The Standard & Poor’s 500 closed the first quarter of 2013 at a record all-time high and returned in a single quarter the kind of gains Wall Street bulls hope to get in an entire year.
For the three-month period ended March 31, 2013, the S&P 500 with dividends reinvested showed a total return of 11%.
That’s especially good considering fears that the economy would be weakened by a triple-threat: the federal tax hike that became effective January 1, an $85 billion slash in federal spending, and the Cyprus economic crisis.
Examining a quarter’s results is entertaining, especially when you have a good quarter. But longer time periods are what really matters to long-term investors, like retirees and pre-retirees.
In the 12 month period that ended on March 31, 2013, the S&P 500 showed a total return of 13.9%.
And the strong one-year performance in large-cap U.S. stocks is part of longer bull market.
The U.S. stock market has launched a broad rally that has carried stocks higher since the financial crisis of 2008.
The five-year chart of the total return on the S&P 500 index gives you a much more revealing look at the current stock market.
In 2008, stocks peaked and began a plunge likely to be remembered for many decades, a descent not experienced by American investors since the dark days that began The Great Depression of the 1930s.
However, the S&P 500, a benchmark of America’s largest publicly-held companies, has roared back over the past four years. The gains have come haltingly, and the comeback has been hard to believe in. Many investors were scared away from stocks by depth of losses in 2008 and 2009 have totally missed out on the comeback, an astounding 100%-plus gain in the large-cap stocks in the S&P 500 over the past four years.
By the first quarter of 2013, the stock prices of companies in the S&P 500 had not only fully recovered back to the highs achieved before financial crisis but they had sustained a rally taking investors beyond their pre-crisis highs. Over the five-year period ended March 31, 2013—from peak-to-trough-to-peak—the S&P 500 stocks showed a total return of 32.7%.
Of course, U.S. large-cap stocks in the Standard & Poor’s 500 represent just a single style in one of many asset classes in a diversified portfolio.
So it’s important to examine investment performance across a wide range of styles and asset classes to judge how broadly diversified stock portfolios are performing.
Looking at how foreign markets versus U.S. stocks shows how much better the returns were for U.S. stock markets over the past five years than markets in other regions of the world.
In the five years that ended March 31, 2013, U.S. stocks handily outperformed major indices benchmarking stocks in Asia, China, the Eurozone, and emerging nations.
Interestingly, over that same five-year period, the U.S. blue-chips that dominate the S&P 500 index (on a price-only basis not including dividends) gained just less than 20% while U.S. Small Caps and U.S. Mid-Caps showed much stronger gains.
Not only have U.S. Small and Mid-Cap stocks, which historically are more volatile than large-cap blue-chips in the S&P 500 index, shown much stronger returns over the five-year period than the S&P 500 but they have clobbered the returns on stocks from all of the major regions around the world.
In the most recent quarterly period, that longer-term trend continued to hold up, although Asia stocks (excluding China) turned in strong quarterly gains and the Eurozone eked out a positive return.
Comparing U.S. stock market returns by style, in Q1 2013 mid-cap value was the leader and large-cap growth was the laggard. However, over the trailing five-year period, the small- and mid-cap growth styles were the clear winners.
The five-year performance numbers show why diversification and rebalancing are so important to investors and how easy it can be to miss out on profits by not adhering to a strategic policy maintaining broadly diversified positions in stocks. Growth stocks have much stronger profits than value shares over the five years ended March 31, 2013. While value stocks fare better than growth shares during many periods, no one ever knows exactly when investors will start to favor growth companies and drive up their stock prices.
With the large-cap value companies returning just 7% in the five years versus 32.1% return on the large-cap growth companies in the S&P 500, it may or may not be time for value stocks to catch up. No one can call turns in the market or in the styles and asset classes that will be in favor next or lose value. The best way to manage the uncertainty is to avoid big bets in any one area and adjust positions periodically to keep your portfolio in balance and aligned with your tolerance for risk.
Analyzing U.S. stock market returns by industry sectors shows a wide dispersion in Q1 2013 returns, with health care, consumer staples, consumer discretionary and utilities shares on top and technology and industrial materials on the bottom.
What’s perhaps most interesting is that Wall Street’s “top” strategists panned utilities, telecom, and the consumer stocks coming into 2013, and they have performed best. Moreover, the top strategists from Wall Street’s largest firms picked technology stocks to outperform this year, but tech stocks were near the bottom of the list when the first quarter ended. (The strategists made their sector picks in a Barron’s cover story published December 17, 2012.)
Of course, a lot can change during the rest of 2013. But this would not be the first time the “experts” on Wall Street have been wrong. Wall Street’s gurus, as a group, have been remarkably consistent in making bad sector calls year after year, though it’s not highly publicized. Looking back on the Barron’s annual “Outlook” cover story featuring Wall Street’s top strategists published every December since 2005 provides strong evidence of just how wrong the most popular forecasters have been.
Predictions about the future of the investment markets usually make a good read. The mantra of “asset allocation, diversification and rebalancing” is boring in comparison. That’s one of the reasons why investors have so much trouble taking the path less adventurous. Taking a flyer on a sector and acting on a recommendation that sounds good at the moment is much easier than planning strategically. It’s much easier than imposing a discipline and adhering to a sensible long-term investment policy year after year through all types of events. So it’s not surprising that during the 2008 financial crisis so many investors gave up their discipline and sold into the weakness.
