Q1 Was a Hit, Will Q2 Be a Miss?

We’re only three days until the end of the first quarter, and it’s been a stunning start to the year. Even with the recent pullback, stocks are near their best first-quarter gains in 14 years. The Dow surged 8%, the S&P 500 12% and the NASDAQ 19%.

So what caused the run-up, and are today’s declines a sign of trouble on the horizon?

First let’s tackle the cause of the Q1 rally. Here it is: the economy improved.

Look at the job market. The most recent report shows the four-week moving average of jobless claims is 354,000. This number breaks the critical 400,000 threshold, which signals that hiring is taking off.

Consumers began spending again. Retail sales saw their biggest monthly jump since the fall, rising 1.1% in February. And the spending was far and wide, from sporting goods to new cars, to electronics. And since 70% of our economy comes from consumers, this should translate to a continued boost in GDP.

Now, what’s interesting is that while the economy continued to improve month after month this quarter, and the market continued to rise, many folks—both on Main Street and Wall Street—refused to believe the rally would sustain.

And their “wait and see” approach has cost them dearly.

I’ll pick on hedge fund managers for a moment to show you what I mean. According to Bloomberg, "The Bloomberg aggregate hedge fund index gained 1.4 percent last month, lagging behind the Standard & Poor’s 500 Index by 2.65 percentage points."

These managers were so paralyzed by fear that their inaction caused them to lag the market. That’s disgraceful.

So now, with the quarter coming to an end, and underperformance threatening their bonuses, reputations and jobs, hedge fund managers are scrambling to move out of their conservative assets and are just now buying stocks at the fastest pace in two years.

The proof? On Tuesday alone, 175 stocks on the New York Stock Exchange hit new 52-week highs—including many big-name blue chip companies.

They Called Me Crazy When I Said Dow 14,200

At the start of the year, I went on the record to predict Dow 14,200 by year-end. My prediction certainly ruffled a few feathers, and I took a lot of flack for taking such a bullish stance. I heard it all. “Louie, you’re off your rocker.” “Louie, you are out of touch.”

Funny how those naysayers have been awfully quiet as of late.

In addition to that Dow prediction, I also released my list of the Top 5 stocks to buy in my free 2012 Profit Playbook.

Now if you never took the time to open that Playbook, you might not like what you’re going to see next.

Here’s a look at how those stocks have performed year-to-date:

My Blue Chip Growth stocks took off with Apple Inc. (AAPL) up 51%, Alexion Pharmaceuticals (ALXN) up 30% and AutoZone Inc. (AZO) up 17%.

My smaller-cap Emerging Growth stocks joined them with CVR Energy Inc. (CVI) up 31% and CVD Equipment Corp. (CVV) up 10%.

I can hear the skeptics now, “Sure Louis, that’s nice, but…

Will the Rally Continue in Q2?”

And frankly, it’s a valid question. After an 8.4% run for the Dow, there will be a pullback. It’s natural to see a little profit-taking. Without this digestion of gains, you get big run-ups and massive sell-offs that ultimately cancel each other out.

However with inventory overhangs, gas prices on the rise and hints that consumer confidence could take a dip, it will be harder for the economy alone to drive the market higher at the same rapid pace as seen in Q1.

Don’t get me wrong, there’s nothing wrong with the economy, and I’m still bullish.

And if you still don’t want to take my word for it, hopefully you were encouraged to hear Ben Bernanke say yesterday said he’s not taking any options off the table when it comes to maintaining the economic recovery.

That’s not to say that there won’t be some challenging headline events for the market to tackle. I see three in particular just ahead.

But know this: If you take the right actions to prepare (which I’ll lay out below), you can look forward to another quarter of profits in the market, as I am.

Challenge #1: Peak Earnings. It is getting increasingly difficult for companies to trump their sales and earnings versus the same quarter of last year. Ever since the financial crisis when companies everywhere took a massive hit to earnings, it’s been easy for companies to post massive year-over-year improvements. Let’s face it, most companies had nowhere to go but up.

Sure it was fun while it lasted, but we’ve always known that these results weren’t sustainable.

So now, the year-over-year comparisons are getting tougher. This does not mean that there’s anything wrong with the economy or the markets. Earnings growth will continue for strong companies, but the growth rate will be slower than what we’ve seen in recent quarters. I expect that the average stock is going to struggle to get much more than 10% earnings growth this year.

Now, that does not mean that all stocks are going to suffer. It means that smart investors are going to have to focus their buying on companies that are able to grow their sales and earnings at a healthy rate that meets or beats the 10% average.

That’s why the stocks on my Blue Chip Growth Buy List have an expected 30% average earnings growth rate, while my Emerging Growth stocks have a whopping 65% average expected earnings growth rate.

To beat the market, you must stick with stocks that can deliver incredible earnings.

Challenge #2: Higher Oil Prices. It’s probably not a surprise that I expect to see the rising price of oil and gasoline becoming a key issue of Q2. Higher prices at the pump mean higher expenses for businesses and less money in consumers’ pockets. And I see prices remaining at these high levels.

What many people don’t realize is that many commodities, like oil, are priced in U.S. dollars. With interest rates at ultra-low levels and with the Fed making it very clear that it will not be raising interest rates through 2013, the dollar has nowhere to go but down. With the value of the dollar on the decline, the price of commodities rises. As you can see, even with some increased production and supply, it’s going to be tough to find any relief from rising prices.

But instead of getting mad, I recommend you get even by investing in companies that benefit from rising oil prices. We have a number of these companies on our Emerging Growth Buy List, including CVR Energy Inc. (CVI).

Challenge #3: A Near-Term Peak in Confidence. Higher gas prices will ultimately impact consumers. We will reach a point where people will have to make choices about their spending as goods become more expensive and transportation expenses take up more of the family budget. Let’s look at the numbers:

Every month, the Conference Board surveys 5,000 households to get their take on current conditions as well as their expectations for the future. The report is interesting as it may predict shifts in consumption patterns and is a further indication of how consumers are feeling about the overall economic picture.

Specifically, in February, consumer confidence held at 70.2. This is near the highest level in the past 12 months and fell in line with economists’ expectations. What got U.S. consumers excited in February were the improvements on the jobs front as well as stock-market gains.

What’s interesting is that this measure of consumer confidence has been on a tear since October, when the index bottomed out around 40. The index has also improved by leaps and bounds since the low point of the recession. The fact that the current reading was flat from last month may be the first signs of the near-term peak in consumer confidence that I’m expecting.

Does that mean it’s time to sell your retail and consumer stocks and head for the bunker? No way.

Although gas prices may impede significant improvements in consumer confidence near-term, there are plenty of consumer stocks that should continue to thrive. Ross Stores (ROST) and Dollar General (DG) are both discount blue chip retailers that have been on a tear (and my Blue Chip Growth Buy List), and will continue to do so as consumers begin to feel the pinch.

Be a Bull for the Crème de la Crème of Stocks

The truth is that even with high oil prices and flattening consumer confidence, there are still many positives that will drive stocks.

The jobs market has made significant strides, GDP is on the rise and hedge fund managers are jumping back into stocks in a major way. These things are going to bring a fresh wave of buying pressure that will lift growth stocks with stellar fundamentals.

So get ready. This is the time when sticking close to the right stocks will pay off big-time, while investing in the wrong stocks could cause some real disappointment.

signed- Louis Navellier
Louis Navellier

P.S. As Q2 events unfold—such as earnings season just ahead—I’ll keep in touch with you via my Market 360 updates like this one, as well as via my daily blog on NavellierGrowth.com. Here’s to a continued quarter of profits.

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