October 2012

Back to the Future

Many investors seem to be a little skittish these days. Perhaps it is the fact that, after a very strong performance in the third quarter, the market has leveled out somewhat. Perhaps it is concern about the results of the upcoming election. Perhaps it is worries about political and economic events abroad.

Certainly, all those things matter to some extent. But in the long run, it is important to remember that the most powerful forces that move the market now or at any time are profits, profits, profits -- and those things that are likely to have an impact on profits.

So where do we stand? Both at home and abroad, there are a number of positive signs.

For example, U.S. companies have been seeing record earnings over the last few years, with billions of dollars of cash on the sidelines. It is possible – perhaps even likely – that earnings will decelerate slightly, weighed down especially by economic difficulties in Europe and China. In addition, many companies have reached the limit in terms of increasing productivity, and it was cutting costs and increasing production that created much of the earnings boom. But earnings remain positive.

What about the overall economic outlook? There is growing evidence that the economy is strengthening, both in the United States and abroad. For example:

  • The U.S. unemployment rate declined to 7.8% in October, down from 8.1% a month earlier. In addition, fewer people are filing new unemployment claims, and retailers are planning aggressive hiring for the holiday season.
  • U.S. retail sales were up 1.1% in September, which followed an increase of 1.2% in August.
  • The Leading Index of the Economic Cycle Research Index, or ECRI, is trending upward. The ECRI is a measure of movement in the economic cycles.
  • U.S. home foreclosures are at their lowest level in five years. In addition, home prices are up significantly in most of the country, which is encouraging potential buyers to act now rather than wait.
  • Europe has seen positive industrial production over the last several months, including in Italy and Greece, which have been hit hard by the eurozone crisis. For example, August production in Greece was up 2.5% over August 2011.
  • Countries around the world have implemented policies designed to stimulate growth, including significant moves by the European Central Bank and the U.S. Federal Reserve.

Of course, there are still many potential problems. U.S. unemployment remains high, and an increasing number of people have stopped looking for work. The looming "fiscal cliff" could prove disastrous unless Congress takes action to avoid it -- which seems questionable considering the ongoing gridlock in Washington.

Elsewhere in the world, Europe still struggles with plans to deal with its huge debt and with unrest in those countries that have instituted austerity measures as a result. Stagnant growth in China is increasingly worrisome, and of course there is always the fear of geopolitical disaster in the Middle East or Africa.

Still, we at Peachtree Investment Partners see reason for cautious optimism. The U.S. economy's improvement is slower than we might want, but it seems to be sustainable. The election next month -- however it turns out -– probably will aid the recovery by removing much of the uncertainty about the direction in which the country will be going in the next four years.

We also continue to believe in a reasoned approach to building a portfolio that emphasizes strong, well-run, competitive companies that pay dividends. Dividends provide an ongoing source of income -- since 1929, reinvested stock dividends have comprised about 50% of the stock market's total return – and they help provide some cushion against market volatility.

Many experts suggest it is possible that companies will increase dividends for the fourth quarter. After all, companies are sitting on a lot of cash, and they need to do something with it. In addition, the fourth quarter is traditionally the time for dividend increases. And, perhaps most significantly, taxes on dividends and capital gains may be increasing after the first of the year.

In short, we think that in general, markets go back to the future. They go up, and they go down. The best approach to market changes is to have a plan and to execute it. Obviously you have to pay attention to what’s going on in the market and in the world, and to adjust your investment strategy as needed. But neither panic nor euphoria is conducive to long-term investing success.

Garry K. Schaefer
Atlanta, Georgia
October 17, 2012

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