Economic Insights: Signs of a Solid 2013 for Stocks

Tuesday, January 29th, 2013

Yield spreads versus bonds indicate that stock valuations have considerable upside.

by Milton Ezrati, Senior Economist and Chief Market Strategist, Lord Abbett

Though U.S. equities have done well during the past year and so far this year, still-attractive valuations offer room for this welcome trend to potentially continue in 2013, even though earnings will likely grow slowly.

Earlier in this recovery, when earnings were growing very strongly, consensus concerns about equities cited the danger of an earnings slowdown. Those expressing this concern pointed out, quite rightly, that such a slowdown would occur inevitably as the recovery matured, especially with economic growth proceeding at such a subpar rate. They worried about how the market would react. Many still do. What seems to have escaped notice is that the slowdown already occurred in 2012 and that the stock market offered good returns despite it.

The prospect of slowed earnings growth seemed fearful enough while earnings grew robustly. Anything would have seemed threateningly slow compared with 2009′s reported earnings growth in excess of 200%. A slowdown still looked foreboding in 2010, when reported earnings for the stocks in the S&P 500^® Index¹ rose more than 50% and operating earnings leaped almost 40%.² A faltering in the pace of earnings growth looked similarly dangerous in 2011, when operating earnings rose near 15%. But when the pace of earnings growth came down to earth in 2012, as per the consensus concern, and grew, accordingly, to best estimates of slightly more than 6%, stock prices were far from shaken. On the contrary, the stocks in the S&P 500 turned in a robust 16% total return for the year. Clearly, the anticipated shock of the dreaded earnings slowdown was much less pronounced than was feared. It was, in fact, nonexistent.

Looking into 2013, slow earnings growth is still a prospect. With real gross domestic product (GDP) likely to expand only 2% or so and inflation likely to run around 2-2.5%, nominal revenues from domestic sources should grow 4.5-5% at best. Overseas exposure, in the emerging economies more than Japan or Europe, both of which are in recession, should add marginally to this top-line growth, bringing it up to about 6%. Meanwhile, profit margins, having risen to about 10% earlier in the recovery and having held there during the past couple of years,³ should at worst hold and could expand. They have, after all, been higher, and approached 11% in 2007. With industry in this country operating at historically low rates of capacity utilization, at about 78.4% of the existing total,⁴ business would seem to have ample operating leverage to bring margins up another notch. But even without grasping at such potentials, the more conservative expectation of flat margins still suggests earnings growth about in line with revenues at 6% or so.

At the very least, equity prices should track that earnings growth in 2013. With existing dividend yields in excess of 2%, such price gains should generate an attractive total equity return of 8% or so for the year. The odds favor at least this much. Otherwise, matters favor a rise in price-to-earnings [P/E] multiples⁵ that would generate still better returns. For one, there is little chance that rising interest rates and bond yields will produce ill effects, especially over the next 12 months. The Federal Reserve has, after all, all but promised that. For another, current multiples on 2012 operating earnings, at about 14 times, are still well below multiples of close to 16 times averaged during the last 20 years. If P/E ratios were to climb just half way back to that 20-year average, the market would generate returns in excess of 20%—and even then, valuations would not look especially extended.

Nevertheless, in the unlikely event that bond yields were to rise appreciably, the effect on stocks would likely be muted. Dividend and earnings yields on stocks are relatively so high, from an historical perspective, that a jump in bond yields would more likely adjust the relationship back toward historical norms than affect stock prices. Chart 1, which exhibits just one of an array of stock-bond yield-spread metrics, shows (as all such charts do) how remarkable it is that current circumstances favor equities. Especially since a rise in bond yields would almost surely signal improved economic conditions and, by implication, improved earnings prospects, multiples could rise even in the face of what otherwise would tend to hold them back. In short, the extremes to which stock-bond yield spreads have gone, however measured, suggest that stock valuations have considerable upside, even with rising bond yields and, especially, if the changed rate environment reflects a substantive relief from the many concerns that have brought relative stock valuations to their present, historically low levels.

