2010 Outlook
February 4, 2010
By John Apruzzese
Partner & Equity Portfolio Manager
The global economy appears to be in the early stages of a classic recovery from severe recession. Whether the US economy has a strong rebound, as some leading indicators suggest, or a more muted recovery with anemic job growth remains unclear. Yet the global economy is more significant to the outlook for corporate earnings, and we are confident in its vigor. So are industry analysts: They forecast 28% growth in operating earnings this year, to $78 per share, followed by a 22% rise in 2011 to $95, which would be an all-time high. But while analysts may be back to their usual optimism, the market is not completely buying it. The S&P 500 sells for just 14 times the 2010 estimate, low for the current interest-rate environment. We expect the market to move higher as earnings growth comes through.
For the first time, emerging markets – led by China – are propelling the global economy. China’s economic stimulus program was so effective that the issue now is how hard to step on the brakes. China also has the advantage of a nearly balanced government budget, and huge foreign reserves afford it far more room to maneuver than developed countries have. The knock on China is its dependence on exports and therefore on vibrant developed economies. Whether or not that is true, China has done a good job of stimulating its domestic economy. Most of its growth may have come from fixed investment, but there is growing evidence of a shift toward domestic consumer demand. We favor investments that benefit from growing consumer spending in emerging markets. We are less enthusiastic about the broader Chinese stock market, given current valuations, because many large companies there have yet to show that they can earn reasonable rates of return on capital through a cycle.
Investors cannot ignore the negative sentiment about unprecedented US government deficits and rising national debt. We are in a tug of war between deflation as household and financial sectors deleverage after the debt binge (bank loans are down $500 billion from last year) and inflation from government deficits and an accommodating central bank. While inflationary policies get the most ink, deflationary forces should not be overlooked. High inflation is a serious long-term threat since the government will eventually win the tug of war, but deleveraging will delay the onset of serious inflation for some time. We expect interest rates to increase – but at a milder pace than the consensus foresees. Nonetheless, we consider it important to have positions in a well-diversified portfolio that will benefit from rising inflation expectations, because it will be difficult to time when those expectations take off.
Editor's Note: John joined Evercore Wealth Management as a founding partner in 2008 and has more than 24 years of experience managing balanced investment portfolios for affluent individuals and their families. You can email him at apruzzese@evercore.com.