3rd Quarter 2012 SMA Commentary
The Consumer Is King
Investors caught the summer breeze during the third quarter and pushed U.S. equities to new highs for the year. Although the economy provided some forward momentum, it was the Federal Reserve’s September announcement of open-ended quantitative easing that ensured the period would end on a positive note. With Europe seemingly on the verge of a severe recession and Asian economies decelerating, the U.S. economy continues to find its footing. Why? In America, the consumer is king, and consumer sentiment is at a post-recovery high despite persistent above-average unemployment. That may seem like a conundrum, yet housing is central to the American economy and after falling for nearly six years since its peak in 2006, an upturn in home prices is fueling the positive trend in consumer sentiment.
Not only is the U.S. consumer king, but his home is his castle—something the Fed well understands. Roughly 69% of American families own a home and the median value of that home is approximately $210,000. Another 49% of Americans own stocks directly or indirectly via mutual funds. The median value of that portfolio is approximately $49,000. In our opinion, stock prices move the needle primarily for those in the upper middle class and above. As equity prices move higher, you get a wealth effect within that demographic. For most Americans, however, equity prices do not mean much. To the broader population the one asset they own of any real monetary value is their house. Thus, housing price deflation or inflation has the more significant impact on sentiment and spending. We believe this positive trend in housing will continue and prove supportive to both equity prices and economic growth.
The strategy bested its Russell 1000 Index benchmark by more than two percentage points during the quarter. Sector allocation was neutral, with strong stock selection in the Technology, Energy, Industrials, Materials, Consumer Discretionary, and Consumer Staples sectors providing the outperformance relative to the index. Top individual contributors included a major technology company, an independent refiner, which announced quarterly earnings that were better than expected and plans for accelerating growth initiatives, and a gold mining stock within Materials.
Stock selection within Healthcare was the primary detractor to relative performance. A pharmaceutical and medical device maker dropped on investor fear that economic weakness could affect sales given the discretionary spending nature of many of its products. Other notable detractors included an airliner manufacturer involved in a labor contract dispute and a home retailer that sold off on concerns surrounding online competition and margin sustainability.
The top three sectors in the portfolio at the end of the third quarter remained the same from the prior quarter—Financials, Consumer Discretionary, and Healthcare. From a bottom-up perspective, we continue to find these three sectors, and the companies we own in them, the most attractive. From a top-down perspective, all three are highly domestic-facing industries. We think the ongoing recovery in the U.S. economy, aided by the upturn in housing, should prove to be a significant tailwind for these areas going forward.
We saw opportunities to expand positions or add new holdings in Healthcare, Consumer Discretionary, Industrials, and Materials during the quarter. Six stocks became full positions through either direct purchases or market appreciation, including a pharmacy benefit manager and a wireless chip-maker. We trimmed or sold outright positions in Financials and Technology, including full positions in an investment bank and a financial service company to fund better relative opportunities.
TAMRO Capital Partners