The Fundamental Case for the 20,000 Dow

Tuesday, August 14th, 2012

by Seth Masters, Chief Investment Strategist, AllianceBernstein

While some people deem stocks expensive relative to 10-year trailing earnings, we take a forward-looking approach. It starts with the premise that the stock market is not a casino and stock prices are not pulled out of thin air: they reflect the intrinsic value of companies’ future earnings.

Let’s start with basics. Stocks represent an ownership claim on a share of company earnings. Hence, stock prices reflect (imperfectly, of course) the value of companies’ current earnings and potential earnings growth. In computing the expected returns for stocks, what matters is the starting price, earnings, dividends (the portion of earnings distributed to shareholders), earnings growth and changes in P/E. As you might expect, low starting prices, high earnings and dividends, high growth, and P/E expansion are all good for future stock returns.

The models we use when investing are complex, but a simple argument makes the point. The expected return for a Treasury bond held to maturity is equal to its yield. Similarly, the expected return for a stock equals its earnings per share (EPS) divided by its price—its earnings yield—if the company has no growth prospects and therefore returns all of its earnings to shareholders. If the company does have growth prospects, it would retain some of its earnings to fund growth. In that case, the expected return equals the dividend yield plus dividend growth. If the company pays out a constant share of earnings as dividends, dividend growth equals earnings growth.

Let’s apply this framework to the S&P 500 Index’s price level of about 1,300. Consensus forecasts call for the index to have $104 in earnings per share this year. If the companies in the index didn’t xpect any growth, they would pay out all their earnings as dividends, and earnings and dividends wouldn’t grow. The S&P 500’s dividend yield would be 8%, as the first row of the display below shows.

If the P/E remained unchanged, the total return would also be 8%, but both the S&P 500 and the Dow would stay at their current level. While a flat index price might be disappointing, we think most investors today would probably welcome an 8% return on investment.

Of course, the companies in the S&P 500 do retain a portion of their earnings to finance growth, so the index’s dividend yield is slightly above 2%, rather than 8%, as the second row of the display shows. What kind of earnings growth should we assume?

What About Growth?

Historically, earnings and the stock market have grown with the economy over time, although they can diverge for several years at a stretch, particularly if market euphoria drives stock prices to very high multiples of earnings or if gloom drives stock prices to low multiples. Nominal US GDP, which includes inflation, has grown 7% a year on average since 1947—and so have the S&P 500’s earnings and price. (GDP growth is more commonly quoted in real, or inflation-adjusted, terms. We use nominal growth here to match data for earnings growth and the stock market.)

The three key variables that drive both economic growth and earnings growth over the long term are inflation (which increases the nominal value of economic output), population growth (which boosts the number of people consuming and producing goods) and productivity (which increases the output per person or per unit of capital).

Inflation is widely expected to average about 3% over the long term; population growth, to average about 1%; and productivity, to continue to rise about 2% per year. Since 3% + 1% + 2% = 6%, 6% is a plausible long-term economic growth forecast; it is actually below both the postwar average and the International Monetary Fund’s projections for the next five years.*

So let’s assume 6% economic and earnings growth. With a constant dividend payout ratio, this would lead to 6% dividend growth. Eventually, this growth rate would probably make investors less gloomy, and the market would rise from its current low level of 12.5 times earnings.

If the S&P 500’s P/E rose to 15—halfway back to its average of 17.6 since 1970—the index’s expected return would be 9% per year. At that rate, the S&P 500 would reach 2,000 in five years. The Dow, which typically trades at about 10 times the S&P 500, would reach 20,000 in about five years.

But as discussed above, the market should arguably be trading at an above-average multiple, since bond yields are so low. If the S&P 500’s P/E rises to 20 times earnings as sustained growth in a low-interest-rate environment makes investors more confident, the Dow could reprice to 20,000 immediately, as the third row of the display shows.

Since most investors today would probably welcome an 8% or 9% return for the next five to 10 years (let alone an immediate market revaluation), the current limited appetite for stocks suggests that investors don’t believe in these scenarios. Most likely, they don’t believe in the consensus forecast of $104 in earnings per share this year or 6% economic growth. So let’s examine the implications for stock returns of lower earnings and slower economic growth.

