Dion Money Management Blog   Money Management for Retirees and Their Families

The “stock market” appears to want a rally. Of course, the market is just an aggregation of the millions of investors and traders who make buy and sell decisions every day. These market participants have, on average, become extremely short-term focused, but while this resulted in a panic drop last fall, it is now producing a surprisingly resilient market. Exports plunging 30 percent in Asian countries was cause for a sell-off, but the S&P 500 Index spent the better part of January bouncing between 825 and 850.

Jobs data out this morning was grounds for another sell-off, but again shares marched higher. The jobless rate in America rose to 7.6 percent as nearly 600,000 jobs were eliminated in January, consistent with the previous two months. As the Bureau of Labor Statistics pointed out, 3.6 million jobs have been lost since December 2007, but nearly half came in the previous three months. The U.S. is on pace for a loss of 7 million jobs in 2009, enough to lift the unemployment rate to around 12 percent.

The implications for the retail, consumer goods, consumer service, and housing sectors are going unexplored today, however, as investors look forward to a stimulus package and to the bank bailout details due Monday from the Obama administration. Shares of financials spiked higher today, with Bank of America up more than 22 percent in morning trading and Citigroup up 10 percent.

On January 28, the S&P 500 Index closed at 874 before sliding back into its trading range; it’s back over 860 today. Technicians will be looking for a higher high either today or sometime next week, and if we get it, perhaps a more significant rally will take place.

Last week I discussed a new position, ETF Market Opportunity fund (ETFOX) that I was adding to most client accounts. It continues to perform well, and as we rebalance your accounts moving forward, I expect this fund will become a larger holding among other growth positions. You can find a more detailed discussion of this fund and an interview with its manager, Paul Frank, in this month’s newsletter that will arrive in the next few days.

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The market continues to search for direction this week. After a near month-long slump caused by changing market conditions and the threat of tighter monetary policy abroad, the S&P 500 has rebounded just as quickly, rising from the floor of one moving average (the 150-day) to the ceiling of another (the 50-day). When only 21% of S&P stocks were trading above their 50-day moving average, the market was reaching a short-term oversold level and was ready to rebound. If it holds here, the correction will have been on par with the conditions investors experienced between 2003 and 2007, which is the last time the markets slowly climbed a seemingly endless wall of worry.

Federal Reserve Chairman Ben Bernanke’s semiannual testimony before Congress this week went largely as expected. Bernanke reiterated the Fed’s earlier statements regarding the need to maintain accommodative monetary policy for as long as economic conditions warrant. Although he did not provide actual signposts that would trigger a change in this stance, he did provide some economic signals that we can identify as significant. These include continued growth in private-sector demand; higher business investment in equipment and software; a tighter labor market; and an improving housing market. Among these indicators, there has already been an improvement in private demand, a rise in hiring temporary staff, and higher capital goods orders, all of which bode well for stability and additional economic strength.

Most client portfolios are currently divided equally between value and growth, and the overall allocation is skewed toward large-cap stocks. Historically, value-style investing has outperformed growth. This is particularly true during cyclical recoveries when the economy is expanding and cash flow expectations are steadier. Growth has outperformed during corrections and recessions when growth becomes scarce and investors are willing to pay more for it. Whether this remains true in 2010 is a story that continues to unfold.

Although we have more visibility this year from companies regarding their earnings projections, growth may be less robust than in previous recoveries because of ongoing headwinds, such as available credit, consumer balance sheets, and future monetary policy.

However, some of these issues are why I continue to emphasize large-cap stocks over small-cap fare. Despite their recent spurt of strength, I believe smaller stocks face a tougher environment ahead and have limited access to capital, even during normal conditions. Tighter credit standards and a reduction in bank lending will curtail their growth prospects, which may lead to additional volatility as the economy rights itself, especially for names of lesser quality.

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The four-week slide for most stock markets ended last week after two-thirds of global markets had declined more than 10% since the mid-January highs. The S&P 500 managed a nearly 1% gain last week, reversing its own 8% decline since Jan. 19. After last year’s outsized rally, which was largely in anticipation of a lasting recovery, this year’s performance has been tempered by fears of stalling or muted growth. But, so far, those fears are largely unwarranted. This week the broader markets marched higher and added nearly 3% to their upswing through Thursday.

