long term charm that maintains our focus on this part of the market.
We also believe holding some reserves in the form of low-paying cash since an increase in market volatility is in the cards after a remarkably calm few months. On the fixed income front, it is apparent to everyone that higher rates are probable and so bond prices have retreated. The selling is probably a little overdone in the short term but the general direction of rates is up. So we will maintain our preference for lower than market maturities and higher than market quality for the time being.
With global growth picking up, we remain invested in commodities and resource stocks. We believe that the relative scarcity of materials and energy used in production and transportation will become more acute acting as a support for prices.
Altavista Investment Team - Winter 2011