As investors say goodbye to a year that will be remembered in the history of financial markets for its volatility – and investors’ obsession with it – one of the most battered, bruised and, yes, volatile, markets has quietly reclaimed its spot as the world’s best performer.

It is, of course, the U.S.

Through November 15, the S&P 500 is up 1.8% year-to-date; the Dow Jones Industrial Average has risen 6.9%; and the NASDAQ, 1.3%.

Meanwhile, the rest of the world’s major equity indices are covered with red arrows, all pointing down.

Across the Atlantic, London’s FTSE 100 (-6.5%), Paris’s CAC 40 (-17.5%), and Frankfurt’s DAX  (-18%) are all well-below break-even. Given the ongoing debt drama in Greece and Italy, and the specter of prospective EU bailouts of both nations, it’s not surprising that European markets have languished. 

In Tokyo, the Nikkei 225’s performance (-17.3%) reflects in part the economic impact of the earthquake and tsunami that devastated Japan in March, combined with a national economy that has been in the doldrums for many years.

That leaves the emerging markets of Asia and Latin America, which became the mantra this year for many financial advisors and investors in search of relief from volatility and low returns. Unfortunately, emerging markets did not provide the haven they sought:

China’s Shanghai Composite Index is off more than 12%; Hong Kong’s Hang Seng Index is down 19%; India’s Sensex is almost 18% in the hole; and Brazil’s Bovespa Index is more than 16% negative year-to-date. Debt and inflation fears have also taken their toll on these markets.

Fundamentally Strong U.S.

While many of the same negative factors – concerns over the European debt crisis, heavy U.S. government borrowing, unsustainable federal budget deficits, high unemployment and anemic economic growth – are at play in the U.S., investors are taking another look at U.S. equities and realizing that this is the place to be.

Despite the market’s volatility in 2011, the long-term fundamentals for U.S. stocks are positive. The broad market continues to trade at an attractive multiple relative to its history and its future sales and earnings potential. According to the U.S. Treasury, global demand for U.S. stocks, bonds and other financial assets totaled $68.6 billion in September. That was the highest since November 2010, as investors sought refuge from the rest of the world.

Meanwhile, corporations reported strong third-quarter earnings and U.S. equity markets came roaring back, with the S&P 500 rising 10.9% in October, its biggest monthly gain since September 1991.

Robust earnings bolstered balance sheets and left many U.S. companies flush with cash. Some are using that cash for mergers and acquisitions to strengthen their market share, increase their scale and efficiencies, and leave them better-positioned to take advantage of growth opportunities when the U.S. economy shifts into full recovery mode.

This type of forward thinking is indicative of strong execution at the company level. Management teams are investing for growth while profitability is high, creating value and returning excess capital to stockholders.

Given that much more investor cash has been pulled out of U.S. stock mutual funds in the past few years than has flowed in, U.S. equities are now an under-owned asset class, though it probably won’t stay that way in 2012.

The Macro View

The U.S. economy remains stuck in neutral. Third-quarter GDP grew 2.5% on an annualized basis, after 1.3% in the second quarter. That is not exactly firing on all cylinders compared with China’s 9.3% third quarter GDP growth. Still, there are some encouraging signs that bode well for stocks.

First, U.S. consumers are deleveraging. They have been paring down their debt levels consistently for three years. Similarly, state and local government leaders, unlike their counterparts in Washington, are also taking steps to cut costs and balance budgets. Many companies anticipated the downturn in the economy and started to rein-in expenses sooner while staying focused on profits.

Second, U.S. banks, unlike their European counterparts, are stronger financially, having recapitalized their balance sheets a few years ago. This is even though the U.S. has the lowest interest rates on the planet. Inflation, excluding prices for food and energy, remains low and the U.S. dollar, though weak, is still a currency that has more confidence built into it over the long term than any other in the world.

Third, through it all, the U.S. remains a country with a long and impressive history of addressing and resolving its most challenging issues. Its track record of innovation and entrepreneurship is unmatched anywhere in the world. The U.S. continues to be a beacon of hope for the rest of the world, which is why we believe we have reached an inflection point and expect U.S. equity prices will continue moving higher in 2012.

What’s Ahead in the New Year

That’s not to say it will be smooth sailing ahead. To be sure, U.S. equity markets are likely not out of the woods. Our old nemesis, volatility, isn’t disappearing just because the calendar says 2012. Serious global and domestic macro-economic issues remain and will continue to affect U.S. markets as will the politics of a presidential election year.

Still, we see pockets of strength in equities, specifically, expansion in oil and gas exploration in North America, infrastructure outside the U.S., and well-capitalized regional banks. In general, we look for companies with what we call a Sustainable Competitive Advantage. The characteristics these companies possess include a leading market presence in a product or a service; an executive management team with a track record of success, innovation and vision; strong financials; and attractive valuation, which we define as three-to-one upside potential versus downside risk.

We believe many opportunities exist across all market caps for equity investors in companies that have a Sustainable Competitive Advantage. In technology, these include the biggest of the big, Google (NASDAQ: GOOG), to smaller, lesser-known but also vitally important companies such as Riverbed Technology (NASDAQ: RVBD) and Acme Packet (NASDAQ: APKT).

In the energy sector, new technology is reopening areas of the U.S. that were heretofore considered closed to new discoveries of oil and gas. EOG Resources (NYSE: EOG) is one of the leading independent oil and natural gas companies that is finding and adding to its reserves in North America. 

In financial services, American Express (NYSE: AXP) is benefitting from consumers’ desire to maintain access to credit and is a leader in the global shift away from cash to plastic. The company posted the highest earnings in its history this year.

Many investors have made money following Warren Buffett’s lead. Earlier this year, Buffett began buying back shares of his Berkshire Hathaway (NYSE: BRK.A and BRK.B), a conglomerate with a leading presence in the insurance industry. If it’s good enough for Buffett, it’s good enough for us. At the time of writing this article, TAMRO is an owner of Berkshire, along with all the other stocks cited above, because we believe they all possess the Sustainable Competitive Advantage needed to prosper in 2012 and beyond, and they possessed the attractive valuation we require of our stocks at the time of purchase.

For U.S. equity investors looking for ways to profit in 2012, there really may be no place like home.

 

 

There is no assurance that any of the stocks discussed above are currently held in the TAMRO portfolio or will be purchased in the future. The stocks identified do not represent all of the investments held in the TAMRO Small Cap and Diversified Equity Composites and are presented as supplemental to fully-compliant composite performance disclosure presentations, which are available upon request. Each strategy’s holdings may change at any time. It should not be assumed that any investment was or will be profitable. Past performance is not a guarantee of future results. To request a complete list of all recommendations made within the past year, contact tamro@tamrocapital.com.

 

 

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www.tamrocapital.com