Despite its attempts to be transparent and prepare investors for adjustments, the Federal Reserve raised the primary credit rate, or discount rate, by 0.25% on Thursday. The only hint that this change was eminent seemed to appear in Chairman Bernanke’s testimony, in which he stated that we should expect a higher discount rate “before long.” It is probable that the lack of additional notice was due to the fact that this adjustment is minor and does not reflect any change in policy. Although the change can be seen as the first step toward tightening, the Federal Funds rate remains unchanged and monetary policy remains extremely accommodative. The Fed has wound down several of its emergency programs this month, indicating that credit conditions have normalized even further.

Additional positive data over the past two weeks included retail sales and manufacturing results. January retail sales surprised to the upside, with a 0.5% increase that beat expectations. Although consumer confidence remains weak, an influx in spending indicates a pickup, especially at the high-end of retail. The sales component, on which gross domestic product (GDP) is based, climbed 0.8% month over month in January, indicating a 2.8% annual rate in the first quarter, which is a stronger annual pace than we recorded during the second half of 2009. This week the Empire State manufacturing index rose by more than expected in February’s reading, but results hinted at trend moderation. The Philadelphia Fed manufacturing survey also climbed higher, but details, such as the new orders component, were stronger.

The corporate earnings picture continues to shape up nicely. Now that more than 80% of the S&P 500 market capitalization has reported, earnings per share (EPS) are estimated to be $17.33 for the fourth quarter, even after accounting for Troubled Asset Relief Program (TARP) paybacks. Adding back the one-time hits implies an annual rate of $74 EPS for S&P 500 stocks, which would be more than 40% higher than the initial $51.50 projections for 2009. Unlike previous quarters, higher sales rather than cost cutting has added to the strong results and positive outlooks. In fact, nearly 70% of companies have beaten their sales estimates, indicating that a sustained recovery in revenues and earnings is underway.

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The uncertainty hampering the markets, the components of which I have outlined in my recent emails to clients, certainly took center stage again this week. There was a renewed focus on Greece and its potential default; speculation continued to swirl over whether a failure to resolve this fiscal crisis would have a contagion effect that could ripple through the rest of Europe, pulling down weaker nations in its wake. This uncertainty has limited investors’ conviction that the global economic recovery is strong enough to sustain lapses in economic indicators or new shocks to the system.

The crisis facing Greece and the eurozone is the type of event that economists always warned policymakers about, believing that a coordination of fiscal and monetary policy would prove too difficult under times of stress. Although the European Union (EU) still lacks a mechanism to deal with events such as this one, it is unlikely that Greece would be allowed to default and risk destabilizing the union at this stage.

Nevertheless, investors do fear the outlying risk of contagion, no matter how remote. More likely, however, the inaction or lack of clarity is fueling these concerns. The latest statements by EU officials lacked concrete details, and there were rumors that Germany was hesitant to move forward. Germany has always feared that its own involvement in a monetary union would lead to demands on its fiscal responsibility, which is why it mandated a “no bailout” clause from the outset. Even today, direct bailouts are unpopular, but in the case of Greece, a combination of fiscal tightening and financial-underwriting by stronger EU nations, or even the International Monetary Fund (IMF), is likely.

Many of the headwinds currently facing the market are actually supportive of core funds such as Federated Strategic Value (SVAAX). Low interest rates, the expected below-trend economic growth, the effects of fiscal stimulus withdrawal, and sovereign debt concerns should have investors focusing on dividends and yield once again.
Dividends did not matter much to investors in the 1990s when stock prices were rising 15% or more, nor did they matter much to corporations that were focused on share-buyback programs, which were used in part to disguise stock-option incentives that otherwise diluted shares outstanding. But after two bear market swoons snuffed out years of price gains, investors once again realize that dividends often provide a stable—and sometimes the only—source of positive real return.

Although dividends per share declined 21% in the U.S. over the course of 2009 due to a strong corporate emphasis on conserving cash, dividend growth is expected to rise 9% this year among S&P 500 companies. However, not all companies will participate. In fact, 30% of companies are expected to cut or maintain their current dividend payments, but 25% are expected to grow their payouts by 25% or more. Instead of searching just for high yield among stocks, which is often associated with high risk (whether it is perceived or not), it is better to focus instead on quality companies that offer solid or rising dividends, such as those found in SVAAX.

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Although there were hints as early as December that market consolidation was looming—lower volume, narrowing trends, fewer 52-week highs—it seems uncertainty finally gripped the market and put a seal on the rally in the near term, tempering everyone’s bullish tune. Any number of traditional catalysts failed to spur bullish market action over the past three weeks, and not even lifting the cloud over Ben Bernanke’s nomination to a second term as Federal Reserve chairman was able to turn the tide. The better-than-expected and near-record-breaking gross domestic product (GDP) estimates that were released last Friday also failed to serve as a catalyst for buying. These conditions brought technicians out in force, each with a seemingly bearish view.