What If Earnings Fall or GDP Growth Slows?

Many people expect earnings to decline because margins are far higher than usual. If corporate spending picks up from the unusually low levels of recent years, margins would fall, and that could drive down earnings.

We think it’s reasonable to expect margins to decline somewhat—although not necessarily to their historical average. But for the sake of argument, let’s look at what would happen if margins declined from 9.5% today to their long-term average of about 6.75%.

Even in this scenario, the S&P 500 would reach 2,000 and the Dow would reach 20,000 in about 10 years. Applied to current revenues, 6.75% margins would reduce S&P 500 earnings by about 30%—to $74, as the fourth row of the display shows.

While there would likely be a severe market pullback initially, if normal economic growth resumed and P/E ratios normalized, the S&P 500 would have a 5% total return and reach 2,000 in 10 years.

But the global economy is now weak, and the European sovereign-debt crisis could end up being a drag on economic growth for years. What if Europe and theUSenter a lengthy period of disinflation? That’s possible, particularly if policymakers are unsuccessful at addressing the world’s serious macroeconomic problems.

So let’s perform a stress test and assume inflation of only 1%, population growth of 1% and no productivity growth at all. That would give us nominal GDP growth of just 2%. A recent survey of professional forecasters said there’s less than a 10% chance that economic growth will be that slow over the next three years.**

What would these dismal economic forecasts imply about future earnings growth and stock returns? If we assume the S&P 500 earns $74 per share this year, 2% growth would still get us to a 4% annualized market return if the market P/E ultimately returns to average, as the fifth row of the display shows. At that rate, it would take 20 years for the S&P 500 to reach 2,000 and the Dow to reach 20,000. Such returns are hardly enticing, but they are still likely to exceed bonds.

Of course, stock-market returns could be worse than 8% (or 4%), particularly in the short term. S&P 500 earnings could fall below $74, and anxiety could cause market valuations to drop even further below normal; both happened in early 2009. Other market shocks are also possible. For example, very high inflation with slow growth could cause price-to-earnings multiples to contract.

But market returns could also be better. Our stress test incorporated draconian assumptions—a 30% drop in earnings plus no productivity growth at all, a very rare occurrence over a 10-year period. Human ingenuity has led to remarkably persistent and steady productivity growth in the postwar period. In recent years, new technology and globalization have driven productivity growth. In the future, these trends and others not yet imagined are likely to continue to drive it.

Faced with uncertainty and traumatized by losses in recent years, investors who are avoiding stocks appear to be assuming that the worst outcomes are highly likely to occur. Or, perhaps, they’ve just lost their stomach for market volatility and are prizing near-term stability over potential long-term gains.

In my next post, I will compare the likely range of outcomes for stocks and bonds.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Seth J. Masters is Chief Investment Officer for Asset Allocation at AllianceBernstein and Chief Investment Officer of Bernstein Global Wealth Management, a unit of AllianceBernstein.

Tags: Alliancebernstein, Chief Investment Strategist, Company Earnings, Consensus Forecasts, Dividend Growth, Dividend Yield, Dividends, Earnings Growth, Earnings Per Share, Future Stock, Growth Prospects, Intrinsic Value, Premise, Price Earnings, Shareholders, Stock Market, Stock Prices, Stock Returns, Thin Air, Treasury Bond
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The Big Picture (in Graphs) for Markets

Monday, June 4th, 2012

by Tiho Brkan, The Short Side of Long

Equities

Equities tend to move in long term generational cycles of about 17 years on averages. Strong upward trends that last about 17 years are called secular bull markets, while sideways trends that also last about 17 years are called secular bear markets. US equities are currently in a secular bear market and have been so since the year 2000.

We seem to be creating a similar outcome to the 1970s secular bear market, where we had a long sideways trading range for about a decade and half. S&P 500 is now approaching the upper range of its trading range, with the current cyclical bull market doubling from its March 2009 lows. Bull markets usually climb a wall of worry, but there is not too many things left to worry about.

