Download earnings growth, central bank policies bode well for stocks in

December 28, 2012
EARNINGS GROWTH, CENTRAL BANK
POLICIES BODE WELL FOR STOCKS IN ‘13
Creating an outlook covering the world’s stock markets is difficult and
some say is as much guesswork as science. Perhaps. Stock prices, at least
in theory, reflect investors’ reactions to fundamental events and
expectations. Additionally, it is critical to understand history when
thinking of market movements. Mass human reaction to stimulus (in this
case economic and socio/political) is as important when thinking of stock
market movement as the study of economics. So while it is important to
provide an economic framework from which to make judgments
concerning asset values, it is also important to understand historical
human reaction to these economic variables.
That being said, we offer the following thoughts concerning the global
equity markets outlook for 2013:
The RiverPoint Team
Valerie L. Newell, CPA
Leon H. Loewenstine, CPA
Victor R. Lassandro III
Pamela F. Schmitt, CFA
Ryan L. Brown
Anthony Roberts III, CFA
M. Patrick Richter, CFPR
Kirk M. Koppenhoefer, CFA
Global Investment Macro Themes for 2013
•
We see high levels of market volatility continuing in 2013, driven
primarily by the uncertainties of the world’s political and economic
environment.
•
Our fundamental worldview holds that structural changes have
become and will remain part of the financial landscape going forward.
This landscape includes changes to occur regarding demographics,
productivity growth rates, the meaning and role of governments and
central banking activities. On balance, we expect that of the developed
economies (U.S., Europe and Japan), the U.S. will grow more rapidly than
the others, and on a more consistent basis.
•
Our fundamental worldview also holds that many of the
developing economies will continue to grow more rapidly and with
different areas of political/economic friction than their more developed
cousins. On balance, we believe the developing economies will grow at
least twice as rapidly as developed economies over a long period of time,
driven by demographic trends and improvements in labor productivity.
The developing economies harbor less-developed banking and social
3 1 2 W a l n u t S t r e e t , S u i t e 3 1 2 0 | C i n c i n n a t i , O H 4 5 2 0 2 | 1 - 8 0 0 - 5 4 8 - 1 6 2 5 | F: 5 1 3 . 4 2 1 . 5 9 4 8 | www.riverpointcm.com
Page 2
RiverPoint Capital Management
infrastructure systems than their more mature cousins. This feature brings
volatility – in that economic, social and subsequent asset pricing volatility
is expected and should be taken advantage of – at the correct times.
•
Over the long-term, we expect inflation risks to rise on a global
scale, as the world eventually moves away from a deflationary bias.
•
For 2013, the U.S. is our favored developed economy and market.
From a developing standpoint, many of the Asian markets hold promise.
We believe the recession in Europe may indeed intensify during the first
half of 2013. With this in mind, investors should take an opportunistic view
towards the European markets.
U.S. Equity Market View for 2013
We rely heavily on our four “market drivers” to give us guidance on
market price direction and magnitude within the U.S. market, with those
four drivers being:
•
Valuation - Based on historical standards, how are investors pricing
an asset? Is the asset priced dearly, or is it “cheap” by historical standards?
The most widely-used valuation metric most investors recognize is the
market’s or an individual stock’s P/E (price to earnings) ratio. Along with a
comparison of current P/E ratios to historical norms, we study Price/Cash
Flow, Price/Book Value and Price/Dividends. All of these measures relative
to historical standards are helpful when attempting to determine if
investors are currently pricing an asset dearly or cheaply.
•
Earnings Growth - Earnings growth (or profit growth) is a
reflection of GDP growth – at least on a “nominal” basis (including
inflation). While at times earnings can grow without GDP growth,
normally this isn’t the case. Historically, stock prices move in the same
direction as earnings growth 70% of the time. In 2013, it appears that
nominal GDP should grow in the 4% - 5% range. If we see nominal GDP
grow in excess of 4%, there is a high probability that earnings growth
should be positive for 2013.
•
Sentiment - What do investors think of the stock market? This is a
perverse factor, one that basically says if investors are bullish on stocks, the
“smart money” should be cautious. Why? If people are bullish on any
asset class it probably means they already own it. There are few buyers left
to drive prices higher. On the other hand, if most investors are cautious or
bearish, this tells us that most of those investors don’t own the asset class,
and have already sold. Consequently, when we talk of sentiment being
bullish it can frequently be a negative indicator.
•
Monetary Policy - Finally, we study and consider monetary policy.
Central bank (the Fed, the ECB, the BOJ being examples) policy is usually
either “loose” or “tight.” “Loose” central bank policies normally occur
when the central bankers are concerned about economic growth being too
3 1 2 W a l n u t S t r e e t , S u i t e 3 1 2 0 | C i n c i n n a t i , O H 4 5 2 0 2 | 1 - 8 0 0 - 5 4 8 - 1 6 2 5 | F: 5 1 3 . 4 2 1 . 5 9 4 8 | www.riverpointcm.com
RiverPoint Capital Management
Page 3
slow or disinflation (which is the case today on a global scale). When
monetary policies are “loose,” typically money supply is rising – usually by
more than the economy can absorb or use for economic purposes. When
this occurs, the excess money has to move somewhere. The excess supply
usually finds its way, through the banking system, into the financial
markets – both stocks and bonds. Stock prices tend to react positively to
“loose” money supply policies.