Chart 1. Stock/Bond Yield Spread, 1987-2012

Source: FactSet. Data from January 31, 1987, through December 31, 2012. The chart is for illustrative purposes only. Past performance does not guarantee future results.
Stocks are represented by the S&P 500 Index. Bonds are represented by the BofA Merrill Lynch 10 Plus Year Corporate Bond Index. Indexes are unmanaged and are not available for direct investment.

But even maintaining an agnostic skepticism about these upside potentials, in profit margins and in multiples, and even staying with the most conservative interpretation of probabilities, prospects still point to a respectable 8%-plus total return from equities.⁶ Of course, anything can happen. An unraveling in Washington or Europe or more severe trouble in the Middle East, just to choose three sources of concern, could derail further market progress. But on the reasonable assumption that such problems, even as they persist, will spare investors any serious deterioration of their assets, earnings prospects and still-attractive valuations make equities look like a good choice for 2013.

¹ The S&P 500^® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.
² All data from Standard & Poor’s.
³ Profit margins data from Standard & Poor’s.
⁴ Capitalization data from the Federal Reserve.
⁵ The price-to-earnings [P/E] ratio is an equity valuation measure defined as market price per share divided by annual earnings per share. All data from Standard & Poor’s.
⁶ Data are from FactSet.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.

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U.S. Exports: A Lower Gear, but Still Cruising

Tuesday, July 10th, 2012

by Milton Ezrati, Lord Abbett

July 2, 2012

Exports have remained one of the few consistent bright spots in this otherwise subpar economic recovery. The growth of exports at times has added as much as two percentage points to the overall pace of the economy’s expansion and is a major reason why American manufacturing has staged a comeback in recent years—a “renaissance” some have called it. But of late, with the dollar rising against both the euro and the yen, and with growth overseas slowing or, in Europe’s case, falling, questions have arisen about the sustainability of U.S. export strength. Doubtless, the pace of gain will slow, but probabilities suggest that the growth will continue.

The American export boom actually took off in 2007, stood up remarkably well during the 2008–09 recession, and has generally picked up momentum since. As Table 1 shows, exports of goods and services jumped 13.3% in 2007 and continued to grow almost apace in 2008, even as the global financial crisis rocked world economies. Unsurprisingly, exports fell during the global recession year of 2009, but they rebounded into 2010 and 2011, despite the disappointing pace of the global expansion. Even more recently, as China has reduced its overall growth expectations and Europe has fallen into recession, export growth so far this year has actually accelerated. Because exports amount to barely 15% of all U.S. economic output, this performance, impressive as it is, could not turn a sluggish recovery into a rapid one, but it has been fast enough at times to add considerably to the pace of growth. In late 2007, net exports accounted for more than half the economy’s overall expansion. In 2010 and early 2011, they accounted for one-third of the economy’s overall growth.

The expansion of the global economy, especially the emerging world, explains some of these gains. The 2007 export jump, especially, reflected the booms in China, India, and other emerging economies that were proceeding at the time and that consumed industrial supplies and raw materials for which the U.S. economy, among others, was in a good position to provide. Of course, the global downturn in the late 2008/early 2009 helps explain the export drop averaged in 2009, but that picture quickly changed as the emerging economies resumed their rapid growth trajectories in 2010 and in the early part of 2011.

Also explaining the American export picture are the declines in the dollar’s foreign exchange rate, which cumulatively enhanced American producers’ price competitiveness. Between 2002 and 2007, for example, the euro rose about 40% against the dollar, while the yen rose more than 15%. These favorable (for exports) currency patterns continued through much of this more recent period too, further enhancing America’s competitive position. In 2007 alone, the dollar cheapened almost 10% against the euro and then rose only slightly since, at least until much more recently. The move against the yen was even more dramatic. Between mid-2007 and late 2011, the yen rose almost 40% against the dollar. Not only did the currency moves give U.S. producers inroads into the European and Japanese markets but, more significantly, they also gave a significant edge against the European and Japanese competition in faster-growing third markets, such as China, India, and Brazil.

There can be no denying, however, that the dollar’s recent gains, if they persist, will strip away some of this competitive edge. In recent weeks, for instance, the euro and the yen have each cheapened almost 5.5% against the dollar. But because previous dollar declines had given American producers such huge pricing advantages, even recent dramatic currency moves leave much of this country’s former global pricing advantage intact. According to calculations by the OECD (Organization for Economic Cooperation and Development), underlying measures of comparable pricing (what econometricians refer to as purchasing power parity), put today’s euro, at about $1.25, only just on a competitive par with dollar-based production. Comparable calculations for Japan show the yen still giving American producers a huge 35% pricing advantage against the Japan-based competition.

