Our 2010 outlook called for a slow-but-growing economy and a focus on dividends and managers that have a history of beating their benchmarks in rising stock markets. We expect to see more of the same in 2011, improving from slow-but-growing to growing but how fast. Our views, as always, are influenced by what we hear and see from the many money managers and economists with whom we work. Doing so allows us to stay open minded in our recommendations.
In our first newsletter of 2011, we share the economic and market views of a few of our favorite money managers. Overall the message seems to be that 2011 should be another good year for equities, despite the possibility of a few set backs along the way.
New Normal Back to Old Normal
People from all over the country come to us for information on money managers and solutions for their investments. Over the last few months we’ve seen a big increase in investors requesting research on money managers. It seems that many investors once again want to take more risk and are looking for money managers to outperform their benchmarks. We think the investor mentality seen during 2009 of “I just do not want to lose what I have” will be tested this year.
Looking Back at 2010
2010 turned out to be a good year for equities, despite numerous headwinds including the “flash crash”, European debt concerns and the debt of the good old United States of America. Here’s how we ended 2010:
- S&P 500 was up 15.1% in 2010
- From losing jobs to gaining jobs
- A gain in retail sales
- Improving earnings and investor sentiment domestically and abroad
2011 – From Recovery Road to Expansionary Boulevard
The chart below shows the average length of expansions and recessions. Even though some are calling the past two years “The Great Recession”, many of the important economic indicators that money managers and economist use are making us optimistic. We believe this expansion could last for a good number of years with “growing but how fast” dependant on these improvements continuing.
Source: NBER, J.P. Morgan Asset Management.
*Chart assumes current expansion started in July 2009 and continued through December 2010. Data for length of economic expansions and recessions obtained from the National Bureau of Economic Research (NBER). This data can be found at http://www.nber.org/cycles/ and reflects information through December 2010. For illustrative purposes only.
Rising GDP
WrapManager’s Investment Policy Committee (WIPC) agrees with the consensus for a 2011 GDP of 3-4%, reflecting a transition from recovery to expansion. One of our favorite economists from JP Morgan, Dr. David Kelly, points to business growth and pent up consumer demand in areas like vehicle sales, housing starts and capital goods orders as main drivers of this growth. Most of these are at or below historical averages.
Source: BEA, J.P. Morgan Asset Management. Data reflect most recently available as of 12/31/10. GDP values shown in legend are % change vs. prior quarter annualized and reflect revised 3Q10 GDP.
Stock Seem Cheap
One of our most bullish predictors for the year end 2011 tells a convincing story on where the price-to-earnings should be for the S&P500. Based on current interest rates, Goldman Sachs finds the P/E ratio should be 16x, supporting their call for 1500 on the S&P500 by year end 2011. The chart below shows past PE ratios. We agree that stocks seem cheap at their current P/E of 12x-13x, considering the historical S&P500 forward P/E ratio of 16.5x.
Source: Standard & Poor’s, Compustat, FactSet, J.P. Morgan Asset Management.
S&P500 on the Rise
There is a wide range of S&P500 predictions from our money managers, but we feel the momentum will continue upward. While there will certainly be moves in both directions, we would not be surprised to see 2011 end much higher. Taking a 14x and 16x forward P/E and the estimated $95 operating earnings on the S&P500, you get a range of 1330-1520. WrapManager’s IPC feels more comfortable with a year end target of 1380.
Improving corporate balance sheets and high levels of cash support our prediction as this typically leads to an increase in M&A activity, share buybacks, increased dividends, and business reinvestment.
Source: Standard & Poor’s, FactSet, J.P. Morgan Asset Management.
Corporate Earnings
This is one of our favorite charts that we follow. In our opinion, earnings more than anything tells us the health of our economy. Growth in earnings is very important for future rises in stock prices. It is expected that 2011 could see 7% revenue growth and corporate profits of $95 with the S&P500 companies. This could be an all time record year for corporate profits. We need to remember that a good portion of 2010 corporate earnings were driven mainly by cost-cutting measures. Going forward we agree with Federated Investors that these profits are now being driven more by top line growth and more sales, with corporate spending accelerating, hiring and jobs expanding and consumer spending following in suit.
