It’s official; the first quarter of 2012 was a great time to own stocks, with the averages delivering their best performance in more than a decade. For the quarter, the Dow Industrials gained 8%, the S&P 500 added 12% and the NASDAQ led with an eye popping 18%. Once again, thank you Apple.
If there is one theme we have seen this year it has to be contrarian. That’s because everybody in the world was super bearish going into 2012. The volatility that hit the equity markets late last year was a reminder how painful it can be to own stocks in a correction.
And we ended up seeing that defensive attitude carry over into the New Year, with a lot of big hedge and mutual fund managers shifting into more conservative segments of the market like large-cap dividend stocks and cash in anticipation of more weakness.
But just like we’ve heard and seen a million times, just when bearish sentiment reaches a peak, the stage is set for a rally as the market begins climbing a wall of worry.
That means anyone who was fully deployed going into 2012 should be well in the green, a sharp turn from 2011, where the only real gains all year came on timing the market and buying dips.
So the market is off to a good start this year, but as always, challenges remain.
Valuation
From a valuation perspective, the S&P500 trades at 14.8X forward 2012 earnings. The 10-year median is 16X, so the valuation picture still looks pretty solid.
The pace of corporate earnings will play a big role in the valuation conversation. Earnings have been the brightest spot of the economic recovery of the last few years, back to peak levels from 2007. But just as every cycle goes through different stages of growth and contraction, margin expansion is peaking. Throw some higher energy costs on consumer spending and Q2 earnings and guidance will be a leading factor in everything to do with stocks and the market in general.
Political Tension
But beyond pure financials, the market will also face political challenges. The rhetoric in the Middle East continues to escalate. The United States just planted a third air-craft carrier outside the strait of Hormuz. This is heavy stuff, these guys aren’t messing around. A military conflict with Iran or any disruptions in the flow of oil will send crude prices flying.
Don’t Forget China and Europe
And don’t forget the Euro zone or China’s “soft” landing. We don’t need to remind anyone that these are huge land mines.
So if you’re left scratching your head as to why stocks have rallied so hard in the face of so many obstacles go ahead and take a look at the central banks.
Central Banks Running the Show
2012 has seen massive interventions from the central banks of the world, as the bankers and politicians dig deep into their bag of tools to keep the global financial system intact. Say what you want about the moral and philosophical implications of central planning, monetary stimulation and currency devolution is a drivers of asset prices. And that has been and will continue to be the main theme going into a big fall election.
So for the time being, 2012 is off to a great start. Many challenges remain, but with correlations between the first quarter and full year strong, the stage could be set for a very solid year of returns.
Let’s get into some updates.
Updates:
The big winner of Q1 was Apple, Inc. (AAPL), by a long shot, with shares up 50% over the last three months. Everyone talked about how insanely undervalued this stock was below $400, so it looks like that conversation finally came home to roost, with shares recently taking out $600. A lot of critics like to talk trash about Apple, but share holders are up huge over the long and short haul and can anyone please show me a better technology company to invest in? So for the time being the Apple juggernaut remains intact.
VeriFone Systems, Inc. (PAY) was also up huge in Q1, posting an impressive 45% gain. The maker of electronic financial transaction systems took a bit of a beating in the sell off last year, pulling back sharply from its all-time high. But the stocks that get hit the hardest in a sell off are usually the ones that gain the most in a rally. And that’s what we see here, with VeriFone back above $50 and trading within 10% of its all-time high just above $56. Bigger picture, this is a growth company operating in the growth market of electronic financial transactions. As a leading name in the space, VeriFone looks well positioned to capitalize on the long-term trend.
Check Point Software, Inc. (CHKP) was also at the top of the charts, hitting a new all-time high while posting a 22% gain in Q1. This software company that specializes in security is benefiting from recent high-profile security breaches in the government and private sector. Security is a huge issue in data and technology, so a company like CHKP is a good way to get a piece of that action.
Energy took a beating in last year’s volatile market, clocking in as one of the worst performing sectors in the S&P 500. But with the bulls taking hold in 2012, the group has been charging higher. That lifted Cimarex Energy (XEC), and exploration and production company to a 22% gain, with shares jumping 23% in one day on strong Q4 results. Moving forward, this is a stock that will have a strong correlation to underlying crude and natural gas prices, so both will function as leading indicators.
The gold bugs were happy during Q1, with Double Gold (DGP) chiming in with a 12% gain. With the central banks getting slap happy on the print machine, the gold story is well in play.
Agriculture also stood out, with Bunge, Inc. (BG) up 20% and CF Industry Holdings, Inc. (CF) gaining 25%.
And finally, a small cap gem named EZCorp, Inc. (EZPW) was also deep in the green, gaining 25% on another good quarter and growing complacency with regulatory concerns. Bigger picture, this is a great investment thesis/idea, because the fact of the matter is that pawn stores and pay day lenders are booming right now with unemployment staying high. The regulatory issues will remain a threat, but the earnings and valuation picture both look compelling.
That’s it for this week and the first quarter of 2012. But until next time, here is an article discussing recent weakness in bond funds as the market regained its appetite for risk assets. Enjoy!
Bond Investors Riding Bumpiness
Your Investment Partner,
Mike