Though combined with slowing global growth, recent dollar strength will retard the future rates of export gain, but it should be clear that relative pricing advantages have hardly proceeded far enough to erase it. For one, trading arrangements are based on ongoing pricing and supply relationships built over long periods of time. Those that have developed in favor of American products during these past years of great American pricing advantages will take a long while to unwind. Given the American advantage implicit in the still pricey yen, it is doubtful that such a process has even begun or will begin for some time yet. If the euro is closer to competitive parity, it still offers no special pricing advantage that would prompt buyers to switch away from established American suppliers. On this basis, exports should continue to contribute to aggregate growth in the U.S. economy, albeit at a reduced rate, say, growing 8–10% rather than within the 14–17% range of the past three years.

Table 1. U.S. Exports of Goods and Services

Source: Bureau of the Census, Department of Commerce.
*Through April annualized.
+ Calculated from December through April and expressed at an annual rate.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.

Tags: American Export, Booms, Economi, Economic Output, Economic Recovery, Export Boom, Global Economy, Global Expansion, Global Financial Crisis, Global Recession, Growth Expectations, Lord Abbett, Milton Ezrati, Momentum, Pace, Percentage Points, Probabilities, Renaissance, Sustainability, World Economies, Yen
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Japan – Glimmers Amid The Gloom

Wednesday, June 6th, 2012

by Milton Ezrati, Lord Abbett

Japan still looks troubled. To be sure, the economy recorded a surprisingly strong 4.1% annualized real gross domestic product (GDP) growth in the first quarter. Much of that growth, though, was due to government spending. Otherwise, the flow of news still points to the same tepid growth that has troubled Japan for more than 20 years now. Four of the last six quarters have shown real declines, including last year’s fourth quarter. This once-powerful exporter faces a deficit on its balance of international payments, while spring data releases show industrial production in decline. The country also continues to face the threat of deflation. Consumer prices have only risen because of past fuel price hikes. Now that the cost of a barrel of oil has declined, Japan will likely again see aggregate price declines. The Nikkei stock market¹ has not missed the point, either. It has fallen some 15% since April. The recent downgrade reflects in part on this economic picture. Still, there are opportunities.

Commentators popularly have identified four proximate causes for Japan’s relapse into weakness. Most obvious is the lingering effect of 2011’s earthquake and tsunami. These have left Japan with only four of its 54 nuclear power reactors in operation, constraining industrial capacities generally and forcing a 25% increase in fossil fuel imports. Both the recession in Europe and severe flooding in Thailand have hurt Japan’s critical export sector. Most important is the rise in Japan’s yen, which has gained almost 40% against the dollar and even more against the euro since 2007. The initial upward move in the yen occurred because Japan was seen as a haven during the 2008–09 financial turmoil. More recently, the yen has offered a haven from the uncertainties of Europe’s sovereign debt crisis. Whatever the cause, though, the yen’s rise has hurt Japan’s export performance and has encouraged a greater reliance on imports.

But there also is something more fundamental holding Japan back, as it has for more than 20 years now. The advancing average age of Japan’s population is a part of that problem. Japan has already reached a point where it has barely over three people of working age for each citizen older than 65 years. Such a shortage of working hands and minds, especially relative to a huge, dependent group of retirees, cannot help but hold back the pace of growth. Making the problem worse, Japan, in all this time, has failed to adjust its economic model for this demographic reality. The economic emphasis remains on manufacturing for export. No nation can stay the workshop of the world, as Japan once was and still strives to be, when so much of its population has reached retirement age, especially when surrounded by the youthful, eager, cheaper labor populations elsewhere in Asia. No doubt Japan would do better if today’s particular problems were to lift. But even so, the economy would still face these fundamental constraints, as it has for two decades when other particulars have lifted.

