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2012: Resumption of the Stock Market Recovery

By Ronald Surz January 8, 2013 Never test the depth of the water with both feet. - African Proverb After feasting on the U.S. stock market’s 54% run-up from 2009 to 2010, we starved for performance in 2011, suffering a 1% loss. Some said the markets were due for a respite, so this lull was healthy, but I felt we were lucky that results weren’t much worse, as they were outside the U.S., and that 2012 would be a disappointment. I was wrong. Stock markets both here and abroad had a good year in 2012. So is now the time to get back into the stock market? Are you ready to jump in with both feet? I’m not. Let’s take a close look at the details of what occurred in 2012 so we can assess the opportunities and prepare for the surprises that 2013 will bring. In particular, let’s look at momentum and reversal possibilities coming into 2013. I’ll give you my opinions, and you should form your own. Here are a couple of facts worth noting about 2012. As discussed in my Q3 commentary, investors bailed from equity mutual funds, which should have depressed stock prices, but corporate-share buybacks more than offset this exodus. Also, much of the stock mutual fund redemptions found their way into stock ETFs, a move from active to passive management. We should not forget the losses sustained in 2008. Despite popular perception, we have just now recovered 2008 losses; the 54% 2009-2010 gain did not offset the 38% loss in 2008. But 2012 has brought the U.S. stock market back into positive territory, with a 3% cumulative return for the five years 2008-2012. We’re above break-even. I begin with a review of the lessons learned in 2012 around the globe and then extend the perspective to the longer-term history of U.S. markets over the past 87 years. My goal is to arm you for thoughtful investment decisions.

-1© Copyright 2013, Advisor Perspectives, Inc. All rights reserved.

. and add my outlook for 2013. -2© Copyright 2013. Inc. stock market I begin with an analysis of the risks and rewards in 2012. stock market returned 16% in 2012. as shown in the following chart. I begin with risk and reward for sectors and styles and then drill down further by examining the cross-sections of styles and sectors. The total U. U.S.000 companies rather than just the S&P 500’s 500 companies. I show total market results for 5. matching the S&P 500’s return.S.The year 2012 in review I’ll review the year by analyzing what has worked and what has not. In the following. using heat maps to identify trends. All rights reserved. Advisor Perspectives.

. despite expectations that government spending would favor them. benefitting some segments of the healthcare market. but with lower risk. Inc. Telephones-and-utilities have lagged the market. Advisor Perspectives. I think these stocks are still a good play. Obamacare will matter in 2013 and beyond. especially if China and India resume their growth. like health insurers. like pharmaceuticals. 4. albeit with relatively high risk.Here are some observations from this graph: 1. Infrastructure stocks – energy and materials – have lagged the total market and have exhibited higher risk. These sectors have disappointed on a relative basis. during which financials lost 42% while the total market lost 5%. which is uncharacteristic for this sector. providing a 20% return with below market risk. the style classifications of fallen financials 2. and undermining others. Medical companies have been among the largest share repurchasers. As described in my 2011 commentary. All rights reserved. This performance is a reversal of the previous four years. -3© Copyright 2013. Healthcare has dominated the market on a risk-adjusted basis. Financials recovered in 2012. returning more than 25%. No news here – performance as usual. 3.

