Market Last Week

In a shortened holiday week, 2012 started off with a bang as the S&P 500 gained 1.6%, the NASDAQ advanced 2.7% % and the Russell 2000 increased by 1.2%. In a reversal of last year’s performance, the S&P Bank index lead the market, gaining 5.6%, while Consumer Staples (one of 2011’s stronger groups) declined 1.0%. The S&P Homebuilders index also posted a strong gain increasing 5.5% for the week as speculators continue to bet on an improving housing market. Global markets were mixed with Greece and China down 4.8% and 1.6% respectively, while Brazil surged 3.3% and India posted a 2.7% gain. Commodity markets were also mixed with the notable outliers being oil and natural gas which gained 3.1% and 2.8% respectively, as fears of an Iran oil supply disruption have spooked investors.

Economic Commentary

In a relatively quiet week, economic news was positively biased both in the US and global market economies. In the US, the December non-farm employment number came in slightly ahead of expectations at 200,000. Private payrolls rose 212,000 in December while average hourly earnings increased 0.2%. The headline unemployment declined to 8.5% due to an increase in jobs combined with a decrease in the labor force. The December ISM Non-Manufacturing number increased from 52.0 to 52.6 reversing a three month declining rate.

Global manufacturing numbers also came in ahead of expectations. The Euro zone December Manufacturing PMI increased 1.5 points to 47.1. The China December Manufacturing PMI increased 1.3 points to 50.3. Keep in mind that a reading above 50 generally is consistent with healthy manufacturing activity. Finally, the India December PMI increased sharply gaining 3.2 points to 54.2. Recent economic data from India has been relatively weak thus investors bid up India shares after a dismal 2011 stock market performance.

Weekly Strategy Thoughts

As of the writing of this letter, the beginning of 2012 looks eerily similar to 2011. On the first day of 2011, the S&P 500 gained 1.1% which was exactly 1.1% higher than the index ended for the entire year! On the first day of 2012, the S&P 500 gained 1.6%. Ironically enough, for the week the S&P ended up with just that first day’s gain of 1.6%. Thus once again, as the New Year begins, investors start off optimistic but that optimism is fragile.

Many of the conditions that haunted the global markets in 2011 are still very much in place today. The US political system is still dysfunctional, the sovereign debt crisis in Europe is still very much intact (just not in the headlines which contributed to the strong December), emerging market economies are still strong but growth rates are decelerating. Finally, US corporate profits are strong but CEO’s are hesitant to either invest (as evidenced by a record $2.2T of cash on corporate balance sheets) or hire new workers (as evidenced by a sub- par jobs recovery.)

One unique difference exists and that is the fact that the yield on the S&P 500, which now stands at 2.1%, is higher than the yield on the 10 year Treasury bond of 2.0% and substantially higher than the yield on the 3 month T-Bill which is just 0.02%. As 2011 progressed and this yield disparity developed, the market rewarded dividend stocks as evidenced by the S&P Utility sector being one of the strongest performers in the index. The market right now is saying “I would rather get a negative real rate of return in the fixed income market than make a bet on the future of the US over the next 10 years.” This condition cannot exist for an extended period of time in our view.

Our Response

As is tradition, Alcoa will kick off earnings season this Tuesday. Based on the number of high profile earnings misses that have already been announced, we would expect a highly volatile EPS reporting season.  Combine the upcoming earnings reporting period with a host of scheduled announcements from Europe and we should expect 2012 to begin much like 2011 acted…volatile.  As such, we remain cautious and plan to react and take advantage of the price volatility that we see on the horizon.

GNCo