For all this less than inspiring economic reality, however, opportunities still present themselves in Japan. Unlike the government in Tokyo, many Japanese companies—global, regional, and local—have made insightful adjustments. They have outsourced simpler jobs elsewhere in Asia and to other continents even as they have retained in Japan those usually high-end aspects of business at which the county still excels. They have built marketing, production, and sales operations in faster-growing areas of the globe, emerging economies, Australia, and North America. But because these companies are headquartered in Japan, their stock prices have remained depressed, despite their adjustments. They have been tarred, so to speak, with the same brush that has depressed stock prices in general. That circumstance has left an opportunity to buy, at very good prices indeed, quality companies that have found ways to sidestep Japan’s problems even as they use its remaining advantages. If it is still too early for broad Japanese investments, matters clearly are ripe for judicious stock picking.

¹The Nikkei 225 Stock Average is the leading and most-respected index of Japanese stocks. It is a price-weighted index comprised of Japan’s top 225 blue-chip companies on the Tokyo Stock Exchange.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.

Copyright © Lord Abbett

Tags: Aggregate Price, Balance Of International Payments, Cost Of A Barrel Of Oil, Debt Crisis, Export Performance, Export Sector, Financial Turmoil, Flooding In Thailand, Fuel Imports, Fuel Price Hikes, GDP Growth, Industrial Capacities, Lord Abbett, Market 1, Milton Ezrati, Nikkei Stock Market, Nuclear Power Reactors, Proximate Causes, Spring Data, Upward Move
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Earnings Growth—Is It Enough? (Ezrati)

Monday, May 7th, 2012

by Milton Ezrati, Lord Abbett

After two-plus years of exceeding expectations, earnings this year seem poised, at last, to reflect the plodding nature of this economic recovery. In 2010 and 2011, even as the real economy managed only a paltry 2.4% average annual rate of expansion, the earnings of S&P 500^® Index¹companies soared, rising more than 47% in 2010 and almost 20% in 2011. Such a pattern could not persist. And this year, the slow fundamentals will almost surely assert themselves. Even so, it would be a mistake to read matters too pessimistically. There certainly is nothing ominous in the pattern. It is, after all, well-established historically that earnings should come into line with slower-growing revenues in this, the third year of economic recovery. Besides, this year’s probable 10% earnings growth, though only about half 2011’s pace, is sufficient to sustain the stock market rally.

This unfolding pattern of surge and moderation is hardly surprising or new. It has, in fact, become a cyclical commonplace, a reflection of the increasingly huge operating leverage of American business. Every year, business relies more and more on machinery, facilities, systems, and other forms of technology, often in place of labor. Because the trend builds a larger proportion of fixed costs into the production model, even slight variations in revenues have an exaggerated impact on the bottom line. In the more distant past, when variable labor costs were a bigger part of the overall production equation, layoffs could reduce a significant part of overall costs and so relieve some of the strain on the bottom line in recessions, and then, when rehiring raised labor costs in recovery, the profits recovery was more muted. But operating leverage has introduced a more volatile pattern.

The dramatic effect was clear during the last recession and in this recovery so far. In 2008–09, when the real economy dropped 5.1% peak to trough over 18 months, revenues followed, but because businesses had little ability to cut costs, the full brunt of the downturn fell on earnings, which, for the S&P 500, plunged from almost $22 a share in the second quarter of 2007 to a loss of more than $25 at the end of 2008. But however much strain the operating leverage imposed in the recession, it has worked in business’s favor in this recovery. As this huge array of productive capital has come back on line, the fixed costs allowed virtually all the additional revenue to fall to the bottom line. And because profits are a small difference between revenues and costs, the small percentage revenues gain have created huge percentage changes in profits. But now, in this third year of expansion, when most of this productive capital has at last become more fully utilized, the effect of operating leverage should dissipate, forcing earnings to follow slower revenues growth more faithfully.

Still, even as 2012 fails to enjoy the remarkable earnings surges of 2010 and 2011, the outlook for this year is not entirely as depressing as some media reports imply. Earnings can still outpace the 5–6% expected advance in domestic revenues because there is still some operating leverage left in the system and because S&P companies gather more than half their revenues abroad. Europe’s recession, of course, will weigh against foreign revenue growth, but the emerging economies should more than offset Europe’s depressing influence. Though these economies, too, have slowed, and that fact has attracted a lot of attention, they still outpace the United States and other developed economies by far. China, after slowing, still registers real growth of more than 8% and India more than 6%. In nominal terms (which, of course, is the way revenues are measured), those economies should still contribute double-digit growth of their part of the 2012 S&P revenues equation. Adding to likely 7–8% overall revenues gains, the remains of operating leverage should bring S&P earnings up to about 10% in 2012.

