Now you see it, now you don’t.

                                                Magician’s quote

While everyone has an opinion of what happens to QE3, the mechanics of the exit show no clear direction. All we seem to know is that it is marching to extinction. The Fed will move when they believe the economic foundation is secure enough to withstand any “shocks” to the system. In actuality, the prognostications range from dire consequences to smooth transition. When the course of action is finally determined, stock market reaction will be short-term at best. We believe that the brief sell-off will be buttressed by the fact the winding down is being accomplished in an environment characterized by a larger than anticipated decline in the federal deficit accompanied by low inflation.

Currently QE3 purchases $85 billion monthly ($1.02 trillion annually) of Treasuries and mortgage securities. The common knowledge depicts a two party market in which the Treasury is selling and the Fed is buying. This results in the misleading confusion of who will fill the void if the Fed stops QE. In actuality, the average daily trading volume of Treasuries is $550 billion ($132.2 trillion annually) with Fed participation less than 1%, even on a big day. Furthermore, the Fed does not participate in regular auctions. Considering the magnitude of the overall market, Fed tapering sales should result in only a slight shift in the supply/demand curve with a marginal increase in supply. To determine the potential of a Fed unwinding of its balance sheet we can examine the cumulative purchases. According to Chairman Bernanke in his speech in Jackson Hole on August 31, 2012: “Three studies considering the cumulative influence of all the Federal Reserve’s asset purchases, including those made under the Maturity Extension Program, found total effects between 80 and 120 basis points on the 10-Year Treasury yield.” Today that yield is 23% higher than when the Chairmen spoke last year.

The most recent estimate for the current year federal budget deficit is $642 billion. At this level the current QE program not only monetizes the deficit but also picks up an additional $400 billion in new debt. Granted Fannie Mae and Freddie Mac are turning excess profits over to the government. Tax receipts are expected to increase. Five years into the bull market and with stocks at record levels, most capital loss carryforwards have been used, resulting in many investors paying capital gains rates as high as 23.9% instead of 15%. Other new taxes include CEO options and for fiscal 2014 higher taxes on hedge funds and money managers. We expect the economy to grow out of the soft patch in the second half of 2013. In the US growth will be led by a resurging consumer, capital investment in durable goods industries, and housing. With price/earnings ratios not reflective of sub 2% Treasury yields, we anticipate a continuation of the bull market for equities with minimal disruption from an orderly exit of QE3.

Our investment strategy remains a full position in equities. The run-up since the beginning of the year and a more bullish sentiment for equities opens the possibility of a correction. Longer term earnings growth should accelerate later in the year as private economy growth accelerates. Along with a dose of inflation this may be the ultimate catalyst for a sustainable bull market and deficit reduction.

Authors:                                                                                                
David Minor                                                                                                Rebecca Goyette

Editor:
William Hutchens

“The news of my death was greatly exaggerated.”

                                                             Mark Twain

Not unlike Twain, who reacted to his reported demise in a London newspaper in 1887, the American consumer has been declared figuratively dead throughout the grinding economic recovery begun in 2009. Consumer spending, approximately 70% of GDP, has been and remains a major catalyst driving stock prices. Housing bottomed in 2011 and its growth in 2012 into today is reflected in renewed consumer’s confidence and restored the wealth effect. Most recently, the employment outlook improved with a monthly average of over 200,000 private new jobs generated this year through April. Job creation is the most significant variable for housing and retail sales and should provide impetus for continued consumer spending as we approach the second half of 2013. Retail sales reported today were higher than expectations, rising 3.7% above April 2012. This follows weak sales in March.

To fully understand the potential of this virtuous circle for post-QE growth we examine the interaction of the job market, housing, retail sales, and stock prices using the S&P. Comparing the S&P 500 to these major sectors we can get an indication of potential relative sector performance resulting from consumer spending. Certain high-yielding individual stocks such as AAPL, EBAY, MA, and V are consumer related, but are classified information technology and are not included in these comparisons.

Beginning from the market bottom, when the proverbial stake had been driven in the heart of all consumers, the S&P 500 has risen 138.3% while the Consumer Discretionary ETF (XLY) climbed 276.5% through May 10, 2013. Despite a softening in economic data during February and March 2013 the S&P 500 is up 14.6%, meanwhile the XLY rose 20%, the Retail ETF (XRT) up 22.7% and the Homebuilder ETF (XHB) climbed 19.9% from year-end 2012 through May 10, 2013.  