This week analysts seemed stuck on that old January barometer—“As January goes, so goes the market”—and whether it will cast a spell on the rest of the year. Although this was the third straight down January in a row, one need only to look at 2009, which was decidedly positive, to cast doubt on this predictor. Plus, a closer review of history provides little support for this annual bellwether, especially when the market finishes down for the month. In fact, since 1953, there have been 23 down Januarys, and these resulted in 13 negative annual returns and 10 positive annual returns, although the overall average is -4.7%. It might be more accurate to include an analysis of all midterm election years and decennial years, given that 2010 overlaps with these as well, but I think it would be wiser to assume that this year has the potential for greater volatility.

One aspect of client portfolios that continues to do well is the fixed income allocation. Although stocks and bonds have been correlated in recent years due to the extreme events within the credit markets, they are resuming their historical relationship, i.e. bonds are appreciating when stocks decline. Among the Federated bonds, Intermediate Corporate Bond (INISX), Adjustable Rate (FASSX), and High Income Bond (FHIIX) will continue to perform well, especially amid higher stock volatility. As I do, the managers of these funds hold positive outlooks on high-grade corporate, high-yield, and even Treasuries in the short term. Although rates are expected to rise, it could take longer than most investors expect.

Please note: Although the IRS is giving most custodians until mid-February to issue their tax documents, Fidelity Investments has informed us that they applied and received approval for an additional IRS extension for their own 2009 Tax Forms. Fidelity’s new deadline for providing tax information is February 28, 2010. This may not affect all account holders, but it is best to expect a possible delay. A notification letter to those customers affected by the later deadline should be sent by February 5.

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Uncertainty continued to weigh on stocks this week. The result was the sharpest sell-off since this bull market began, causing the broader indices to lose 5% from their 16-month highs. Although much of the trouble emanated from Washington, news from China also made investors skittish. The selling subsided at the outset of this week, as investors looked to pick up attractive shares at reduced prices. After rising nearly every month since last March, stocks need to consolidate and digest the latest round of economic data, corporate earnings, and legislative agenda.

Trouble began with the election of Scott Brown in Massachusetts, which put the U.S. health care reform in jeopardy. Washington appeared to immediately digest the implications for its current legislative initiatives, as well as other policy issues such as financial reform and taxation. Without 60 Democrats, the Senate no longer had the majority to control the agenda or pass one-sided legislation.

Nevertheless, President Obama last week added to the uncertainty by announcing a proposal that, on the surface, appeared to be a sweeping pass at new bank regulation. However, it essentially lacked the details to achieve widespread support, nor did it propose a timeframe, which would allow analysts to estimate the impact of any change. Although the high probability of financial reform has been an unsettling prospect for months now, the timing and aggressiveness of the announcement still came as a surprise. The State of the Union address delivered this week mixed a defiant defense of this agenda with calls for unity among legislators.

Additional uncertainty out of Washington during the last two weeks surrounded the confirmation of Fed Chairman Ben Bernanke. Once additional senators announced their opposition to his re-election to a second term, the President reaffirmed his support, announcing that he still considers Bernanke the best person for the job. Although the chairman is battle-tested and knowledgeable about depression-era tactics to right the economy, his ability to read the tea-leaves and correct current policy were the more important questions at hand. On Thursday, Bernanke won approval from the Senate.

Actions taken by China to curb lending growth were the most important of global developments causing uncertainty. By raising reserve ratios and restricting lending outright at the most aggressive banks, China was clearly pulling in the reins. This caused ripples in all markets, but especially those trades benefiting from expansionary policies.

Please note: Although the IRS is giving most custodians until mid-February to issue their tax documents, Fidelity Investments has informed us that they applied and received approval for an additional IRS extension for their own 2009 Tax Forms. Fidelity’s new deadline for providing tax information is February 28, 2010. This may not affect all account holders, but it is best to expect a possible delay. A notification letter to those customers affected by the later deadline should be sent by February 5.

Despite a solid start to the latest round of corporate earnings reports, stock markets declined this week due, in part, to legislative uncertainties. After an initial rally on Tuesday to begin the holiday-shortened week, political events took center stage as a Senate election and financial reform proposals had investors reassessing this bull rally and the prospect of higher returns in the short run.

