Another good month for the markets, as investors appear to looking beyond the bad economic news and toward a late-year recovery. The month of May sported meaningful gains for all major market segments, with the Dow Jones Industrial Average ahead by 4.06%,the S&P 500 better by 5.31% and the NASDAQ 100 ahead by 2.86%.Dividend-paying stocks appear to be regaining some of their luster, as they out-paced their “growth oriented” peers by a nice margin for the month, most notably among financials and basic materials stocks.
The continued advance off of the March lows has been driven not so much by great news, but by increased evidence that the trend in worse news is getting better. As confusing as that sounds, if the economy can’t get any worse, then by definition it can only get better and investors are responding to the prospect of better earnings later this year. During the first quarter, earnings for companies in the S&P 500 fell by 39% when compared to earnings from the same quarter last year, led by a 104% decline in consumer staples companies, an 83% decline in consumer discretionary companies, and a 75%drop in earnings at materials companies. What really matters for the markets, however, is that asset inflows for equities (and commodities and real estate) have all begun to improve nicely, while capital outflows from fixed income assets and bear market assets has been solid as well. Follow the money, and we’re now starting to see a trend in favor of “at-risk” assets and away from no-risk and risk-free assets (at least for now).
The Appleton Group Composites™
For the second month in a row, all of our firm’s core managed portfolios (Appleton Group PLUS, Tax Managed Growth and Appleton Group Portfolio) ended the month with the same investment allocation they began with. All three portfolios are heavily over weighted in equities, which is consistent with the more favorable prevailing market trend. Our allocation to defensive investments (cash, fixed income and bear-market securities) is minimal. Should the prevailing trend supporting equities remain in place, we will continue to hold this more assertive posture and participate nicely in the continuation of the rally. All of our firm’s portfolios have made solid progress off of the March lows, and while they are trailing the overall markets right now, we continue to be sharply ahead of the game over the last one-year and three-year periods. We recognize that investing is a marathon, not a race, but that we don’t want to leave a lot on the table as the markets continue their charge higher. We also recognize that the recent advance is due mainly to hope – the hope that the worst economic news is now behind us and that the ensuing recovery will lead to higher earnings. Companies have to deliver more solid earnings in the upcoming quarter, and if they don’t the markets may yet again swoon. Big moves upward followed by big moves downward are a good environment for our proactive management style, and we believe that the “five steps forward, three steps back” dance of the last several months is just fine.
The big story of the past few weeks will be the bigger story of the upcoming quarter: the huge move down in the dollar. The U.S. Dollar has fallen sharply in comparison to the euro, having moved fromapproximately1.24 all the way down to 1.42 as of the end of May. It doesn’t sound like a big move, but this type of move usually takes several years to play out and has occurred in just a few months. The implications for earnings are huge, as this move makes American goods a lot cheaper overseas, and it adds a big enhancement to the earnings of any company that exports goods abroad. Couple this with the severe cost-cutting measures that companies have enacted over the past six months, and we just might have a recipe for a sharp upside surprise in corporate profits in the quarter.