8. We have to eat. This pattern usually reverses. Look for these companies to defend well if we see another recession. Consumer staples underperformed the market with less risk. I use Surz Style Pure style definitions throughout this commentary. Value investing does dominate over long periods. A heat map shows shades of green for “good. Consumer discretionary stocks were the next best performing.” which in this case is good performance relative to the total market. This suggests that investors have style conviction but disagree. Many quantitative managers employ momentum in their models. Given the uncertainties facing the U. for both momentum and reversals. large-value technology stocks were a drag on performance in the year. As shown below. Christmas spending did not confirm this perception. with risk near the market. saving more and spending less. Accordingly. Core frequently performs better or worse than both value and growth. says that large value (LGVL) stocks in the consumer staples (STAP) sector earned 13. Technology stocks did not deliver returns commensurate with their risk. All rights reserved. See the bibliography at the end of this commentary for articles that describe the exploitation of momentum effects. value gets my vote over core and growth in 2013. after financials. Core stocks. and I think these stocks will come back in 2013. -4© Copyright 2013. until 2012 when distressed financials were once again properly classified as value stocks. By contrast.9%. For example. defined as those in between value and growth. at least those with jobs. Fundamental managers use heat maps as clues to segments of the market that are worth exploring. I would not expect consumer discretionary stocks to continue to lead in 2013.have distorted some benchmarks. I think financials will disappoint in 2013. But the safety implied in the word “value” is offset by the fact that we are likely to see increases in interest rates in 2013. with relatively low risk and low return. The following heat map provides insights for both quantitative and fundamental investors. Value outperformed growth. although growth was riskier. which will hurt banks because they invest long and borrow short.9% in 2012. with spending roughly the same as 2011. Inc.S. despite the risk incongruity. Advisor Perspectives. 5. reading 13. The cells show performance in 2012. 6. the cell in the upper left corner. with some liking value while others like growth. Investors perceived that consumers had sacrificed long enough. while value and growth stocks have taken off. so I’d expect core to move to a more natural position in 2013 between value and growth. much like mid-cap frequently performs better or worse than both large and small. have stood still. . economy with the debt crisis and the possibility of another recession. 7. Next I look at style-sector cross-sections to hone in on what is hot and what is not. as a flight to safety. 9.

4 20.6 27. as shown in the following chart.8 22.5 21.shades of red are bad. -5© Copyright 2013.6 15.9 2. Energy stocks. indicating underperformance.2 16.1 -4 27.6 3.7 1.1 5.1 10.1 23.3 11.7 17.3 5.4 9.3 18.3 27. best and worst performing stocks in the S&P 500 for 2012.8 SCVL 13 22. I doubt this will continue. Inc.9 TOTL 11.1 24 19.5 15.3 16. Yellow is neutral.2 15. increases.9 32.6 19.9 22.9 7.5 11. Drilling down even deeper. I think companies should continue to do well.3 19.8 As you can see. Financial stocks dominated the biggest contributors.6 11 -6.9 5.6 14. or an inflection point? STAP DISC HLTH MATL TECH ENER INDU UTEL FINC TOTL LGVL 13. steady path.7 19. while technology and energy were the biggest detractors.9 13 -2.7 13 26 10.2 22.5 18.8 SCGR -3 21. large value technology stocks will come back in 2013.4 19.9 26. except large growth.1 15 24. there are 81 cells of interest (either dark green or dark red).4 18. but not mid-cap Telephones-&-Utilities. The idea is to focus on the dark greens and dark reds for clues on momentum and reversals.2 29.3 4. . with the exception financials.5 0.3 17. Selective Technology. Likely to continue on a smooth. Large and small financials.8 LGGR 11.8 17. we can identify the biggest. I think these stocks will do I don’t think this market leadership will better in 2013 as industrial demand continue into 2013. of mid-cap growth.1 15. Can we expect more of the same in 2013.9 26.4 2.2 26.7 25.4 0.8 13.2 MDGR 5.3 2 27.6 35.3 21.5 5.9 33.8 MDCO 21 20.3 18 13.9 MDVL 12.7 -5 16. Small health care companies.1 4.8 25.8 3.9 15. with key observations as follows: Winners Losers Large consumer discretionary companies.2 LGCO 5.2 11.6 SCCO 25.1 -10.3 3.4 -3 2.2 16.3 12.5 11.5 27. Stocks like Hewlett Packard and Dell.3 8.8 16. All rights reserved. Advisor Perspectives.1 24 25.

stock market Now let’s turn our attention outside the U. Advisor Perspectives. All rights reserved. regions and styles for the year. . outperforming the 16% return for the U. earning 18%.Non-U.S. where the total foreign market earned 20%. using the total market. -6© Copyright 2013. Inc.S..S. The Europe Australia and Far East (EAFE) index performed somewhat worse than the total foreign market.S. The following chart shows the performance and risk (standard deviation) of non-U.

