Profiting on the Anxiety of Friends.

June 6, 2011

Global equities clawed their way higher last week despite reports of weak economic data and Greek debt issues. Weak U.S. reports sent the dollar lower, even as the Group of Eight said that the "global recovery is gaining strength and becoming self sustained."
U.S. GDP clocked in at 1.8%, below the 2.1% expected by economists. Consumer spending slowed last month as commodity prices went up. New claims for unemployment benefits unexpectedly rose to 424,000 last week.
And the housing market? Well, while the global economy has managed to keep its nose above water, the U.S. housing market has tripped into a double-dip downturn.
Case/Schiller showed that home values fell. Again. Nationally, home prices are back to mid-2002 levels, having fallen 5.1% since this time last year. More importantly, the data reveals that without artificial government stimulus, housing will likely continue to drop.
Why? Econ 101. When supply outstrips demand, prices must fall. And this problem will not soon be resolved.
CoreLogic estimated in March that about 1.8 million homes were more than 90 days delinquent, in foreclosure or bank owned. This "shadow inventory" will soon be added to the 3.9 million homes sitting unsold in April.
The CFO of D.R. Horton, one of the nation's largest homebuilders, recently said that housing will remain a problem in 2012.
Considering all of the above, one might be prone to sell assets and seek refuge. Don't.
My Neighborhood Index tells me that this year could be a barn burner. You may recall the explanation of My Neighborhood Index as being the inverse of a weighted average of my buddy's opinions on the markets. In other words, the index suggests the antithesis of their median opinion.
Also known as the Fire Pit Indicator, my index is telling me that this could be a good year for equities.
Why? My friends are very pessimistic, bordering on abject surliness. All of the opaque economic data, coupled with the market volatility of the last month, has blinded them to the fact that, even with the recent correction, the S&P 500 is up 5.8% this year. The Dow is up 7.5%. And we're not even halfway through the year.
Since 1900, the average annual return for the Dow Jones Industrial Average has been 9.4%. So, not even half-way through the year, and these markets have already achieved 80% of the 110-year average annual return.
Next, consider the current environment. Inflation is low. Interest rates are low. The dollar is dropping. Earnings are up. Corporate credit is improving. The Fed is accommodative. And finally, this happens to be the third year in the presidential cycle.
Historically, these tend to be good years for stocks.
Analysts at Bespoke Investment Group recently considered which other years most closely resemble 2011, running correlation data of the daily closing prices of the S&P through May 20th going back to 1928.
Turns out that of the top-ten years with the highest correlation to the daily price movements of 2011, the five years with the highest correlations, and eight of the top ten from a pure performance standpoint, were all third years of the presidential cycle.
And of these years, the average overall performance from May 20th through December 31st was 8.30%. That would be in addition to what transpired January 1st through May 20th.
Further, 1995 is on that list. That year's political climate was eerily similar to 2011. Both years followed a midterm election featuring Republicans sweeps that forced a Democrat President to migrate to the center.
And in 1995, the second half of the year saw the market return 18.63%.
This may seem like a long road to travel to simply find a bit of solace in the heightened anxieties of friends. It is.
But, once a contrarian, always a contrarian. And, hopefully my friends have wisely chosen their financial counsel. Perhaps he is someone who will meld their anxieties into tactical market moves. Moves that can be used to ease their nerves by gleaning a solid rate of return on invested capital.
Bottom line? This year, as we've said all along, continues to hold promise. The sectors and regions we've targeted for outperformance continue to meet expectations. There will be lots of curves in the road. But we will navigate those together. Stay tuned.

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