It’s been a strong year for the major U.S. stock indexes, but investors are holding their breath that double-digit returns achieved through the first three quarters don’t plunge off the "fiscal cliff" looming at the end of 2012.
With the presidential election a little more than two weeks away, all eyes are on the White House and the feared fiscal cliff that would bring mandated tax increases and spending cuts if the president and Congress fail to modify present legislation.
"I take a positive view of the market but also caution that stocks have come a long way in a short time and that valuations are up as a result," said local stock expert Dwight Melton. "This would logically make stocks vulnerable to a sell-off on the first indication of unsettling news."
Melton, co-founder of the Hawaii Stocks and Options Group, had a 48.8 percent return at the three-quarter mark of the Star-Advertiser’s 10th annual investment contest. The strong gain boosted his hypothetical $20,000 portfolio to $29,767.79 and, barring a fourth-quarter collapse, will enable Melton to become the first four-time winner of the contest.
Richard Dole, CEO of Honolulu investment bank Dole Capital LLC, was second with an 18.3 percent return that increased his portfolio to $23,651.91. He was followed by Barry Hyman, private client group vice president for the Maui branch of FIM Group Ltd., up 16.8 percent to $23,354.82; and Norm Caris, a Kauai resident and manager of institutional sales for investment bank Caris and Co., down 6.3 percent to $18,733.
By comparison, the Dow Jones industrial average was up 12.2 percent through the first nine months, the Standard & Poor’s 500 index was ahead 16.4 percent and the Nasdaq composite index was up 20.7 percent.
Melton’s best performer in the third quarter was Direxion Retail Bull 3X (up 23.7 percent), which returns 300 percent of the Russell retail index. He has been aggressive all year by investing in sector funds that return 300 percent of the underlying index. For the final quarter he bought the Direxion Energy Bull 3X and ProShares UltraPro S&P 500.
Hyman, who pulled out of negative territory at midyear with an 18.3 percent return in the third quarter, said it doesn’t matter for the stock market whether Barack Obama or Mitt Romney wins the presidential election.
"As the time before the election and the fiscal cliff has dwindled, global markets have rallied," Hyman said. "Markets are leading economic indicators. But what are they indicating? Are they indicating that whoever is elected, they will eventually do the right thing, or are they indicating it doesn’t really matter? My take is the latter."
Hyman said markets rise from levels of low valuations and continue to do so until they reach levels of overvaluation.
"The current bull market started at the bottom in March of 2009, and based on long-term cycles, there is a long way left for it to rise until reaching unsustainably high levels," he said.
Hyman noted that the market rallied during the third quarter when Obama took a clear lead in the polls, and then rallied further the day after it was widely considered that Romney won their first debate.
"That tells me there are two factors happening simultaneously," he said. "First is that investors gripped with fear have already moved their wealth to cash. The second is that we are in a bull market. Those motivated by fear are already in cash, and thus there is little of their money in the market to pull out when events look negative to them. That leaves those who see opportunity invested."
Dole said the market this year has been stronger than he expected, but thinks investors could see a pullback. As such, he sold Honolulu-based Alexander & Baldwin, which now is solely a real estate and agriculture company since spinning off ocean shipper Matson at midyear. A&B was his best performer in the quarter with a 17.3 percent gain. He turned defensive for the final three months of this year by purchasing Chicago-based Exelon, a public utility holding company engaged primarily in renewable energy which also offers an attractive 5.6 percent annual dividend yield.
Dole said the fiscal cliff can be avoided if one party wins the presidential election and both houses of Congress, but he says that is unlikely, especially with an Obama win.
"Romney is closer to the center politically than President Obama and more apt to compromise on the budget should he win the presidential race," Dole said. "Falling off the fiscal cliff would most likely lead to a recession and possibly a significant fall-off of stock prices. Obviously, risks of a market correction are high over the course of the year."
Caris is pessimistic about what lies ahead.
"It looks like we have a weak economy with the potential for inflation — a double negative due to tax and fiscal policy in Washington," he said.
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