and this region had the highest standard deviation of monthly returns. Surprisingly. and has the lowest risk. As shown below. 3. The EAFE index underperformed the total foreign market primarily because it has no allocation to emerging markets. Value stocks are usually less volatile than growth stocks. with a 9. Investors are fleeing the U.S. value stocks have been the most volatile. Japan is priced to sell. returning more than 27%. Japan’s problems began in the early 1990s when its real-estate bubble burst. and other economies that are suffering from the economic crisis. Inc. Japan has performed worst. the best performing region. 4. Emerging markets performed best. Advisor Perspectives. Twenty years of suffering sets the stage for a Japanese recovery and better relative performance in 2013. All rights reserved. This is a manifestation of the benefit of diversification. 5. alongside Australia and New Zealand. . The total market has lower risk than every region except Japan. but not this -7© Copyright 2013. and they have had the highest return. 2.Here are some observations from this graph: 1.5% return. It is also riskier because it is not as diversified as the total foreign market.

4 26 17.4 -5.1 39.5 33 23.9 19.5 UK 23.2 9.9 32.5 -8.5 23.6 22 12 25.6 19.1 44.4 28.8 15.3 20.6 22 15.7 EMRG 35.1 27.4 14.3 5.3 15.6 SCCO 43.6 10 15.1 20.5 17.9 16.1 -21.5 32. but with less risk than growth.7 9.1 5.2 23.7 29.2 36.8 20.8 3.4 21.3 49.5 10. Investors are seeking safety outside the U.7 -0.8 26.8 27.7 39.1 16.4 9.7 27.9 23.8 33.8 13.3 1.3 50.3 15.1 36.8 40.1 12.5 13.2 AUST 30.5 31.8 18 18.2 25.6 TOTL 23.6 14.1 OTHR 13.3 15.6 0.8 26.5 11.3 20 SCGR 18.1 23.7 27.2 2.9 26 17.6 13.7 31.1 15.7 26.7 5.6 15.7 7.. favoring value stocks I also examine the cross-sections of styles-sectors-countries in the following heat maps.1 16.5 21.2 4.4 20.8 25. Core stocks have performed in between value and growth.5 19.5 34.1 25.2 16.8 23.5 24.year.3 13 26.4 21.1 42 3.6 3.2 32.7 7.2 29.5 TOTL 23.7 4 20 44.1 37.3 39.3 2.3 SCVL 43.6 SCCO 22.1 10.8 22.1 21.8 26.8 33.2 MDVL 38.6 30.9 26.8 13.7 32.6 20.2 13.6 20.1 9.1 16.4 20 SCGR 17.4 MDCO 24.2 28 23.1 30.S.4 16.5 APXJ 19.4 MDCO 46.6 32.6 27.6 33.2 35.8 37.5 41.2 3.1 22.9 47.1 -5.7 25 31.5 13.1 21 16.5 19.6 30.9 21.1 9.3 40 38.6 LGCO 22.4 25.2 -8© Copyright 2013.2 MDGR 31 3.4 23.5 CANA 24.5 6.2 12.7 9.5 15.9 19.5 7.1 12.2 37.2 28.8 20.9 20.2 MDVL 31.3 21.8 21 9.4 1.8 26.6 25.5 16.7 18.2 14.4 27.8 4.6 43.4 5.2 LGGR 14.8 10. Inc.1 28.2 25.6 20.9 -3.1 -2.8 14.5 37.8 9.7 11.7 27.8 5 24.6 25.3 3.1 23.6 21.2 17. All rights reserved.2 19.8 15 20.2 UK JAPN CANA AUST APXJ EURO EMRG LATN OTHR TOTL LGVL 25.8 23.2 29.3 26.5 25 21.8 -2. Growth stocks lagged in performance as they did in U.5 26.2 0.5 17.5 28.5 LATN 23.4 16.9 11.2 20.3 18.1 31.8 16.7 EURO 28.S.1 30 25.5 11.8 21.5 27.9 36.6 9.9 8.1 27.5 10.3 19.9 28.6 -5.9 6. Advisor Perspectives.2 6 38.9 21.8 23.3 SCVL 25.7 25.6 20.2 23.3 24. .4 18.4 11.8 JAPN 8.9 27.2 5.5 9.6 24.4 20.8 28.8 25.3 20. STAP DISC HLTH MATL TECH ENER INDU UTEL FINC TOTL LGVL 15.8 39.2 MDGR 28 21.6 25 19.2 30.3 27.4 7.1 26.2 20.6 LGCO 22.5 34.2 27.8 15.8 14.5 20 20.5 28.8 -3.2 9.2 LGGR 26.