That growth, though half last year’s pace, should nonetheless allow equity markets to hold the gains they have already made and likely rise further. Even after market gains of the last six months, valuation measures are far from stretched. Price-to-earnings multiples, after all, depending on which of the seemingly endless calculations one chooses, show a market that at worst is near its historical valuation benchmark, allowing it room to keep up with earnings at least. Since, in most other respects, valuations are still more attractive, equity price advances should exceed the earnings growth. Stocks, relative to Treasury bonds, offer valuations not seen since the early 1950s or even the Great Depression. Next to corporate bond yields, equity valuations look less dramatic, but still suggest considerable upside potential. It is noteworthy that, even today, dividend yields on many stocks atypically exceed the yields on the firm’s own bonds.

Since earnings, though slowing, are still showing substantive growth, the most conservative interpretation of valuations would suggest that equities should hold this year’s gains so far. Anything other than the most conservative interpretation suggests greater gains.

¹The S&P 500^® Index is widely regarded as the standard for measuring large cap U.S. stock market performance and includes a representative sample of leading companies in leading industries.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.

Tags: American Business, Bottom Line, Commonplace, Dramatic Effect, Earnings Growth, Economic Recovery, Forms Of Technology, Layoffs, Lord Abbett, Market Rally, Milton Ezrati, Moderation, Operating Leverage, Production Model, Proportion, Recession, Recessions, Reflection, Stock Market, Trough
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A Wake Up Call on the Economy (Ezrati)

Wednesday, May 2nd, 2012

Economic Insights: A Wake-up Call on the Economy
Business and investors alike must face the reality of a plodding economy.

by Milton Ezrati, Lord Abbett & Co.

The recent weak jobs report should serve as a wake-up call to economic reality. The disappointing news that payrolls in March expanded at only a meager 120,000 was far from momentous in itself. But it should, nonetheless, remind investors and businesspeople that earlier signs of strength overstated the fundamentals and that the recovery, though reasonably secure, was plodding all along, as it has for some time now and will likely continue to do.

Economic statistics seem at times to have their own ebb and flow, sometimes overstating and sometimes understating the underlying fundamentals. Sadly, these often meaningless data variations can create false feelings about economic possibilities—enthusiasm, when the statistical flow leans toward the strong side, or despair, when it leans on the soft side. Investors, in particular, succumb to such swings in attitude, but, to a lesser extent, so do businesspeople. So, it was with a string of insupportably good numbers late in 2011 and earlier this year.

Unseasonably mild winter weather created a particularly pronounced distortion in the much-beleaguered housing sector. Sales of new and existing homes through February indicated growth of 11.4% and 8.8%, respectively, over the same period in 2011. New home construction showed a gain of almost 35% over a year ago. Though these were welcome signs that the worst of the housing slide had passed, the degree of strength was suspect. After all, credit standards at banks had remained tight, as they still are, and lending for real estate had continued to decline. The housing market still showed an inventory overhang of unsold properties, both in the official statistics and in foreclosures not yet executed. Declines in housing prices, by 4%-plus from a comparable period in 2011, according the S&P/Case-Shiller Housing Price Index,¹ also suggested something less robust than the sales and building statistics implied. The full array of available information was sufficient to conclude stability, but little more.

The jobs figures have followed a similar pattern. After disappointing reports through much of 2011, the pace of payroll expansion picked up in 2012, with reports of almost 250,000 net new jobs created each month in January and February. While this was welcome after a long soft patch, many, it seems, lost sight of the still subpar nature of even these improved rates of expansion. Past cyclical recoveries showed payroll gains closer to 400,000 a month or more. The basic picture, though improved, still exhibited the cautious management attitudes toward hiring that have dominated since 2009 and for the same reasons, uncertainty and the legacy of fear after an especially difficult recession. As with other aspects of the economy, the recovery in jobs was still plodding. It was, then, hardly surprising that a month or two would offer news of even less adequate jobs growth. And it arrived with the meager payroll growth for March.

