July 2011 Market Outlook
We have made general market commentaries in many recent portfolio reviews on the seemingly déjà vu aspects to this Spring and Summer’s market movements, and accompanying economic and fiscal “narrative” as compared to those of a year ago.
To briefly recap; the current state of the US stock market is one that is down from its early April highs. Along the way this year have been numerous hurdles for investor sentiment to clear, including (but not limited to) historic geo-political upheaval in the Middle East, a tragic and economically disruptive natural disaster in Japan, continuing fiscal uncertainties (and accompanying, sometimes riotous protests) regarding several European Union states, and, verydisheartening economic data here at home. Of course, current attention is on the evolving debt-ceiling debates/negotiations/debacle unfolding in Washington—more on this later—and unemployment figures that seem to be creeping back up to their 2009 highs.
It was only a year ago when we remember watching weeks upon weeks of oil spilling into the Gulf of Mexico. The inability to quickly and efficiently plug this leak added an intangible gloom to the unfolding debt crisis in Greece, and speculation of a Eurozone financial melt-down. On top of all this, employment, housing and GDP data released in June of 2010 clearly depicted a slowing—if not stalling—US economic recovery from the 2008-2009 recession.
A year ago, the S&P 500 was in the midst of a roughly 16% correction from its April 2010 highs. So far this year, the market has corrected (at worst) 7.11% from its April highs—though we are several percentage points above that at this writing.
Our point in this recap is to remind investors that while “current events” should seem to have a logical correlation with market movements (and often the media strains to imply this)—this is most often not the case. Last year’s “current events” news stories depicted a dismal end to the nascent economic recovery—yet the S&P went on the close out the year over 15% higher than it began! News stories focus on the past. In today’s media-rich environment and rapid news cycles, this is quite often the very recent past—but it is the past none-the-less. As we (and others) have repeatedly pointed out; stock markets are forward-looking discounting mechanisms, focused on the future. In truth, we have no idea where the S&P 500 ends up this year—but we do not see any fundamental reasons why we should expect a retreat from current levels by year end.
- Speaking strictly of fundamentals, we can say that we do think the market is reasonably valued; consensus estimates for the S&P 500 for 2011 are $98 in earnings. This implies a current valuation of about 13.39%, or ~2% below historical averages. Factoring in general domestic economic growth rates, this number makes sense to us. We may see this estimate revised up as the year progresses.
- As we write, earnings season is underway. Less important to us are 2Q results, as many will report the (expected) dampening effects of the Japanese tsunami, and higher oil and materials prices in Q2. More important to us (and here, we admit to being a bit optimistic) will be forward-looking revisions, including subsequent analyst revisions (again, we are assuming an upward bias, on average).
Our cautious optimism stems from the Power of Zero Interest Rates theme we expounded upon in our April OUTLOOK, coupled with generally strong balance sheets and to-date negative downward revisions (likely too negative).
- We expect increased demand and economic activity in Q4 and beyond from China and other major growth-market players to boost economic activity here and in the EU.
- Lastly; as mentioned, much of the news and indeed most economic indicators are reporting history. Non-Farm Payroll figures (released the first Friday of every month) have generally been the source of angst regarding economic recovery for much of the last three months. As we reminded in our September 2009 OUTLOOK, payroll numbers are the most lagging of lagging economic numbers. We are as revolted as anyone at the percentage of willing workers without jobs in this country….but we will not look at these figures as indicative of imminent economic trends.
Did anyone hear the news last week? “China GDP Hints at ‘Soft Landing’”; headline, WSJ China Real Time, July 13, 2011.
This is especially encouraging to us and should be to our clients, as China and other major Growth-Market economies play an important role in our overall equity allocations. Recall our April, and indeed January commentaries about BRIC and other Growth-Market equity performance essentially treading water—due largely to the aggressive central bank tendencies of these countries in combating inflation.
China’s GDP was reported at a growth rate of 9.50% in Q2, slightly better than expectations of 9.4%. Most encouraging though, was the surprising 15.1% manufacturing production growth figure as compared to 13.1% estimate (growth of 13.5% from May vs. expected contraction of 1.50%).
By definition, and now by consensus, Chinese efforts to curb inflation are seen as largely successful in engineering a “soft landing”. We also view this positively as supporting CCR WM’s thesis that continued (and expanded) US and EU economic growth depends on BRIC and growth-market consumption to an increasing degree. This consumption now seems safe-guarded for the time-being.
US Debt Ceiling:
And now on to the Dark Side:
We’re fairly certain that 100% of our clients understand the downside here. Quite obviously, the failure of the U.S. Government to meet its financial obligations not only renders every mildly optimistic statement made in the preceding paragraphs moot, but will quite likely have a major impact on every aspect of every American’s day-to-day quality of life.
We’re a bit reluctant to comment too specifically here, as the likelihood of the political realities changing between this writing and the time this document reaches your inbox is very high….but here goes:
1) Imagine: You’re a high-ranking politician (President, Speaker, Leader, whatever). On your watch the United States not only defaults on its financial obligations, but looses its AAA credit rating.
We think this is the easiest way to put aside the “tennis match” aspect of this debate process in the near term. We can think of 535+1 people who likely know that no amount of finger-pointing will evade most unflattering entries into history books.
2) If “certain death” in terms of US Credit is so imminent (days—if not weeks away, as would seem as you have your morning cup of coffee and read through the gory details), then why is the US stock market up ~6% for the year, up 25% from a year ago, and why is the ten year Treasury yield back under 3%?
As mentioned…markets are in fact discounting mechanisms, and hundreds of millions of investors are choosing not to believe the doomsday scenarios being painted daily by politicians and pundits. In fact—with every recent piece of negative news, the time-tested flight of (billions) of skittish dollars continues to flow into US Treasuries—purportedly in jeopardy of default! For us, this simply enforces our conviction that a deal will probably be struck (at the 11th hour, and 59th minute, perhaps). Surely, such a deal will please no one—but we’ll then be on to worrying about other things.
Oil is once again trading below $100 per barrel. We attribute this to our most recent series of tepid economic reports (since our April OUTLOOK). We refer back to our commentary of China (as also look at China as a proxy for most of the rest of the growth-market universe). China is the largest importer of petroleum in the world. All indications seem to be a pick-up of growth in Q4 and beyond.
We reiterate that within the commodity universe, OIL should be the focus in searching for any discernable “value”.
Gold has recently punched through several technical resistance levels, and we are fairly certain we will see higher prices ahead. We attribute most of Gold’s current allure to the Euro fiasco—and much prefer gold investments to any attempt to “short the Euro”—which has almost always been a loosing trade of late.
As previously mentioned, CCR WM, previously overweight Silver vs. Gold, has now inverted this relationship in our models. Given Silver’s ~36% run-up ytd (far beyond anything explainable from a fundamental standpoint), we prefer gold’s higher volume trading structure and closer (inverse) correlation to major currencies.
We expect base-metals to eventually correlate with energy prices given certain evidence of China and BRIC’s economic turnaround in Q4 and 2012.