See chart below. Unlike the U. Latin America and Emerging Markets. there are no clear sector patterns. precipitated by their nuclear disaster. Despite the setbacks. this is a reversal that I doubt will continue. Infrastructure spending in 2013 will reverse this trend. Like the U. Smaller companies in the UK. Losers Japan .S. best and worst performing stocks in the EAFE index.. especially energy and utilities.S. -9© Copyright 2013. like Australia. All rights reserved. As in the U. analysis above. Market leadership is likely to turn to countries less affected by the economic crisis. Energy & Material stocks across the board. I think infrastructure spending will increase. I expect better relative performance in 2013.Key observations are as follows: Winners Financial stocks in all styles and countries. as shown in the next table. .S.. . the long suffering in Japan has positioned it as a value play – a bargain. especially financials and consumer discretionary. we can review the biggest. Advisor Perspectives. Inc.

Inc. All rights reserved. The 87-year history of the U. . There are many lessons in this table. bonds. Advisor Perspectives. For example. so it’s worth your time and effort to review these results. Tbills and inflation. capital markets The following table shows the history of risk and return for stocks (S&P 500). T-bills and inflation. here are a few of the lessons: .10 © Copyright 2013. bonds (Citigroup high grade).In the remainder of this report. I provide a longer term 87-year history of stocks.S.

All rights reserved. but they have been about as efficient in the most recent 44 years. We paid the government to use their mattress. Advisor Perspectives.S. The Sharpe ratio for bonds is .29 for bonds.43% inflationary environment. T-bills paid less than inflation in 2012. 2.) . Bonds were more “efficient.38 for stocks in the first 43 years.56 versus .38% in 1969-2012.08% in a 1.5 times that of the previous 43 years: 1. Average inflation in the past 44 years has been about 2. at . 4. which is surprising in light of low interest rates. The past decade has been the second worst for stocks across the past eight consecutive 10-year periods. but the Sharpe ratio for both is about the same in the more recent 44 years. dollar. . resulting in material decreases in interest rates.1.11 © Copyright 2013. America has benefitted from confidence in the U. It’s a “Limbo” market: How low can you go? (The “Limbo” is a dance contest where participants attempt to pass below an extended pole that is progressively lowered.” delivering more returns per unit of risk than stocks in the first 43 years. earning 0. 3.25 for stocks and . Inc. Long-term high-grade corporate bonds fared very well in the last three years. The decade 1963-1972 was slightly worse. 5.65% in 1926-1968 versus 4.