The unemployment rate has offered a similarly false signal of faster improvement than the fundamentals can support. Falling from 9.1% of the work force last August to 8.2% more recently, the figures, on the surface, suggested considerable progress in turning the jobs market around. But much of this improvement reflected the decisions of frustrated job seekers to abandon their search and exit the work force altogether. Because the unemployment statistics count only those actively seeking employment, these drop-outs lowered the measured unemployment rate, even though no one found a job. But the existence of frustrated job seekers fits the picture of sluggish recovery. In March, those of working age not in the work force increased by 333,000. During the past year, this group has grown by almost 2.3 million. Though not an especially encouraging trend, and surely a sign of continued slow growth, the pattern had quite the opposite impact on the statistics. What is more, any substantive uptick in the pace of hiring, even just to 250,000 a month, will likely tempt these frustrated job seekers back into the search and, because they will not likely find jobs immediately, cause a temporary rise in the recorded rate of unemployment. No doubt that rise will generate an equally false sense of retreating fundamentals.

As the weaker statistics remind people of the plodding nature of this recovery, the more excitable, no doubt, will speculate, again, about a “double-dip” recession. Such speculation arose in 2010 and 2011 on similar stretches of weaker statistics. Both scares were false and no more justified in the fundamentals than the recent enthusiasm was. If a spate of soft numbers now causes another such scare, it, too, would likely be wrong. In the meantime, the underlying message of continued slow progress in this economy’s recovery is clear. Businesspeople will have to continue to position themselves for uninspiring growth. For investors, the slow growth will also be less than inspiring, but, crucially, it still can support an earnings expansion that, given still cheap market valuations, should propel equity markets higher, despite the distinct absence of an economic boom.

¹ The S&P/Case-Shiller 20-City Home Price Index measures the residential housing market, tracking changes in the value of the residential real estate market in 20 metropolitan regions across the United States

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.

Tags: Businesspeople, Comparable Period, Declines, Despair, Ebb And Flow, Economic Insights, Economic Possibilities, Economic Reality, Economic Statistics, Economy Business, Housing Market, Lord Abbett, Mild Winter Weather, Milton Ezrati, New Home Construction, Official Statistics, Overhang, Strong Side, Wake Up Call, Welcome Signs
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Is China Serious about Currency Reform? (Milton Ezrati)

Wednesday, April 18th, 2012

by Milton Ezrati, Lord Abbett

04.16.2012

Recently, China’s central bank governor, Zhou Xiaochuan, made comments that drew less attention than they deserve. First, he suggested that market forces would play a bigger role in setting the value of China’s currency, the yuan (or renminbi). He also mused that the yuan should rise further against the dollar and on foreign exchange markets generally. An announcement Saturday, April 14, by the People’s Bank of China relating to increased flexibility in the trading band of the currency would appear to confirm Zhou’s serious intent. There is room for two responses to this seemingly new Chinese positioning, one cynical and the other much more positive and hopeful.

On the cynical side, there is history. China has long strived to promote its exports by keeping its yuan cheap to the dollar and other major currencies. The global pricing advantage this policy has given Chinese goods has enabled the country famously to raise its share of global exports from nearly zero in the early 1990s, when it initiated the policy, to upwards of 12% more recently. The accompanying business and employment opportunities have propelled China to enviable aggregate growth rates throughout this time.

For these two-plus decades, China’s relentless adherence to this policy has led Beijing to resist all pressure for yuan appreciation, whether from by the United States, the European Union, or others. Beijing’s leadership set the tone in the early 1990s. In 1993, when under secretary of the Treasury, Larry Summers, demanded currency revaluation on behalf of President Clinton, Beijing, far from bowing, devalued the yuan within six months, and by a massive 60%. It then locked in the currency at that cheap price against the dollar. The move undercut pricing in most of the rest of Asia and ultimately contributed to the Asian crisis of 1997–98, referred to more commonly as the “Asian Contagion.” It was not until 2005 that Beijing allowed some upward movement in the yuan’s foreign-exchange value, and even then it kept tight control, allowing only frustratingly slow and slight appreciation.