The election of Scott Brown in Massachusetts put U.S. healthcare reform in limbo, if not outright jeopardy. As a result, I expect healthcare sectors and the pharmaceutical industry, in particular, to receive additional investor support over time. Among my favorite healthcare picks are iShares Dow Jones U.S. Pharmaceuticals Index Fund (IHE) and ICON Healthcare (ICHCX), which have both been long-term holdings in my fundamental portfolios for more than a year.

Healthcare stocks lagged the market during the early part of this rally, but momentum improved as investors turned to undervalued and defensive sectors and the outcome of the much-debated healthcare reform appeared more benign. As it stands, even if the Senate bill passes, the pharmaceutical industry likely only has a 3% – 4% earnings exposure. But if reform fails due to the latest political headwinds, IHE should benefit as this uncertainty is lifted. ICHCX allocates 47% of its portfolio to the pharmaceutical industry, but the fund also has exposure to healthcare services and healthcare providers, making this a more diversified means of gaining an overweight to the sector.

The last time that healthcare reform failed, pharmaceutical stocks outperformed the broader market by approximately 130% over a five-year period. Although we can never count on history to repeat itself, history often serves as a good guide during times of uncertainty. During the last bout of similar uncertainty—when healthcare reform was seemingly at advanced stages—pharmaceutical stocks traded at historic lows, just as they do now. If the reform fails altogether, I expect pharma stocks to outperform again moving forward. But even if the current Senate bill passes, this rather benign reform has limited impact on the pharmaceutical companies comprising IHE and ICHCX. Given the two likely reform scenarios, these stocks look set to get re-rated in the eyes of investors.

Finally, although the IRS is giving most custodians until mid-February to issue their tax documents, Fidelity Investments has informed us that they applied and received approval for an additional IRS extension for their own 2009 Tax Forms. Fidelity’s new deadline for providing tax information is February 28, 2010. This may not affect all account holders, but it is best to expect a possible delay.

If you missed last week’s commentary, I wanted to quickly highlight the recent recognition of my flagship newsletter, the Fidelity Independent Adviser, by Mark Hulbert. For more than 10 years, The Hulbert Financial Digest has independently tracked my newsletter model portfolios and has the unique ability to verify my long-term track record, as well to compare these results to hundreds of other advisers. My newsletter was one of seven to pass his criteria for risk-adjusted returns for several periods over the past 10 years. If you would like to read the article, please click here to visit the Barron’s web site.

The stock market is receiving accolades of its own, or at least a growing chorus of fans, as evidenced by sentiment indicators such as the Investors Intelligence poll. This poll indicates that a high level of bullishness has returned among investors—one not seen since the heady days of 2007. This coincides with the risk-appetite measurements that I have discussed in the past, and the first two weeks of trading in 2010 have accentuated these extremes. By Thursday, global markets had climbed another 3% on average, with many of last year’s relationships resuming their trends—such as the U.S. dollar weakening, commodities rising, and developed and emerging-market stocks appreciating.

Despite the fact that stocks have launched 2010 decidedly into positive territory, I caution investors against becoming either too greedy or complacent. Although 2009 ended with strong gains, this year will most likely test the strength and stamina of the economy and the market. It will also be a year of policy change and continued uncertainty. Nevertheless, I am expecting several positive trends to continue, such as improved economic readings, a firming labor market, and sustainable growth in global economies.

The fourth quarter earnings season got underway this week, and judging by early guidance, companies should log surprisingly positive results. In fact, this should be the first quarter in nine that year-over-year earnings growth is positive. Of course, one reason is that earnings plummeted in the fourth quarter of 2008, making year-ago comparisons easy to beat. This was especially true of financial companies, whose earnings were devastated by the credit crisis and the stock market collapse. But the cost cutting that ensued across all sectors means that any revenue growth will considerably boost corporate profits. In addition to financials, the technology and consumer discretionary sectors have rebounded considerably from the standpoint of earnings.

Unlike the outset of the previous two earnings seasons, however, the stock market has already rallied in anticipation of positive results, meaning that gains over the next several weeks will be muted if significant positive surprises do not materialize. Nevertheless, valuations remain modest from the standpoint of forward-looking P/E ratios and interest rates are at historically low levels, providing even more reason for investors to bid up quality, dividend-paying stocks over the course of 2010.

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It is nice to begin the year with accolades, so I appreciate the fact that this week Mark Hulbert recognized the long-term track record established by my flagship newsletter, the Fidelity Independent Adviser. For more than 10 years, The Hulbert Financial Digest has independently tracked those model portfolios and has the unique ability to verify the results and compare them to hundreds of other advisers. The Fidelity Independent Adviser was one of seven to pass his criteria for risk-adjusted returns for several periods over the past 10 years. If you would like to read the article, please click here to visit the Barron’s web site.

