The U.S. equity market has recently reached historic highs, recovering all the losses from the financial crisis and Great Recession. Are these gains justified, or is this a kind of “sugar high” induced by easy monetary policy in the U.S. and elsewhere? Portfolio Manager Ed Keon posits that the recovery in prices could be real, and that this bull market could have a way to go. Ed examines major impactors of U.S. GDP, including government, consumption, net exports, and inflation, and his findings indicate that the U.S. could see much more robust economic growth than most expect over the next few years.
Generally unheralded by the media, we are in the midst of what we might call a “quiet bull market” in US equities. Yes, we said a “bull market” in equities, for despite substantial market uncertainty over the past few years, stocks (the “riskier asset class”) have achieved positive returns in each year since 2010, most notably in 2012 when the S&P appreciated by more than 15%. Far from fading, this trend may very well continue in 2013, despite persistent, manifest difficulties in major developed and emerging markets (US, deficits and “fiscal cliff”; EU, recession and sovereign bond collapse; China, real estate deflation and declining external growth). Risk will remain, but so might the competitive returns we need. This paper, which updates our annual “Turbulent Teen” market review, takes on the topic of risk and return, particularly how now may be the time to re-evaluate this classic relationship if one is to profit from harsh market realities that might continue for several years.
Are emerging market equities still attractive? We think so -- both now and over the next several years. Although they can be volatile, emerging market countries are growing faster than developed markets and they have demonstrated greatly improved resilience by outperforming developed economies since the end of the global financial crisis. With increasing affluence and an expanding middle class, these countries will have growing spending power. The economies are quite dynamic, and we expect sources of growth to shift from region to region and from sector to sector in coming years. We believe an investment process that adapts dynamically to these changing sources of growth and focuses on active bottom-up stock selection, while taking advantage of breadth to constrain risk exposures and improve the consistency of alpha, is the best way to capture the significant opportunities available in the emerging markets.
In this year-end edition of “Turbulent Teens,” we update two issues we addressed in earlier versions: equity and bond valuation, and the ongoing crisis in Europe. We also examine two issues many investors are increasingly concerned about: the outlook for the U.S. and the rest of the developed world, and the potential for a real estate-induced bubble in the largest emerging market, China. On all of these fronts, we are cautiously optimistic, though significant hurdles remain to be overcome. We believe if we can absorb the painful lessons of these turbulent times and learn from them, a new period of stronger, more sustainable growth might start before this decade concludes.
In light of the recent historic drop in bond yields and the tremendous economic, financial and political uncertainty facing us, this white paper asks, Are bonds still the place to be, or are equities attractive despite the risks? Our short-term quant models have become more defensive on equities, but our multifactor, longer-term asset allocation models favor stocks. We certainly understand the trepidation out there. But when real returns from “safe” assets are likely to be near zero for a while, and when dividend yields are higher than bond yields in many cases, we think that assets such as stocks may offer attractive returns over bonds for the long term.