The crisis of confidence in August (which was a most unforgiving month) has moved through to September. The core challenge for investors at the beginning of the month was Europe and how they plan to deal with the market concerns. But the current headwinds are not a September quarter 2008 issue when Lehmans defaulted. This is the September quarter 2011 and there are many key differences. A global recession is a rare event. While possible it remains improbable given current global conditions will be expansionary vs 2010, and this includes the sharp growth downgrades, and therefore earnings downgrades, that have already been made. The very uneven nature of global growth (and therefore earnings) only elevates market uncertainty. A global coordinated policy response that addresses European concerns is required. We already have the play book from late 2008. While elevated investor caution is warranted let’s address some investor concerns.
Some key points for all investors to reflect:
1. Global growth has been revised sharply lower vs expectations six months ago but it will be positive. Global recessions are rare events. Further, the contribution to global growth is increasing via emerging markets. Global growth will be around 3.0% for calendar 2011 and around the 3.0-3.5% range for 2012. The developed world will grow just below trend at 1.5% in 2011 and close to 2.0% for 2012. Importantly, the emerging economies (developing world) will grow around just above 5.0% in both 2011 and 2012. When economies expand, earnings are generated. The business cycle model will persist.
2. Global monetary policy is stimulatory but there is room for further global central bank coordination and stimulus. Note, cash rates in the large emerging economies remain high (Brazil, Russia, India, and China short rates are 12.0%, 8.25%, 8.25% and 6.56% respectively). Cash rates in the commodity export economies are also relatively high vs G3 economies (Australia, Norway, New Zealand, and South Africa). Finally, the ECB Rate is 1.50%. The upcoming 6 October meeting would be a good time to cut their “relatively” high rate vs other major developed economies and reinforce their European Financial Stability Facility (EFSF) program.
3. Market volatility is a normal event. Excessive volatility is not. Investor fatigue may be a factor given the market movements over the past few months but there is no need to be changing long-term strategic benchmarks. Yes, the current headwinds out of Europe are challenging investor confidence (a crisis of confidence perhaps). Further, investors have been disillusioned with both the US (August) and current EU political process. But democracies will always have an open debate that is adversarial in nature. This will not change but it does create elevated market uncertainty in the current climate. But the recent market reaction will be a clear signal to the EU political process that they must be vigilant and work towards a plan with the ECB, IMF, and other global policy decision makers. It may very well bring forward the response the market is looking for.
4. Of course equity valuations remain very cheap. They remain extraordinary value on so many measures (1 year forward PE, trailing PE, Earning Yield vs Bond Yields, PB etc). An earning yield above the dividend yield for equity markets is not typical. While the dividend could be cut (it is a promise after all, not a legal obligation like a coupon), the high payout ratio implies income from equities will continue. There are many examples of quality dividends that will continue to contribute to your core equity portfolio. The corporate balance sheet remains in much better shape vs 2008.
5. Defensives are doing what they should in the current market climate. Cash, Bonds, REITs and Alternatives are outperforming equities. The UBS Composite Bond Index is up nearly 10% vs a year ago. That is why bonds are a defensive asset class. Within equities, defensives are becoming relatively expensive. No surprise really.
2. Global monetary policy is stimulatory but there is room for further global central bank coordination and stimulus. Note, cash rates in the large emerging economies remain high (Brazil, Russia, India, and China short rates are 12.0%, 8.25%, 8.25% and 6.56% respectively). Cash rates in the commodity export economies are also relatively high vs G3 economies (Australia, Norway, New Zealand, and South Africa). Finally, the ECB Rate is 1.50%. The upcoming 6 October meeting would be a good time to cut their “relatively” high rate vs other major developed economies and reinforce their European Financial Stability Facility (EFSF) program.
3. Market volatility is a normal event. Excessive volatility is not. Investor fatigue may be a factor given the market movements over the past few months but there is no need to be changing long-term strategic benchmarks. Yes, the current headwinds out of Europe are challenging investor confidence (a crisis of confidence perhaps). Further, investors have been disillusioned with both the US (August) and current EU political process. But democracies will always have an open debate that is adversarial in nature. This will not change but it does create elevated market uncertainty in the current climate. But the recent market reaction will be a clear signal to the EU political process that they must be vigilant and work towards a plan with the ECB, IMF, and other global policy decision makers. It may very well bring forward the response the market is looking for.
4. Of course equity valuations remain very cheap. They remain extraordinary value on so many measures (1 year forward PE, trailing PE, Earning Yield vs Bond Yields, PB etc). An earning yield above the dividend yield for equity markets is not typical. While the dividend could be cut (it is a promise after all, not a legal obligation like a coupon), the high payout ratio implies income from equities will continue. There are many examples of quality dividends that will continue to contribute to your core equity portfolio. The corporate balance sheet remains in much better shape vs 2008.
5. Defensives are doing what they should in the current market climate. Cash, Bonds, REITs and Alternatives are outperforming equities. The UBS Composite Bond Index is up nearly 10% vs a year ago. That is why bonds are a defensive asset class. Within equities, defensives are becoming relatively expensive. No surprise really.
In summary, there are many challenges ahead for investors. Strategic benchmarks are set to create wealth over the longer term that reflects expected returns and risk appetite. The business cycle model is not broken. Economic conditions remain expansionary vs 2010 levels and large downgrades have been made. Strong global policy coordination is required to address Europe, the biggest market concern. In this market environment it should be no surprise that the core part of your equity portfolio (or your superfund) should look for as much earnings certainty as possible. There is clear value that is being discounted in both quality large cap defensive and cyclical stocks. Further, your defensive asset classes are doing what they should do. In the meantime, as market concerns remain elevated, investors should remain focused on their long run objectives and risk appetite because volatility is always part of the market. It is the excess volatility that challenges investor behaviour.
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