June 07, 2012 5:24:09 pm
It’s too tempting to resist, using that old Wall Street cliché of “climbing a wall of worry” to describe the recent behavior of the stock market. Rebounding from a year in which we witnessed an event that many thought could or would never happen—the downgrading of US debt by Standard & Poor’s—we saw the markets jump-start the new year with a vengeance as we experienced the best first quarter since 1998, based on the S&P 500’s return of 12 percent.
No doubt there were many reasons to be anxious as the year turned: European politicians appeared to be gridlocked over how to tackle a tottering mountain of sovereign debt, policymakers in the US seemed to be running short of options, and emerging markets were not providing the cushion that many investors had hoped for. The general view, as expressed in a December 19, 2011 article in Barron’s magazine, was that there would be more muddling through in early 2012. "Buckle up!" warned the respected publication. "For investors frightened by the stock market's volatility in the past six months and tired of worrying about places in Europe once given little thought, 2012 promises scant comfort—at least in the first half."
As an investor, if you had taken that advice, you might be ruing it now, as global equity markets (as measured by the MSCI World Index) have registered their best start to a calendar year in 21 years. The index was up by just over 10 percent in US dollar terms as of the end of February. You have to go all the way back to 1991 to find a better start.
What’s more, much of the leadership for the turnaround is coming from the US, an economy that many observers were writing off just two years ago in favor of the emerging powerhouse economies in Asia. The US benchmark S&P 500 was up by nine percent at the end of February. This is also its best start since 1991 and returns the index to the levels of June 2008, before the Lehman collapse.
Even Europe, the epicenter of concerns for much of the past year, has exploded out of the blocks in 2012. The Euro Stoxx 50 was up by nearly 12 percent over the first two months of the year, with the German market rising by close to 20 percent in US dollar terms.
This renewed buoyancy extended to Asia, where the MSCI Asia Pacific Index has registered 10 consecutive weeks of gains, its longest uninterrupted winning streak since 1988, and powered by strength in energy stocks. Australian stocks have firmed as well, up 12.5 percent year to date in US dollar terms—although in local currency terms, the gain has been less stellar at just over seven percent.
Why the change in mood? There are several catalysts to explain the market turnaround so far in 2012.
First, by the end of last year, market participants were discounting a lot of bad news, including a few catastrophic hypothetical scenarios. Fears of mass defaults in Europe and a possible breakup of the euro were seen as entirely possible.
While Europe can hardly be described as being out of the woods, the agreement by creditors on a new round of official funding for Greece has eased nerves, as has the European Central Bank's provision of another half-trillion euros in cheap funding to financial institutions.
Second, there have been signs of a turnaround in the US economy, at least compared to the view the market was taking a few months ago. At that time, another recession was seen to be in the cards. Since then, data has shown an improvement in the labor market, a rise in manufacturing orders, and a climb in consumer confidence.
Third, central banks are pumping out massive amounts of cheap cash—essentially printing money—to provide liquidity to the financial system and to support the recovery. As well as the ECB's latest cash injection, Japan and Britain have recently extended their so-called "quantitative easing" programs, while China has cut the reserve requirements for its banks.
Of course, just as it was wrong to extrapolate the pessimism of last year into 2012, it would be foolish to forecast that the rest of this year will resemble the first two months in tone. No one knows how markets will perform going forward, because that requires an ability to forecast news. You can always guess, of course, but that's not necessarily a sustainable investment strategy. Or we can look to the past to give us some idea of what we might expect—though past results are no guarantee of future returns, either.
Disclaimers aside, let us review similar periods. According to Yardeni Research, over the last 66 years there were 17 times when each of the first three months of the year posted positive S&P 500 returns like we had this year. The average total yearly return for those 17 years was 20.2 percent, with NONE of those years posting a negative return. I repeat, past results are no indication of future returns, but according to another popular research firm, Ned Davis Research, there have been 11 instances since 1930 where the S&P 500 posted returns above 10 percent in the first quarter and the median return for the next three quarters was 6.95 percent.
After reading this market review, many of you will turn on the TV or go on the internet and the wall of worry will be staring you in the face once again. But please keep in mind how the stock market seems to work. When the future seems bleak, the stock market just seems to climb the wall of worry like an ivy vine, spreading its riches as it climbs.