Don’t Panic

As of the close of business yesterday, the Dow Jones Industrial Average was down 1,136 points, or 6.8%, since the end of 2013. The venerable average was down 5.3% in January, which lead many seers to warn that the market would therefore be down for the full year. I’m here to disagree with that sentiment. I believe that this is simply a long overdue correction in a bull market that began in March 2009 and remains in place today.

Quite simply, the fundamentals underpinning this bull market remain in place. Corporate balance sheets remain pristine and profits continue to grow. The Federal Reserve remains committed to keeping interest rates artificially low and will inject liquidity into the system at the first sign of danger. Congress has already passed a budget deal and is likely to approve an amendment to the debt ceiling without a protracted fight. And finally, the economy continues to grow, albeit at a somewhat modest pace. All of this suggests that the stock market should again move higher.

Keep in mind that there are relatively few alternatives to an intelligently constructed stock portfolio when it comes to saving for your future. Interest rates at the bank are actually negative when viewed after taxes and inflation. Government debt is not much better. Corporate debt generally has positive yields, but you’d have to extend the maturities too far into the future to reap any reasonable yields, and in doing so you would incur significant interest rate risk. On the other hand, there are many solid, blue-chip stocks that pay annual dividends of 3% or better and are increasing those payments at rates far better than inflation. Good examples include Pfizer (PFE), Verizon (VZ), Proctor and Gamble (PG) and Chevron (CVX). [Disclosure: All four stocks are among the Top 25 positions held by Werlinich Asset Management] And while you enjoy those dividends, you also have the possibility of long-term capital growth.

For example, defense giant Lockheed Martin (LMT) pays a dividend that yields 3.5% at the current price. And the stock has tripled over the past ten years, which represents an average annual growth of about 12% per year for the past decade. While there is no guarantee the stock will continue that rate of growth for the next ten years, if it only grows at half that rate, the stock could double over the next decade, not including the dividend payments. What bond can give you the same growth potential? [Disclosure: LMT is the 3rd largest position held by Werlinich Asset Management.]

When looked at through a longer term prism, an intelligently managed stock market portfolio remains the best option available in order to save and invest for long-term growth and future financial security. 

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Market Achieves Record Levels

About an hour into trading today, the S&P 500 and the Dow Jones Industrial Average have both surpassed previous all time highs and achieved significant milestones. As I write this around 10:30am, the DJIA is at 15,003, marking the first time in history the venerable index has reached that level. Similarly, the S&P 500 is at 1,616, the first time that index has ever been over 1,600. And the Dow Jones Transportation Average is only 7 points below its high. Should the DJTA move to record levels concurrent with the DJIA then we’ll have a bullish confirmation according to Dow Theory. This is all great news.

Yet surprisingly, given these lofty levels, the overall enthusiasm seems relatively muted. There are no fireworks, no parties on the floor of the stock exchange and relatively muted commentary on CNBC. I think that’s a good thing. It suggests that this in not a period of “irrational exuberance”, like 1999. Corporate balance sheets and earnings are in much better shape than in 1999 or 2008 and the global economy continues to be propped up by central bankers. So as long as the money continues to flow unabated, the good times should continue.

That being said, it appears to me that market sentiment remains relatively bearish, or at best very overly cautious, despite the record levels. I think too many individual investors have remained on the sidelines since the crash in ’08, missing out on this stupendous rally. Also, the plethora of contradictory economic news, both in the US and around the world, has left market participants confused and scared. It seems as though every day one economic statistic reveals a slowing economy while another suggests that everything is more robust than expected. Earlier this week the PMI data indicated that the manufacturing sector was slowing. Comments by the Federal Reserve seemed to confirm that thesis. Yet today it’s all wine and roses after the BLS released a stronger than expected employment report. More jobs were added than expected in April, and February and March were revised higher. Additionally the unemployment rate dropped to 7.5%, the lowest level since the crisis began.

It’s possible that since the DJIA and S&P have now breached important psychological barriers that the rally will really take hold as cash begins to move from the sidelines and investors and money managers who have under-performed the market rush to add equity positions. If that is the case, the broad market could move markedly higher from here, dispelling the old adage to “sell in May and go away”.

Conversely, these lofty levels could spur some investors to take some profits and wait for the inevitable correction. We’ve already had a great year after only four months. I certainly would have signed up for a 12% return for the year. If this momentum continues, we could be looking at 20%+ returns for the year. Only time will tell as there is still a long way to go before the story of the market for the year is fully written. Personally, my clients and  I remain almost fully invested, but we’re selling weaker holdings into the rally to raise some cash for the next buying opportunity.

Solid earnings

Lots of big earnings announcements today. DuPont (DD) beat expectations but offered cautious guidance, thanks to Europe (a theme that will follow through many earnings announcements). AT&T (T) also beat expectations. Lockheed Martin (LMT) beat expectations and raised FY guidance but offered cautious outlook thanks to looming spending cuts. Texas Instruments (TXN) beat estimates but offered very weak guidance. UPS (UPS) misses estimates and lowered guidance. Overall, a pretty good day, showing US corporations, by and large, are going better than expected. Apple (AAPL) announces after the bell.

Monday news

Lot’s of news today centered around Chinese M&A and earnings. The Chinese are taking advantage of lower prices to pick up some companies on the cheap. The big earnings story was that McDonald’s (MCD) had their first quarterly miss since 2005. Looking deeper it appears the majority of the problem was simply the strong dollar hurting their F/X conversions. Not a big deal to me. The bigger problem is Spain, and the rest of the PIIGS. It seems like there is indeed going to be a big default coming- no surprise there. Anybody paying attention knows there will be MASSIVE defaults in the Euro zone; it’s just a question of when and how big. Interestingly, the market has recovered almost half the early losses, with an hour and a half before the close. Fun way to start the week.