YOUR INVESTMENTS| May 1, 2014
Dear Friends and Clients, The stock market has traded mostly sideways this year but both the Dow and the S&P 500 hit new highs during April. One would have expected it to trade lower after a 32% gain in the S&P 500 last year. The fact that it has not pulled back significantly speaks to the underlying strength of the market. The Nasdaq is slightly down for the year, but 12 stocks accounted for its entire decline during March. Not exactly a broad sell-off. There has been a rotation out of the momentum/growth stocks that did so well last year to more value-oriented stocks like Utilities and other defensive dividend paying sectors. Whether value/dividend stocks will outperform momentum/growth for the balance of the year remains to be seen. We have adjusted our portfolios accordingly. While there are always reasons to worry about the market, there are also several reasons for the continuing market strength. We will discuss both below and give you our outlook.
IN THIS ISSUE
How Are We Doing? Factors Moving The Markets Summary
How Are We Doing? The Dow has not fallen in April since 2005. This year did not disappoint. However, we have had eight weeks of Up/Down - Up/Down price movement. This is the first time in seven years that we have seen that. This kind of market makes investors nervous, so let's look at some facts in this section and below. There seems to be a floor under the market that has prevented any healthy correction after such a long up market. As of April 30th, the S&P500 is less than 1% below its all time high, the Nasdaq is down the most at only 5.6% below its recent high and the Dow is at an all time high. The debate among institutional investors is not whether to be In or Out of the market - it is whether to be in Growth Stocks or Value Stocks! The three month chart below illustrates the rotation out of Growth stocks (represented by the Nasdaq) which, unlike last year, are underperforming. It also shows that the S&P 500 (representing more value stocks) is outperforming. Our models are all up and our performance is between the two extremes since we maintain a more balanced portfolio.
The key to managing money is to objectively try to stay in-sync with the market when it is in an uptrend and try to avoid big losses in a down trend. Since the first of 2014, we have reduced our weighting in growth stocks and added more value stocks. We have included below a chart of our equity model performance compared to the S&P500 and the Nasdaq since 12/31/2000. You can see the long-term results of this process.
401(k) Models are managed differently at times. Please see your plan Investment Performance Summary or login to your account for current performance.
Bond yields have dropped since the first of the year, pushing up the value of bonds (not shown on charts), but over the last twelve month period as a whole, bonds have underperformed equities. We look for equities to outperform bonds going forward - in spite of their underperformance during 2014 so far.
Factors Moving The Markets U.S. ECONOMIC OUTLOOK Last month we said, "The crucial issue for the stock market is whether we see the economy accelerate during the second half. If the U.S. gains momentum during April (as is expected), we should see the stock market push higher." The U.S. is gaining momentum. Let's look at corporate earnings for a clue as to what the U.S. economy and the stock market should do this year. We have stated several times over the last few years that the two can move in opposite directions - but not for very long. Right now we see corporate earnings and sales giving us a look at where both are going. In the Bloomberg chart below, we illustrate the results of the companies of the Russell 1000 that have reported 1st quarter earnings. It is quite illuminating. We chose the Russell 1000 because it represents the largest 1000 U.S. companies. We feel that it is a good representation of the U.S. non-farm economy. Notice on the "All Securities" row that 636 of the 1011 companies in the index have earnings growth of 5.54% over last year. The significant thing is that three months ago, it was predicted to be almost zero because of the harsh winter we experienced. Notice also that Sales Growth was 3.08%, which is up from prior quarters. In prior quarters, companies were growing profits without growing sales. That was good for pushing up stock prices (higher earning = higher stock prices) but not good for the economy because no sales increases means no new jobs being created. With 3.08% increased production from our largest companies during a quarter held back by tough weather, it is an indication that the U.S. is back on the growth path!
Just in the last couple of days, we have had a number of encouraging economic reports: • • • • • • • •
ADP said the U.S. economy had added 220,000 private sector jobs in April, ahead of forecasts. The jobs data provide strong evidence that weak GDP in the first quarter did not lead to a collapse in growth. Consumer spending surged in March by the most in five years - a sign that the economy is gaining momentum going into the second quarter. Household purchases, which account for about 70% of the economy, climbed by 0.9% for the month, the most since August 2009, after a 0.5% gain in February. Incomes climbed 0.5% in March, the most since August and exceeding the Median Bloomberg forecast. Consumer spending adjusted for inflation increased 0.7%, also the most since August 2009. Spending on durable goods surged 2.7% after adjusting for inflation, the biggest gain in four years, following a 1.3% increase in February. The Fed said "Growth in economic activity has picked up recently, after having slowed sharply". They said the economy is gaining momentum as consumers spend more - even as the Fed is cutting back on economic stimulation. The PMI (Purchasing Managers Index) and the ISM (Institute of Supply Management) both reported strong numbers this morning for the month of April.
ON THE NEGATIVE SIDE • • • •
Economic stimulation from the FED in the form of Quantitative Easing is shrinking. The Ukraine crisis is likely pushing energy prices higher. The housing recovery is slowing (although home prices have climbed over 11% nationwide over the last year). The "Sell in May" hysteria is here again. Just remember that over the last 20 years, 65% of the time the market was up in May by an average of 1%.
CONCLUSION As we stated last month, we do not expect a stellar market growth year in 2014 like we had in 2013. Neither do we expect the market to decline. We expect modest market growth while the economy gains momentum. Those gains will not come without increased volatility. Don't let the market shake you out. Last year was a record year for corporate capital investment and expansion. This year it is accelerating! More cash means more growth, purchases of other companies, bigger dividends, and more stock buy-backs. All of these are good for the stock market.
Summary Remember that while the summer months starting in May are usually weaker than Fall and Winter, they are still positive on average. Summer usually brings volatility but our job is to stick to our process. The market will tell us what to do. Grantland Rice, the famous sports writer, once said: "The race is not always won by the swiftest, nor the contest by the strongest, but that is the way to bet". Those of us in the
investment business do not have the luxury of dealing in certainty, so continuous assessment of the objective measures of the probabilities must remain the guiding principal in all our investment decisions. And finally - on a lighter note - we quote the famous philosopher and baseball player Yogi Berra: "A nickel ain't worth a dime anymore". We remain positive on the markets. To your financial success,
Lane & Marty Kerns
Important Disclosures Past Performance is not a guarantee of future results. Current performance may be lower or higher than the performance quoted. Kerns Capital Management, Inc. ("KCM") Model performance figures, unless otherwise described, represent a composite of all individual portfolios managed in accordance with the investment category, are after the deduction of KCM's actual management fee, and include reinvestment of dividends and earnings. The composites contain accounts structured with mutual funds that are managed with a view toward capital appreciation. Standard Deviation and Alpha are calculated monthly and then annualized to be consistent with Morningstar速. The S&P 500 Index is an unmanaged composite of 500 common stocks. This index is widely used by professional investors as a performance benchmark. You cannot invest directly in an index. The Dow Jones Industrial Average is a price-weighted average of 30 of the largest and most widely held stocks traded on the New York Stock Exchange and the Nasdaq.