My Investment Home Run

Bob Froehlich Hartford Investor May 25, 2011

I realize that we find ourselves in the thick of the playoff season for both NBA basketball and NHL hockey. While I will watch some of the games (if there is nothing else to do), I'm really not a big basketball or hockey fan. Quite frankly, I would rather watch a baseball game in May when the games really don't matter, than watch basketball and hockey in May. Could it be that their seasons go way too long to keep my interest? That's another topic for another time. Right now, as an old baseball guy, I'll give you what I think just might be the next investment home run.

My investment home run is comprised of seven issues, one that corresponds to each of the seven letters in the words "home run." "H" is for history. "O" is for oil. "M" is for money. "E" is for economy. "R" is for retail. "U" is for U.S. mergers and acquisitions and, finally, "N" is for new workers.

Let me touch on each of these issues beginning with history. Just because something has happened in the past, it doesn't mean it will happen in the future. That's why one of the footnotes at the end of all of my commentaries reads, "All economic and performance information is historical and does not indicate future results." While I understand that just because something has happened in the past it doesn't mean it'll happen in the future, I'm a student of history, and I personally believe that history is one of our greatest teachers.

I was fascinated by a piece of research recently put together by Strategas Research Partners, Jason Trennert's firm. Jason and I were recently on CNBC's Kudlow Report together. I believe that Jason is one of the best big-picture thinkers on Wall Street today. Anyway, here's their history lesson. Strategas looked at the historical performance of the Standard & Poor's 500 Index1 for years in which the Index was up 5%-10% in the first third (January-April) of a calendar year going back to 1950. In all but one instance, the Index continued to climb higher the remainder of the year.

Since 1950, there have been 16 such occurrences. In 1950, in the first third of the year, the Index was up 7.0%, it moved 14.7% higher over the remaining two thirds of the year to end 21.7% higher for the year. In 1951, in the first third of the year, the Index was up 9.8%, it moved 6.6% higher over the remaining two thirds of the year to end 16.3% higher for the year. In 1955, in the first third of the year the Index was up 5.5%, it moved 20.9% higher over the remaining two thirds of the year to end 26.4% higher for the year. In 1956, in the first third of the year, the Index was up 6.4%, it moved 3.8% LOWER over the remaining two thirds of the year, but still ended positive for the year at 2.6%. Thus, 1956 was the only time in the 16 occurrences since 1950 when the market didn't continue to climb higher after posting a 5-10% gain in the first third of the year. While it didn't go higher, I think it's interesting to point out that the Index was still positive for the year.

Continuing with my history lesson, there was one more occurrence in the 1950s, two in the 1960s, two in the 1970s, two in the 1980s, and three in the 1990s. Since we entered the new millennium in 2000, there have been two occurrences. The first in 2006, when in the first third of the year the Index was up 5.0%, it moved 8.6% higher over the remaining two thirds of the year to end 13.6% higher for the year. It also happened last year, in 2010, when in the first third of the year the Index was up 6.4%, it moved 6.4% higher over the remaining two thirds of the year to end 12.8% higher for the year.

Why am I making such a big deal about this now? It's because in the first third of this year the Index was up 8.4%. So if you believe in looking at history, here is what history has to say. In the 16 occurrences prior to this year when the Standard & Poor's 500 Index was up 5-10% in the first third of the year, in all but one instance (15 out of 16) the Index continued to climb higher the remainder of the year. Also, in the one occasion where it didn't climb higher for the remainder of the year in 1956, the Index still posted a positive return for the entire year. So that means that every time, (16 out of 16) when the Index was up 5-10% in the first third of the year, the Index ended the year positive.

While no one knows how the 17th occasion happening this year will play out, on the previous 16 occasions, the average return for the remainder of the year was +11.5%, putting the full year average return at +18.2%.

Now think about this for a minute as it relates to the Dow.2 The Dow ended the year 2010 at 11578, and if it, too, were to gain 18.2% for the year, the Dow would end the year at 13685! That is just one or two good trading days away from 14000. All I can say is see ya' at 14000 baby!

