Kathy Klein Presents Positive Case for Global Equities

On January 31, Marietta portfolio manager Kathy Klein presented an optimistic outlook for global stock markets to about 90 retirement professionals attending a luncheon sponsored by the Greater Milwaukee Employee Benefits Council.

Kathy opened with a brief review of the challenging market conditions of 2011, when a relentless flow of negative news events convinced many investors that Europe and the U.S. were headed for a double-dip recession. Most of the world’s stock markets declined: the All Country World Index excluding the U.S. slumped 13.7% and the leading emerging-economy markets crumbled more than 18%. The U.S. faired better, not so much because the U.S. economy was attractive, but rather because it was viewed as a safe haven in troubled times. Within the S&P 500 Index, the defensive industry sectors of utilities, consumer staples, and health care were the major winners, and the biggest losers were the economy-sensitive, cyclical industrials, materials, and financials.

Kathy then pointed out that conditions in early 2012 have improved dramatically. The U.S. economy is accelerating, the European policy-makers seem determined to deal effectively with their sovereign-debt crisis, and declining inflation in the emerging economies is permitting their central banks to adopt pro-growth initiatives. Market trends have correspondingly reversed. Global stock markets, led by the emerging-economies, have surged. Within the S&P 500, last year’s leading industry sectors are now the worst performers and vice versa.

The obvious question posed by this reversal is: can the positive market trends of January extend through 2012? Here, Kathy emphasized the importance of the current synchronized global accommodative policies of central banks. It was just such a synchronized global stimulus that was the most important catalyst in lifting the global economy out of the recession of 2008-09 and triggering a new bull market.

Kathy also noted that in many leading global markets the fundamentals and technicals are positive. Time did not permit her to explore these conditions in all of these markets, so she limited her discussion to the U.S. market. In particular, she identified nine indicators which historically have been associated with bull markets. These included GDP growth, strong corporate balance sheets, compelling valuations, subdued inflation, low interest rates, an accommodating Fed, and large cash reserves.

A very interesting and relevant observation made by Kathy was that sluggish GDP growth of 2-3% in the U.S. should not necessarily lead investors to conclude that prospects for U.S. stocks are at best modest. To the contrary, since 1960 periods of weak-to-moderate growth have provided the best S&P 500 gains.

Key to Kathy’s positive case for the U.S. market is continuing profit growth coupled with a very attractive valuation. A high-single digit profit gain in 2012 by S&P 500 stocks in combination with P/E multiple expansion to a non-recession level could produce a solid, double-digit advance for this benchmark index. P/E valuations for the international markets are even lower, and the prospect of a very considerable market advance in the emerging markets is pronounced.

Kathy pointed out that negative news events could again upset the positive case, but concluded with Marietta’s 2012 upbeat investment recommendations:

1.       Be open to the positive case for equities

2.       Take a longer-term view (avoid excessive responses to headline news)

3.       Adopt a global perspective (take advantage of international opportunities)

4.       Watch for risk-on, risk-off decoupling

5.       Beware of macro investing (watch the policy makers)

6.       Track closely the fundamental progress of your securities

Global Stock Markets off to Strong Start in 2012 Led by Emerging Markets

So far this year global stock markets have risen at a rapid pace; extending the rally begun in the fourth quarter of 2011.  Since January 1, the S&P 500 gained 4.5%, a starting year rally not seen since 1987. Over the same time period, the iShares MSCI Emerging Markets Index Fund (EEM) gained 9.1%, the fastest rise since 2001.

Articles in the Financial Times and Bloomberg have noted a pattern in this rally. The biggest decliners last year have led the charge this year. Year to date the EEM, which lost 21.1% in 2011, has gained twice as much as the S&P 500. On a sector basis within the S&P 500, financials, industrials, and materials have been leading the recent rally. These same sectors have greater exposure to emerging markets and were among the worst performers last year. Utilities, health care, and consumer staples had been the best performing sectors in 2011 but have been among the worst performing sectors in 2012.

Economists attribute the surge to a number of reasons:  in the U.S., positive economic data continues to flow, manufacturing is growing, jobless claims are falling, and the unemployment rate is ticking down. Corporate profits remain high and Fed policy continues to be accommodating. Earnings season has begun with 60% of reporting companies beating expectations. Many global central banks are lowering rates in order to promote growth after two years of raising rates. As mentioned in Marietta’s blog Promising News from China, recent events in China indicate that economic stimulus and easing will likely come soon to this engine of global economic growth.

Three weeks do not make a year, but a continuation of current trends could result in 2012 being dramatically different from 2011.

Promising News from China

On January 17, China announced that its economy expanded 8.9% year over year in the 4^th quarter. The news triggered a 4.9% jump in the Shanghai stock market, which was the largest single session gain since October 2009. On this news, the U.S., European and other global markets also rose.

The 8.9% GDP growth is the slowest advance in 10 quarters and is attributed to slowing export demand and a weakening property market. This increases the pressure on Premier Wen Jiabao to ease monetary policy, which would be viewed by investors as a strong positive for the Chinese stock market. On the other hand, the 8.9% was above the 8.7% median estimate of a consensus of economists, and well above the 8% that policy makers consider necessary. This supports the argument that the Chinese economy will experience a “soft landing,” which would also be very positive for the Chinese and other global stock markets.

A “soft-landing” in China and other leading economies is very important to the positive economic and market forecast presented in our January 3 Outlook. Emerging economies now account for 50% of the world’s GDP and approximately 70% of GDP growth. Healthy and sustainable growth in the Chinese economy is thus necessary for a global economic expansion requisite to support a resurgence of international markets. The news is very promising, but not decisive.