Such a backdrop makes it easy to dismiss Governor Zhou’s comments as just so much rhetoric. After two decades of tight control, it is hard indeed to see China accepting much market influence on its currency. And since the yuan today remains 11% cheaper against the dollar than it was before China’s first grand devaluation, Governor Zhou’s speculation about whether market forces might raise its value further looks less insightful than obvious. The yuan’s modest depreciation so far this year raises still more questions about such a market-oriented commitment. Of course, market forces always move in uneven patterns, but it is nonetheless suspicious that, in 2010 and 2011, when Beijing aimed to slow the country’s growth rate, the yuan appreciated gradually, in its usual controlled way, but now that Beijing wants to promote growth, it has suddenly gone the other way. The pattern certainly speaks less to market forces than to Beijing’s usual currency management.

Still, cynicism aside, Governor Zhou’s comments may also contain a more positive, forward-looking aspect. Most encouraging is the link he made between the yuan’s value and China’s now-clear efforts at internal development. Beijing has come to recognize the vulnerabilities of export-oriented growth policy, especially during the 2008–09 global recession. Accordingly, it has begun to think increasingly about internal development as a second engine of growth, but also as a way to spread the benefits of economic development and avoid social unrest. As papers posted on China’s central bank and other government websites also make clear, Beijing realizes that the country cannot expect to increase its global export share over the next 20 years at the same rate it has in the past. China’s great success with its 2008 stimulus package has further encouraged the domestic development decision by proving the huge potential returns it offers. But Governor Zhou’s remarks are the first time Chinese officials have publically recognized that the shift requires a rise in the yuan’s foreign-exchange value.

Matters surely will unfold slowly. For the sake of jobs and incomes, China will continue to support its exports until it has achieved a critical mass of internal development, including a broader consumer sector, to support aggregate growth. But the governor’s comments should build conviction here in the United States and elsewhere in the world that China clearly plans to move along this path. Because broad-based domestic development will have more difficulty than exports in generating rapid growth, the picture offers reason to expect that China will exhibit slower growth going forward than it has in the past. But at the same time, the prospect promises increased opportunities for producers in the United States and elsewhere in the world to sell into a growing domestic Chinese market. It also promises that, in time, global trade patterns will find relief from the imbalances previously imposed by China’s once single-minded focus on exports.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.

Copyright © Lord Abbett

Tags: Aggregate Growth, Asian Contagion, Asian Crisis, Bank Of China, Central Bank Governor, Chinese Goods, Currency Reform, Currency Revaluation, Cynical Side, Foreign Exchange Markets, Global Exports, History China, Larry Summers, Lord Abbett, Milton Ezrati, S Central, Secretary Of The Treasury, Serious Intent, Yuan, Zhou Xiaochuan
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MIlton Ezrati: The Fed Shifts Gears

Tuesday, April 10th, 2012

Tags: Ben Bernanke, Encouragement, Fed Chairman, Federal Reserve, Fourth Quarter, Gears, Good Reason, Harbinger, Industrial Loans, Inflation Fears, Labor Department, Lord Abbett, Milton Ezrati, Monetary Stance, New Approach, Qe, Recent Developments, Skepticism, Subtle Change, Sudden Interest
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Economic Insights: When Will Corporate Cash Flow? (Ezrati)

Tuesday, April 3rd, 2012

by Milton Ezrati, Lord Abbett

One of the great constants in this otherwise inconstant environment is the strength of corporate finances. Financial excesses and the need to de-leverage concern governments and households, not the corporate sector, which actually came out of the 2008–09 financial crisis and recession with its finances in good order, and has only strengthened them since. The question now is how and when companies will deploy these impressive financial resources—whether on capital spending, hiring, or, especially, on the mergers and acquisitions (M&A) that typically proceed from strong corporate finances.

Huge cash holdings constitute the most impressive aspect of this financial strength. At the close of 2011 (the most recent period for which complete data are available), cash on non-financial corporate balance sheets had risen to more than $1.9 trillion—a jump of almost 60% from the dark days of 2008 and more than 50% from the last cyclical peak in 2007. Cash and cash equivalents have risen, so that today they constitute almost 13% of all corporate financial assets, up from 9.4% in 2008 and 9.1% in the cyclical peak year 2007. They amount to some 14% of all corporate liabilities, up from 9.2% in 2008 and 9.7% in 2007, and almost 12% of corporate net worth, up from 8.9% in 2008 and 8.0% in 2007.

