In the first quarter of 2012 stocks continued the rally that began in the fourth quarter as improved U.S. economic data encouraged investors to buy stocks.
The quarter produced the best performance for U.S. stocks since 2009. The S&P 500 gained 12.6% during the quarter led by stocks in cyclical sectors such as information technology, consumer discretionary and financials, while the defensive telecommunication services and utilities sectors lagged.
The sizeable gains in the first quarter can be attributed to solid earnings growth, better than expected U.S. economic data (jobs, manufacturing, consumer sentiment), an apparent resolution in the Greek debt crisis, and sentiment that the European debt crisis has stabilized.
The economic data reported during the last quarter shows the economy is still expanding at a modest pace and has vastly improved from where it was in April 2009 at the worst of the recession. The latest available gross domestic product data showed that GDP grew at a 3.0% rate in the fourth quarter of 2011, a significant increase from the 1.8% rate of the third quarter of 2011. The modest but steady U.S. economic growth of the past few quarters has been accompanied by a reduction in unemployment and a gradual improvement in job creation. The unemployment rate fell from 8.5% in December 2011 to 8.2% in March 2012 and weekly initial jobless claims trended lower. At the same time, inflation and interest rates have remained low and relatively stable. The Federal Reserve remains committed to maintaining its accommodative monetary policy, saying in March that it expected to keep interest rates at their current low levels through at least 2014.
Given the outsized gains in the first quarter and outlook for recession in the European economy, we have a cautiously optimistic outlook. Euro zone leaders have made progress in addressing the sovereign debt crisis, especially as it relates to Greece, but concerns remain the majority of the reforms are more fiscal than structural. As a result, recession in Europe and the resultant slowdown in much of the rest of the world cannot be entirely averted.
Due to this slowdown, especially in China, the IMF recently lowered its estimates for global GDP to grow by 3.3% in 2012. The outlook for the U.S. is more optimistic than Europe, with modest economic growth expected, though encumbered by the baggage of the financial crisis, including a weak housing market, heavier regulation, and bitterly divided political leadership in an election year.
The current outlook for growth in the second quarter is for the expansion to continue real growth in the 2.0% to 2.5% range. After the second quarter, the consensus economic forecast includes real growth at a pace slightly below that of the first and second quarter, a gradual upward drift in interest rates and inflation, and continued improvement in corporate profits. At some point in 2012, market participants will begin to focus on the November election, and at that time economic conditions are not going to drive the market as much as earlier in the year.
Other than some major catastrophe, the equity markets, in our opinion, appear to be undervalued relative to other investments such as bonds. With yields on good quality stocks considerably higher than quality bonds, stocks seem to be the better value. Unlike bonds, stocks increase dividends over time and have the chance of appreciation. We expect the market to continue the day to day volatility and believe investing for the long term will more than compensate investors for the risk they are taking.
Dumont & Blake Investment Advisors, LLC
March 31, 2012