April 2011 Peak View Newsletter
from Jim Onorato
Following a two week long losing streak in the stock market an already robust rally resumed. The Dow recently closed at 12,505, its highest level since June 2008 and 91% above its March 2009 low. The S&P 500 at 1343 is now also near its bull market peak and up 98% from its March 2009 low. The Dow is still 12% below its October 2007 all time high of 14,164 and the S&P 500 is 14.5% below its record high of 1565. As one analyst quoted by Bloomberg put it “the market is at a three–year high because earnings are also at a three–year high.” S&P companies have beaten analysts’ estimates for eight straight quarters. They are loaded with cash. By historical measures they are modestly valued. Standard & Poor’s is estimating earnings of $96.69 for the S&P 500 (as a whole) this year, putting its P/E at a little under 14. Recently tech stocks like Apple, IBM and Intel and financial firms such as Morgan Stanley and energy firms such as Halliburton have turned out strong results and are upbeat about the future.
Smaller US company stocks are beginning to look a bit overvalued. As measured by the Russell 2000 (the most popular index for smaller U.S. companies) the P/E ratio for this year’s estimate is about 20 times earnings. Small cap stocks are becoming expensive relative to large cap stocks. Typically in an economic recovery small companies initially lead the market which has been the case over the past two years, The Russell 2000 has increased over 130% since the March 2009 low. Smaller companies are usually able to trim expenses and become leaner more quickly than large companies leading to larger profit increases.
Unlike smaller companies the large S&P 500 companies continue to do more business outside of the U.S. One example is Coca Cola which derives 70% of its revenues outside of the U.S. Considering that the Unites States is only about 5% of the world’s population there is extraordinary future growth potential for large U.S. multinational companies in the developing world. The middle class in many developing nations is growing very quickly. This creates long term demand for billions of people around the world that are becoming more affluent to buy a lot of U.S. made goods. Although our economy is recovering slowly it does not preclude large multi–national U.S. companies from future growth potential abroad. Given the difference in valuation of large vs. small company stocks, this may not be a bad time to reduce exposure in smaller companies and increase exposure to large multi–national U.S. stocks.
For many years a prudent portfolio allocation was thought to be 60% stocks and 40% bonds. This may be a time where a larger than normal allocation to stocks may the better way to go. Interest rates have nowhere to go but up from which will pressure bond prices. Although rates may not increase until sometime later this year or even next year, it appears inevitable that this will happen. Investors who under more normal conditions may allocate 60% to stocks and 40% to bonds should consider a 70/30 or 75/25 allocation for the foreseeable future. Make no mistake; bonds have been great investments for the past 25–30 years as interest rates which went from historically high levels have gradually moved to historically low levels. The bull market in bonds that began in the early 1980’s has ended and investors should adjust their overall allocation accordingly. If interest rates rise over the next few years making bonds more attractively valued and should stocks continue to rise and become fully valued or slightly overvalued investors should consider returning to a more traditional stocks/bonds allocation.
Many of our clients and friends participate in 401–k plans through the companies they work for. With the vast array of investment options available in most 401–k plans, attempting to properly allocate a 401–k portfolio can get very confusing. Since our investment management practice specializes in using mutual funds to construct our clients portfolios we are somewhat familiar with the mutual fund world. We would be happy to review your current 401–k allocation and available investment options and give you our thoughts. We are always here to help you.
Best Regards,
James Onorato
President
April 23, 2011