However, the wrenching losses of that period have been erased for investors who stuck with their long-term plan, who did not try to time the market, and who remained committed to investment policies established in “normal” times and not reformulated a long-term plan in the midst of a global financial crisis.
The five-year returns on the Standard and Poor’s 500 industry sectors hold a lesson for investors. A widely accepted narrative in the aftermath of the financial crisis of 2008 was that consumer discretionary spending couldn’t possibly rebound given the persistently high unemployment and mountain of household debt facing consumers. But the American consumer has proven far more resilient than most analysts ever expected. In fact, rather than languishing, the Consumer Discretionary sector index has been the best-performer of the 10 S&P 500 industry indexes over the past five years, and by a wide margin. Meanwhile, technology stocks, the perennial favorite among Wall Street strategists, have been a consistent laggard.
Examining a broad set of asset classes represented by exchange traded funds and indexes shows that gold has truly shined over the five years ended March 31, 2013. Keep in mind, this five year period encompassed the stock market financial-crisis plunge as well as its comeback since The Great Recession. This was an unusual five-year period by historical standards.
It is unlikely that the next five years will look anything like the past five years. So you can’t simply extrapolate from the last five years to determine which assets classes will be best over the coming five years.
One thing we do know: investors bid up gold prices over the last five years because the world economy nearly came undone. Commerce between nations could have seized up quickly because financial institutions lost confidence in one another and feared they would not get paid. Fear drove gold prices up.
In addition, as the Fed pursued an easy monetary policy and liquefied the economy to keep interest rates low and encourage economic activity, many investors began to worry about inflation. That also drove gold prices up.
Neither inflation nor economic collapse materialized, and the world economy is more stable than it was five years ago.
Risks remain, however. The European banking crisis, saber rattling with Korea, a reversal of the growth in China and any number of other possibilities that no one could imagine could cause another collapse. But as more time passes since the dark days of 2008 and 2009, investors are returning to normalcy, regaining confidence, and returning to some of their old financial habits.
As an example of how unexpected events and trends influence markets, consider the narrative around consumer spending. Consumer spending was by expected to remain weak for years after The Great Recession of 2008.
But look at what’s happened: Consumers have paid down their debts and household balance sheets are as strong as they’ve been since the early 1980s, according to data from the Federal Reserve through December 31, 2012 (and released March 13, 2013.
Comparing consumers’ monthly flow of income to their fixed recurring monthly expenses, including debt service, shows that consumers’ ability to cover their monthly “nut” has seldom been better.
The Federal Reserve’s financial obligation ratio measures consumers’ fixed expenses compared to disposable income. It’s good measure of consumers’ ability to make discretionary expenditures because it includes all of consumers’ fixed recurring monthly expenditures such as payments on mortgages, credit cards, car loans, and other debts that hinder consumer spending. It has fully recovered and, at 15.5%, means that households have 84.5% of after-tax income available for discretionary spending.
Consumer spending, which accounts for 70% of U.S. economic activity and is the main driver of the economy, underpins the recovery and is a strong positive underpinning for stocks.
While there is much good news about the economy, the rise in stocks has led to flood of predictions in the press warning investors that could are due for a fall. Indeed, a correction is possible. However, no one really knows if or when it will happen.
Economist Fritz Meyer, an independent source of economic analysis, looked back on the forecasts made in the Barron’s annual forecast by Wall Street’s “top” market strategists, and the results are shown in this chart. For example, in December 2012, when the S&P 500 traded at 1426, the analysts in Barron’s predicted the index would close 2013 at 1562. It closed the first quarter of 2013 higher than what the experts had predicted for the entire year!
Looking back on the predictions of the strategists since the first Barron’s forecast in December 2005 shows that the forecasts are not too far off the mark in times of normal growth in the economy. However, strategists are blindsided by turns in the economy. For example, in December 2007, analysts predicted the S&P 500 would close the year by rising to 1640, but the market plunged more than 40% in value.
If consumer spending holds up and the economy continues to grow, then corporate earnings are likely to continue on their current trajectory. And corporate earnings are the single most important determinant of stock prices.
The consensus forecasts of Wall Street analysts for earnings on the S&P 500 stock index, as of March 21, 2013, was for $112 per share in 2013 and $125 per share. That kind of earnings growth, which seems reasonable given the strength of the economy, could propel the stocks in the S&P 500 in 2013 and 2014 to follow the trajectory shown in the square markers in red.
Crisis in Europe has not derailed the American economy, the nuclear threat from North Korea has not caused a stock plunge, and the social and political upheaval in the Mideast has not undone the market’s steady rise.
hose factors could change and stocks could fall. But the underlying factors that could push U.S. stocks higher were positive signs as of the end of the first quarter of 2013.
Outside of the U.S., global leading economic indicators continued to pick up through Q1 2013, even in Europe. The IMF’s January global economic forecast shows gradually accelerating economic growth around the globe through 2014. Important to this picture is the shallow recession expected to persist in Europe through 2013 notwithstanding their fiscal challenges, and despite the basket case, Cyprus.
The U.S. economic outlook as measured by gross domestic product is derived from a monthly survey in The Wall Street Journal of 50 top economists. In the March survey, the consensus view of economists was for gradual acceleration of economic growth through the rest of 2013, even after the weak, fiscal-cliff-impacted final quarter of 2012. Economists warned of rising interest rates because of the economic expansion in the quarters ahead.