Februrary 2011 Peak View Newsletter
from Jim Onorato
In 2010 the U.S. stock market logged its second straight gain following the crushing losses stocks suffered in 2008. The broadest measure of the U.S. stock market, The Standard & Poor’s 500 stock index, finished 2010 with a yearly gain of 13% - 15% if dividends are included. The small- and mid-capitalization indexes rose about 26% for the year. Wall Street strategists generally are bullish about the market’s prospects in 2011.
Looking out at the investment landscape for 2011, it seems pretty clear that most equities are reasonably priced and most bonds are not. You get a fair amount of earnings and dividends for your buck in the stock market, and you get very little income from bonds. In 2009-2010 smaller U.S. company stocks that generally pay little or no dividends led the market higher. Now that bonds offer very little return investors are migrating to large dividend paying U.S. companies. So far in 2011 the large blue chip companies have been leading the stock market.
The economic environment has improved and the markets reflect that. Company earnings have increased dramatically over the past two years but many of the drivers of the recent improvement are not sustainable such as corporate cost cutting and federal stimulus. Household debt, despite recent reductions, remains very high and that will restrain spending until it is paid down. The weak labor market is another significant problem. Although the headlines are getting more positive, employment remains weak and it will take years for employment to return to pre-recession levels. High unemployment not only dampens spending it also drags on another problem: housing. I know people who have recently had their homes appraised because they were either refinancing their mortgage or putting their home on the market and in most cases the appraisals came in at values that their home would have sold for 15-20 years ago. That is very sobering.
There is an overhang of housing supply that is likely to keep pressuring home prices well into 2011. The huge supply along with the expiration of homebuyer credits has in fact sent home prices sliding again. With many mortgage holders already owing more than their home is worth, and with unemployment still quite high, the cycle has not finished playing out yet.
That said, things are better and there is reason to be more optimistic than a year ago. Consumer spending is edging up, employment is less bad and companies around the globe are benefitting from demand in the stronger emerging market economies.
Given both the positives and negatives with the economy, stocks still appear to be fairly valued. The S&P 500, at its current level of about1300, is currently valued at 13 ½ times projected 2011 profits. The historical average for the market is about 15-16 times projected earnings. A valuation of 15 times projected 2011 earnings would put the S&P 500 at about 1450 which is an 11% increase from current levels.
Historically a portfolio was considered well diversified if it consisted of 60-65% equities and 35-40% bonds. This may be a time (at least slightly) to overweight your portfolio in equities. Investing is a dynamic process and should not be done in a vacuum. Just because a certain portfolio allocation has been the way to go in the past does not mean it should not be adjusted to reflect significant changes in valuation of certain asset classes – in this case bonds. We generally rebalance our clients’ portfolios annually. This year we talked with many of our clients and suggested tilting their portfolios slightly more toward equities.
Best Regards,
James Onorato
President
February 14, 2011