Commentary and Articles
1st Quarter 2012 Quarterly Synopsis
“A Measured Approach”
Financial markets breathed a sigh of relief this quarter as several factors that contributed to overall uncertainty in 2011 developed trends of stabilization and improvement. Central banks globally participated in maintaining liquidity in the European credit market, easing market participants' concerns of a default by Greece on its debt obligations and allowing investors to turn their focus toward measures of economic productivity. That attention was met with positive trends in indicators of employment and consumer spending in the US; and signs of stabilization in the housing market. As a result, equity markets posted their highest first quarter returns since 1998, and US Treasury yields increased signaling a reduction in risk-aversion.
Believe it or not, the US economy is close to three years into an expansionary period. Since the economy bottomed in mid-2009, most economic growth has been driven by business rather than consumer spending. Businesses have benefited in this environment partially from having previously cut excess labor capacity during the recession. Corporate profits have been growing rapidly, and profit margins are now at all-time highs. We expect margins to revert towards the long-term historical average, but are more concerned with how far, how long, and most importantly why they will decline?
Taken as a whole, businesses are at or under capacity necessary to support any further increase in demand and must increase head-counts in order to satisfy that demand. If businesses hire at a meaningful level, it is likely that margins, and thus earnings, will come under pressure in the coming months. For overall economic expansion to continue, consumers will have to take the baton and build on top of slowing growth in corporate profitability. Under these circumstances, moderate compression in corporate profit margins should only be viewed negatively by the market if accompanied by a flat or rising unemployment rate.
A headwind to the above scenario is the possibility of an unhealthy level of inflation - a reduction in the purchasing power of the dollar. For various reasons banks are now more than ever the levy that holds inflation at bay through what some may consider punitively conservative lending practices that prevent potential multiplication of the monetary base.
Excess bank reserves have remained at unprecedented highs since 2008. Over the long-term, as banks become healthier in the eyes of regulators and begin lending more and thus introducing new money into the economy, we expect both producer and consumer prices to rise at an increasing rate. The deterioration of purchasing power that inflation causes will only be offset if additional credit extended by banks to businesses and individuals is used to create economic value rather than to fund consumption, as was the case from 2003 through 2007.
The stock market often serves as a leading indicator of GDP, but it is important to note that the market's response is often outsized and short-lived relative to underlying economic conditions. In fact, much of the gain coming out of the recession has been in response to the initial over-reaction of the market to deteriorating economic conditions. Currently, our analysis indicates that the market has caught up to the economy, but has not yet exceeded realistic expectations of performance going forward. That said, the market has been on a razor's edge since late 2007, contributing to increased volatility that pushes prices in wide moves both up and down. In this type of environment, the cost of timing the market comes not only in the form of downside participation, but also in incorrectly timing a re-entry and missing out on substantial gains. For this reason, we consider an adjustment of asset allocation to equities based on fundamental drivers of the market over time rather than current market sentiment alone.
Systematic portfolio rebalancing ensures that gains resulting from significant moves in one area of the portfolio are not lost when the market changes direction, but are instead realized and reinvested into the broader portfolio. An example of this occurred when into the recent run-up in the stock market, a portion of gains in the equity portion of the portfolio were realized, and reinvested into less volatile income-producing assets.
Portfolios benefited this quarter from continued exposure to US and international equities. About 3% of the overall gain in closely-followed large capitalization equity indices was due to a 48% increase in AAPL, which has been a holding in many client portfolios since early 2009. Strong performance in additional Information Technology holdings Accenture (NYSE: ACN), Oracle (NASDAQ: ORCL), was partially offset by Google’s (NASDAQ: GOOG) underperformance relative to peers and the index during the quarter. Additional outperforming sectors for the quarter included the Consumer Discretionary and Healthcare sectors.
We remain cautious in our approach to traditional fixed income vehicles due to historically low interest rates on benchmark US Treasury bonds. We continue to scour corporate and municipal bond inventories for suitable issues that are not over-priced, while also taking advantage of higher yields delivered by oil and gas master limited partnerships.
WHM Capital Advisors is a financial advisory firm providing research, analysis and advice to a diversified global client base that includes institutions, corporations and high net worth individuals. Founded in 2002, the firm’s areas of expertise are in valuation consulting, succession planning, mergers and acquisitions advice and investment management. In addition, the firm has a related technology company that designs applications to analyze complex financial issues for clients.
Contact: WHM Capital Advisors
The Tower at 1301 Gervais St., Suite 1920
P.O. Box 7426, Columbia, SC 29202