February 7, 2023

Fundamentally: That Offshore View Is Looking Foggier

IN January, conventional wisdom said that three long-term trends were likely to persist in 2011: the dollar would continue to fall, commodities would keep roaring and foreign stocks would outpace domestic ones.

Two of these predictions have gone awry since early May, as the dollar has surged 5 percent against the euro while commodity prices have sunk by more than 19 percent. These developments may also lessen the appeal of foreign stocks, some market strategists say, worsening the odds for the third prediction, too.

So far this year, shares of companies in developed markets overseas have risen 3 percent, less than half the gain of the Standard Poor’s 500 index.

Emerging markets, meanwhile, have had a worse start to the year. Shares of companies in fast-growing economies like India and Brazil have lost value while returns for Chinese stocks have been relatively flat.

Chalk it up to a couple of factors, strategists say. First, China has been stepping on the fiscal brakes, aiming to prevent asset bubbles in its red-hot economy. And central banks throughout the emerging markets — including India and Brazil — have begun to raise interest rates in an effort to slow inflation.

These moves help to account for the recent pullback in commodity prices. Crude oil, for example, is down 13 percent from its peak three weeks ago.

But while lower commodity prices may reduce some inflationary pressure in an economy, they often lead to selling in commodity-related sectors of the market, said Alec Young, international equity strategist at S. P.

International stocks generally have higher correlations with commodities markets than do domestic equities. While energy and materials companies make up less than 16 percent of the S. P. 500 index of domestic stocks, those two categories account for 27 percent of emerging-market stocks.

“For a long time, that was a good thing for the emerging markets,” Mr. Young added. “But right now commodities seem increasingly volatile,” and that could create a headwind for those markets’ shares.

Mark D. Luschini, chief investment strategist at Janney Montgomery Scott, said companies in commodity-producing countries like Russia and Brazil could struggle, not just because of uncertainty in raw material prices, but also because so much of their growth is tied to serving China’s needs. “If China has a hiccup” stemming from its efforts to slow the economy, he said, “it’s going to cause a blowback to all those emerging-market countries.”

Not everyone thinks these stocks are at such risk. James W. Paulsen, chief investment strategist at Wells Capital Management, says the emerging markets have underperformed domestic shares since last fall, when central banks in developing nations began to tighten monetary policies by lifting interest rates.

“But I think they’re just about done doing that,” he said. And many other risks in emerging markets, he added, have already been priced into the market.

On the other hand, Mr. Paulsen said he expected the dollar to at least stabilize as investors realized that the United States economy was likely to accelerate while economies of other large industrialized nations would probably keep slowing.

Europe, with its debt-related problems, is growing at roughly half the pace of the United States while Japan’s economy has been disrupted by the recent earthquake and tsunami. If the dollar strengthens, Mr. Paulsen said, American investors will lose an advantage they have enjoyed in foreign stocks: price appreciation based on a weakening dollar.

ALL of this could make investing in Europe and Japan less appealing. And more uncertainty could also refocus investor attention on valuation, another fundamental factor.

While there is a growing sense that stocks in general are becoming expensive, strategists agree that one market area is still relatively cheap: large, blue-chip companies with little debt and with stable, though unspectacular, earnings growth. This group of so-called high-quality companies would include names like Microsoft and Coca-Cola.

What’s more, the bigger these high-quality stocks are, the cheaper they seem to be, said Ben Inker, head of asset allocation at the asset manager GMO.

Yet for reasons Mr. Inker said he didn’t quite understand, “the domestic market has far more than its share of these types of stocks than foreign markets do.”

That’s just one more reason that foreign investing could be a whole lot harder this year.

Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.

Article source: http://www.nytimes.com/2011/05/22/your-money/22fund.html?partner=rss&emc=rss

Fundamentally: A Bounce Isn’t Enough to Recover From a Bubble

DESPITE recent volatility in global markets, domestic stocks have doubled in value in the last two years, the fastest such gain since the Great Depression.

And financial shares have fared even better, soaring more than 160 percent since the long stock rally began in March 2009.

But will the broad market in general and financial stocks in particular resume this torrid pace? Perhaps not.