Source: Standard & Poor’s, Compustat, FactSet, J.P.
Morgan Asset Management. Earnings estimates are for calendar years and taken at quarter end dates throughout the year. Actual reported are annual
operating earnings reported by Standard and Poor’s.
JP Morgan points out that the bull-run after a bear market cycle averages 68 months. We are up from the lows and only 22 months into the recovery. Needless to say, history indicates we have a long way to go before reaching the average.
US Employment Levels
We expect unemployment to slowly decline through 2011, ending the year just below 9%. BlackRock expects 2-3 million jobs will be created, which would bring unemployment to this level. Federated Investors adds to this, anticipating healthy US businesses to accelerate hiring in the spring due to a fading of factors that previously slowed hiring.
Source: BLS, J.P. Morgan Asset Management. Data reflect most recently available as of 12/31/10.
Bonds and Interest Rates
As the economy improves, it would not be surprising to see a 3.5% 10-Year Treasury and a 4.5% 30-Year Treasury rate. WrapManager’s IPC understands that many investors allocate to bonds and that many should hold bonds. Our main fixed income theme is to hold more of the short to intermediate maturities, with a slight reduction in the total allocation. We are not of the camp that inflation is coming, and do not see it becoming an issue until employment is closer to 8%. Recent news of outflows from bond funds signals to us an increasing investor confidence in risk assets such as stocks, but not a reason to get completely out of bonds.
Source: Federal Reserve, FactSet, J.P. Morgan Asset Management. Data are as of 12/31/10.
International Markets
Emerging and developing economies are leading the recovery according to Wells Fargo. Neuberger Berman breaks it down into developed and developing economies. Balance sheets at many firms in developed nations are back to pre-crisis levels. Stronger growth in emerging markets will support these firms, especially those with a global reach.
Developing markets are supported by strong demographics – growing, young populations and balance sheets that look strong on the company and individual level. These populations have an increasing ability and desire to spend money to improve their lives. Infrastructure (roads, airports, etc) have not kept pace with the years of expansion, and governments will need to spend to address these deficiencies.
Headwinds to the 2011 Expansion
While our equity outlook for 2011 is positive, we believe long-term issues such as the budget deficit, geopolitical tensions, European sovereign debt, the threat of municipal defaults, and the potential for stubbornly high unemployment will most certainly be on the front pages. Should these cause a pullback in the market, they could provide entry points for equity investors. The biggest concern we see would be the price of oil going back up and staying above $110. This acts like a tax to economic growth and could lead to a change in our outlook. These unexpected events could result in normal 6-10% downturns in the markets that may last for a period of time. It’s important to remember that these do occur often in a bull market and are to be expected. Regardless of when these issues come to the forefront, we will strive to recommend money managers to our clients that are well positioned for what we think lies ahead. For now, we believe investors looking to own equities might want to transition from worrying about the double-dip and look to buy the dips.
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The opinions expressed are as of January 18, 2011 and may change as subsequent conditions vary. Information provided in this report is for educational and illustrative purposes only. This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are derived from sources deemed reliable, are not all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. This is no guarantee that any forecasts made will come to pass. The S&P 500 Index is widely considered representative of the US equity market. Index returns do not reflect any fees or expenses. It is not possible to invest directly in an index. WrapManager, Inc. is not a tax advisory firm. We recommend you contact your tax attorney or CPA prior to utilizing any of the tax-related strategies mentioned or discussed. Returns and experiences will vary for each client. Each client’s risk tolerance and investment objectives are unique to them. Opinions expressed are those of WrapManager, Inc. and are subject to change without notice and are not necessarily those of Prospera Financial Services, Inc., its directors, parent company or its affiliates. Securities offered through Prospera Financial Services and cleared through First Clearing, LLC. Prospera Financial Services - Member FINRA/SIPC.