The tools of transition for the consumer away from QE are subtly coming into play. A foundation of consumer confidence is building, providing the underpinning for further advances in earnings for consumer related stocks. In fact, our proprietary research of 115 consumer stocks shows an increase of 14% in 1Q2013 earnings over the same period last year, well-above the 5.2% for 92% of the S&P 500 capitalization reported.

Our investment strategy remains a full position in equities. The run-up since the beginning of the year and a more bullish sentiment for equities opens the possibility of a correction. However, the impact of Fed expansionary policy on asset values has more than offset any definable correction to date. Longer term earnings growth should accelerate later in the year as private economy growth accelerates. Along with a dose of inflation this may be the ultimate catalyst for a sustainable bull market and deficit reduction.

Authors:
David Minor
Rebecca Goyette

Editor:
William Hutchens

“Catch-22”

The current US foreign policy of re-engagement expounded by President Obama in his 2009 Cairo speech is on the cusp of failure. By shunning unwise foreign entanglements, the President believed that the Administration could focus on nation building (universal health, immigration reform, alternative energy, and broader government regulation). However, the trade-off rarely resembles the expectation. Immediately, the Arab Spring and its initially perceived benefits come to mind. Balancing US interests and values is difficult; in the Mideast it is impossible.

Syria has become the focal point for US foreign policy as the Bashar Assad regime’s dependence on Iran for military aid increases. Whether the US is openly drawn into the Syrian civil war is questionable, but the assurances made by Obama during the most recent visit to Israel increases potential US exposure in the region. As the US resets the ever-fading redline in the Mideast sand, Israel took action. Using air power, the Israelis attacked the store of Iranian missiles earmarked for Hezbollah to be used in the continuing cross-border rocket assaults reaching further and further into Israel. These attacks pinpointed advanced missiles, located outside Damascus and ready for shipment. A broadening beyond Syria’s borders will push Iran into the open. A Mideast crisis would clearly disrupt oil shipments and could cascade into unchartered consequences qualifying as a Black Swan. Markets globally will react negatively.

The unemployment data released for April, along with the upward revisions for February and March, at the very least, convinced the equities market that jobs are holding their own. These data gave reassurance that the soft patch in the economy experienced over the past few months was just that, and not as pervasive as many commentators believed. It was widely acknowledged the stock market, despite an uneventful earnings season punctuated by weak guidance, moved higher in response to Fed quantitative easing. Perhaps it was partially attributable to a better earnings and economic outlook over the rest of 2013.

Our investment strategy remains a full position in equities. The recent run-up since the beginning of the year and a more bullish sentiment for equities opens the possibility of a correction. However, the impact of Fed expansionary policy on asset values has more than offset any definable correction to date. Longer term earnings growth should rebound later in the year and along with a dose of inflation may be the ultimate catalyst for a sustainable bull market and deficit reduction.

Authors:                                                                                                
David Minor                                                                                               
Rebecca Goyette

Editor:
William Hutchens

HUTCHENS INVESTMENT MANAGEMENT NAmeD BY LIPPER MARKETPLACE As Top FUND IN LARGE CAP EQUITY CATEGORY

Naples resident William Hutchens’ firm Hutchens Investment Management announced today that Lipper MarketPlace has recognized the Large Cap Equity product as a top performing fund in its category.

Lipper MarketPlace (formerly known as "Nelsons") maintains a database of information on over 2,000 investment managers and their investment products. The investment performance of the Hutchens Investment Management Large Cap Equity product ranks 34th out of 666 products (6% percentile) in this category for the 12-quarter period ending Sept. 30, 2012.

“We appreciate this honor and remain committed to providing the highest quality investment services to our institutional and high net worth clients. Our investment process, methodology and philosophy will continue to add value over the long term by controlling risk and focusing on fundamentals,” said William Hutchens, CFA, founder of Hutchens Investment Management. He lives in Naples and is a board member at Lorenzo Walker Institute of Technology.

About Hutchens Investment Management

Hutchens Investment Management’s team includes three senior professionals, two CFAs, and a client service staff dedicated to handling the most complex of issues. The firm has $85 million in assets under management for institutional investors, endowments and foundations, family offices and high net worth individuals. Hutchens Investment Management has outperformed benchmarks for 15 years on an absolute and risk-adjusted basis and has a track record of superior long term, risk-controlled returns.