First Quarter Review

Stocks posted their best quarterly gain in 13 years and the first quarter was one of our best thanks to energy issues. Had you known three months ago what was soon to be in the news (Japan, Egypt, Libya, the dollar, soaring commodities prices, etc.), you would surely have expected tough sledding ahead for stocks, maybe even much lower prices.

One can't help but wonder what it would take to undermine stock prices since neither war, nor revolutions, high unemployment, the ongoing housing recession, or natural disasters seems to do it. I can answer that. A downturn in the outlook for economic and profit growth would surely do it. An increasing likelihood of a sharp rise in interest rates would do it, too, but that is not in the cards for months unless inflation accelerates. I for one worry less about inflation even though commodity prices have soared. Commodities are a very small (10 percent) component of the inflation calculation. The day will come when inflation will be two or three percent and interest rates will be higher. No doubt about it. But not soon.

Investing is all about the economy and future earnings, and that explains why stock prices are rising. The outlook on both fronts is improving. GDP rose at a 3.1 percent rate in the fourth quarter, faster than previously estimated. Little noticed was that had it not been for an inventory draw down, growth would have been more than double that rate. That’s a strong economy. When inventories are rebuilt, which is inevitable of course, look for GDP growth to top 4 percent.

The economy and strong corporate profits explains why 117 companies in the S&P 500 raised dividends in the first quarter by a record $16.6 billion. Last year only 78 raised theirs. Companies have $940 billion in cash on their balance sheets. Expect more good news on dividends.

The drivers of the bull market are solidly in place. Those are earnings growth, cash being put to work, stocks’ attractive valuations relative to other investments, and the Fed’s injections of liquidity. As for he last, there is an old (and time-tested) adage: “Don’t fight the Fed.” That was good advice two years ago; it’s good advice now.

Past performance does not guarantee future results. Consult your financial advisor before purchasing any security.