Liquidity still drives this stock market

March began with the “Ukraine selloff” and the S&P 500 Index (SPX) even went negative for the year in the middle of the month.

However, dovish comments from Fed Chairwoman Janet Yellen at the end of the month sparked a rally and the first quarter closed in positive territory. The most notable action to me was that growth/momentum stocks, as exemplified by the biotech index, have begun underperforming value stocks.

Two big winners, which reflect this change in market sentiment, were Seagate Technologies (STX) and Wells Fargo (WFC) both of which trade well below the market’s roughly 16x (forward) multiple and each gained over 7% in March.

The old adage about “when everyone expects something to happen in the market it probably won’t” is coming true in two areas. I’m referring to the universal belief that interest rates were bound to rise with the onset of tapering, and also that equities were due for a pullback.

I hereby plead guilty to subscribing to both those notions, neither of which has come true. The lesson to me is clear: outperformance relies on good stock-picking, rather than sharing a popular macro view of the world. Being part of the crowd might feel safer, but it will likely lead to mediocrity as far as I’m concerned.

That said, I still believe that eventually interest rates will rise, particularly at the longer end of the yield curve. In addition, I would be prefer to be buying stocks in an environment with more fear, which would result from a selloff. Nonetheless, I have been finding numerous opportunities and have initiated positions in several new names over the past month or so.

For me the key issues driving equities remain the enormous liquidity in the system, the lack of attractive alternatives, the positively sloped yield curve, the reasonable (no longer cheap) multiples, and the discrepancy between the yield on equities and the yield in bonds.

Other supporting factors included the still skeptical retail investor, the continuing support of the Federal Reserve, and the institutionalization of hedge funds who are now emphasizing low volatility and “robust risk management” rather than excess returns.

My opinion regarding the US economy hasn’t changed either; it continues to improve slowly but steadily. Recent data include the rising demand for bank loans, increasing consumer confidence, and the ISM manufacturing index, which has now had 10 consecutive months of improvement. Connecting all these dots suggests to me that now is a very good time to be an active manager in equities.

As for my existing positions in the Reasonable Price Portfolio on the Covestor platform, E. I. du Pont de Nemours and Company (DD) remains among my favorite stocks. In my opinion, the company is becoming far more growth oriented.

In addition, the company has cut expenses. DuPont now has two tailwinds, in my opinion: an expanding economy and significantly lower input costs due to the booming production of natural gas liquids in the U.S.

Historically WFC trades at 11-14x earnings, and even at $49 it is well below that peak. The steep yield curve is a boon for all banks, and WFC is Warren Buffett’s biggest holding.

Apple (AAPL) tends to trade well when there are new products approaching, which is the case today. Being able to use Microsoft’s Office on an iPad won’t hurt either. I have now way of knowing for sure, but it’s widely believed that AAPL will raise it’s dividend too on the next earnings report.

Dish merger or no Dish merger, DirecTV (DTV) is a low multiple stock (11x estimates) with a large and growing user base in my opinion. I particularly like the Latin America growth prospects with the World Cup and Summer Olympics looming.

At the same time, the market is acknowledging that there is a role for Seagate (STX) in the cloud.

DISCLAIMER: The investments discussed are held in client accounts as of March 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.

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