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August 2012 Investor Letter

Dear Investors,

Last month the S&P 500 was up by 1.26% and the stock market is almost back to its 2012 highs after a big rally to begin August. Currently the S&P 500 index is just below the 1400 level, which is only 20 points lower than it was before prices began their usual summer swoon. On paper, it has been a good year for equities, but the mood surrounding the market certainly doesn’t reflect the numbers. Most investors remain downbeat.

One reason that the mood is negative is that even though the S&P 500 is up 10% year to date, much of this gain is relative to a generous starting point. The S&P 500 began the year 9% below its highest level from 2011, and so most of this year’s gains have served to recover lost ground from last year. When people look at their account statements it doesn’t feel like anyone has made a whole lot of progress, because compared to this time last year, the index has only risen modestly.


Another part of the negative mood can be attributed to the fact that rising indices are masking some troubling underlying trends in individual securities. July was a brutal month for many stocks that reported earnings. Small earnings misses were penalized with huge declines in market value, while earnings beats didn’t seem to be met with huge increases. This pattern along with ongoing weak market volume suggests that some segments of the market have “gone bid-less” meaning that when sellers are looking to exit a position there just aren’t enough buyers to accommodate them at the prevailing market price. Mutual fund flow data continues to confirm that more individual investors are exiting the equity markets than entering them.

For the indices to be rising, of course there have to be some segments of the market that are doing well though. Prices have been rising in larger, blue chip, more “defensive” names as investors look to avoid volatility. Since these companies tend to be larger, they have an outsized weighting in the indices and thus buoy the index value. However, many of these companies are less likely to be held in an actively managed equity portfolio and so many mangers are watching a much different market than the indexes are implying. CNBC reported this morning that only 13% of active managers are actually outperforming so far this year. This has increased the overall level of skittishness in the market, which can lead to exaggerated moves, both up and down.

Because we are extremely price sensitive investors, the market movement has left us in an interesting position. On the one hand declines in individual stocks have led to some excellent bargains. But on the other, the indices are returning to levels at which I’m not as comfortable committing a larger portion of our cash. As I’ve written before, I think it makes sense to end 2012 somewhere around 1450 on the S&P 500. If anything, July’s data makes me more inclined to think the target should be lower, not higher. Given what I see as an increasingly difficult environment, I took the opportunities created by the market to sell some of our positions and raise extra cash in our portfolios. Especially as the Presidential election begins to come into greater focus, the months ahead could be a bumpy ride.

Scott Krisiloff, CFA

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Comment   |  6 years, 8 months ago from Santa Monica, CA