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The stock market advanced robustly in the first quarter of 2013 on a strengthening economy in the U.S.
Manufacturing indices indicated expansion, personal spending rose, employment increased and the housing market firmed, adding to the perception of wealth and boosting consumption. Economists are revising upward their GDP forecasts accordingly. While the economic growth seen in the first quarter might be mitigated in Q2 by cuts in federal and state government spending (when the full impact of “sequestration” will be felt), it is quite possible that U.S. growth will accelerate in the second half of the year.
U.S. companies, flush with cash, are increasing dividends and repurchasing their shares, which adds to their earnings by reducing the number of shares trading on the market. Cash based M&A activity (Heinz, Dell, etc.) is on the rise due to cheap financing. This also amounts to a net withdrawal of equity from the market, effectively lowering the amount of shares trading in the market. Even with the S&P 500 at new highs, investors seem nervous about current levels, with the financial press arguing that the current rally is being driven by printed money. It is usually a good sign to experience a strong first quarter, at least historically. Since 1945, the frequency with which the S&P 500 rose during the rest of the year after a positive first quarter has been 85%. However, given the market’s recent strength it would not be surprising to see a small pullback in Q2, as the P/E ratio of the overall market has climbed above its average.
The economic landscape since 2008 has not been representative of a “classic” recession based on a normal business cycle, but a recession caused by a banking crisis. Historically, this kind of recession is more persistent. As a consequence, central banks worldwide are beholden to support the economy and will continue to do so. The Cyprus debacle, another in a series of European banking-led crises, is still calling into question the fragility of the banking system. While the bank deposit guarantee in the Euro-zone will remain intact at € 100,000, depositors of higher sums in Cyprus will suffer losses of up to 60% of their deposit. This “solution” will spare most Cypriots and penalize wealthy Russians who have traditionally used Cyprus as a tax-free zone to hide their accounts from the Russian government. Still, the shadow of doubt has now been sown on the safety of deposits within the banking system, and raises questions over which governments may next attempt to “confiscate” private deposits in order to shore up the banking system. The European Central bank, in concert with the EU and the IMF, are thus supporting the European economy and banking system aggressively. The Bank of Japan is stimulating the Japanese economy at “full throttle” with its ultra-low interest policy (Japanese 10 year government bonds offer only a one-half percent yield). The Federal Reserve Bank in the US is unlikely to change its stimulative measures in the near future. As long as governments continue borrowing/printing in order to compensate for consumers , interest rates will remain low.
And as long as interest rates remain low, the quest for yield will continue to support high dividend yielding stocks.

When a nation’s broad money supply growth exceeds its GDP growth, a boost in stocks and real estate generally follow. When inflationary consequences finally arise out of current U.S. monetary policy, it will be time for increased investor caution.
For now, there is little inflationary pressure coming from the velocity of the money supply, and job growth is still not yet sufficient to stoke any inflationary fires.

For the first quarter of 2013, the Dow gained 11.25%, the S&P 500 increased 10% and the Nasdaq rose 8.2%.

Grant Rogers

Partner

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