Global equity markets posted solid, and in some cases spectacular, gains in the first quarter of 2012. In Asia, Japan’s Nikkei Index ended the quarter up 19.3%, Hong Kong’s Hang Seng Index was up 11.5%, and the Shanghai Composite Index was up 2.9%. Europe, as represented by the STOXX Europe 600 Index, gained 7.7%. And in the United States, the S&P 500 Index posted its best opening quarter in 14 years, advancing by 12.0%.
Investor euphoria was short-lived, however, as focus in recent weeks has turned to renewed fears about the sovereign debt crisis in Europe, with Spain and Italy now taking center stage. And in the United States, the Federal Reserve has indicated that further quantitative easing (jet fuel for equity markets) may not be necessary. Compounding the macro concerns is growing angst over the direction of corporate profits. As a result, market bulls have pulled in their horns, suggesting that the old adage “Sell in May and go away” may hold true for 2012.
Below are some of the past month’s most compelling stories:
- The direction of corporate profits seems to be top of mind for most investors and, as is usually the case, there are two schools of thought when it comes to where margins are headed, or at least how soon they will get there. PIMCO’s Neel Kashkari acknowledges the concept of mean reversion when it comes to profit margins, but he also points out that the timing of that reversion matters. He sees corporate profits remaining strong in the near future, citing, among other factors, slow but steady global growth, a lack of wage pressure, and low interest rates. GMO’s James Montier, in his white paper titled “What Goes Up Must Come Down,” finds fiscal deficits behind the high profit margins of many countries, suggesting that fiscal retrenchment will ultimately cause margins to fall before long. Noting that Wall Street analysts forecast margins to rise through 2013, Montier wryly adds, “This simple-minded extrapolation gives us some comfort because the Wall Street consensus has a pretty good record of being completely and utterly wrong.” Montier will be featured as a speaker at the upcoming CFA Institute Annual Conference in Chicago.
- Oaktree Capital’s Howard Marks’s periodic letters to clients are almost always informative and thought provoking, and his latest memo is no exception. Inspired by reading a reprint of BusinessWeek’s 1979 seminal article, “The Death of Equities,” which preceded one of the greatest bull markets in stock market history, Marks reminds readers of the value of being a contrarian. Investors, he notes, “tend to be too positive at the top and too negative at the bottom.” Given stocks’ poor performance relative to bonds over the past decade, reasonable valuations, and the prevailing negative sentiment, Marks suggests that now, like 1979, is not the time to abandon equities.
- Corporate governance watchdogs took notice when Google recently announced a 2-for-1 stock split. What raised eyebrows was news that the new shares to be issued would be nonvoting. The move effectively allows the company’s founders, Larry Page and Sergey Brin, and Chairman Eric Schmidt, to retain majority voting control while still selling a portion of their shares and issuing new shares to employees. Google has maintained a dual-class share structure since going public in 2004, so this move should come as no real surprise. It does, however, highlight what it means to be a minority shareholder. Perhaps trying to soften the sting, Google also announced what were strong first quarter earnings, soundly beating estimates. Notably, however, advertising pricing, as measured by the average cost per click, declined 12% over the past year.
- Facebook is another tech giant highly dependent on advertising revenue and, with its IPO slated for May 2012, this company too will soon be tasked with quarterly reporting. The company’s shares have stopped trading on secondary markets to allow for an accurate shareholder count prior to their public debut. This did not stop Facebook from surprising almost everyone with its recently announced purchase of photo sharing site Instagram for a cool $1 billion. The deal was described by some, including John Gapper of the Financial Times, as a defensive acquisition. If he hasn’t already, CEO Mark Zuckerberg will soon discover that there is no shortage of suggestions as to what he needs to do to sustain Facebook’s stunning pace of growth. (Wall Street Journal columnist Holman Jenkins’ prescription for success is nothing if not ambitious — and worth a read.)
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