Gross profit margins are now at record highs and a mean reversion will eventually follow. Mean reversion in gross profit margins will be fundamentally bad for S&P 500 company earnings, which are also at record highs, and therefore the overall stock market value. Let us remember that all the major buying opportunities since World War 2 have been as low gross profit margins, not at highs – especially record highs.

Bonds

Interest rates, and therefore bond prices, tend to move in very long term generational cycles known as the Kondratiev Long Waves. These waves tend to last about 50 to 60 years from trough to trough or from peak to peak. The last major inflection point occurred in 1981, as interest rates on the US Treasury 30 Year Long Bond peaked around 15%. Prior to that, rates were rising for about 30 years and since than we have experienced declining rates for about 30 years as well. At the next major inflection point, which is slowly approaching, interest rates and equities should bottom while commodity prices should peak.

Viewing the global macro situation from the closer point of view puts forward a strong correlation betweens stocks and bonds due to the de-leverging cycle Western world is currently facing. Periods or phases of turmoil have so far been associated with “flight to safety” or “risk off” trade, where investors buy bonds (lower interest rates) and sell stocks (or other riskier higher beta assets).

With the risk assets prone to further crisis events out of Europe and potential up-and-coming global recession, bond interest rates have most likely not properly bottomed just yet. Nevertheless, we are definitely in the last euphoric stage of a 30 year bond bull market (from 1981 until present). The final trough in rates will also be associated with a stock market bottom, just like in late 40s and early 50s.

Commodities

Commodities also tend to move in long term generational cycles and correlate in the opposite direction to the stock market. Here the same type of time frame also applies, where strong upward trends that last about 17 years are called secular bull markets, while sideways trends that also last about 17 years are called secular bear markets. Commodities are currently in a secular bull market and have been so since the year 1999.

While the S&P 500 has been moving sideways for about 12 years, Continuous Commodity Index has been rising over the last 13 years. During the current secular bull market, commodities have experienced two major corrective periods, first during 2001 recession and second during 2008 recession. Currently, commodities are once again experiencing a cyclical bear market correction, within the overall long term secular bull market.

Summary

Risk assets like equities and commodities should remain under pressure in coming quarters, while safe havens, even though extremely over stretches, could still benefit during the turmoil. World faces many problems coming into 2013, from US to European debt issues and now a meaningful economic slowdown in Asia, after years of powerful growth. China, the worlds largest consumer of many commodities and a fertile ground for many Western company expansions (especially luxury ones), could have huge implications on risk asset prices shall it suffer a major recession. Majority of the problems will definitely come to forefront as soon as the US elections finishes by the years end, if not sooner.

While many investors think they are doing the right thing being contrarians at present and buying risk assets due to sour negative sentiment, my view is that it will only be useful for a decently strong tradable rally, which I also plan to participate in. Furthermore, these same investors also believe central bankers will backstop any problems with money printing. However, that will most likely not be the case until the QE dosage increases substantially.

At present every major risk asset from Crude Oil to Australian Dollar, from DAX to Copper and from GEM equities to Gold has retraced 100% of their Twist / LTRO multi-month rally and has also failed to better their 2011 highs during the process. This is an extremely negative price action as these types of 100% re-tracements are not common at all, if one was to assume we are in strong cyclical bull market. Most likely the inflation trade from March 2009 lows has ended for some risk assets in May 2011, while for others it has ended just recently in May 2012.

Copyright © The Short Side of Long

Tags: Bear Markets, Bond Prices, Bull Markets, Commodity Prices, Company Earnings, energy, Generational Cycles, Global Macro, Gold, Gross Profit Margins, Inflection Point, Long Waves, Lows, Mean Reversion, Record Highs, Secular Bear Market, Stock Market Value, Stocks And Bonds, Tiho, Upward Trends, Us Treasury, World War 2
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Wintergreen’s David Winters and Davis’ Chris Davis on Finding Value

Sunday, December 18th, 2011

On this week’s WealthTrack, Consuelo Mack interviews two investors of the Ben Graham and Warren Buffett school of value investing. Chris Davis shares three generations of investment lessons he is applying at the Davis Funds. Also on the show, Wintergreen Fund’s David Winters explains his market and peer beating global strategies.

In Canada, David Winters manages CIBC Asset Management’s Renaissance Global Markets Fund, Renaissance Canadian Core Value Fund, and the Renaissance Optimal Global Equity Portfolio.

