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Strategy Update – April 2012Submitted by Stonebrook Capital Management on April 28th, 2012
“Millions saw the apple fall, but Newton was the only one who asked why.”
-Bernard M. Baruch, American Investor & Statesman
In popular myth, Sir Isaac Newton is said to have formulated his theory of gravity from watching an apple fall to earth from an apple tree. After a successful first quarter of the year, which saw our biggest stock position, Apple Computer, soar over 50%, we are left pondering the laws of gravity as they pertain to stocks and the stock of Apple in particular. Apple is just one of the stock positions which performed exceptionally well. Other standouts in the quarter include: Cummins Engine (+35%), Priceline (+26%), Chipotle Mexican Grill (+25%), and Yum Brands (+21%).
We noted at the end of last year that stocks had become extremely attractive on a valuation level and that some of the world’s best companies were also some of the cheapest stocks. We have increased our allocation to stocks over the past six months and have been able to add outstanding companies to the portfolios.
Where do we go from here? Do stocks continue to defy gravity based on their still attractive valuations or will we see a pullback in equity prices due to some setback in the fragile global recovery? While the odds of a pullback in equity prices seem to be rather high over the short term, we are optimistic that the full year will be a good one and further gains in equities are likely by year end. This is based on the fact that equities are still fairly cheap when compared to other asset classes (particularly government bonds) and that large institutional investors, as well as the retail investors, remain highly underinvested in equities. The possibility of higher prices in equities is very plausible. Consider that, in the first quarter of 2012, stocks outperformed bonds by a very wide margin, yet inflows to bond mutual funds outpaced inflows to stock mutual funds by a 5-1 margin. Normally at market peaks, stock funds attract large net purchases, the opposite of what we are seeing now. We expect the portfolios to perform well over the rest of the year.