Ramblings of a Portfolio Manager

Despite international concerns and related volatility late in the month the US Equity Markets largely turned in positive gains for January, 2011. Large cap stocks outperformed small caps, however, the Kettle Creek fund generated a positive return for the month as our low exposure to companies deriving revenues from foreign sources protected us from the continuing concerns in Europe while our overweight position in energy and shipping benefited the fund during the late-month turmoil in the Middle East.

January is best described as a month during which the same old fears regarding China and Europe continued to stalk the equity markets but went largely ignored, having been fully discounted over the prior quarter. With little to no new information being added into the equation the US equity markets climbed the proverbial wall of worry for most of the month, despite a brief, one-day sell-off at the end of the month on fears of unrest in the Middle East, sparked by riots in Egypt. Even these concerns over tensions in the Suez were short-lived as the market resumed its upward climb on the final day of the month.

In the US front, most economic data came through better than expected, with the exception of housing and employment, which continued to languish although many economists blamed the poor weather (principally in the Northeast) and were quick to remind investors that both are lagging indicators in an economic recovery. The one area of concern in the string of positive December data was new home sales which, released at the end of the month along with equally soft Case-Shiller home price data, were weak enough to ignite talk of a double dip in housing. Yet even that data couldn’t derail the rally, which pushed ahead despite the temporary weakness in housing and related stocks.

January also kicked off earnings season for most US companies and as the month began there was some concern that expectations had been elevated too high. Not only had analysts, encouraged by Q3 reports, QE2 impact and the positive developments on Capitol Hill, raised their forecasts significantly for Q4 earnings but traders and portfolio managers had further boosted those expectations through the whisper network. Along with the nearly straight run in US equities since the September lows, the record investor confidence it engendered, the high earnings expectations anxiety gave a great deal of material for the “correction” hand-wringers in the media. With the exception of two very bad days in the Russell 2000 and the one-day across the board sell-off on Middle East fears, however, the correction never came. With so many investors so worried about investor enthusiasm and the correction it was supposed to create, the sentiment essentially created a non-self fulfilling prophecy.

Our outlook on the US equity markets continues to be favorable for 2011 and into 2012. Late last year we were a little concerned about the recent bump in investor confidence, however, with so many other portfolio managers sharing the same concern, we essentially have a wall of worry ahead of us rather than a stock market bubble. In addition, with many emerging markets now in tightening mode and turmoil erupting in the Middle East—along with rising rates at home thanks to a strong economy—we believe that investment capital will begin to flow into US stocks, giving ample support for the theory that the US will be the place to invest for the next 18 months.