Both managers feel it is the wrong time to flee stocks. But Could Europe not drag the U.S. economy into recession and negatively impact company earnings? Click below to find the answers.

Source: Wealthtrack, December 16, 2011.

Tags: Asset Management, Ben Graham, Canada David, CIBC, Company Earnings, Consuelo Mack, Core Value, David Winters, Davis Funds, Davis Shares, Economy, Europe, Global Equity, Global Markets, Global Strategies, Investment Lessons, Investors, Recession, S David, Stocks, Three Generations, Value Investing, Warren Buffett, Wealthtrack, Wintergreen, Wrong Time
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Crescendo? (Saut)

Tuesday, November 1st, 2011

Crescendo?

by Jeffrey Saut, Chief Investment Strategist, Raymond James

October 31, 2011

Webster’s defines the word “crescendo” as, “The peak of a gradual increase; or a climax.” And, that’s the climatic feeling I got last Thursday when the D-J Industrials (INDU/12231.11) sprinted some 340 points on the European euphoria to close above 12000 for the first time since August 2, 2011. Such action caused one old Wall Street wag to exclaim, “Buy on the cannons and sell on the trumpets!” Clearly we bought on the “cannons” back on October 4th when the indexes broke below their respective August 8th and 9th selling-climax lows. That “call” was driven by the belief the October 1978/1979 analogues would continue to play. Recall those late 1970s patterns saw the averages slightly undercut their “selling climax” lows before the bottoming process was complete. Accordingly, we termed this year’s October peek-a-boo “look” below the early August lows as an undercut low and advised participants to buy the index of their choice.

Gotcha’ Nouriel Roubini … Gotcha’ Harry Dent … Gotcha’ Robert Prechter, for while such pundits were contemplating the end of financial life as we know it, the S&P 500 (SPX/1285.09) looks to have posted its biggest monthly gain since October 1974 (~16%); and likely the tenth best month since 1928. Verily, from the October 4th intraday low (1074.77) into last Thursday’s intraday high (1292.66) the SPX has gained ~20.3% with many investment vehicles doing much better than that. The culprits for the massive move have been better than estimated economic reports (which have taken recession fears off of the table), a kiss and makeup from Merkel and Sarkozy, and great 3Q11 earnings reports. In fact, as of this morning, the 323 companies in the S&P 500 that have reported thus far have showed year-over-year earnings up 24.3% with revenues better by 12.8%. That’s a company earnings “beat rate” of 64.7% combined with a revenue “beat rate” of 63%. The result has left the SPX’s consensus 2012 earnings estimate nestled around $109, implying a forward P/E ratio of 11.7x. Given such metrics I’ll say it again, “To an underinvested portfolio manager (PM) the current news environment is a nightmare.” Yet surprisingly, the world remains profoundly underinvested in U.S. stocks.

Underinvested indeed, for as repeatedly stated, I could not find one European PM that had more than a 15% weighting in U.S. equities despite the fact their benchmark index has a ~43% weighting. Even here in this country most endowment funds have less than a 10% weighting in U.S. stocks. Ladies and gentlemen, there is no way an endowment fund can achieve its mandated return of 6% – 9% per year using 2.3%-yielding 10-year Treasuries. Manifestly, all we need is for PMs to realize this, and decide it’s time to reallocate money by switching out of fixed income and into equities, for the SPX to do better than most expect. To be sure, that’s what we expect, which should cause professional money to chase stocks higher driven by performance anxiety. Therefore, we continue to favor the strategy of buying “dips.”

That said, the upside skein has left the markets overbought in the short-term with 93.6% of the SPX’s stocks above their 50-day moving averages (DMAs). Back at the market lows that figure was only 4%. Additionally, the McClellan Oscillator remains about as overbought as it ever gets. Moreover, the “buying stampede” now stands at session 19. Readers of these missives know such stampedes tend to run 17 – 25 sessions, with only one- to three-session pauses and/or pullbacks, before they exhaust themselves on the upside. Therefore, with the major averages up against overhead resistance levels, as well as trading around their 200-DMAs, it would not be surprising to see a longer pause (or pullback) than the one- to three-session pattern we have been experiencing since the 10/4/11 lows. To us, the real question is – will the SPX get a pullback to the often mentioned pivot point of 1217, or will any pullback be short and shallow? Well, by our work the equity markets still have a lot of internal energy to power their way higher, so our sense is the SPX will keep pushing higher in the months ahead with only shallow pullbacks and sideways pauses along the way.

