|Forbes.com, Spring, 2012. This article was written with Oliver Pursche, the Co-Portfolio Manager of GMG Defense Beta Fund. It was part of a series of articles developed under an agreement with forbes.com to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site, forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.|
Vince Lombardi said he never lost a game, he just ran out of time. This kind of logic works in reverse too. That is, relative to the market predictions I made at the close of 2011, I’d like to declare victory and call game over while I’m ahead. To wit:
Prediction 1: The S&P 500 Index will rise by at least 10%. Check.
Prediction 2: Greece will begin official negotiations to exit the euro. Very possible.
Prediction 3: President Obama wins reelection. Ever more likely as Republicans engage in assured mutual destruction and the employment picture improves.
Prediction 4: China will allow the Renminbi (yuan) to rise nearly 8% against the dollar. This has not occurred yet, but is tracking well. Back in December, I said, “China will continue to lower rates in the first half of the year to spur on growth,” which it has occurred. On March 14, it was widely reported in the mainstream press that China has eased lending restrictions at its’ four largest banks. And China has officially stated that they will allow the Renminbi to “float” more.
Prediction 5: The commodity bull-run resumes in 2012. See gas prices. Check. Also see Morningstar Long Only Global Commodity Index, up nearly 6% year-to-date, and more than 6% over the last 13 weeks.
Prediction 6: Europe will spend most of the year in a recession. It’s currently in a mild recession, and few expect it to move into positive growth territory this year.
Predictions 7: The United States will avert recession, with GDP growth below 2%. Recession averted, GDP growth is most likely to be above 2%.
Prediction 8: The 10-Year Treasury bill yield will move towards 3%. The 10-year Treasury rate was 1.97% at the beginning of the year. Now it’s 2.29%. Moving in the right direction.
Prediction 9: Brazil’s stock market, one of the worst performers in 2011, is going to be one of the best performers in 2012. Check. With a YTD return of approximately 20%, the Bovespa is one of the world’s top performers among the G20 nations.
Prediction 10: More shoes will drop in 2012. It’s still early.
All this being said, the big question on investors minds should be whether or not the upcoming earnings season will derail the market.
There’s plenty of good news to be sure: U.S. economic data continues to impress, the European debt crisis continues to abate, and the turmoil in the middle east has assumed the unarresting character of the status quo rather than an actual crisis.
But markets are forward looking: they barely care what is happening, and definitely don’t care what has happened. And that’s where there could be trouble and the potential for a repeat of 2011’s summer sell-off and market volatility.
Specifically, earnings have progressively weakened–ever so slightly–over the last three quarters. Fourth quarter 2011 earnings (announced in January and February of this year) were their weakest since the market crisis of 2008. Within the S&P 500, only 62% of companies beat earnings per share (EPS) estimates, and only 57% beat revenue estimates–roughly 10% less than the “beats” for the same quarter a year ago. More importantly, earnings estimates for 2012 are compressing with the consensus estimate (based on Bloomberg data) of 10.4% growth in 2012, versus 11.7% growth for 2011.
No one has a crystal ball, but investors can pick up the scent of trouble early if they are paying attention. Specifically, look at the so-called “pre-announcement” activity at the end of March and the beginning of April. Typically, companies begin to “pre-announce” (often poor) earnings at the close of a quarter to get bad news out of the way during market rallies. In late December and early January, a historically high 52% of companies that pre-announced earnings, warned of disappointments.
I recommend getting paying close attention to pre-announcements, and if you sense trouble take defensive measures.
Here are some ideas on sectors and companies I think could outperform the broader market in up, down and sideways conditions.
Retail stocks. In particular look at those catering to high- and low-end consumers. Dollar Tree Stores (DLTR) and Tiffany (TIF) are two perennial favorites (we own DLTR).
Utilities. They’ve underperformed so far this year, but the strong dividend and steady business could make these stocks appealing to investors in more troubling times. Entergy (ETR) and Exelon (EXC) are utility companies among our holdings.
Big pharma. Pick ones with good growth and good dividends and you’re unlikely to go wrong as consumers jettison discretionary spending for necessities. Abbott Laboratories (ABT) immediately comes to mind and is one of our top holdings.