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April 2012 Investor Letter


Dear Investors,
It’s said that markets are ruled by fear and greed, but for the last several years, there has been much more of one than the other.  Since the S&P 500 peaked in 2007, there have been glimpses of the latter, but the market has mostly been dominated by the former.  For the first time in a long time greed appears to be creeping back into the picture though.  The S&P is up more than 12% for the year, and investors are starting to think about how much money they can make investing in stocks rather than how much they can lose.

This transition is a natural progression in an economic cycle and suggests that despite grim prognostications Americans may not have to adjust to a “new normal” after all.  The bottom of a recession is always marked by extreme despair, and from that point investors must slowly climb a proverbial wall of worry until sentiment flips from pessimism to optimism.  In 2008 it appeared that the US economy could be entering an extended depression.  Since then the economy has healed precisely as cyclical theory predicts it should.  The average economic expansion since World War II lasts 60 months and March was the 33rd month of this one, so we are roughly in the middle of a typical cycle—the perfect time for greed to overtake fear.
We began the year worried about a European collapse and Chinese slowdown, but as the quarter ended, these worries no longer held much sway over US markets.  Even when a negative headline would cross the tape, the markets largely ignored it.  Focus was on a resurgent United States, an economy described as “robust” several times in the most recent ISM survey.  The quarter was so good that there was only one day that the S&P 500 lost 1% or more.  Last year there were 48 such days, and on average since 1957 a 1% decline happens 26 times per year (6 times per quarter).

While I’m not surprised that sentiment improved last quarter, I am extremely surprised by how fast it happened.  Even with an optimistic view, my expectation to start the year was that the S&P 500 might reach 1450 by year-end.  This would represent a 16% gain, which I thought would make stocks slightly overvalued, consistent with this part of the cycle.  At 1420, the S&P 500 is already within 30 points of that level though, which means that either my price target was wrong or the market isn’t going to rise much more between now and the end of the year.  I don’t have any problem if my forecast was wrong (in fact I expect it to be) but while the data has confirmed my initial optimism, it hasn’t exactly exceeded it.  So far I haven’t seen anything that suggests my target needs to be revised higher, which is why I continue to expect a pullback.

I’m constantly on the lookout for reasons why my target might need to be revised though.  April will be an important month to assess the need for revision, as companies will start to report earnings for the first quarter.  If it appears that earnings are on pace to grow faster than expected then it’s possible that the first quarter was just the start of something much bigger for the market.  Conversely, if 1450 is the right target then the market will have to effectively move sideways between now and the end of the year.  With 9 months left in 2012, that’s a long time to go without some sort of hiccup.  As summer approaches seasonality will begin to be a headwind for the market just as expectations may be reaching a near term high.

Scott Krisiloff, CFA
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Comment   |  6 years, 7 months ago from Santa Monica, CA