Next up is "O" for oil. It seems that everywhere I travel, everyone has the same concern-the high price of oil will kill our economy and destroy our markets. While at some point that will be true, I believe we're a far cry from that point. The high price of oil and gasoline only impacts the economy and, in turn, the market, once behavior changes. Until then, the only thing that matters is some components of our economy will do better, while others will do worse with higher energy prices.

Think of it like this: Every month we are given a pie (our wages), and with higher gas prices, a bigger slice of that pie now gets spent on energy. We still spend the entire pie- we just spend it and allocate it differently. People are very unhappy about filling up that Sports Utility Vehicle and watching the bill hit triple digits. Although they whine and complain, people still continue to drive that SUV. In other words, behavior didn't change, they still spend the entire pie, only now they spend it a little differently. Until consumer behavior changes, it simply means that some industries will do better while others will do worse. High gasoline prices certainly make the oil producers and the oil service & equipment sectors a good looking investment. Also, coal becomes a much more attractive alternate for energy, helping that sector as well. Railroads continue to do well with higher gasoline prices as more companies take their products off the highway and put them on the railway. Finally, public transportation systems (buses and subways) should witness increased ridership with higher prices. So clearly there are some winners with higher oil prices.

On the flip side, who are the losers? The most obvious are the airline industry and trucking industries, both big consumers of oil and gasoline. Also, hotels and fast food resturants will suffer as there is not enough of the pie left over to spend on them anymore. Finally, amusement parks tend to take a hit with higher oil and gasoline prices.

My point here is that different industries and sectors will win and lose as the price of oil and gasoline climb higher. But as long as consumer behavior doesn't change (i.e. consumers still spend the entire pie), the economy will be fine and so will our overall markets. So when does consumer behavior change? Many thought it was when gasoline got over $3.00 a gallon. Boy, were they wrong. But at $4.00 a gallon there is still no change in sight. My best guess is that north of $5.00 a gallon, consumers might begin to spend less of their pie, hoarding it to pay for higher gasoline prices in the future. Until that time, sit back and enjoy the ride as an investor. Remember, somebody is making money in the market everyday, whether the price of gasoline is $1.00 a gallon or $5.00 a gallon, they will just make it differently. If someone is going to make money, it might as well be you.

Speaking of money, let's move on to my next letter, "M" which is for money. It's not just the money that matters, but that the money is in motion. There are two important money-in-motion trends worth watching. First is the value of dividend payouts by the Standard & Poor's 500 companies. This number is reported on a quarterly basis, and at the end of the first quarter of 2011 the amount was close to $55 billion, which is a 14% increase on a year-over-year basis. The second trend, share repurchases, is even more dramatic. The value of announced share repurchases by the Standard & Poor's 500 companies, which again is reported quarterly, was more than $70 billion. This $70 billion value of announced share repurchases for the first quarter of 2011 is a whopping 81% increase on a year-over-year basis.

Let's move on to my next letter, which is "E" for the economy. While most strategists who are bearish on our economy and our markets point to the most recent Gross Domestic Product (GDP) release of +1.8% as proof we are in trouble, I see it as proof that harsh weather really matters. Let me remind you that this +1.8% number was for the first quarter of 2011. Harsh weather may be an understatement, as unprecedented snowstorms blanketed major regions of the country in both January and February.

As a result, residential construction fell at a 4.1% annual rate, while nonresidential construction plunged by an almost-unheard-of 21.7% annual rate. Consumers, who account for two thirds of our economy, cut back as well. In the fourth quarter of 2010, there was a 4.0% increase in real consumption, while in the first quarter of 2011 that number dropped to only a +2.7% level; again, attributed to the weather, as many shoppers couldn't make it to the malls or shopping centers. Keep in mind all the weather did was postpone that shopping for a later date.

