2011 was a year marked by volatility in the stock market mainly due to uncertainty about growth in the global economy.  All year, headlines questioned whether there would be a double dip recession. The fourth quarter saw the upside to that query as markets globally rallied.  Small caps led for the interim period yet large cap stocks led for the year.  Most of the strength in the quarter came in October reflecting encouraging news on corporate earnings.  This belied arguments for a double dip.  Incremental news on the U.S. economy, reflecting a pick up in GDP growth and less hostile employment results, corroborated a more constructive market outcome.

 

Last year we postulated that large cap could be big in 2011 and that U.S. domestic stocks would be recognized and preferred by investors because of sentiment, valuation and improving fundamentals.  Well, not only were large U.S. stocks the best performing equity market for the year but it was the second year in a row where U.S. stocks in general provided superior returns on the global equity stage.  It’s time for their close up!  A trend seems to be developing that warrants further attention from investors.

 

The TAMRO Diversified Equity portfolio (http://www.tamrocapital.com/products.html)is broadly diversified, with sector allocations resulting from opportunities we identify at the stock level through our bottom-up fundamental analysis and valuation work.  Notable shifts in sector allocation during the quarter were a decline in the weight of health care due to sales/profit-taking based on valuation and an uptick in the information technology sector weight.  The major trend that has resonated within technology is the move by corporations toward cloud computing to increase flexibility and efficiency.  Those companies that facilitate that shift came into our valuation target range and provided the incremental opportunities.  Information technology ended the year with the largest sector allocation in the portfolio, followed by financials and industrials.

 

While the financial sector was the worst performing sector in the market in 2011, we began increasing our exposure in the third quarter, having identified companies we believe to be clear leaders that executed throughout the financial crisis, where valuations became compelling.  Importantly, while European banks need to raise additional capital, U.S. banks met their requirements a few years ago, thus placing them in a more competitive position.  Our exposure to industrials is based on high-quality global leaders where economic uncertainty has depressed valuation.  TAMRO’s three fundamental investment categories Leaders, Laggards and Innovators represent 78%, 8% and 14% of the total portfolio, respectively. The major change from the prior quarter was a net increase in Leaders.

 

Q:  The equity markets were volatile in 2011, but ended basically flat.  What are your thoughts on the stock market and economy in 2011?

 

A:  This was a mixed year for investors. Large cap stocks, particularly growth stocks, registered positive returns for the year and superseded mid and small cap stocks.  While the returns in the U.S. equity markets were inconsequential from an absolute return perspective, they provided a better return relative to the rest of the world.  In fact, this was the second year in a row where the U.S. outperformed world markets.  Heading into 2011, we believed U.S. equity markets would be attractive for three reasons: 1) Sentiment - we saw U.S. equities as an under-owned asset class, particularly U.S. large cap stocks 2) Valuation and Fundamentals - we found both compelling and 3) Balance Sheets - U.S. companies were flush with cash and that liquidity would allow for flexibility.  We still believe all of the above to hold true for U.S. equities.  With an estimated 16% increase in corporate profits in 2011, based on S&P 500 earnings, and a flat market, valuation is still compelling, particularly for large cap stocks.

 

Q:  How did TAMRO’s Diversified Equity strategy do last year?

 

A:  It was a challenging year with the Diversified Equity portfolio lagging the benchmark, the Russell 1000 Index. Poor stock selection in technology and consumer discretionary was not offset by strength in other sectors.  While a deceleration in the economy created weakness, there were also company specific miscues that detracted from performance.  Specifically, product transitions are never facile and with Research In Motion the only thing in motion was its stock price on a downward path.  We believed the company’s superiority in the enterprise space due to its secure network together with its overseas market share lead would provide a cushion.  Unfortunately, competition from Google, with its Android operating system, and Apple, with both its iPhone and iPad, caused the company’s market share to erode over the course of the year.  Yes, it is still part of the portfolio; profitability and cash flow remain robust, as does the company’s overall customer growth.  A much delayed product transition should begin to take hold later this year and we believe the transition should reawaken investors’ interest in the company.  In the meantime, valuation is discounting no improvement whatsoever in operating fundamentals.  Please see our investment commentary write-up on our website for more information:www.tamrocapital.com/products.html.

 

Q:  What is your outlook for 2012?

 

A:  We believe U.S. stocks should provide investors good to average returns for the year.  We believe large cap stocks should have an edge over small and midcap stocks due to superior valuation and improving fundamentals.  The domestic economy will likely register continued subpar economic growth and global markets should also remain subdued due to credit issues in Europe and softness in export markets, which is the key driver for emerging economies.  As this is an election year, we believe there will continue to be volatility in the U.S. market.  We hope to take advantage of near-term downward volatility to add to best-in-class companies at more compelling prices.

 

 

(c) TAMRO Capital

www.tamrocapital.com