If that strategy proves correct, the question then becomes what to buy. In addition to the names so often mentioned in these reports, we turn to the invaluable Bespoke Investment organization and their “triple play” screen for a “shopping list.” Bespoke defines “triple plays” as, “Companies that have recently beaten their earnings estimates, beaten revenue estimates, and have raised forward earning guidance. Typically less than 5% of companies reporting during any given earnings season will report triple plays, which makes them extremely rare.” Names in that group, which have recently reported such metrics and are followed by Raymond James’ fundamental analysts with a favorable rating, include: Abbott Labs (ABT/$54.22/Outperform); Advanced Micro (AMD/$5.94/Outperform); Chubb Corporation (CB/$68.62/Outperform); Citrix Systems (CTXS/$73.37/Outperform); Extra Space Storage (EXR/$22.82/Outperform); Intel (INTC/$24.98/Outperform); McKesson (MCK/$84.41/Outperform); Panera Bread (PNRA/$133.96/Outperform); Select Comfort (SCSS/$20.53/Strong Buy); Tractor Supply (TSCO/$71.19/Strong Buy); and Vocus (VOCS/$20.27/Strong Buy). To further refine this list, we used our proprietary trading algorithms and found these names to be potentially the timeliest: ABT, CB, EXR, INTC, PNRA, SCSS, and TSCO.

As for the plethora of emails I received about, “Did we finally get a Dow Theory “buy signal?” It does appear that a “buy signal” has been registered with both the D-J Industrials and the D-J Transports rising above their respective recent reaction highs, as can be seen in the chart on page 3. That upside breakout came after both indices made new closing reaction lows on October 3, 2011; hence, the “buy signal” seems valid. This means the Dow Theory “sell signal” of August 4, 2011 should prove to be a false signal, as we have repeatedly opined for nearly two months. Of course, the longest keeper of Dow Theory, namely Richard Russell, has stated that there never was a sell-signal since he is using the July 2010 reaction lows of 9686.48 and 3906.23 to get a sell-signal, while I used this year’s closing lows of March 16th. If one follows Richard’s method it implies that he probably didn’t get a Dow Theory “buy signal” either since he likely would need both averages to travel above their respective 2011 reaction highs of 12810.54 and 5618.25. Recall, it was an upside non-confirmation from the Industrials, which failed to confirm the Tranny’s new all-time high of July 7, 2011 at 5618.25, that lead to the ensuing ~17% decline for the senior index. Let’s hope it doesn’t play that way again.

The call for this week: I will be traveling again this week, both in the country and out of the country, so these will be the only strategy comments until next Monday. If past is prelude, something dynamic should occur within the markets during my travels. My guess is that it will be some sort of trading top given all the aforementioned metrics. However, despite the near-term overbought condition, the stock market has staged a strong upside breakout above the now two-month trading range, as well as above the Dow’s 200-DMA (11973.09). This is remarkably similar to what happened in the October 1978 and October 1979 analogues. The upside skein from the October 4th lows has also been accompanied by four 90% Upside Days and two consecutive 80% Upside Days. The breakout has been confirmed by the advance in the Cumulative Net Points and the Cumulative Net Volume indexes suggesting the rally is sustainable. Given this, we continue to favor the strategy of buying “dips” rather than selling strength.

Click here to enlarge

Copyright © Raymond James

Tags: Analogues, Cannons, Chief Investment Strategist, Company Earnings, Crescendo, Culprits, Early August, Earnings Reports, Economic Reports, Harry Dent, Indu, Investment Vehicles, jeffrey saut, Last Thursday, Massive Move, Raymond James, Recession Fears, Roubini, Spx, Verily
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Expect the Unexpected (Capital International’s Long View)

Thursday, August 25th, 2011

Expect the unexpected

by Capital International Asset Management

So far, 2011 has been marked by natural disasters in Japan, escalating unrest across the Middle East and North Africa, surging oil prices, Standard & Poor’s downgrade of the U.S. long-term credit rating, and volatility in the global stock markets.

