Our markets have had a tremendous run during the first quarter of 2012. The P/E multiple on the S&P 500 has expanded to 14 from 13.2 since the beginning of the year and earnings for the first quarter are coming in very strong. According to Bespoke, as of 4/20/12, 72% of the companies that have reported earnings have beaten estimates. This would be the second highest beat rate since 2000! There are still plenty of companies left to report earnings but it’s definitely a strong start.
In fact, if you ignored the rest of the world, one might think everything is not so gloomy. Unfortunately, we cannot; because our economy and stock market are deeply connected to what the global economy is doing. We all know the markets do not go up in a straight line, and given this tremendous run, it probably wouldn’t take much negative news to cast a shadow on our markets making them extremely accident prone.
After returning from several weeks in India, the one conclusion I can make is that India, and much of the rest of the world, is in a slowdown. In fact, just shortly after returning the Reserve Bank of India cut interest rates by 50bps. They are also experiencing a real estate bubble similar to ours.
That is a picture I took of a New Delhi condo ghost town similar to ones you could find in Miami, Vegas or even Portland, Oregon a year or so ago. Literally thousands of condos, partially constructed, sitting empty.
China is in some type of “landing,” soft or hard, but neither is good for global growth. a recent research paper highlighted the importance of China in the global economy; estimating variation in China’s output has three times the effect on Latin America today compared to the mid-1990s. Earlier this month, China surprised us with the largest trade deficit on record. This deficit is likely driven by declining exports to Europe and rising bills for commodities like oil.
The only bright spot in Asia is Japan. They are looking better with an anticipated 2% GDP growth in 2012 but it will be driven mostly by reconstruction spending.
The biggest concern is Europe. Euro-region debt has risen to 87.2% of GDP, the highest point since the start of the Euro. Spanish Treasury rates are flirting with 6% and many view 7% as the point where government borrowing costs become unsustainable. The European Central Bank (ECB) has already cut rates to a record low of 1% and provided over $1 trillion dollars in liquidity to the European banks. Europe is far from out of the woods.
After weeks of travel my perspective suggests some very specific actions:
- Continue to rebalance and maintain slight overweight in lower risk and lower volatile equities in the US.
- High yield US corporate credit continues to be a good risk-reward trade off with favorable valuations and opportunities.
- Look to average into emerging markets to dampen the potential volatility in the coming months.
While the US economy is in much better shape this Q2 than Q2 of 2010 or 2011, the markets are reflecting that strength; making them extremely accident prone to some well anticipated but not well discounted shocks in the rest of the world.
Tim Phillips, CEO – Phillips & Company