33 5.57 1.21 5.00 8.58 .22 .23 4.35 8.44 2.30 16.56 .75 13.34 .06 12.71 2.58 .69 1.55 .15 .22 1.69 1.74 12.73 5.42 .33 2.81 .79 .12 15.-----1.18 .27 1.48 1.05 1.12 © Copyright 2013.24 .01 3.90 5.61 4.36 7.25 1.05 8.65 1.12 3.29 5. Inc.46 4.16 8.77 4.84 5.67 3.64 .98 10.38 7.29 .25 8.91 1.77 2.49 ______________________________________________________________________________________________ 1928-1932( 1933-1937( 1938-1942( 1943-1947( 1948-1952( 1953-1957( 1958-1962( 1963-1967( 1968-1972( 1973-1977( 1978-1982( 1983-1987( 1988-1992( 1993-1997( 1998-2002( 2003-2007( 2008-2012( 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 5 YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) -12.01 .06 4.43 .15 -.17 2.42 2.09 1.34 3.-----15.74 15.83 .89 9.61 4.02 cpi -------------RETURN STNDEV -----.45 .22 9.30 3.83 ______________________________________________________________________________________________ 1926-1968(43 YRS) 1969-2012(44 YRS) 10.24 .47 15.61 19.13 .29 .MARKET HISTORY FOR PERIODS ENDING DECEMBER stocks --------------------RETURN STNDEV SHARPE -----.74 .34 2.39 .76 2.17 2.31 12.67 19.85 6.23 -.44 10.21 2012( 1 Year) ______________________________________________________________________________________________ 1926-2012(87 YRS) 9.47 .47 14.40 12.32 6.20 14.10 .84 .03 .77 17.05 28.21 .37 1.70 8.01 3.25 8.46 .43 -.29 4.50 1.62 14.06 .97 2.56 .13 1.75 .37 .34 10.21 15.52 .43 2.48 4.21 -5.67 6.10 .54 . Advisor Perspectives.81 3.31 .75 15.05 .43 .47 2.93 6.32 4.61 6.35 13.80 2.57 6.42 8.51 3.83 .74 2.25 .56 .85 .46 5.25 3.91 16.27 6.52 1.18 .44 9.02 -.70 13.61 7.29 5.83 .04 6.30 .30 10.65 4.79 7.40 12.35 3.68 16.67 Source: PPCA Inc.46 3.73 3.94 8.08 2.07 17.25 2.08 .25 7.35 .09 13.88 .57 13.92 13.66 4.71 31.02 .82 .17 9.38 .36 10.18 . .20 9.24 ______________________________________________________________________________________________ 1933-1942(10 1943-1952(10 1953-1962(10 1963-1972(10 1973-1982(10 1983-1992(10 1993-2002(10 2003-2012(10 YRS) YRS) YRS) YRS) YRS) YRS) YRS) YRS) 9.30 6.17 8.26 .02 1.08 13.38 2.56 1.05 11.63 2.87 1.36 .90 .06 .62 2.24 t-bills -------------RETURN STNDEV -----.06 .81 2.40 2.18 10.83 13.19 2.84 19.30 .53 2.05 .32 1.27 1.07 .84 .58 .43 1.19 4.21 6.08 .-----.24 .82 2.37 13.85 19.88 3.45 .17 8.65 1.14 4.72 .25 1.45 . All rights reserved.46 7.17 1.69 .59 .00 2.18 2.49 .94 13.91 .-----5.-----.21 6.67 .37 .25 4.66 1.74 .41 -.47 22.05 16.35 .25 -.54 -.10 .38 .15 1.80 9.51 bonds --------------------RETURN STNDEV SHARPE -----.48 .59 14.87 4.53 40.08 .43 4. .30 5.27 -.38 .-----.35 17.75 2.95 3.88 20.76 .55 12.45 .43 .01 -.40 3.60 8.27 -.06 4.59 .56 12.90 .13 8.78 13.48 .91 2.42 2.29 1.10 26.

Additional perspective is provided by the following histograms of stock and bond returns. Inc. .13 © Copyright 2013. Advisor Perspectives. . All rights reserved.

.14 © Copyright 2013. Advisor Perspectives. . All rights reserved. Inc.

Ron can be reached at (949)488-8339 or Ron@PPCA-Inc. Chuan-Yang.php . www. Ashish. GA. 5 • October 2004 Link1 Sapp. All rights reserved. Comments welcome.advisorperspectives. The 52-Week High and Momentum Investing.com For a free subscription to the Advisor Perspectives newsletter.advisorperspectives.Appendix: Articles on Momentum Investing    George. and its Target Date Solutions subsidiary. The Journal of Finance • vol. Does Stock Return Momentum Explain the “Smart Money” Effect? Article first published online: 27 Nov 2005 Link2 Wikipedia.15 © Copyright 2013. He is also Vice President of eVestment in Marietta. no.com/subscribers/subscribe.com. CA. Momentum Investing Link3 Ronald Surz is President of PPCA Inc. lix. Inc. Advisor Perspectives. visit: http://www. . Thomas and Hwang. both in San Clemente. Travis and Tiwari.