Clearly, recent events have shown the world remains an uncertain place, says Capital Research and Management Company (CRMC) portfolio manager Jim Rothenberg. But over his 40 years of investment experience, Jim says he’s come to expect the unexpected. “Those four decades of experience have led me to the conclusion that surprise and change and the unexpected are the norm, not the unusual,” Jim says.

Standard & Poor’s 500 Composite Index has also experienced its share of “shock events,” but for many decades the market has demonstrated an ability to overcome adversity. The market’s resilience has been particularly evident in its climb from the March 2009, an advance that is largely due to solid company earnings, says CRMC portfolio manager Greg Johnson.

“Earnings have been one of the key determinants of the market’s strength, and that’s a testament to how well corporate America has done over the last couple of years,” according to Greg. He and other portfolio counselors attribute much of the strength of the U.S. market to opportunity for U.S. companies. “The developing nations are fueling overall world growth,” says CRMC portfolio manager Claudia Huntington. “As the world becomes more integrated, where a company is headquartered isn’t as important as where it does its business. Well-managed companies in industries that have global characteristics expand to where they can find opportunities.”

Although the economy, markets and political events have commanded attention recently, the focus for investment professionals at the Capital organization remains on finding companies with sustainable growth prospects, strong cash flow and healthy balance sheets. “Over time, if you invest in successful, leading companies, we believe that approach will be more consistently rewarding than basing investment decisions on some estimate of future macroeconomic developments,” says CRMC portfolio manager Brad Vogt.

Uncertainty is likely to always be a factor for investors, Rothenberg says. “I think a diversified portfolio is the best prescription, and that portfolio should explicitly address the realities of a much more global world,” Jim says. “But don’t forget to expect the unexpected, because next time will also be full of surprises.”

Over the S&P’s history, periods of strength have often followed weakness

click image to enlarge

Source: S&P. Based on average annual total returns in US$ of 74 rolling 10-year periods, divided into quartiles. The range of returns for each quartile is as follows: Quartile 1 (top/best quartile), 15.91% to 20.04%; Quartile 2, 11.06% to 15.28%; Quartile 3, 7.06% to 10.66%; and Quartile 4, –1.38% to 6.72%. The average return for the years after the best and worst periods is the average of the average annual total return of the periods following each period in the top and bottom quartile, respectively. Data are not available for future 10-year periods; therefore, the last return for the “next 10 years” is for the period 12/31/00– 12/31/10. The S&P 500 Index is unmanaged, and its results include reinvested dividends and/or distributions but do not reflect the effect of sales charges, commissions, account fees, expenses or taxes.

• Over time, the stock market has demonstrated strength in the face of adversity.
• The chart depicts the best and worst 10-year returns for the S&P 500 since 1927. The 10 years ended December 31, 1958, had the highest average annual return, or 20%.
• The data for the worst 10-year periods show that the market has demonstrated the ability to recover and advance after extended periods of decline. Past returns aren’t predictive of future results, but history suggests that equity investing may still hold opportunity for long-term investors.

“Investors who stay the course will be better
positioned to participate in the market’s eventual
recovery. The key is to maintain a longterm
view and a well-diversified portfolio.”
— Jim Rothenberg, portfolio manager,
Capital Research and Management Company

click image to enlarge

• Every recovery is different, the size of a company may be a factor in how its share price is affected by economic and market cycles. Historically, smaller companies have been the most severely impacted by an economic downturn or market decline. If they survived, smaller companies have also been most likely to experience the most dramatic increases. Conversely, the value of large companies has been slower to rise.
• The chart shows that since the low on March 9, 2009, the advance among U.S. small- and mid-cap companies has outpaced larger companies.
• Large companies have fared relatively well, but they haven’t experienced the same surge since the market’s bottom and may be undervalued.

