Sutton Place Capital Management LLC
New York, New
York
January 8, 2013
S&P 500: 1457.15
VIX: 13.62
““Almost
Back to Basics”
Summary of the Fourth Quarter and Outlook
The gain in the
stock market during the fourth quarter was led by several sectors including
Financials, Industrials, and Materials. The Telecommunication, Technology
and Utility sectors lagged. The market growth for 2012 was very
concentrated, specifically in financials and a few selective stocks. The
financial sector’s performance finished last in 2011, but an accommodating
regulatory environment aided a strong rebound. Nevertheless, it was a
difficult final quarter to the year when it came to planning for 2013. Tax
codes dictate a lot of business decisions and the year finished with a
politically charged month.
In 2013, expect there to be less volatility but more aggravation as uncertainty
will be the issue for the first half of the year. Although there were
answers provided about the tax piece of the fiscal cliff, a lot of matters were
pushed out. The market has accepted that a lot of the issues have not been
resolved, but a compromised solution provided a floor. The lack of clarity
on the scope of spending cuts leaves questions about future layoffs and the
appetite for corporate and consumer spending. But fewer and fewer
obstacles are in the pipeline and once executives unlock the padlock on the cash
reserves, the market should explode. This event is sometime in the future.
Right now, we move into earnings season which has an outlook for low
expectations; but at least the market readily understands earnings season
compared to Washington politics.
Economic Background
The outlook for
the global economy is still weak and may grow about 3% in line with the year
just ended. The outlook for growth by the major economies should be about
2% for the United States coupled with a contraction in Europe and single high
digits for China. As such, very similar picture to last year. Last
year was marked by persistent low interest rates as central banks attempted to
stimulate their economies and postpone the worry about inflation. Low
rates are expected to continue worldwide. European debt issues received a
lot of bailouts to sustain their economy and the bulk of the pain has yet to be
felt by the individual countries who are will be facing stiff labor issues.
The current year
will look similar to last year, but under the surface, will be more encouraging
for equity investments. This is because of three reasons: 1) time profile
has improved; 2) risk of spillover from Europe is more contained; 3) oil
constraint on global growth is less tight. This combination bodes well for
growth over the next few years.
Market Valuation and Equity Strategy
At the time of this note, the Standard and Poor’s 500 Index
trades at 13.50 times 2013 full year estimates. This is a very fair level
to add to the equity allocation when looking out beyond the next two years.
The longer-term forecast is due to the struggle that the U.S. equity market
faces to expand its valuation multiple due to low growth in revenues compared to
a trillion dollar government deficit. Our portfolios have a large cap bias
and these names grow into their valuation as the economy displays sustainable
signs of improvement. It is unlikely that the third quarter contraction in
the S&P earnings is a one-off experience. Fourth quarter earnings were
impacted by inertia due to the fiscal cliff, ravishing storms, and global growth
concerns. The pullbacks that negative news should offer will be viewed as
a buying opportunity.
During the quarter just ended, the Utilities position was sold in
favor of companies with faster growing dividends. Energy holdings were
re-allocated to companies with more favorable growth models. In our
opinion, the valuation for a consumer staple company and its spin out was
reached and swapped for a younger peer with stronger margin prospects.
Current shifts to the holdings include adding to financials and evaluating
companies who should benefit from improved auto and housing sectors. A
slight rise in yields will help banks and, a better tone from China, will aid
materials and chemicals. Since the 2008 debacle, our investment attitude
towards financials has been to underweight this sector in comparison to the
allocation in major indices primarily because the fundamentals of the money
center banks warrant asset write downs. Government decisions have been
very favorable to those financial institutions but at some time, the two have to
balance out and this is a tricky situation for investment choices. The
investment preference has been to gain exposure to the financial sector through
insurance stocks, preferred securities or bonds issued by money center banks.
As decisions on the tax piece of the fiscal cliff became less of a cliff hanger,
the preference for mergers or acquisitions may supplant spin outs.
At current market levels, the total return expectation for stocks offers a
better value to bonds as the tone for unemployment and lending has improved.
Fixed Income Strategy
The challenge looking into the current year is yield which is low
and will move modestly higher. The 10-year Treasury note finished
2012 at 1.88% and likely will finish just above 2% in the current year.
The positives for the bond market are that inflation is not likely to rise much
and the Federal Reserve will provide a strong basis for the market with its
mortgage back securities and treasury purchases. The Federal Reserve
continues to target key short term rates to remain at zero through mid 2015
though this trigger point is now data based not calendar based.
Nevertheless, short-maturities are unattractive and the preference is to own
preferred stocks with a less than three year call option. Returns for
preferred stocks should remain positive, but come from income rather than price
appreciation. Bond maturities under five years are preferred and we will
selectively dip down on the credit spectrum. With a Medicare surcharge
implemented on higher income earners, municipal purchases are more attractive,
but the long term appeal will depend on the outcome of the debate on tax policy
changes.
Regards,
Maribeth Holland
Portfolio Manager and CIO
(646) 401-2780
Information and opinions
presented in this email are provided for informational purposes only and are not
to be used or considered as an offer or solicitation of an offer to buy or sell
securities or other financial instruments. Sutton Place Capital Mgmnt (“SPCM”)
has not taken any steps to ensure that the advice referred to in this report are
suitable for you and it is recommended that you consult an accountant if you are
in doubt about any such advice. Information and opinions presented in this
report have been obtained or derived from sources believed by SPCM to be
reliable, but SPCM makes no representation as to their accuracy, timeliness or
completeness. SPCM accepts no liability for loss arising from the use of the
information presented in this report. Past performance should not be taken as an
indication or guarantee of future performance.