A Tale of Two Markets
May 17, 2013
"It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair."
—Charles Dickens, A Tale of Two Cities
The U.S. stock market, as measured by the S&P 500 Index, is up 17.3% year-to-date through May 15. This is pretty impressive, given the doom and gloom in the newspapers about Europe's recession, slowing growth in China, and the U.S. government's sequestration cuts (anyone remember the sequester?).
Somewhat lost in the discussion about the market's heights is that 2013 has been a tale of two markets. Earlier in the year, the S&P 500 Index was driven by big moves in the utilities, health care and staples sectors, while the financials, materials and consumer discretionary sectors lagged. The increase in the consumer staples sector has led to some price differences that border on outrageous. Earlier in the year, the S&P 500 Index was driven by big moves in the utilities, health care and staples sectors, while the financials, materials and consumer discretionary sectors lagged. The increase in the consumer staples sector has led to some price differences that border on outrageous. We've seen household and personal products companies trade at close to 20 times 2013 estimated earnings (with some companies even higher), while a number of large cash-rich tech companies are trading at closer to 10 times estimated earnings.
Initially, this made some sense. Conservative investors seeking yield have turned to stocks, since bonds don't currently provide much of it. Which is more attractive to a saver: U.S. 10-year Treasurys yielding under 2%, junk bonds yielding less than 5%, or utilities and staples stocks yielding 4% to 5% with the potential to grow their dividends a bit over time? As the yield chase continued during the early part of 2013, the stock prices of companies that investors viewed as stable dividend payers rocketed higher.
To All Things There is a Season
S&P 500 Index Performance, by Sector
January 1 – May 2 versus May 3 – May 15, 2013
Past performance is no guarantee of future results.
The "seasons" in the market abruptly changed on May 3 as two events caused investors to shift their mindset from "safety first" to "all aboard." First, European Central Bank Chairman Mario Draghi gave a speech where he basically said "cheap money is here to stay." Second, initial jobless claims in the U.S. came in at a level not seen since the early days of the recession, which gave investors hope that the U.S. economy was getting stronger.
When this happened, it was as if a bell went off. The market shifted focus from "safe" dividend income to companies with a lot of cash and the ability to increase the returns of that cash to shareholders through higher dividends and buybacks.
Throughout the stock market, companies with cash are in demand as investors seek not only nice dividends today but also the opportunity to grow that dividend in the future. A focus on current yield has morphed into a focus on growth in payouts, at least for now. For the nine trading days from May 3 to May 15, the utilities sector declined 1.7%, while the S&P 500 Index was up 4%. The laggards from earlier in the year, industrials and materials stocks, gained 5.5% and 4.8%, respectively. Industrials generated one-third of their year-to-date gains through May 15 since May 3, while materials earned more than half of their year-to-date return in that same short time.
We think that in the near-term the market will continue to favor large companies with excess cash on their balance sheets and lots of free cash flow that they can put toward dividends and buybacks. Capital management is the new king.