April 3, 2012

First Quarter Review and Second Quarter Outlook

Last week marked the end of a very strong first quarter for the stock market.

For the quarter, the S&P 500 index rose 12.0 percent, its strongest start to a year since 1998. In fact, the index ended the quarter 3.4 percent above the average year-end projection of strategists surveyed by Bloomberg. In other words, the market gained more in the first quarter than analysts thought it would gain for the whole year.

Looking back on the strong start, analysts pointed to an easing of Europe's debt woes, a strengthening global economy (at least in some areas), rising consumer sentiment in the U.S., and supportive Federal Reserve policy, according to Bloomberg and CNNMoney.

Speaking to The Wall Street Journal, Bob Doll, chief equity strategist at BlackRock, summarized the quarterly nicely when he said, "This year has been all about people coming away from the abyss that the world might end, and putting risk back on."

Some analysts suspect this year's strong start may be déjà vu all over again (hat tip to Yogi Berra). Stocks roared out of the gate in 2010 and 2011 only to drop later in the year, "as the U.S. economy faltered and Europe's crisis worsened," according to The Wall Street Journal.

Potential spoilers for the market over the next few months include:

• Renewed European debt woes, particularly in Portugal and Spain.
• Renewed weakness in the U.S. economy, possibly due to unseasonably warm weather in some parts of the country that may have "pulled forward" some shopping and construction activity.
• High gasoline prices, which could take a big bite out of consumers' pocketbooks.
• Slower corporate earnings growth and profit margins that may down from near record levels.
• An economic slowdown in China that exceeds expectations.

Sources: The Wall Street Journal, Financial Times

So far this year, investors have shrugged off the worries and plowed higher. With supportive Federal Reserve policy underpinning the market, that old adage seems to apply - "Don't fight the Fed."

Data as of 3/30/12	1-Week	Y-T-D	1-Year	3-Year	5-Year	10-Year
Standard & Poor's 500 (Domestic Stocks)	0.8%	12.0%	5.7%	21.4%	-0.2%	2.1%
DJ Global ex US (Foreign Stocks)	-0.2	11.0	-9.6	17.6	-3.9	5.3
10-year Treasury Note (Yield Only)	2.2	N/A	3.5	2.7	4.7	5.4
Gold (per ounce)	-0.1	5.6	16.6	21.5	20.2	18.6
DJ-UBS Commodity Index	-1.5	0.9	-14.8	9.8	-3.8	3.4
DJ Equity All REIT TR Index	1.8	10.5	12.2	45.5	-0.1	10.3

Energy Demand: Oil vs. Natural Gas

WHILE GASOLINE PRICES ARE HITTING RECORD HIGHS for this time of year and oil has shot past $100 per barrel, natural gas prices are plumbing 10-year lows, according to The Wall Street Journal. What are the implications of this large price disparity for America's long-term energy security?

As indicated below, gasoline, oil, and natural gas are critical to the U.S. energy picture as they account for a large percentage of our energy use.

Energy Demand by Fuel Source in the U.S. in 2010

• 37 percent petroleum products (includes oil and gasoline)
• 25 percent natural gas
• 21 percent coal
• 9 percent nuclear
• 8 percent renewable

Source: U.S. Energy Information Administration

Oil, in particular, is deeply entwined in our economy as 10 of the past 11 recessions were preceded by an oil price shock, according to Moody's Analytics. Even the 2008 economic crisis, which on the surface was triggered by the subprime mortgage crisis, was accompanied by a massive spike in U.S. oil prices to a record high of about $145 per barrel in July 2008, according to Reuters. As oil prices rise, gasoline prices are likely to rise, too, because gasoline is a by-product of oil refining. In fact, a 42-gallon barrel of oil yields about 19 gallons of gasoline, according to the U.S. Department of Energy.

So, where does natural gas fit in the U.S. energy story?

Interestingly, new technology including horizontal drilling and hydraulic fracturing ("fracking") has led to a substantial increase in the supply of natural gas. The Department of Energy has even said we have more than a 90-year supply of natural gas at current consumption rates. This massive supply is one reason why natural gas prices are so low right now.

One plus for natural gas versus oil is that almost all of the natural gas we consume is produced domestically while 45 percent of the oil we consume is imported, according to Financial Times. With natural gas prices low and supply abundant, we're starting to see more emphasis on using natural gas instead of oil.

As the U.S. continues to regain its economic footing, it's critical that we have the right mix of energy sources available at a reasonable price. Historically, that's not always happened and, consequently, it's an important factor that we monitor on a regular basis.

Weekly Focus - Think About It

"Worry does not empty tomorrow of its sorrow, it empties today of its strength."

—Corrie ten Boom, author, Holocaust survivor

Best regards,
Sean M. Dowling, CFP, EA
President, The Dowling Group Wealth Management

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