Investors Fear Deja Vu All Over Again


U.S. stocks have suffered their sharpest decline since November, reflecting renewed concerns about the European debt crisis, weaker-than-expected U.S. employment numbers, and diminished expectations for stimulus from the Federal Reserve.

Near-term action will hinge on March-quarter results, and a pullback to 12,400 or even 11,500 on the Dow Industrials would be consistent with a typical bull-market correction. For now, with quality names available at reasonable valuations, we're keeping 90% to 93% of our buy lists in stocks.

Seasonal tendencies

Seasonal concerns may be adding to the selling pressure. The Wall Street maxim of "sell in May and go away" proved to be mostly good advice in 2010 and 2011, and many see the market positioned for a repeat performance.

As was the case a year ago and two years ago, stocks hold solid year-to-date gains heading into first-quarter earnings season. Also eerily reminiscent: U.S. economic data is showing signs of softening after a decent start to the year; U.S. gasoline prices are near record levels; formerly stalwart growers like China, India, and Brazil are showing clear signs of slowing; and the European debt crisis is flaring up as the adequacy of past policy responses is questioned.

Today's differences from one and two years ago are also worth noting:

Valuations. For the capitalization-weighted S&P 500 Index, today's forward P/E is roughly unchanged from a year ago – and about 7% lower than two years ago.

Expectations. Expectations of year-ahead growth for the U.S. economy and S&P 500 earnings are much lower than 12 and 24 months ago.

Bond yields. Yields on 10-year Treasury bonds are near 2.0%, down from about 3.6% a year ago and 3.9% two years ago. Yields on AAA corporate bonds are near 3.9%, down from respective levels of 5.2% and 5.3%.

Rules of thumb

Over the last 80 years, returns on U.S. stocks have been much higher from November to April than from May to October. The difference is so stark it seems unlikely to be purely the result of chance. But such back-tested rules of thumb tend to work until they suddenly don't, and that is usually around the time they hold maximum sway with investors.

Have we reached that point? Probably not, as sentiment surveys and option prices suggest complacency remains the norm among both individual and institutional investors. Still, it's worth remembering that another long-lived Wall Street axiom says the market will do whatever causes the most pain for the most investors.

With so many portfolio managers expecting a market pullback or a choppy sideways slog into summer, investors should not entirely dismiss the potential for a "buying panic" if encouraging first-quarter results lift the major averages above recent highs. While that possibility is not the primary reason for our mostly invested posture, it figures in our calculations.

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