Consider how stocks have fared over a much longer stretch — since the end of the previous bull market, in March 2000. Last Thursday was the 11th anniversary of the bursting of the technology bubble, a reminder of how long it may take investments at the center of a major market plunge to return to their past glory.

For example, though most sectors of the Standard Poor’s 500-stock index are now trading above their levels of March 2000, the overall index is still slightly below where it was then. And technology and telecommunications stocks — the market’s best performers leading up to the 2000-02 bear market — are still down around 60 percent, on average, from their peaks 11 years ago; blue-chip growth stocks are off about 35 percent.

What’s the moral of this story? Don’t count on a complete recovery anytime soon, said Sam Stovall, chief investment strategist at Standard Poor’s Equity Research. “It could take 15 years for stocks to work off the effects of a major bubble,” he said.

Mr. Stovall has studied market recovery periods in the years after World War II. He has found that while it usually takes stocks about 14 months to return to previous highs after a mild bear market, and five years, on average, to bounce back from a severe downturn of 40 percent or more, it typically takes even longer to recover from a bubble.

He noted, for example, that after oil prices peaked during the energy bubble in 1980, it took 16 years for some categories of oil-related stocks to recover to their pre-bubble highs. And after gold peaked in 1980 at around $850 an ounce, it took 28 years for the price to return to their pre-bust perch. (Of course, even at $1,426 an ounce, gold still hasn’t recovered to its 1980 levels when adjusted for inflation.)

The reason that recoveries take so long “is that a true bubble occurs only when valuations are taken to extremes, and it usually requires at least two bear markets to bring those valuations back to historic norms,” said James B. Stack, editor of the InvesTech Market Analyst newsletter.

To be sure, one could argue that the valuations of financial shares have never skyrocketed the way those of tech shares did in the late 1990s.

In fact, at the end of 2007, when the global credit bubble had popped, the price-to-earnings ratio for financial stocks stood at around 17, according to Bloomberg. That’s about on par with valuations for the broad market at the time.

Yet that happened because the reported profits of financial companies had soared leading up to the plunge, Mr. Stack said, so that earnings — the “E” in the P/E ratio — generally kept pace with rising prices.

“But in reality,” he said, “many of those earnings were built on artificial sources of income that were not only going to dry up but reversed course when the asset bubble popped.”

Another reason to believe that financials may soon hit a ceiling, Mr. Stack said, is that “there are still too many people waiting to get out” of those shares. In other words, many investors are still holding onto financial stocks not out of faith, but because those shares are still so far below their October 2007 peaks — about 50 percent, on average — that they’ve have been waiting for a bigger rally before selling.

Haven’t financials surged over the last two years? Yes. But Jack A. Ablin, chief investment officer at Harris Private Bank, notes that since the first three months of this rally — when financial stocks bounced back the most — these shares have actually lagged behind the broad market. Since the start of June 2009, the S. P. 500 has gained 42 percent, versus just 34 percent for the financial stocks in the index.

Mr. Ablin said that “conditions during this stretch couldn’t have been any better for the banks,” alluding to the government’s efforts to keep short-term interest rates near zero, assuring substantial profits when banks relend that money to customers. “Yet this is all we got to show for it,” he said. “That would suggest that it could take many years for the fundamentals of this sector to recover.”

AS for the broad market, it’s hard to imagine how much longer it can keep up the pace of the last two years, some market strategists say.

Beyond the threat of rising inflation, as well as various geopolitical risks, valuations are becoming stretched. David R. Kotok, chief investment officer at Cumberland Advisors, says a simple way to judge the frothiness of the market is to consider the ratio of total domestic stock market capitalization to gross domestic product. “History says that when stock market capitalization is about 55 percent or 60 percent of G.D.P., stocks are a great bargain, which was the case during the March 2009 lows,” Mr. Kotok said. “But when stocks are 110 percent of G.D.P., it’s time to sell.”

Today, the stock market is worth about 95 percent of G.D.P. “So,” he said, “I don’t believe the market has a large strategic move upward from here in the short term.”

Paul J. Lim is a senior editor at Money magazine. E-mail: fund@nytimes.com.

Article source: http://feeds.nytimes.com/click.phdo?i=20516d56cb02a670c4261331533e387f