Craig Allen: U.S. Positive Economic Performance Divergence Continues

For more than six month, U.S. economic data has signaled a consistent improvement in the nation’s economic performance — an anomaly when compared with most developed countries, especially those in Western Europe.

While countries such as Greece, Portugal, Spain, Ireland and even Italy struggle with crushing sovereign debt levels, skyrocketing interest rates, political chaos, civil unrest and soaring unemployment, U.S. economic indicators and corporate performance have steadily improved. The problem is that investors seem more concerned with international problems and less with our improving domestic situation. At some point in the near future, however, the collective weight of improving data should overcome the negativity from foreign markets, leading to much stronger U.S. stock market performance.

On Friday, we’ll see December’s reports on consumer spending and confidence figures, auto sales, productivity data, manufacturing and services data, and nonfarm payrolls. In addition, we’ll have earnings reports from some of the largest companies, including ExxonMobil, Pfizer, UPS, Merck and Amazon.

In fact, more than 100 Standard & Poor’s 500 companies will report this week. Facebook may also file for an initial public offering this week; something that has been highly anticipated for many months and underscores the improving IPO market conditions that are making it much more favorable for companies to sell stock.

Last week GDP for the fourth quarter was reported up 2.8 percent on an annualized basis. While this was a strong improvement from the third quarter’s 1.8 percent annualized growth, it fell short of economists’ expectations of 3 percent to 4 percent growth for the quarter. Still, GDP appears to be moving in the right direction, setting us up for what I believe will be 3 percent to 4 percent overall GDP growth in 2012.

One concern regarding fourth-quarter GDP is that there was a sizable build in inventories. While this can be viewed as a negative in that some prefer to see GDP growth strictly from spending rather than investing in inventories, it can also be seen as a positive future indicator, since companies will only build inventories if they believe demand will increase in the near future.

The University of Michigan Consumer Sentiment Index was also revised upward last week, to a 75 reading, which was better than economists expected, and which is a strong reading for this index. The Thomson Reuters/University of Michigan final index of consumer sentiment climbed to 75 from 69.9 at the end of December.

The median estimate in a Bloomberg News survey called for 74, which matched the preliminary reading. A strengthening labor market and higher stock prices contributed to this increase in confidence. The 75 reading for January is the best level for consumer confidence we have seen in almost a year. (The index averaged 89 in the five years leading up to the most recent recession that ended in June 2009.)

The S&P 500 ended last week on a slightly down note, with the index sliding about 2 points Friday, but finished the week up about 0.1 percent overall. Of the 172 S&P 500 companies that have reported quarterly earnings so far, 65 percent have beaten the consensus estimate. This is slightly lower than the 73 percent average from S&P 500 companies over the past four quarters, but is still a strong positive indicator of overall earnings improvement for U.S. companies, for the quarter.

While I recently trimmed some positions and sold financials after a sizable jump from their December lows, I am long-term bullish on U.S. stocks. I have a 1,500 target for the S&P 500 sometime during 2012, which is a still a 14 percent gain from the current 1,313 level for the index. (I initially set my 1,500 target for the index on Jan. 1, when the S&P 500 was 1,258. A move to 1,500 from this level would represent a 20 percent increase in the index. Click here for a previous Noozhawk column: Tumultuous Year for Stocks Ends with a Whimper.

I look for a pull-back in the short run, which is why I raised some cash recently, but I feel that U.S. economic indicators are consistently improving, and in the longer term, this will have a positive impact on stocks. At some point, investors will be forced to stop focusing on foreign concerns, and to start recognizing the significant improvement we are witnessing at home. Valuations for U.S. stocks continue to improve as earnings grow, leading to an increasingly compelling overall valuation for U.S. markets, as compared with foreign markets around the globe.

I am not a believer in diversification to reduce risk in portfolios, but there have certainly been opportunities for attractive gains in some foreign markets over the period since the U.S. recession of 2008-2009. Today and going forward, comparative valuations between the U.S. markets and those of foreign countries make investing in U.S. equities much more compelling.

Should U.S. markets pull back somewhat in the short term, I will be an aggressive buyer. I have roughly 70 percent to 80 percent exposure for my equity allocation at present, with about 20 percent to 30 percent cash available. I am hoping for a 5 percent to 10 percent pull-back in U.S. equities markets overall, or about 130 points in the S&P 500, with a more significant retraction in the financials.

Once I put my cash back to work, I expect the most effective investment strategy to shift to a “buy-and-hold” approach from a “stock picker’s” market. I will look to hold positions throughout 2012, looking for a 1,500 target level for the S&P 500. As the economic picture unfolds, this expectation could certainly change, so I will remain, as always, flexible with regard to my investment process.

If economic indicators continue to show steady improvement, however, we should see a positive increase in employment and consumer spending, which should push GDP growth toward the upper end of my expected range — towards 4 percent annualized growth for 2012, and should set us up for even stronger growth in 2013.

— Craig Allen, CFA, CFP, CIMA, is president of Montecito Private Asset Management LLC and founder of Dump Your Debt. He has been managing assets for foundations, corporations and high-net worth individuals for more than 20 years and is a Chartered Financial Analyst (CFA charter holder), a Certified Financial Planner (CFP) and holds the Certified Investment Management Analyst (CIMA) certification. He blogs at Finance With Craig Allen and can be contacted at .(JavaScript must be enabled to view this email address) or 805.898.1400. Click here for previous Craig Allen columns. Follow Craig on Twitter: @MPAMCraig.