Aside from the powerful cash flows that permitted such accumulations, it is the high and persistent levels of uncertainty that have kept the funds in cash instead of flowing into other corporate uses. Speaking volumes to this motivation is the fact that the bulk of this cash sits neither in time nor savings deposits nor money market shares nor in commercial paper, but rather in checkable deposits. These have grown remarkably—more than 1,500%, in fact—since 2008. The high level of uncertainty behind this behavior is hardly surprising either, on at least four counts.

First and primary as a behavioral motivator is the legacy of the 2008–09 financial crisis. Still fresh in managers’ collective memories, these events have kept companies sensitive to how suddenly economic and financial conditions can change and, consequently, how valuable ready, liquid assets can be. But more, because bank credit standards tightened during the crisis and by and large have remained tight since, companies have lost the conviction that they can borrow should the need arise. It does not help in this regard that many banks during the crisis withheld formerly well-established corporate lines of credit, an act that has left in its wake conviction among corporations that they ought to rely more on self-financing. The sovereign debt problems in Europe, threatening a rerun of 2008–09, have only redoubled this conviction.

Second, Obamacare has contributed, too. Whether a good idea or a bad one, good legislation or not, the huge changes built into this complex law impose tremendous uncertainty on corporate decision making, particularly about hiring. The natural response in the circumstance is to hold back on major corporate decisions and the enlarged cash holdings are an obvious financial reflection of that posture.

Third, the Dodd-Frank financial reform has had its own separate influence. Although this huge piece of legislation covers only financial corporations, it does nonetheless create uncertainty among all companies about future financing, both availability and cost. In this regard, whether Dodd-Frank is good law or bad, it has surely had an effect similar to the liquidity problems of 2008–09, even though it was ostensibly designed to correct them, adding to management convictions that they can no longer rely on credit lines from financial institutions and need, therefore, to do more than previously to cover their short-term cash needs for themselves.

And fourth, if these matters did not weigh heavily enough, corporations must also cope with the uncertainties surrounding the federal budget debate. Without knowing the nature and size of future federal spending or taxes or even the federal government’s prospective borrowing needs, it is difficult for managers to gain any sense of the future and, consequently, how to deploy their resources.

But for all this, there are tentative signs that corporations are beginning to use some small portion of this cash accumulation. Though compared with past cyclical standards hiring has remained subpar (hardly a surprise in such an uncertain environment), it has nevertheless picked up some in recent months. Corporations have also increased capital spending, raising such outlays by almost 8% over the course of 2011—hardly a boom, but certainly faster than sales have risen and a use for some of these surplus funds. At the same time, corporations have shown a modest willingness to extend themselves by accepting a rise in their trade and tax payables. Together, these have risen more than 13% during the past year, faster than sales and even than cash balances.

Still, it will take time before a return of confidence can move matters beyond these recent, tentative expressions. Cash and the lack of confidence it reflects remain high. There is, however, a tremendous potential for dramatic expansion in corporate spending, hiring, and M&A activity from even a modest improvement in confidence. Especially because equity market valuations these days make it cheaper to buy than to build, the M&A potential, with its always immediate market impact, looks particularly powerful.

The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

Investors should carefully consider the investment objectives, risks, charges, and expenses of the Lord Abbett funds. This and other important information is contained in each fund’s summary prospectus and/or prospectus. To obtain a prospectus or summary prospectus on any Lord Abbett mutual fund, contact your investment professional or Lord Abbett Distributor LLC at 888-522-2388 or visit us at www.lordabbett.com. Read the prospectus carefully before you invest.

Copyright © Lord Abbett

Tags: Cash And Cash Equivalents, Corporate Balance Sheets, Corporate Finances, Corporate Liabilities, Corporate Sector, Dark Days, Economic Insights, Excesses, Financial Assets, financial strength, Impressive Aspect, Lord Abbett, Market Shares, Mergers And Acquisitions, Milton Ezrati, Money Market, Motivator, Net Worth, Peak Year, Speaking Volumes
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