“You can invest in a number of large-cap
stocks with great balance sheets, cash flow,
earnings outside the U.S., that are
reasonably managed, for about 80% of
what the market multiple is for
small- and mid-cap stocks.”
— Greg Johnson, portfolio manager,
Capital Research and Management Company

click image to enlarge

Source: Ernst & Young, Global IPO Trends, 2011; FactSet; and MSCI USA, MSCI World ex USA and MSCI Emerging Markets Investable Market Indexes. The MSCI Investable Market Indexes represent approximately 99% of the equity investment opportunity set. For the U.S. and other developed countries, the minimum market capitalization is $342 million; for developing countries, it is $171 million. The number of new companies shown for each country on the map represents initial public offerings (IPOs) attributed to the domicile nation of the company undertaking an IPO, as of December 2010. Greater China includes China, Hong Kong and Taiwan. The rest of the world constitutes 64 countries with 1% or less IPO activity by number of listings or capital raised. The total number of securities shown in the bar chart for each country/country group labeled “5 years ago” and “Today” is as of May 2006 and May 2011, respectively.

• Around the world, the number of listings for new companies regained traction in 2010, with 1,393 initial public offerings. The capital raised in 2010 was double the amount raised in either 2008 or 2009.
• The bulk of the action occurred in greater China, where 509 new listings raised nearly $132 billion in capital, nearly half of the funds raised globally during 2010.
• The evolution of equity markets has been under way for several years, led by developing countries.

“The brisk growth in China, India and much
of the emerging world has opened up new
markets and business opportunities.”
— Carl Kawaja, portfolio manager,
Capital International – Global Equity

Urbanization: A trigger for infrastructure growth and consumer spending

click image to enlarge

• Rapid urbanization offers opportunity for global companies, as more people leave subsistence agriculture for better economic opportunities in cities worldwide.
• Africa is now almost as urbanized as China and has as many cities with 1 million people as Europe. China has more cities with 1 million people than any other region.
• As incomes rise, demand grows for consumer goods, schools, railroads, financial services and hospitals. Many of the companies that appear well-positioned to benefit from expansion into developing countries are based in the United States and Europe.

“I believe this is an extremely strong
tailwind, and it’s one of the most positive
long-term factors in building portfolios at the
Capital organization.”
— Shelby Notkin, portfolio manager,
Capital International – U.S. Equity

click image to enlarge

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. The statements expressed herein are informed opinions, speak only to the stated period, and are subject to change at any time based on market or other conditions. Additionally, in the Multiple Portfolio Counselor System, differences of opinion are common, and the opinions expressed by an individual do not necessarily reflect the consensus of the team. Forward-looking statements are not guarantees of future performance, and actual events and results could differ materially from those expressed or implied in any forward-looking statements made herein. This document is for informational purposes only and is not intended to provide any tax, legal or financial advice. Capital International Asset Management (Canada), Inc. or its affiliates assume no liability for any inaccurate, delayed or incomplete information, nor for any actions taken in reliance thereon. The information contained about each product or firm, as the case may be, has been supplied without verification by us and may be subject to change. The Capital International portfolios are available through registered dealers. For more information, please consult your financial and tax advisors for your individual situation. Capital International Asset Management (Canada), Inc. is part of The Capital Group Companies, Inc., a global investment management firm originated in 1931. Our funds are subadvised by our affiliates, Capital Research and Management Company and Capital Guardian Trust Company (part of Capital Group International, Inc.). These groups, which manage equity assets independently from one another, are among the world’s largest providers of global/international equity investment services. Some of the investment professionals featured are not directly involved with managing the Capital International portfolios.

Visit us at http://capitalinternational.ca

Tags: Adversity, Canadian Market, Capital Research And Management Company, Company Earnings, Composite Index, Corporate America, Determinants, Developing Nations, Global Characteristics, Global Stock Markets, India, Infrastructure, International Asset Management, Investment Experience, Investment Professionals, Natural Disasters In Japan, North Africa, Oil Prices, Portfolio Manager, Resilience, Rothenberg, S Market, Volatility
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The Silver Lining for Markets and the U.S. Economy

Sunday, August 21st, 2011

The Silver Lining for Markets and the U.S. Economy

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

Call it choppy, volatile, fickle or lively, market action continued to disappoint this week. Frightened investors pulled out more than $40 billion from long-term mutual funds for the week ended August 10, according to the Investment Company Institute.

