“Common sense tells us that consumer spending growth comes from highly employed, well-compensated labor, and we are far-far from even approaching that elemental condition. The fact is that near double-digit unemployment has resulted from numerous business models that are now broken: autos, home construction, commercial real estate development, finance, and retail sales.” Bill Gross, PIMCO
August closes another month of gains in stocks, but stocks would require still more gains to offset the losses of last fall. Stock price gains have been very strong in the emerging markets, as investors bet those markets will continue to “decouple” from slow growth developed economies. Below is a schedule of returns (as of August 28, 2009) for selected mutual funds to assist in understanding market returns:
August closes another month of gains in stocks, but stocks would require still more gains to offset the losses of last fall. Stock price gains have been very strong in the emerging markets, as investors bet those markets will continue to “decouple” from slow growth developed economies. Below is a schedule of returns (as of August 28, 2009) for selected mutual funds to assist in understanding market returns:
After such a run in prices from the market lows of March, many market experts are expecting a pause or even a pullback. Beyond this, at Payne Wealth Partners we are concerned about the economy, particularly in the U.S. and other developed countries. This is a theme we have developed in prior writings and the facts continue to support this thinking.
High levels of unemployment (with no expectations of relief anytime soon), wealth effects of house price and market declines over the past two years, and constricting credit are resulting in reduced consumer purchases. Consumer confidence as measured by the University of Michigan Consumer Sentiment Survey Index is at about 65 and has been range bound this year between 55 and 70. Compare this to an index in August of 2007 of 83 and in August of 2004 at 96.
Corporate revenues also reflect consumer concerns as, per Goldman Sachs, the sales of the S&P 500 companies in the 2nd quarter were down 16% from a year earlier, after a similar decline of 14% in the 1st quarter. Overall profits for the S&P 500 companies beat expectations because of reductions in expenses as evidenced by selling, general and administrative (SG&A) expenses that were down 6.4% in the 2nd quarter (also per Goldman Sachs) versus a year earlier. Expenses can only be reduced so much, and it will take true revenue growth to push stock prices higher over the long-term.
The monetary actions of the Fed and other central banks around the world coupled with government spending programs have worked to slow economic declines (U.S. 2nd quarter GDP down only 1% annualized) or in cases like France and Germany (each up about 1% annualized in 2nd quarter) return to economic growth. But government supported growth is not the same as sustainable growth and we have yet to see how economies worldwide will perform without the significant public sector subsidies. Although risks of deflation remain due to excess capacity as companies operate at reduced levels due to reduced customer demand, the high levels of government involvement seem to point to higher inflation in the long-term (another theme we have discussed for some time). Given our concern about sustained economic growth we presently have targeted the stock position in our portfolios near the low end of our allowed ranges.
There is a part of the world with true economic growth and that is the emerging countries. Most of these countries have below-average levels of government debt and are not running the high budget deficits of the U.S. and other developed countries. They don’t have expensive programs like Medicare and Social Security that further threaten already strained budgets. And their citizens are emerging consumers, as opposed to the developed country consumers whose excessive past consumption has left them with high levels of personal debt. To us this means capital invested in emerging countries will generally have a better opportunity for good return than that in developed countries. Additionally, currencies of these emerging countries should reflect their better balance sheets and perform better than that of the U.S. and other developed countries.
With the emerging country advantages in mind we have for some time targeted ½ of our international stock positions to be in emerging markets. The table above shows the return advantage emerging markets have experienced as compared to U.S. stocks. We are now establishing a targeted 5% position in emerging country bonds in all portfolios to reflect the long-term currency advantage we expect. This will be funded by a shared reduction in U.S. investment grade bonds and in high yield bonds.
To conclude, we are pleased with the significant recovery experienced in stock prices but at the same time we are concerned that conditions may not exist for sustained real economic growth. Given our concerns, we have our portfolios positioned to underweight stocks (as compared to neutral positions). We do continue to believe in the story of emerging countries and see their economic advantages as favoring both their stocks and their currencies over the long-term.
High levels of unemployment (with no expectations of relief anytime soon), wealth effects of house price and market declines over the past two years, and constricting credit are resulting in reduced consumer purchases. Consumer confidence as measured by the University of Michigan Consumer Sentiment Survey Index is at about 65 and has been range bound this year between 55 and 70. Compare this to an index in August of 2007 of 83 and in August of 2004 at 96.
Corporate revenues also reflect consumer concerns as, per Goldman Sachs, the sales of the S&P 500 companies in the 2nd quarter were down 16% from a year earlier, after a similar decline of 14% in the 1st quarter. Overall profits for the S&P 500 companies beat expectations because of reductions in expenses as evidenced by selling, general and administrative (SG&A) expenses that were down 6.4% in the 2nd quarter (also per Goldman Sachs) versus a year earlier. Expenses can only be reduced so much, and it will take true revenue growth to push stock prices higher over the long-term.
The monetary actions of the Fed and other central banks around the world coupled with government spending programs have worked to slow economic declines (U.S. 2nd quarter GDP down only 1% annualized) or in cases like France and Germany (each up about 1% annualized in 2nd quarter) return to economic growth. But government supported growth is not the same as sustainable growth and we have yet to see how economies worldwide will perform without the significant public sector subsidies. Although risks of deflation remain due to excess capacity as companies operate at reduced levels due to reduced customer demand, the high levels of government involvement seem to point to higher inflation in the long-term (another theme we have discussed for some time). Given our concern about sustained economic growth we presently have targeted the stock position in our portfolios near the low end of our allowed ranges.
There is a part of the world with true economic growth and that is the emerging countries. Most of these countries have below-average levels of government debt and are not running the high budget deficits of the U.S. and other developed countries. They don’t have expensive programs like Medicare and Social Security that further threaten already strained budgets. And their citizens are emerging consumers, as opposed to the developed country consumers whose excessive past consumption has left them with high levels of personal debt. To us this means capital invested in emerging countries will generally have a better opportunity for good return than that in developed countries. Additionally, currencies of these emerging countries should reflect their better balance sheets and perform better than that of the U.S. and other developed countries.
With the emerging country advantages in mind we have for some time targeted ½ of our international stock positions to be in emerging markets. The table above shows the return advantage emerging markets have experienced as compared to U.S. stocks. We are now establishing a targeted 5% position in emerging country bonds in all portfolios to reflect the long-term currency advantage we expect. This will be funded by a shared reduction in U.S. investment grade bonds and in high yield bonds.
To conclude, we are pleased with the significant recovery experienced in stock prices but at the same time we are concerned that conditions may not exist for sustained real economic growth. Given our concerns, we have our portfolios positioned to underweight stocks (as compared to neutral positions). We do continue to believe in the story of emerging countries and see their economic advantages as favoring both their stocks and their currencies over the long-term.