Let's keep the ball rolling, so to speak, and move on to the letter "R" which stands for retail. I believe one of the best measures for retail sales is the Chain Store Sales (ICSC) Index. ICSC stands for the International Council of Shopping Centers, and this index is also commonly referred to as the Goldman Sachs-ICSC Index. I prefer to look at the three-month average, which in April of 2011 stood at 113.6. To give you some perspective on this number, before the sub-prime mortgage crisis and financial system collapse in late 2006, the three-month average was just above 108. It dramatically fell below 103 at the end of 2008 at the peak of the crisis. So not only has this consumer index completely rebounded back to the pre-crisis level, it just keeps going higher and higher. I guess the consumer isn't dead after all.

Next up in my Investment Home Run alphabet soup is "U" for U.S. mergers & acquisitions. It's my opinion that the single best barometer for U.S. business confidence is the mergers-and-acquisition trends. When chief executive officers (CEOs) are not very confident about the future of the economy or the future of the market, they are very reluctant to make a large capital commitment by buying another company. Conversely, when CEOs are confident about the future prospects for the economy and the markets, they want to buy market share by acquiring another company. It's truly that simple: Merger-and-acquisition trends may tell you everything you need to know about business confidence.

So what do the current trends tell us? Mergerstat issues a quarterly Value of U.S. Merger & Acquisition Deals Index. At the end of the first quarter of 2011, the value of U.S. M&A deals was almost $200 billion. Even more impressive, on a year-over-year basis, the value of U.S. merger & acquisition deals was up an unbelievable 139%. Remember, the trend is your friend, and in this case the trend I see in business confidence couldn't be better.

My final letter is "N," which stands for new workers. New workers will explain why things simply don't feel any better even with employment improving. Think about this for a minute. The most recent employment report showed that for April 2011 we added 244,000 new jobs. Maybe even more impressive was the fact that private-sector hiring hit a five year best of 268,000. Then, if you add in the revisions to the February and March jobs report, the April jobs number with revisions was up a cumulative 290,000.

So why doesn't it feel like it? In a word, or I should say in two words, it's "new workers." Employment is still down-6.5 million from its peak in 2007. At the same time, the U.S. working age population for April 2011 hit 239.1 million. When employment was peaking back in 2007, the U.S. working age population stood at 232.6. This difference in working age population, by the way, is exactly 6.5 million more workers, talk about a double doozie. We're still down 6.5 million jobs from our peak, and now we have another 6.5 million new workers entering the working age population. That, my friends, is why the employment picture doesn't feel good, and probably won't feel good for quite some time.

Let me bring this commentary to a close with my signature pearls of wisdom quote; this one is about home runs. It's an anonymous quote and it goes like this: "You can't hit a HOME RUN unless you step up to the plate. You can't catch fish unless you put your line in the water. You can't reach your goals if you don't try." Hopefully this commentary will help you reach your investment goals with your financial advisor by following my investment home run strategy.

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PAST ECONOMIC PERFORMANCE DOES NOT ENSURE FUTURE RESULTS.

The views expressed here are those of Dr. Bob Froehlich. Dr. Bob Froehlich's views are not necessarily those of The Hartford and should not be construed as investment advice. They are subject to change. All economic and performance information is historical and does not indicate future results.

Dr. Bob Froehlich’s sources of information include Bank of Canada, The Bank of England, Bank of Japan, Bloomberg News, Business Roundtable, China Investment Corporation, CIA. World Fact Book, CNBC, Congressional Budget Office, Deutsche Bank, The European Monetary Union, Federal Reserve Board, The Financial Times, Freddie Mac, FOX Business, Goldman Sachs, International Monetary Fund, International Strategy & Investment, Journal of Commerce, Merrill Lynch, PIERS Global Intelligence Solutions, Strategas Research, Thomson Reuters, Union Bank of Switzerland, U.S. Census Bureau, U.S. Department of Commerce, U.S. Department of Labor, U.S. State Department, U.S. Treasury Department, The Wall Street Journal, and The World Bank.

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