October 9, 2012
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Despite investor concerns about the economy, stock markets have delivered substantial returns in the year to date, with the S&P 500 returning more than 16% and Europe, Australasia, Far East (the EAFE index) delivering more than 10%. This growth has been in the face of investor withdrawals from equity mutual funds. So if mutual fund investors are selling, who is buying?
The September 24 issue of Investment News reported that in the year-to-date investors have withdrawn $32 billion from equity mutual funds. All things equal, this sales pressure should have depressed stock prices. Mutual fund withdrawals were the yin of 2012 markets.
But all things have not been equal. Several publications, including the Wall Street Journal, CBS Money Watch, and USA Today, attributed the market’s rise to stock buybacks totaling more than $300 billion, dwarfing the $32 billion in mutual fund withdrawals. Share buybacks were the yang of 2012 markets.
Corporations have an ongoing capital budgeting decision. They can reinvest profits, pay them out as dividends or purchase company stock. Reinvestment is the right decision if there are profitable opportunities that exceed the company’s cost-of-capital. It would appear that some corporations found share repurchase to be the best use of their profits, indicating that management cannot find profitable projects or corporate investments. Corporations have amassed a lot of cash, so we could see a continuation of stock repurchases. Stock markets could continue to rise despite high unemployment, since corporations are buying back shares rather than investing in their companies.
In the chart that follows we see that the S&P 500 had experienced a trough-to-trough cycle in the first five months of the year and has been increasing in value since May. The market has recovered from its May lows. In the following, I examine the sector and style results for the year to date, and then report on a couple of interesting developments.
US stock market
The following chart shows the performance and risk (standard deviation) of sectors and styles for the year-to-date. Here are some observations from this graph:
- The total stock market has returned 15.3%, lagging the S&P500’s 16.4% return. Larger companies have outperformed small.
- Infrastructure stocks – energy, materials and industrials – have lagged the total market and have been higher risk. These sectors have disappointed on a relative basis, despite expectations that government spending would favor them.
- Consumer staples and telephones-and-utilities have lagged the market, but with lower risk.
- Healthcare has dominated on a risk-adjusted basis, providing a 20%+ return with below market risk. Medical companies have been among the largest share repurchasers.
- Financials recovered in 2012, returning more than 20%, albeit with relatively high risk, which is uncharacteristic.
- Core stocks, defined as those in between value and growth, have stood still, with relatively low risk and low return, while value and growth stocks have taken off. This suggests that investors have style conviction but disagree, with some liking value while others like growth. We use Surz Style Pure style definitions throughout this commentary.
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