After an extremely volatile 2011, the 1st quarter of 2012 brought us what can best be described as “Surprise Surpise Surpise”. If this sounds familiar, it is because this was once the catchphrase of noted philosopher Gomer Pyle (I know some of you reading this have no idea who I am referring to.) Our “Surprise” times three is that we had a largely unexpected, almost perfect, quarter. The S&P 500 was up +12.59% during the first quarter 2012, making it the best first quarter since 1998 (BTN Research). The unemployment rate fell, economic growth improved and overall consumer confidence came back. While the real estate market remains a significant issue, it showed the best signs of improvement in over five years, and the fear about the Eurozone Debt Crisis did not happen, YET anyway. We battled rising gas prices, which we will discuss more in this commentary, but the net result is we finished with the best first quarter the Market has experienced since 1998.
The area of most noted improvement was in regards to unemployment. The unemployment rate fell from 8.9% to 8.2% (Department of Labor) in the first three months of the year, following an acceleration of labor growth. In addition, initial claims for unemployment benefits have steadily declined this year, dropping to 359,000 in the most recent week. Initial claims have remained below 400,000 since mid-October, and offer support to the notion that labor markets are shifting to a healthier phase. One point of note related to employment and the broader economy, is that economists believe the warmer-than-typical winter weather brought forth spring and summertime demand, leading some to think that growth over the summer months will give back some of its positive momentum.
Manufacturing has been an area of strength for the US economy during the recovery. Important sub-sectors such as new orders, production and employment were all relatively healthy throughout the quarter, indicating forward growth momentum.
At the same time, there are concerns that consumers may be on an all-out spending spree. Personal consumption expenditures showed a 0.4% increase in January, which was outdone by a 0.8% jump in February. Those numbers were not matched by income growth, though, which only rose 0.2% in each of the first two months. The saving rate fell to 3.7% and is quickly retreating to early 2008 lows. One issue at hand for consumers is higher gas prices, which is eating away at income. Further gains in spending will be unsustainable at current income growth rates and the low savings rate. This could present a headwind without an easing of gas prices to offset modest income gains.
Lastly, we have the upcoming US election. Some issues that will have to be discussed (even though politicians are trying to not address them), are expirations of the Bush tax cuts, temporary payroll tax cut and extended unemployment pay. We also at some point are going to need to discuss the deficit and what is going on with social security. Globally, we will also see new leaders as elections are being held in several different countries including France, Greece and China.
US Equities: Unlike most foreign markets, US stocks maintained their momentum through March and finished the quarter up nearly 13% (Bloomberg). The Market’s surge was a big surprise throughout the quarter, as neither the S&P 500 nor the Dow Jones Industrial Average experienced a negative 1% day until March. This phenomenon has only occurred three times in the past 50 years (Bespoke Investment Group).
First quarter returns were fairly balanced in regards to large, small, and mid cap stocks performed within 50 bps of one another. Microcaps were the exception, as that market segment outperformed large caps by approximately 240 bps. Microcaps are bouncing back from a near double-digit drawdown in 2011. We saw growth stocks outperform their value counterparts. This is a continuation of trends seen not only in 2011, but for most of the past five years. Evidence of this trend was apparent at the sector level, where technology and consumer discretionary stocks – both heavy growth index components – performed exceedingly well. If not for the strong rebound in financials, the performance disparity would have been even larger.
When looking at some of the performance of the stocks in the first quarter, I would like to highlight Apple, now the world’s largest company at a $582 billion market cap. The stock finished 2011 up nearly 26% and then rallied an additional 48% in the first quarter. In the process, shares plowed through the $500 mark for the first time in mid-February and then $600 a month later. Barclays Capital has attributed 15% of the S&P 500’s performance so far this year to the single company. So, all of you parents out there – keep buying your kids those iPads and iPhones.
While Apple experienced exceptional performance in both 2011 and 2012 this was not the norm for the rest of the Market. The top two performing individual stocks in the S&P 500 for the 1st quarter 2012 were ranked 487 & 488 for the calendar year in 2011. The top performing individual stock from the S&P 500 Index in 2011 (+101% gain) was ranked #500 out of 500 stocks for the 1st quarter of 2012.
International Equities: International stocks underperformed the US in the first quarter. Japan’s local return of 19% during the quarter was decimated by a declining yen, which has come under pressure from the Bank of Japan’s aggressive efforts in combating deflation.
European stocks were given a modest lift due to euro appreciation in the first quarter, as a locally denominated return of 7.7% increased to 10.8% for US investors. In looking at the different countries performance, it was wide ranging: Spain (-3%) and Portugal (+1.6%) were the weakest performers, while Germany (+21.1%) was among the best. The UK, which alone makes up more than one-third of the European index, had a lackluster return in first quarter following relative outperformance in 2011.
Emerging markets posted the strongest first quarter return above other major global segments, though performance reversed in March. The Europe, Middle East, and Africa (EMEA) region was strongest, posting a 16% return, followed by Latin America (+14.7%), and then Asia (+13.4%). The top performing global countries were from the EMEA region, including Egypt, Turkey, and Hungary – all 20%+ performers. Unfortunately, the combined market cap of these countries only makes up roughly 2% of the broad emerging markets index.
China held back emerging market returns both directly and indirectly in first quarter, as the country’s 9.9% return lagged most other countries and concern about a slowing growth weighed on investor psyches. This was most evident in March, when China was the worst performing country in the global index with a 7% loss.
As we move into the 2nd quarter and beyond, the question is, “Where do we go from here?” This is a very interesting time in that while things look good, very good actually, there are many “eyebrow raisers” on the horizon. Historically in years where there is a Presidential election, the Market is flat until the election and then goes up regardless of the outcome. Many of the things that were predicted for 2012 did not materialize in the first quarter; however, the second quarter is already showing some signs of volatility.
The last item I would like to point out is that if you maintained your account during the “Great Recession”, then you should see that your account has fully recovered. The S&P 500 from 2/28/09 through 3/31/12 has gained +104.5%. This is the time to consider your allocation risk. If your allocation is too aggressive, now is the time to make a change when you are sitting on top of the mountain, not when you are at the bottom looking up. While you may still be years away from retirement, we are all four years older than when the Market last peaked and thus four years closer to retirement.
Lastly, and with the above in mind, if you have not reviewed your account in a while, now would be an ideal time to do so. I wish everyone a very happy spring, and if we can be of any assistance, please do not hesitate to contact me directly at (216) 595-0700.