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TheStreet Open House

Still finding bargains in this stock market

Stocks in this article: PG

By Karagosian Financial

The last quarter of 2013 was a tough act to follow as was the full year. The year 2014 had a slow start in the U.S. stock market. With January down, February rebounding and March moving sideways, domestic stock indices managed to have a flattish first quarter.

The S&P 500 Index (SPX) was the best performing out of the three major U.S. indices with an increase of 1.3%. (It also hit a record closing high on the first day of the second quarter.) The Dow Jones Industrial Average (DJIA) had a loss of less than 1% and the Nasdaq Composite (COMP) gained a fraction of a percent in the first quarter. Given the crisis in the Ukraine, a banal stock market performance was tolerable.

The trailing 12 month P/E ratio of the S&P 500 is approximately what it was a year ago (17.0% as of April 21). Even though stock prices in the aggregate rose quite a bit, valuations at least for this index have not. Also the dividend yield is still a healthy 2.0% or so, just slightly below this time last year.

The trend of dividend increases has carried into 2014. Recently Procter & Gamble (PG) announced a dividend increase adding to another fifty or so large companies announcing dividend increases in the first quarter.

Healthcare stocks again were one of the better performing sectors last quarter as they were at the end of 2013. The best performing group,though, was utility stocks, increasing 9% in the first quarter. These stocks typically do better when interest rates are declining which is what happened at the start of 2014.

Utilities are typically purchased for their attractive yields therefore when bond yields decline their dividend yields appear more desirable. REITs (Real estate investment trusts) also did very well last quarter for similar reasons.

Consumer discretionary stocks had the worst performance by far in the first quarter with a loss as a group of over 3%. The especially bad winter weather was often blamed for the poor performance in this sector which includes companies such as retailers, and auto manufacturers.

Foreign developed markets, as represented by the MSCI EAFE (based in US dollars) index, were actually unchanged for the first quarter. Surprisingly with the conflict in Eastern Europe, the European markets did better than the Asian markets. Many emerging markets declined last quarter both in local currency terms and when measured in U.S. dollars on slowing growth concerns, particularly in China. Interestingly, the MSCI East Europe index excluding Russia was one of the few positive emerging market indices in the first quarter.

After a posting a rare negative total return last year, bonds rebounded in the first quarter of 2014. Although most investors expect that the long term trend in interest rates is that they will go higher, in the near term it is hard to predict (same as the stock market).

The Barclays U.S. Aggregate Bond index had a total return of 1.8% last quarter. The best performing bond market segment was long term Treasuries with a gain of 7%. Although the Federal Reserve has continued its tapering of buying longer term Treasuries, demand for these securities was met by investors seeking "safety" in addition to probably some portfolio rebalancing as demonstrated by bond fund inflows in the first quarter.

As of March 26th, bond mutual fund inflows year to date were $21.7 billion (which compares with domestic stock inflows of $16.4 billion).

Emerging market bonds, in contrast to EM stocks, fared relatively well last quarter with a gain of close to 4%, although it was a very volatile period. Municipal bonds also had a good showing as the Barclays Municipal Bond Index returned over 3%.

A lack of new tax free bonds coming to the market led investors to bid up existing bonds. Investment grade bonds had a solid first quarter performance (2.9%). With a low risk of default, they continue to have a slightly positive yield compared to Treasuries.

What's the outlook for the market? Even with large gains in 2013, valuations remain similar to the year- ago period. This tells me that profits, in the aggregate, have nearly kept up with stock price increases; thus the market did not become increasingly expensive.

At current prices I am still finding plenty of good buys in the stock market. Bond yields are still depressingly low, but improved. In general, bond prices will likely continue suffering, but be partially offset by the coupon it pays.

Factors that might temporarily boost stock market returns are the increased flow of funds into equities (something that started occurring again in late 2012), and continued mergers and acquisitions and dividend increases stemming from huge cash stores on the balance sheet. These are all things we have covered the past three years and little has changed.

In my opinion, I do not expect much help from the government. My reasoning is that if it could have been done to boost the economy, it would have been done already, and in the current political environment, further initiatives such as tax cuts are unlikely in the near future.

Investors should consider this; since the great economic meltdown of 2008, it has been a very bumpy and painful road for Americans. Yet, since January 2009, the stock market has just about doubled (up 98%). This is a reflection of profits that have recovered and balance sheets that are likely the strongest in a half century.

Companies have simply become more efficient. Unfortunately, this increased efficiency and the elimination of many industry bubbles; i.e. real estate, are keeping unemployment high. No, the economy has not roared back, but there remain many sound investments that should do even better when the economy accelerates.

DISCLAIMER: The investments discussed are held in client accounts as of March 31, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.

Karagosian Financial

Karagosian Financial

The professionals at Karagosian Financial Services have more than 40 combined years of research and investment management experience in strong

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