Stocks launched 2010 decidedly into positive territory, shaking off their year-end stupor with conviction. After meandering through two holiday-shortened weeks of light trading, which nevertheless pulled stocks slowly higher, Monday’s action was much more reminiscent of the trading that had carried most assets well off their 2009 lows. All fingers pointed at the weakening U.S. dollar as the chief culprit. The greenback resumed its inverse relationship with most asset classes, including commodities, which were up across the board yesterday.

Gold and oil stole the headlines within the commodity markets. Most analysts and investors were looking for signs that the inflation trade was back on. Although the appetite for risk declined toward the end of December, it remains at extreme levels not seen since 2006 and 2007, which was during the heart of the last bull-market run. Moreover, the trends look set to continue if these assets can reach new highs. Last weekend Federal officials reiterated their desire to see interest rates remain low for an extended period of time.

Gold corrected more than 10% from its peak levels in December, and could once again offer favorable risk-adjusted returns. The metal has not yet reached extreme levels relative to other commodities, such as oil, or even stocks. One only needs to look back to the first quarter of 2009, when an ounce of gold bought 25 barrels of oil, compared to today’s 14 barrels. For its part, oil appears to have stabilized and is again moving beyond $80 per barrel. The onset of colder weather and larger-than-expected drawdowns has provided the right mix of news to send prices higher. If the Organization of Petroleum Exporting Countries (OPEC) can stick to their agreed-upon production levels, or if emerging market demand materializes anew, the price of oil could catapult toward $90 per barrel in the near term.

One struggle that has yet to reconcile itself completely is the relative strength of growth investing over value investing. After significant outperformance by value-style investing from the 2000 peak through 2006, growth resumed its leadership role in 2007. The defensive names typically associated with value investing began to appreciate toward the tail end of 2009, but growth looks set to regain the lead in 2010.

With the start of the new year, all eyes are on the first week, and the often-referenced “January effect.” This is the notion that the outcome of the first five trading days determines the direction of the entire year. While a positive first-five trading days may give the year a statistical edge, the rest of the month will be just as important this year, as investors assess whether last year’s trends will dominate the first half of 2010.

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Stocks continued to meander their way through the last two months of 2009, including the shortened trading week ahead of Christmas and the New Year. Yet, they did manage to stroll beyond resistance levels toward new highs, even though this failed to spark any great reaction or follow-through on behalf of the bulls or of the bears due to light trading volumes. The S&P 500 quietly surpassed the 1,121 threshold, which was an important technical milestone. Because it has reached this level on low volume and during poorly attended trading sessions, however, a truer test will be its ability to hold the line here once trading resumes in force next year.

The year ended far better than most would have predicted at the March lows, when the headlines were still full of bad news and the most dire predictions. The bear market — ushered in by the bursting of the real estate bubble, the ensuing financial meltdown and credit crunch and the global recession that followed — was the second-worst in the last 80 years. The 20-month slide ended this year only after an unprecedented government response of tax cuts, stimulus spending, and financial bailout packages.

If 2009 was an important year in stemming those losses and in setting the groundwork for a lasting economic recovery, 2010 is shaping up to be the year when the recovery’s strength and stamina will be tested. For its part, the Dow Jones Industrial Average has rallied more than 19 percent year to date, and nearly 60 percent from its bedeviling bottom, placing its climb among the strongest of major market rallies from potential secular lows. Now, after settling into a seven-week trading range, the index looks ready to break out.

In the short term, I expect to rely on some of the funds that have recovered strongly in 2009, such as Federated High Income Bond Fund (FHIIX) and ICON Information Technology Fund (ICTEX), which have provided returns of more than 50 percent and 46 percent, respectively, year to date. I also expect to hold funds such as Federated Strategic Value Fund (SVAAX), which has recovered more than 40 percent from its March lows, yet only has a 12 percent return year to date. The fund is beginning to outperform both the Dow and the broader S&P 500.

With the advent of the New Year, I would like to remind you how important it is to review your investments in their totality. Dion Money Management strives to be your most trusted advisor, and we are more than happy to review any investments managed by other advisors or that you manage on your own. We can perform a portfolio review and provide a clear picture of your complete asset allocation, making recommendations to position your investments opportunistically in 2010 that are in line with your risk tolerance.

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