January 27, 2013
The stock market is at a five-year high after gaining 13.4 percent last year and carrying investors on a remarkable four-week run so far in 2013.
With the Standard & Poor's 500 index up 5 percent in less than a month, investors are torn between fearing a market peak and relaxing for the first time in years. The S&P closed Friday at 1,502.96, the closest it's been in years to its high of 1,565 on Oct. 9, 2007 — the point it hit before careening 57 percent in the financial crisis.
While stocks such as Groupon and Apple have showed recently that investors can be brutalized by the stocks they adored at one point, it's been difficult to make a mistake when picking broad sectors in the stock market. Last year, all 10 were benevolent to investors. And the largest gains came in sectors people might have assumed were the most vulnerable.
As worries eased about a financial crisis emanating from European banks in 2012 and U.S. housing prices stopped plunging, the financial companies of the S&P 500 gave investors gains of 28.8 percent. And despite high unemployment and stagnant wages, consumer discretionary stocks, or companies selling everything from cars to clothing, jumped 23.9 percent.
Safer bets — the companies that tend to do best when people are buying necessities in a weak economy — delivered less. Health care stocks, which tend to provide the medical help that people need regardless of the household budget, climbed 17.9 percent, and consumer staples, items such as soap that no one wants to skip, rose 10.8 percent.
Now, as analysts have been emboldened by modest earnings gains for the fourth quarter of 2012, and rising stock markets throughout the globe, investors are being urged to become more daring. The emphasis is on cyclicals, especially industrial companies and those that sell basic materials to manufacturers. They are called cyclicals because they are driven by cycles in the economy — thriving when prosperity is expected and diving amid recessionary concerns.
Lombard Street Research points out that gains of 16.5 percent in Europe and the 13.4 percent in the S&P 500 in 2012 happened "in anticipation of an economic recovery that is yet to materialize."
Yet, the head of the European Central Bank, Mario Draghi, delighted investors Friday when he said Europe could begin to recover from its recession in the second half of this year. Hopes are also rising for China and Japan, which are both stimulating their economies aggressively.
Recent reports from China point to growth stronger than was expected, and if the trend continues, investors assume a more robust Asian economy will generate demand for basic materials and construction equipment such as that made by Peoria-based Caterpillar.
The Standard & Poor's investment policy committee noted in a recent report that expectations of global growth "are beginning to creep higher." The committee now is forecasting the gross domestic product will grow 3 percent this year, versus the 2 percent forecast a few months earlier.
Even with some gains in the economy, however, analysts are warning investors to watch carefully to make sure the latest enthusiasm for stocks doesn't carry them to such high levels they will fall.
The S&P committee notes that indexes for large, small and midsize stocks already "have cycled into overbought territory," meaning stocks are starting to look pricey. But they are warning investors not to run for the exits: "Just sit back and enjoy the ride," the committee says. "Investors are notorious for selling a rally too soon."
JPMorgan strategist Thomas Lee has been providing clients similar advice. While too much affection for stocks can push them to a point where they topple because prices are too high given company profits, Lee doesn't think the market is there yet.
He noted in a recent report that an American Association of Individual Investors reading is showing optimism for stocks so extreme, it's near the level that has preceded every prior "correction" — or short-term dive in the market. But hedge fund managers are still showing restraint with stock investing. They are less exposed to stocks than three months ago, Lee said.
Lee does think the market will go through a sharp correction before midyear and fall to 1,350. Other analysts also have concerns about midyear as Washington again debates the debt, European debt concerns bubble back up, and higher payroll taxes take a toll on U.S. consumption.
Yet, Lee thinks the market will climb to 1,580 by year-end as the recovery continues and as investors see better value in stocks than in high-yield bonds. He notes that the price of cyclical stocks, compared to their earnings, is significantly cheaper than in 2007, and net income has climbed 55 percent.
Goldman Sachs' strategy team also favors basic materials, industrials and information technology but is skeptical of consumer discretionary stocks and consumer staples, which the team notes appear expensive.
Consumer discretionary stocks have outperformed the S&P 500 for five years in a row by a cumulative 49 percent, the team noted in a report.
Consumer discretionary stocks and energy stocks have gained the most this year, with energy up 7.6 percent and consumer stocks up 7.3 percent, according to Standard & Poor's analyst Howard Silverblatt. But since late 2007, consumer discretionary stocks have far exceeded every other sector — gaining 47 percent while financial stocks have lost 45 percent, energy lost 2 percent, materials lost 7 percent and industrials lost 4 percent.