Expect big changes as the second quarter unfolds. The stock market is showing signs of maturing and the rally is thinning out. Big investors are focusing more on quality names, abandoning the more speculative plays that fueled the outperformance of the past year. Earnings quality and fundamental performance is going to take center stage — you need to be ready for a major sea change.
The quarter will see continued volatility as a result of economic news. Keep an eye on the decoupling of the Conference Board consumer sentiment measure, which was negative last month, and the University of Michigan survey, which showed a more upbeat consumer. Amid news about government spending cuts and planned reductions, we will get a better read on how the very important U.S. consumer feels about the world.
The international economy will also provide additional volatility as news out of Europe and Asia can often roil the U.S. markets. News from Cyprus and other European nations continues to hit the market almost every day, and there is always the question of who is next. The world’s economies still have many severe problems — Italy and Spain could easily cause some wild swings in the U.S. markets.
This earnings season will be one of the most important in some time. We will see the market begin to separate the real winners with strong fundamentals from the weaker companies. The earnings growth rate is forecasted to be rather anemic this quarter, so only the very best companies will emerge unscathed. I expect the market advance to continue — but it will not be as broad as it has been. And those companies that fall short of analyst expectations will be punished. We may also see some selling from the “sell in May and go away” crowd after the strong first quarter.
The good news for investors is that by focusing on the best stocks with the strongest fundamentals, you can take advantage of the expected volatility to buy great stocks at great prices. Look at just the past few days — some fundamentally excellent stocks are currently outstanding bargains, and volatility is creating an entry point.
Winnebago Industries (NYSE:WGO) is what I call a “triple-A” stock. Portfolio Grader has the stock as an overall “A,” and it receives an “A” on both fundamentals and quantitative metrics as well. The bottom line was back in the black last quarter and the company blew away Wall Street expectations. The backlog tripled as demand is soaring; the CEO said he thinks the RV market is headed back to prerecession levels. In spite of that, traders have taken profits prematurely and pushed the stock back to a very attractive entry point.
The real estate recovery is boosting the performance of another “triple-A” stock that is now at a great buy point. Stewart Information Services (NYSE:STC) provides title and other real estate services, and business is booming. Profits have exploded and revenues are growing at a very healthy pace as homebuyers return to the market and need the company’s services. 2012 was the best year the company had since 2006 … but skeptical traders have pushed the stock lower, giving us a chance to buy at bargain prices and reap the benefits of a continued housing recovery.
Bottom line? Focus on quality issues and take advantage of market volatility to ride the maturing bull market to greater gains in the second quarter of the year.