What do these four “market drivers” tell us about potential stock market
returns for 2013?
Valuation – Below we present the four valuation points mentioned above
for a number of geographic regions:
The data above suggests the world’s equity markets, overall, are valued in
“neutral” territory, with the U.S. slightly overvalued and foreign markets
undervalued. We consider valuation to be a neutral factor at this time on a
global scale, and valuation to be a slight negative factor in regard to the
U.S. markets.
Earnings Growth - We believe the world will avoid a global economic
contraction during 2013. That being said, there are areas of weakness
(Europe) and areas of reasonable strength (emerging economies). Our
current outlook is calling for “real” global GDP growth (excluding
inflation) to be 2.2% for 2013. Combining that with our view of global
inflation (2.0% - 2.5%) for the upcoming year leads us to project nominal
GDP growth in the 4.2% to 4.7% range for 2013. While lower than historical
3 1 2 W a l n u t S t r e e t , S u i t e 3 1 2 0 | C i n c i n n a t i , O H 4 5 2 0 2 | 1 - 8 0 0 - 5 4 8 - 1 6 2 5 | F: 5 1 3 . 4 2 1 . 5 9 4 8 | www.riverpointcm.com
Page 4
RiverPoint Capital Management
averages, this growth rate should lead to rising revenue and profit levels
for the world’s corporations, in aggregate. Again, rising profits normally
lead to higher stock prices. We count earnings growth as a positive factor.
Sentiment - Sentiment factors change, at times somewhat rapidly.
“Crowd” sentiment (non-professional investor sentiment) is currently at
59.8% bullish. Following is the history of the “Crowd” poll:
This data covers results from 12/95 to current. We currently count
sentiment as a “neutral” factor.
Monetary Policy - Current monetary policy, no matter how measured,
cannot be described as anything but “loose.” All three major central banks
(U.S., ECB and Japan) have launched “QE” operations, which lead towards
money supply infusions into each respective banking system. Our friends
at Ned Davis Research have done some interesting work regarding
“excess” M2 growth rates (M2 being money and close “substitutes” for
money). In this case, “excess” being defined as money growth at a rate
above the growth in industrial production, factoring in changes in
commodity prices. This measure looks at money supply growth in relation
to demand for money for the “real” economy to function. By this measure,
the Fed is currently growing M2 at a +4.5% rate.
Following is historical data going back to 1960 showing resulting stock
market movements when the Fed has been loose/tight with M2 growth by
this measure:
As can be seen from the above, the U.S. is well within the range of excess
money growth that historically has led to higher stock prices. Count
3 1 2 W a l n u t S t r e e t , S u i t e 3 1 2 0 | C i n c i n n a t i , O H 4 5 2 0 2 | 1 - 8 0 0 - 5 4 8 - 1 6 2 5 | F: 5 1 3 . 4 2 1 . 5 9 4 8 | www.riverpointcm.com
RiverPoint Capital Management
Page 5
monetary policy as a strong positive factor in our view of the stock market.
So, where does this all leave us? While a mixed bag of indicators is present,
on balance our Four Market Driver analysis leads us to the conclusion that
stock prices may indeed move higher as the year 2013 unfolds. Our outlook
for earnings growth and central bank activities provide two strong market
drivers that argue for higher stock prices. By our reckoning, current
valuation is slightly overvalued and sentiment is rather neutral. These
items place a limitation on how strong the upward move may be in stock
prices. Currently we believe stock prices will trade within a trading range
of 1325 to 1575 (S&P 500). We wouldn’t be terribly surprised to see U.S.
stocks generate returns of 7%+ during the year.
So, all-in-all, count us in the bullish camp – but with full recognition that
our “base economic case” is probable as long as the following five
fundamental events occur:
1.
The U.S. does not fall off the Fiscal Cliff for very long. The U.S. stays
out of recession during 2013.
2.
The world stays out of broad-based war.
3.
A meaningful military-based action does not occur in the Mideast.
4.
China adopts policies fostering a stabilization of overall economic
growth.
5.
Leaders in Europe continue to make progress towards a closer fiscal
political union.
THE ENTIRE RIVERPOINT TEAM WOULD
LIKE TO THANK OUR CLIENTS FOR THEIR
CONTINUED TRUST AND LOYALTY.
WE WISH YOU A SAFE AND PROSPEROUS
NEW YEAR!
3 1 2 W a l n u t S t r e e t , S u i t e 3 1 2 0 | C i n c i n n a t i , O H 4 5 2 0 2 | 1 - 8 0 0 - 5 4 8 - 1 6 2 5 | F: 5 1 3 . 4 2 1 . 5 9 4 8 | www.riverpointcm.com