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The following is an excerpt from Kirr Marbach & Co.’s fourth-quarter client letter, available in full at kirrmar.com.
Stocks posted strong performance in 2012, with the S&P 500 tallying a return of 16 percent. As always, these gains were hard to come by as investors’ confidence and resolve were tested by sharp sell-offs from early April to early June and following the election in November.
Investors who heeded FDR’s advice—“When you get to the end of your rope, tie a knot and hang on”—were amply rewarded for staying the course.
Even with robust gains in 2012, we think the overall U.S. stock market is reasonably valued, particularly given the historically low level of interest rates. As contrarians, we view it as a positive that investors’ collective mind-set continues to be dominated by widespread fear and doubt.
While this dour outlook is understandable, given the serious challenges and the media fanning the flames 24/7, it has been costly to many investors.
We are sanguine on the stock market’s prospects for 2013 because sentiment remains negative and expectations for economic growth in the U.S. and overseas are overly pessimistic. The overall pace of growth in the U.S. remains slower than we (or the Federal Reserve) would like to see, but the overall recovery from the Great Recession has broadened to the point that it should be much more sustainable and less susceptible to shocks.
While the Eurozone is in recession, the change in focus from a contractionary austerity policy to a policy promoting economic stimulus should help. Borrowing costs for governments throughout the Eurozone have dropped significantly. Similarly, China has been easing its economic policy, which should promote growth in 2013.
We agree with skeptics who point out that with corporate profit margins near historic highs, earnings growth will be harder to come by. However, as confidence regarding the global economy improves, the market’s earnings multiple has ample room to expand. Further, as long as earnings continue to grow (even slowly), the environment for stocks should remain positive.
We continue to believe the risk/reward proposition for U.S. Treasury securities is unfavorable. If investor confidence and appetite for risk improve, rates are likely to move higher. Indeed, as the stock market started 2013 on a firm note, the yield on the 10-year jumped to the 1.90 percent level.
We think some investors who have piled en masse into an asset class perceived as “safe” may be in for a costly education that, as rates rise, bond prices fall. You can, indeed, lose money in “risk-free” bonds.
Stocks have started strong in 2013, with the S&P 500 reaching a five-year high. No doubt, part of the explanation is the “fiscal cliff” crisis that was averted, albeit temporarily and at the last moment.
Unfortunately, it is likely investors will have to endure other trips to the precipice of doom during the months ahead. The next crisis could be the U.S. debt ceiling, or it could be something else. It is vitally important we maintain an unemotional, disciplined approach, especially during difficult times.•
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Kim is the chief operating officer and chief compliance officer for Kirr Marbach & Co. LLC, an investment adviser based in Columbus, Ind. He can be reached at (812) 376-9444 or mickey@kirrmar.com.
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