Sprinting out of the Gate

The S&P 500 closed at 1408.47 last Friday, March 30th, the last trading day of 2012’s first quarter. For the first quarter, the Index rose by 12.0%, representing the best first quarter performance for the market since 1998.

There are still several factors weighing on the market, such as the European debt crisis, the stubborn weakness in the U.S. housing and labor markets, and the uncertainty surrounding the future of personal income and corporate tax rates in this country, with a presidential election looming just seven months away.

Then there’s the matter of the stock market’s performance itself. For “gravity” investors, i.e. those who subscribe to the theory of “what goes up must come down,” the S&P 500’s 28% advance since the beginning of last October is surely unsettling, to say the least. It would seem that a solid argument could be made to take profits at this level, and return to equities at some future point.

I disagree with this approach. While a pullback, or perhaps even a correction (defined for our purposes as a decline of 10% from a recent high point), is a distinct possibility for later in 2012, stocks still do not seem to be very overvalued, whether on the basis of price/earnings, or looking at their dividend yields relative to the yields on Treasuries.

In addition, recent history indicates that the stronger-than-expected performance in the first quarter does not necessarily bode ill for further gains over the balance of the year.

This year marked the ninth time in the past 60 years that stocks posted a double-digit gain in the first three months of the year. In seven of the eight prior such occurrences, stock rose further from that point over the remaining nine months of the year. In other words, the market closed higher on December 31st of that year than it did on March 31st. The only time that the market declined over the final nine months of the year after increasing by more than 10% in the first quarter was in 1987 (when stocks advanced by 20.5% in the first quarter). Losing 25% of its value on a single day (October 19th) certainly didn’t help the market’s cause. It is worth noting that even in that year, the market eked out a full-year gain of 2.0%.

So, while past performance is no indication of the future, and there’s still plenty of big things to worry about, it would not be unreasonable to expect some more gains from the stock market in 2012, although they’re likely to be more moderate than what we saw in the first quarter.