1-25-2013 Update

The S&P 500 Index is up approximately 4% year to date, having reached a 5-year high.  Global equities also did well, lifted by China’s GDP of 7.9% in the fourth quarter. Also, industrial output and retail sales continue to accelerate. The strength of U.S. holiday retail sales suggest that the fiscal cliff — and the risk of higher taxes — did not deter consumers. December retail sales were up 0.5%, ahead of the 0.2% forecast. Consumer and Business health is improving

Deleveraging continues for households, albeit at a slower pace as we are starting to see consumers starting to spend more of their income which will help sustain economic growth.  Household net worth has returned to its pre-Lehman peak from 2008

  • Debt service burdens are at the lowest in 20 years (peaked at 14.1% in 2007 and is now 10.4%)
  • Debt-to-income levels have improved and should continue to support consumer spending in 2013
  • Home prices are rising again (inventories for new and existing homes are down and should lead to rising prices)

In the business sector, companies are well-positioned to ramp up capital expenditures once fiscal policy uncertainty is lifted. With an estimated $2 trillion in extra cash on balance sheets, low interest rates, and last year’s spending hiatus, pent up demand should accelerate capital spending. There has been an influx of high-profile global capital goods companies investing in the U.S. as a result of a bullish U.S. energy outlook.  This is positive for U.S. manufacturing, as an alternative to rising foreign wages, trade restrictions and supply chain disruptions.

As earnings reporting season is underway, we are seeing a small positive surprise overall.  Net inflows into equities finally have started to rise in January 2013 after years of outflows to bond funds. The huge valuation gap between stocks and bonds has started to get more attention and will continue if the global economy improves and bond returns begin to disappoint. The gradual rise in long term interest rates that should start as the macro economic data continues to strengthen will likely set the stage for a significant reversal in fund flows.

A Potential Path Forward Emerges in D.C. seems to be emerging

Following brutal negotiations over the fiscal cliff, the House approved a bill this Wednesday to suspend the nation’s $16.4 trillion debt ceiling through May 18 to avert a U.S. default on its legal obligations and buy Washington more time to negotiate budget priorities.  This three month extension was welcomed by Senate Democrats and Obama said he will sign it when it reaches his desk.  This bill includes a provision that requires the House and Senate to pass respective budgets by April 15th (something the Senate has not done since 2009) or the salaries for the lawmakers in their chamber will be held in escrow until a budget is passed.   Congress must also deal with a March 1st deadline when across the board spending cuts kick in after being initially delayed in the year-end “fiscal cliff” deal.   Current funding for the federal government is projected to run out on March 27th.

Fundamentals Should Drive Decisions

Many clients have asked us what our plan is for the uncertainty that will build leading up to the Washington debt ceiling showdown.  You probably already know our answer… Trying to time short term volatility is impossible.  We have seen the same scenario already with all the political drama.  So we recommend investors stay disciplined with their asset allocations and be prepared to ride out any short term storms that may result from the impending political circus.  This decision is based on our positive outlook for the economy and excellent valuations for stocks.  The Federal Reserve will remain in expansionary mode until unemployment improves.  Outside the U.S., central banks are putting the pedal to the metal, particularly in Japan. The positive correlation between stocks and weakness in the yen suggests that U.S. equities may benefit. We believe profit growth could pick back up later in the year due to increased sales overseas.

Earnings this week

This was a very active week from an earnings release standpoint.  Some highlights of the week include:

IBM exceeded analyst expectations and raised its profit forecast as a result of the company’s strategic shift towards focusing on their software divisions.  Johnson & Johnson (JNJ) missed analyst estimates, but hinted that they may try to sell or spin-off its diagnostics unit for blood and cholesterol tests.   McDonald’s (MCD) profits rose more than expected on higher dollar menu sales and help from seasonal items like the McRib sandwich.  3M (MMM) is hitting all-time highs after it announced its Asia Pacific sales are picking up in the region.  AT&T (T) narrowly missed analyst EPS estimates, but rose when the company increased its sales forecast for 2013.  Microsoft (MSFT) beat analyst expectations even after spending more than anticipated on marketing for the new Windows 8.  Procter & Gamble (PG) rose after beating analyst estimates and raising its 2013 earnings forecast.  Apple Inc. (AAPL) exceeded analyst EPS estimates but fell sharply on slowing growth.