The eurozone crisis fueled the outflows as economic growth figures for several eurozone countries disappointed—a hard trend to break given the austerity measures being implemented. Relatively, U.S. stocks have only suffered a fraction of the pain (down roughly 5 percent year-to-date as of August 16) felt by investors in the U.K. (down 9.2 percent), Germany (down 13.2 percent), France (down 15.1 percent) and Italy (21.9 percent).

Given this landscape, the International Strategy and Investment Group (ISI) lowered its forecast for global growth to 2.5 percent in 2012. That’s down from the 4-5 percent growth level many were estimating.

There is a silver lining: Despite all the negative news out there, the global economy will continue to grow.

In fact, the U.S. economy has had several positive developments recently. The four-week average for unemployment claims dropped to 402,000 during the week ending August 13. There is still a large chunk of America unable to find a job, but that group has shrunk 13 percent since August 2010 and is about 40 percent of peak 2009 levels.

Many S&P 500 companies have leveraged strong economic growth in emerging markets and a weaker U.S. dollar into higher profits. Second-quarter 2011 earnings for companies in the S&P 500 Index have been superb with nearly 71 percent of company earnings beating expectations, per ISI.

According to Citigroup, this continues a trend established in 2010 when year-over-year earnings for the S&P 500 were up more than 38 percent, more than double the historical average during the first full year following a recession.

In addition, the strong earnings report is across all sectors. These companies are also sitting on nearly the largest cash cushions as a percent of market capitalization (about 11 percent) we’ve seen in 20 years, Citigroup says. Markets have historically bottomed when cash as a percentage of market cap reaches 9 percent.

We’ve also seen a surge in U.S. money supply (M2). ISI says M2 has surged $460 billion (about 5 percent—38 percent on an annualized rate) over the past eight weeks. Though the rise is largely due to a plunge in institutional money funds, increased money supply means more funds are available to be lent out, pushing down borrowing rates. Access to this “cheap capital” can increase confidence and entice businesses to put cash to work.

Around the globe, two recent bright spots have been Taiwan and Russia. Taiwan’s equity market is technology heavy, says BCA Research, and the market’s performance tends to track the global information technology sector, not global markets. BCA says that Taiwan is set to outperform because “after two decades of stagnation, domestic demand has been showing signs of reviving…[and] equity/currency valuations remain attractive.” In Russia, strong cash positions and subdued credit flows since 2008 mean Russia’s “equity and credit markets are likely to outperform in the months ahead,” BCA says.

Those investors who have been waiting for a bounce in the markets may not have to wait too long. We mentioned last week that the S&P 500 has historically experienced strong upward moves after the CBOE Volatility Index (VIX) reaches extreme levels. Research from Citigroup backs up this assertion, showing the average return for the S&P 500 is 5.5 percent (three months), 9.4 percent (six months) and 18.9 percent (12 months) following a breach of the 35-40 on the VIX.

The Neverending Story of a “Gold Bubble”

Gold continued to make headlines this week, reaching nearly $1,900 an ounce on Friday before resting around the $1,850 level. Gold’s 15 percent rise to new nominal highs over the past month has rekindled “gold bubble” talk from many pundits. Long-term gold bulls have been forced to listen to these naysayers since gold reached $500 an ounce. If you would have joined their groupthink then, you would’ve missed gold’s roughly 270 percent rise since.

That said, gold is due for a correction. It would be a non-event to see a 10 percent drop in gold. This would actually be a healthy development for markets by shaking out the short-term speculators while the long-term story remains on solid ground.

Forty years ago this week, President Richard Nixon “closed the gold window,” ending the gold-backed global monetary system established at the Bretton Woods Conference in 1944 and kicking off a decade of stagflation for the U.S. economy.

At the time, $1 would buy 1/35th an ounce of gold. Today, $1 will net you about 1/1,178th an ounce of gold. Put differently, “One U.S. dollar now buys only 2 cents worth of the gold it could buy in 1971,” says Gold Stock Analyst. This means that consumers have lost roughly 98 percent of their purchasing power compared to gold over the past 40 years.

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